Getting the most out of pay increases
Countless articles have been written about the exorbitant salaries and stock options sometimes found in corporate America. Although it is interesting to read about the executives who earn millions each year, such information has little relevance for most smaller and mid-sized companies. For typical employers, the issue is: In tough economic times, how do we leverage our limited financial resources to create and motivate top performers?
Building and supporting a culture that says “We recognize and reward exceptional effort and results” should be the primary goal of every employer’s compensation and reward program. Why build this culture? Achieving results brings profitability, increased productivity, high morale and improved retention. The direct link between compensation and corporate profitability is clear.
Essential components of this culture include:
- An ability to recognize standout performance and a willingness to differentiate between high contributors and other employees.
- An incentive-based or variable compensation program that’s tied to the achievement of collective and/or individual goals, and
- A reward and recognition system that provides immediate, specific, customized strokes to employees who go above and beyond.
A brief history of compensation
Pay for performance is not a new concept. In the days when farmers and tradespeople bartered grain and horseshoes, all pay was performance-related. If the blacksmith slept all day, or produced only defective horseshoes, he earned nothing. With industrialization, the notion of pay for performance carried over in the form of factory piecework. Measuring performance was simple, and pay was commensurate.
As labor unions and collective bargaining gained favor in the early 1900s, the notion of uniform wage increases for the entire labor pool took hold. Pay raises became a function of the bargaining unit’s strength along with increases in the cost of living. The star performers earned about the same as the weakest links, and differentiating among employees became prohibited and uncomfortable.
In recent decades -- as “knowledge workers” have emerged and cost-of-living increases have dwindled -- employers have moved away from across-the-board salary increases and instead have experimented with innumerable formulas for linking compensation to results.
In doing so, most employers’ goals are the same: Make a portion of salaries a variable rather than fixed cost. Motivate the top performers to soar, thereby generating more revenue. Push the “good enough” performers to achieve more. Weed out the employees who contribute little.
Some employers have achieved tremendous success with the performance-based compensation and reward systems, and others still struggle to find the right balance.
The merit pay challenge
Today’s employees continue to measure their value -- and their spending -- by the size of each year’s annual pay increase. But as revenues stagnate or decline, the pool of money with which to reward performance shrinks. How does one dole out meaningful merit increases when resources are so scarce?
Nationally, average exempt-level salary increases as a percentage of current salary are projected at 3.9 percent, according to Hewitt Associates. Non-exempt employees and executives can expect to receive an average of 3.8 percent and 4.1 percent, respectively. Rochester increases are running slightly behind the projections. Because experts predict that base-salary increase pools will stagnate for the foreseeable future, mastering ways to effectively reward performance – without permanently boosting base-salary rates – is essential. Amid the talent war a few years ago, some companies showered their employees with fancy cars, frequent parties and fat bonuses to win their loyalty.
Incidentally, if you don’t already use a merit-based approach to base-salary increases, think carefully before inaugurating this approach today. With a small pool of cash to draw from, it’s difficult to make a positive impact, and most employees will be disappointed with what they get. Nonetheless, you can get started on building a performance-based environment that doesn’t involve base-salary increases.
Tools you can use
So what can you do right now to reward employees without locking yourself into escalating base salaries?
1. Invest in your best. It’s more important than ever to know who your “A” players are. Forget the tired phrase, “People are our most important assets.” It’s only the right people who are a company’s best assets. Before meeting with employees to discuss salary reviews, make sure you know who your best performers and essential employees are, the ones who are driven to deliver extraordinary results and help build a great company. If your performance appraisal process – formal or informal – shows most employees as high performers, your process may need to be more rigorous. Consider revising it.
2. Talk about “total compensation increases” for the coming year. For example, rather than focusing on pay raises alone, tell an employee that he or she is receiving 3.2 percent of salary in a base-salary increase; 2 percent of salary in increased benefit contributions; and 2.5 percent of salary in a profit-sharing award. It’s your job, as the employer, to make sure employees understand the value of their benefits package. Too often employees remember only the amount on their pay stubs. Consider providing each employee with an annual “total compensation statement” to reinforce the message.
3. Recognition. As management expert Rosabeth Moss Kanter says, “Compensation is a right. Recognition is a gift.” Getting people to do their best job requires more than compensation. Employee surveys continually show that employees place high value on such factors as “being appreciated for work done,” “feeling in on things” and “having a manager who is sympathetic to personal problems.” These factors don’t require money, just an awareness and thoughtfulness on the part of management. The data tell us time and again that it’s not the money or item we provide in recognition of that employee’s value; it’s the act of recognizing the performance – often with a simple “thank you” that makes a difference.
4. Use lump-sum payments. Some employers effectively differentiate among employees by providing a lump-sum payment for the top performers in addition to a modest base-salary increase. Other employers use lump-sum increases more broadly to control ongoing payroll expenses. Though this is seldom a long-term solution because it can impact pension and other benefit accruals and leave your employees vulnerable to higher salary offers, it can make good sense when salary costs are running higher than the competition’s.
5. Adopt a variable pay plan. Variable compensation is a management tool that provides flexibility while sending a powerful message about the importance of achieving goals. Once limited to executives and salespeople, variable-pay practices have filtered down to the rank and file, as companies ask employees to meet demanding performance goals. A good variable-compensation plan is simple and effective at achieving the desired results. If participants do not understand how the plan works, it’s too complex! Enlisting the help of an expert to design and implement these plans will help avoid costly mistakes.
When it comes to using your compensation dollars to build performance and profitability, just do it! Many cleverly named reward and recognition programs die on the vine, strangled by bureaucracy and oversold by management before they get off the ground. If you simply start rewarding deserving employees quietly and often, co-workers will get the message. Make it your New Year’s resolution to seek out the help you need and get started.
