Key Factors in Determining Salary Increases

Once you’ve got a salary increase matrix (see below), determining increases should be simple—but it’s not.

Several approaches are commonly used for determining salary increases.

• Performance/merit systems are the most common.
• Across-the-board or general increases are often tied to increases in the cost-of-living index.
• For unionized employees, the collective bargaining agreement will include a negotiated provision for wage increases that usually includes a fixed general annual increase that may be combined in some instances with merit provisions and cost-of-living escalators that add to the across-the-board increase when the cost-of-living index goes up more than a predetermined amount.
• Many employers utilize a grid system with low, middle, and high ranges to determine what an employee’s wage should be based on job performance and current salary.

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Factors for Determining Salary Increases

While job performance is a major factor in any pay raise decision, other factors may be considered as well:

• The employer’s overall financial situation.
• The department’s or division’s “budget” for raises.
• The employee’s length of service.
• The employee’s qualifications (i.e., the scarcity of certain talents in the labor market and the likelihood that the employee will be paid more for them elsewhere).
• How much other employers in the local area are paying for similar jobs. Employers sometimes look to wage surveys of similar organizations within their labor market area for guidance in setting or adjusting wage rates. Most employers use “pay budget” surveys rather than compensation surveys when comparing their annual increases to those of other employers.
• What the employee requires in the way of incentives.
• General economic conditions–the inflation rate, changes in the cost of living, etc. Increases in the cost of living should be a major consideration when deciding on a budget for pay raises. The primary tool for measuring the cost of living is the Consumer Price Index (CPI), which is issued each month by the U.S. Bureau of Labor Statistics. Some organizations have an “escalator plan,” which grants employees across-the-board increases in proportion to increases in the CPI.

Bonuses

Long-service employees with good records who have been ineligible for wage increases because they have reached the top of their rate ranges may also be rewarded with bonuses. This practice provides employees with an incentive, but does not create red-circled rates. Furthermore, unlike increases in base pay, a bonus is not locked in–it doesn’t have to be given year after year. Because it’s discretionary on the part of management, it may be given only when the employee’s performance warrants it.

Longevity Increases/Employees at Top Range

A “longevity increase” is a special pay raise awarded to employees whose pay has been frozen because they are at the top of their pay bracket. Companies that give longevity raises sometimes stipulate that the employee is eligible for only two or three increases of this type during the entire term of the employment.

When inflation is low or when compensation brackets are not adjusted regularly, longevity increases help keep the compensation system in order. If such an option is not available, supervisors may artificially upgrade jobs to get pay increases for good workers who have been locked in at the maximum for their grade, and this can distort the company’s organizational structure. Longevity increases, bonuses, or enhanced benefits are options that can take the pressure off the pay program in such circumstances.

From longevity raises to incentive plan design, compensation is full of challenges. “Maintain internal equity and external competitiveness and control turnover, but still meet management’s demands for lowered costs.” Heard that one before?
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