Paying: Giving (real) pay increases to good people

Good people should get pay increase right? If they are good? More than the cost of living (i.e. a real increase).

This we call a merit increase, and while it’s not rocket science, there are a few things going on that we need to talk about, and think about.

It’s standard practice

Many, most, (maybe even practically every) formal salary reviews has some element of merit, some additional component above the cost-of-living increase for some employees to reward their contribution and to secure their ongoing engagement and retention. Sometimes increases don’t happen; sometimes financial or economic hardship leads organisation to decide not to give pay increases a) above the determined cost of living increase or b)at all.  These happen, and sometimes happen often,  but even if they happen often, very few organisations larger than a handful of employee have a deliberate strategy to never give pay increases other that a universal increase. 

The base- the increase in cost of living

Before the increase for merit, they need an increase to meet the cost of living, how much they need to go up every year to stay still.

Typically the Consumer Price Index (CPI) is used for this, rather than inflation. Generally they are similar, if not identical, but CPI is considered to be more accurate to the cost increases people see in their expenditure. Just be careful to use the annual rate, not the quarterly rate.

Deciding ‘Good’

Now the hard part- who is good, and how much? Some things are hard to define, but easy to recognise. Sometimes our perception is performance is too subjective, susceptible to bias, and often skews towards friendly, instead of hard working.

Most of the time, employees performance rating are grouped, and often fall into a normal bell shaped distribution. Each system has their own iterations, but most I’ve seen are general these categories- poor, fine, good, star.  Poor employees often get no increase (not even cost of living), fine get just cost of living, good get an small increase, stars get a larger increase.

Small business don’t have to do this; you can give everyone more if you want. A core reason to do this is retention- the more you pay them well, the less likely they will leave.

The merit increase:  small but forever

So let’s talk the common outcome of most merit increase, a 1-2% pay increase above the cost of living.  Hardly cause for champagne.  Often merit pay increases are accepted, but rarely celebrated.  1.05% increase above CPI after a busy and difficult year is not hugely appreciated, so the temptation is to dig deeper into the pocket.

The counterpoint is that unlike bonuses, merit increases are forever- well, until they leave.  Ideally a complex remuneration system would have the mechanisms to reward current efforts through a bonus, but these aren’t common.  Its not uncommon to find employees on higher salaries due to past performance, which is not reflected in their current value; often the highest paid person in a band isn’t the best performer, but was the best performer.  For the HR practitioner, it important to balance the immediate needs to entice the employee to stay, while avoiding perpetually rewarding past glories.