More Employers Rethink Annual Raises

More Employers Rethink Annual Raises

Back in June, General Electric hinted that it was considering doing away with annual raises and replacing them with some sort of more targeted system. If it were to do so, GE would be abandoning a practice followed by the vast majority of US employers, some 90 percent of which give out raises to all employees on a fixed annual date, while only 1.2 percent of companies increase base pay on a discretionary timetable. However, other organizations are also having second thoughts about the annual raise, which they say is too small to meaningfully motivate or differentiate employees, Rachel Emma Silverman discovers at the Wall Street Journal:

Average merit raises for U.S. workers have hovered around 3% for the past five years, as employers have kept the budgets for raises relatively low, despite improving labor markets. Pay surveys report companies expect few changes next year if inflation stays low. That doesn’t give companies much to work with. Moreover, managers are reluctant to increase base pay further because higher payroll costs could result in heftier prices for customers, says Tom McMullen, a senior compensation partner with Korn Ferry Hay Group.

Laura Sejen, managing director of talent and rewards at consultancy Willis Towers Watson, urges employers to “eliminate merit raises as we’ve known them” and focus on meaningful bonuses for high performers. … “The annual raise is like smearing peanut butter one millimeter deep for everybody. It’s better to smear the peanut butter where you see really strong contributions happening,” says Kris Duggan, the chief executive of BetterWorks, a three-year-old management software firm.

Replacing regular raises for everyone with bonuses only for high performers carries risks of its own, however, as Bloomberg’s Rebecca Greenfield notes:

It’s unlikely that companies will do away with regular pay increases. Employees would revolt and then quit. Performance bonuses already have become an increasingly large part of worker compensation, making up 12.7 percent of payroll as of 2014, up from 3.9 percent in 1988. Pay adjustments might also come on a different time scale. BetterWorks … reviews employee performance every month and adjusts salaries accordingly. Other companies might go in the other direction and consider a longer pay cycle.

No matter the change, companies risk alienating employees. While the best workers could potentially see big changes on their pay stubs, few workers will stand for no raise at all. “Practically speaking, it would be very difficult for a company to say zero raises,” said Sejen. “There’s a need to remain competitive.”

Indeed, I wonder whether companies can survive with only high performers—what about solid performers? If they don’t receive a merit increase or a “meaningful” bonus, they will realize that they won’t be able to achieve their personal financial goals at this company and go elsewhere. This turns job-hopping into the only viable option to increasing take-home pay.

It’s also interesting to contrast this movement away from merit raises to the UK investment firm that recently decided to stop giving bonuses and put its employees on a flat salary instead. There seem to be two rather distinct philosophies at work.