To pay for performance, give the salary increase a break

Originally published in HR.com

When an employee does an outstanding job, managers want to reward their performance. The chance to do this is with the annual pay raise. The trouble is that managers also have to give everyone else a raise at the same time, and tight budgets leave little room to manoeuver. Mercer’s 2018/2019 US Compensation Planning Survey found that top-performing employees get an average increase of just 1.7 times more than colleagues with on-target performance. On a base salary of $60,000 that works out to a new rate of $62,820 for a top performer compared to $61,620 for the on-target performer. The best performing employees may be wondering if it was worth the effort.

This situation often occurs because there is a longstanding misconception about the annual salary increase. For years, employers have thought of it as “merit” pay – a permanent financial pat on the back for employees’ performance. This perception does it a disservice. Yes, the pay raise represents how much employers value an individual’s contribution, but it also symbolizes much more. It sends employees messages about how they are valued compared to colleagues and how they are valued relative to the market.

Yet, if the salary increase wears many hats, it usually gets one shot – once a year – to fulfill these multiple objectives. And employers expect it to do so with an amount that plateaus at 3% of payroll. Mercer’s latest US Compensation Planning Survey revealed salary increase budgets for 2018 were flat at 2.8% and projected to be only 2.9% for 2019.

As a result, the impact of the salary increase on performance is often muted, with employees receiving mixed messages that leave them dissatisfied. Research by Mercer | Sirota shows that employee satisfaction with pay for performance has been on a downward trajectory over the last five years, dropping from 55% to 47% between 2013 and 2017. This is of particular concern given the historically low unemployment rate in the US, and that nine out of 10 executives expect stiffer competition for talent in upcoming years, according to Mercer's Global Talent Trends report.

So, how can employers help the salary increase be more effective? Here are four ways:

1. Take the pressure off the pay increase. The salary increase is not the only means of compensating top performance. Companies can remove one of the pay increase’s roles by relying more heavily on one-time incentive programs to deliver differentiated rewards, such as bonuses or a one-off long-term incentive grant to reward outstanding performance. Well-designed recognition programs are also an effective way to empower managers to create a culture of rewarding performance year round.
2. Leverage the power of careers. One of the more effective ways to deliver base pay growth to top performers is through career growth combined with meaningful market-driven promotional increases. Research shows that some organizations may be coming up short on promotional increases, with an average promotional award of 7.8%; Mercer’s compensation surveys show a typical differentiation between career levels of 15% to 20% or more. Mercer’s November 2018 update of the US Compensation Planning Survey found that companies may be making a shift. Projected promotional budgets for 2019 jumped 42% year over year – increasing to 1.7% of payroll, up from 1.2% in 2018. This suggests that companies may be looking to prioritize growing talent from within.
3. Be methodical about pay equity. Many managers and employees loathe the annual performance management process, especially since it could be fraught with bias and poor methods for assessing contribution. Additionally, any (conscious or unconscious) inequities in the performance management system could filter through to the merit pay process and exacerbate pay inequality. To tackle the issue, some companies have started to use technology to eliminate that bias. Algorithms can aggregate and analyze data to recommend more accurate individual salary adjustments, based on market rates and pay equity. Technology is not a turnkey solution to the unequal distribution of pay, but when overlaid with human judgment it gets closer to a consistent approach to pay within an organization.
4. Focus on the employee experience. Competitive compensation is important to get right, yet companies should recognize that employees today are looking for more. They want to enjoy what they do and where they work, and they want an employer that supports them both inside and outside of work. Employees today face continually blurred lines between work and home, and companies recognize that and are responding by expanding programs to help them with their lives outside the office. Personalized programs and coaching for new parents, paid sabbaticals to recharge or pursue purpose-driven initiatives, and caregiving concierges to assist with arrangements for aging parents are just a few examples of emerging benefits being offered. Companies that expand the view of rewards successfully are able to differentiate the employee experience in a way that other employers are hard-pressed to replicate.

Rethinking Pay for Performance

With all these alternatives to the salary increase, the temptation is for employers to worry that they may be spending more on pay. But limiting the salary increase budget could be an ineffective method of cost savings if not keeping pace with the market. The costs simply manifest elsewhere, like with increased turnover, onboarding replacement talent, and reactive pay adjustments throughout the year to keep up with market realities. Embracing a new model enables employers to leverage one of their greatest assets – their people – to compete in the future of work.