By Garold L. Markle
When it comes to the annual ritual of handing out raises, the seemingly sacrosanct touchstone that we refer to as “pay for performance” is either a massive misunderstanding or a big lie. You don’t pay for performance with base salaries in your organization. You can’t pay for performance with base salaries in your organization. Most importantly, you shouldn’t even want to.
In order to debunk this misguided mythology, we must have an adult to adult conversation about money. That means we’ll have to exclude from the dialogue any reference to Santa Claus, the Easter Bunny, or Hanukkah. I’m not your daddy and you’re not my kids. These are the facts of life.
In the real world, regardless of the type of organization, raises must originate from four very logical variables which are clearly rank-ordered in terms of importance.
First and foremost, any individual’s personal raise is affected by a devilish throttle that is totally beyond his control: the organization’s Budget. Think of raises like pie. If you want to accurately forecast how big someone’s slice might be, the best question to ask is “How big is the pie?” If you’re attached to the US government for the past two years, for example, the conversation ends here. By congressional edict, the answer is zero. According to most HR surveys, the grand majority of organizations in the US and Canada over the past four years have experienced at least one zero budget. For many organizations salaries have been frozen for multiple years. Those in more pressing circumstances have even had instances where they’ve had to cut salaries.
So, in a bad economic climate, what happens to “pay for performance?” The reality is that we keep our good performers around. Slackers and dead weight get laid off. If you try selling survival as just reward, however, you’ll likely experience more than a little backlash. Many surviving employees, backfilling for downsized compatriots, have never worked harder or contributed more than in a zero budget year.
So, let’s try this again. In an organization with no money for raises, do you really need to know anything about an individual’s personal effort or contribution to calculate her raise? Unfortunately, not. Budget trumps any other variable.
Let’s be real both ways, however. Budgets are established by an organization’s ability to invest more in fixed costs (payroll) with open eyes to total compensation paid by relevant competition. If things are tight with your company, but the business climate is reasonably robust in your area, those in control may need to ante up anyway to avoid losing top talent to the competition. This is true, even if it is painful to do so.
Assuming you are fortunate enough to have a Budget, the second variable used to calculate any individual’s base salary adjustment is also out of her control. The technical term for this is Compa-Ratio. Think “replacement cost.” In other words, what are you paying this employee already, compared to the market for her position? The higher the ratio, the smaller the raise. Violate this principle at your own peril. Allowing a direct link between performance and percentage of increase without a tethering reference to Compa-Ratio will eventually price you out of the market.
I spent the first nine years of my career working in HR for the most profitable organization ever invented by man — Exxon-Mobil. They made salary decisions based on Compa-Ratio because they knew anything else would not be sustainable. If Exxon-Mobil can’t afford to go directly from last year’s performance to this year’s base salary increase, how can you?
Assuming your organization has money and your employee has room compared to the market, the third most important variable in determining her increase is Performance. Finally! Just remember, however, the grand majority of variability is taken out of the equation before Performance kicks in.
Even more sobering, if you’re fortunate enough to be able to award a top performer a high percentage increase this salary cycle, you need to be very careful about implying a direct connect between performance and pay. Next year your budget may vanish. More importantly, when your young hotshot starts showing a little grey hair, he’ll probably be approaching the top of his salary band. It’s no fun telling a senior contributor the hard truth about how things really work after years of selling the more pleasing mythology. If you’re not careful, your senior contributors will think you’re trying to take advantage of them based on age. That can lead to anything from a shrug of the shoulders to a class action lawsuit.
The fourth and final factor that influences annual salary treatment is Potential. Is your raise seeker silly enough to want more responsibility and good enough to earn it? Those who have ability to and probability of climbing another rung on the ladder can be moved more briskly across a salary grade and can rise closer to salary range maximum in anticipation of jumping to a higher grade. As most workers have a limited number of job grades to ascend over the course of their careers, the positive impact of Potential is typically short lived.
So let’s sum things up. Base salary administration is not and cannot be sexy. Performed properly it’s clinical. The controlling influence of 1) Budget, 2) Compa-Ratio, 3) Performance and 4) Potential are universal facts of life. The sooner we acknowledge them and have a “birds and bees” conversation with our workforce, the sooner we’ll have employees that interact with us as fully functioning adults.
So, what can you do to move compensation conversations away from The Big Lie?
1. Create and Calibrate a Multi-Tiered Compensation System. Make sure that you utilize the correct Applicable Labor Force data and properly tailor your jobs to fit your population. Rent an expert, if you don’t have professionally trained internal compensation design competency.
2. Adopt a Clear and Cogent Compensation Philosophy. Choose one that is grounded in reality. My universal favorite is extremely simple and I’ve used it for dozens of organizations: “We pay you fairly for what you do.”
3. Create Salary Administration Guidelines. Provide clear written instructions to supervisors and managers on how your system works. Train them to be able to both use and explain it.
4. Develop Compensation Conversation Templates. These cookie cutter documents should empower a manager to properly communicate an annual raise (or lack thereof) in sixty seconds or less. If you’d like a free sample, send me an E-Mail to request a set of forms that can be customized to cover a variety of situations.
5. Leverage with Bonus and/or Profit Sharing Programs. Craft incentive plans to reinforce and reward more directly for performance. Be careful, however, not to sub-optimize by encouraging managers to drive up numbers in their individual functions at the expense of the greater good.
Garold Markle is a widely traveled speaker, consultant and executive coach. He is CEO of Energage, Inc. and author of Catalytic Coaching: The End of the Performance Review as well as the training CD: Salary Talk–How to Discuss Pay so Employees Feel They’re Treated Fairly. For more of Gary’s teachings, go to Energage.com or email him at email@example.com.
This article was first published in Catalytic Coaching Newsletter in May 2012.