In two previous posts, we’ve been discussing the need for, and the merits of, implementing a hierarchical pay raise structure as opposed to a more or less flat structure whereby all employees generally receive about the same pay increase.
A more hierarchical pay raise structure focuses allocated money for pay increases on top performers while providing little to no raise for average to below-average performers.
In taking this approach, companies address the fact that employees value greater pay more than most forms of compensation while keeping costs relatively low. Here we discuss some steps and best practices for implementing such a policy.
Identify Your Top Performers
The goal of a raise in a hierarchical system is to retain top talent and incentivize employees to improve performance. In order to do this, you need to identify those in your company who are bringing the most value and represent the characteristics you want others to emulate. This should be based as much as possible on empirical data as opposed to gut feelings or favoritism.
Have your managers rank their staff (no ties!) and provide feedback on how they came up with their rankings. Design your performance reviews with an eye toward the amount of value employees provide to the company, and review them with that concept in mind.
Come Up with Your ‘Formula’
It’s very straightforward to decide you want to increase average pay by 3% and then apply that 3% evenly across all employees. It’s more difficult to do that while giving different percentage increases to different employees with different current wage levels.
It may take some trial and error, and you will likely need to revisit your percentages each year as wages increase, and there may need to be some subjectivity and case-by-case determinations, which is why we put “formula” in the heading in quotations.
One thing to keep in mind is that each year, you are setting expectations for pay raises for future years, especially with employees getting the biggest raises, and those raises will become bigger and bigger in absolute dollar amounts every year.
For example, an employee making $100,000 a year who receives a 10% pay increase in Year 1 will cost the company an additional $10,000 in Year 2. Giving that employee the same percentage increase on his or her new $110,000 salary for Year 3 will cost $110,000 x 10% = $11,000.
It’s extremely important to be transparent about the criteria used for determining who gets what raise when there will be disparate outcomes. Even though pay increases are typically confidential, employees talk to each other, and without transparency, there can very easily be bad blood in the office.
Employees should be told on a collective basis what the criteria for higher raises are at the beginning of the year and be given feedback on an individual basis at the end of the year on why they received the raise they did.
Employees understandably value greater compensation; however, with a limited amount of money to spend, companies need to prioritize where that money goes. By implementing a hierarchical pay increase structure, employers incentivize the skills they value the most while keeping their top performers happy.