2017 Salary Budget Surveys from various survey sources have been released and the forecast is clear: another year, another 3%.
While the economy and labor market are strengthening, and inflation remains low, employers are still being cautious with a fourth consecutive year of similar increases. “Three percent” doesn’t send shockwaves, but it does confirm the sustained impact the practice has on the national labor market, as well as the need for companies to stay competitive.
Is it time to allocate the 3% differently?
While merit increases haven’t budged, another story is making its way into the headlines: Companies are restless to do something differently, to spend the 3% budgets more purposefully. It starts with a growing dissatisfaction with the practice in general – for such a large spend, only 40% of employers think merit increases effectively drive performance.
This has resulted in many organizations allocating the merit budget differently between high performers and low performers. Employees who received the highest marks in 2015 were granted an average salary increase of 4.5%, compared to 2.5% given to average performers and .7% given to lower performers.
With a 3% budget, however, managers face a zero-sum game where they perceive rewarding their stars means aggravating their underachievers.
No wonder managers feel like players in a losing game. The resulting margin has more bark than bite, with only half of all employers and managers agreeing it effectively differentiates pay.
Performance-based merit increases may not be an efficient use of resources either. In an interview with Bloomberg, Laura Sejen, research leader at Willis Towers Watson, claims that “we spend a lot of time trying to figure out how to divvy up that 3 percent and there’s really not much of a return on investment.”
Revisiting salary base and increase
For many organizations, it may well be time to revisit the purpose of the base salary and annual base pay increase investments. Here are some paradigm-shifting questions organizations are beginning to ask:
- If most of the budget is meant to reflect “market movement,” why are we disguising it as “merit”? Do all increases need to be differentiated?
- Should base salary increases really be tied to last year’s performance? What about employee potential? What about critical skill possession and development?
- Is the “annual” increase cycle the right cadence?
- Would your organization answer these questions this way for all job functions or all talent segments? Does a one-size-fits-all approach to merit increases still make sense?
As the answers to these questions begin to unfold uniquely by organization, new approaches will emerge.
For example, hours of agonizing over budgets may be avoided by setting formal budgets for each performance tier, or separating across-the-board market adjustments from a smaller number of top performers who are eligible for differentiated merit increases.
Adjusting the frequency
Staggering the frequency of increases – multiple increases annually for top performers, less than one increase annually for low performers – may be another cost-effective way to deliver meaningful rewards tied to specific periods of performance.
Pay-for-performance is only one aspect of a larger compensation mechanism, in which a competitive base salary is still the most influential component. Our Global Work Force Study shows that employees continue to list base pay as the number-one driver of attraction and retention.
One size doesn’t fit all
Getting it right matters, and it takes work. It means being conscious of the difference between maintaining competitive salaries and differentiating based on performance. It means recognizing that “one size doesn’t fit all,” and customizing rewards by key talent segment is part of a larger trend in an evolving workplace. And ultimately, it means that managers must be equipped and willing to deliver thoughtful performance management and maximize the effectiveness of base pay programs.
The Global Work Force Study also finds that increased attentiveness pays off: managers spending at least 7 hours of performance management per employee annually are 10%-15% more likely to report merit increases as a performance driver than managers who spend less than 7 hours per employee annually.
As low inflation rates and ongoing pressure on bottom line margins continue, 3% merit increases are likely to be the norm for some time to come. In aggregate, the spend amounts to a considerable upward pressure on fixed costs. Maintaining the old-school application of annual base pay increases, and ignoring the new wave of merit thinking, may soon be too large a risk for organizations in a competitive labor market.
Guest blogger Steven Boland is an Analyst in the Rewards, Talent, and Communications Group (RTC) in Willis Towers Watson’s Chicago office, where he focuses on broad-based compensation consultation to help clients create competitive and globally consistent compensation strategies.
Sandra McLellan leads the Willis Towers Watson North American Rewards practice and is based in Toronto. In addition to her expertise in Global Total Reward management including strategy, job leveling, base salary, incentive design, performance management and linking culture and rewards, Sandra is a member of our Global Job Leveling Management Committee Team which oversees the development of our intellectual capital in these areas.