Numerous organizations annually publish U.S. employers’ projected pay increases for the upcoming year. So, when your CEO asks you to budget increases for next year, you just average those numbers and multiply them by your annual payroll cost, right?
Not so fast. Understanding what other organizations are projecting for pay increases is just one piece of the planning process. Let’s look at the various components of the compensation planning process.
Look at the Midpoints
First, you should look internally. There is a great deal of analysis that should be completed as part of your planning. With your compensation philosophy in hand, compare your actual salaries to the midpoints of your salary ranges. Are you paying competitively? You can answer this question by calculating the compa-ratio (actual pay/midpoint of the salary range).
Paying at midpoint would result in an answer of 1.0. If your calculation turns out to be less than 1.0, this may indicate that your actual pay rates may not be staying competitive in the market, even though your salary ranges are competitive. If your average compa-ratio is low, this may be an indication that you should budget higher increases to stay competitive with the market and reduce the risk of turnover.
Another way to use your compa-ratio analysis is to identify if you have any employees below the minimum of the salary range, particularly if you plan to move your salary ranges over the next year. These adjustments need to be included in your budgeting process.
Pay Equity
Do you need to budget for any pay equity increases? If you find that the pay of new hires and the pay of employees who have more tenure with the organization are too close together, then you may need to budget equity adjustments for the more experienced employees. If this compression is not addressed, your experienced employees may take this as a message that the only way to get a pay increase is to change organizations. Your talent-acquisition team and pay surveys can be helpful in identifying trends in the market for starting pay rates and which positions need more attention (or dollars budgeted).
Another part of budgeting for pay equity increases is determining if there is a misalignment of pay among peers with equivalent education, experience, and performance levels. Pay equity laws require that employees with similar duties be paid similarly regardless of sex or sex and another protected class. Disparities that cannot be explained by legitimate factors should have an equity adjustment budgeted.
Workforce Planning
Part of the budgeting process should include workforce planning. In addition to your current employees, what positions are open and what new positions do you expect to fill in the next year? Should you budget the pay to be at the minimum of the salary range, at midpoint, or higher in the salary range? What divisions or departments in your organization expect to have increased demand or growth? Does more money need to be budgeted for these teams?
Another step in the compensation planning process is to consider promotions that may take place next year. This may be career development promotions (Examples: Engineer 1 to Engineer 2 or Production Operator 2 to Production Operator 3). You may also anticipate new promotional opportunities that may develop as part of organizational growth or reorganization.
Merit/Seniority Pay Hikes
The next part of your budgeting process will be for merit or seniority increases. Some organizations increase employee pay by the same percentage, as part of an annual process that rewards tenure. Other organizations have a “pay-for-performance” philosophy. The higher the performance level, the higher the merit increase. A merit matrix can be useful in providing managers guidelines for increases based on performance and, sometimes, position within the range. Pay increases can be budgeted by the distribution of performance ratings across the employee population.
What to Leave Out
There may also be some positions you do not include in your budgeting process. This may be union employees who have increases based on a negotiated contract. Executive pay may be determined by your board. Also, are there any positions that may be eliminated next year so they should be removed from the budget?
The Effect on Benefits
Keep in mind the impact of pay increases on your benefits budget. Pay increases often increase the cost of life/AD&D insurance, disability insurance, retirement, workers’ compensation, and taxes, such as Social Security, Medicare, and unemployment.
Employers Council can support your compensation planning process through surveys, Payfactors’ PEER online tool (free for Employers Council members), training classes (reduced rate for members), and other resources. Click here to learn how to become an Employers Council member.