Introduction to compensation management

Compensation management is one of the key human resources functions. It involves determining an appropriate salary and benefits package for each role in your organization. 

Although salary is important, it’s not the only factor employees consider when deciding whether to stay with their current employer or seek opportunities elsewhere. Offering health insurance, flexible spending accounts and other benefits can help you retain more team members.

Employers can stay competitive and demonstrate their commitment to valuing their workforce by setting clear salary thresholds and implementing merit increases through performance-based reviews or skills-based promotions. A well-structured compensation plan motivates employees and can help your company build a reputation as a fair employer, making it easier to attract and retain talent.

Tips for implementing salary increases

If you want to use salary increases to reward employees or make your organization more competitive, consider following these tips.

Review your company’s finances

Before adjusting your compensation strategy, it’s helpful to think about the potential impact on your company’s finances. Unlike merit-based bonuses, salary increases aren’t a one-time expense. 

They have a long-term impact on your company’s payroll expenses. If you offer bonuses or other incentives calculated as a percentage of an employee’s salary, the cost of those incentives will also increase accordingly.

For example, if you offer a 15% yearly bonus to an employee earning $100,000 per year, you can expect to pay $15,000. If that person’s salary increases to $110,000 per year, their annual bonus would be $16,500, a $1,500 increase.

Be transparent about your budget

If your business budget doesn’t support substantial increases, disclose that information in a one-on-one meeting with each employee. Team members might expect larger raises based on company performance or industry standards, so it’s important to address these expectations.

Transparency helps employees understand you’re doing your best to offer substantial increases. Team members may also feel more satisfied if they know they’re receiving the largest pay increase possible.

For situations where raises aren’t built into review cycles, you might have employees submit formal requests for raises, supported by company data or performance metrics. Reviewing these requests can help you assess employee expectations and prepare for one-on-one meetings. 

Take cues from competitors

When you post a job advertisement, you’re competing with other employers in your industry to attract and retain talent. In the context of compensation management, it’s helpful to monitor industry news and stay ahead of changing compensation trends. For example, you can review competitors’ job posts to find out the starting salaries for key roles.

You can also use salary benchmarking to determine how much competitors are paying and how often they’re giving salary increases. Benchmarking involves collecting internal salary data and comparing it to compensation data from other companies using tools such as Indeed, the Bureau of Labor Statistics (BLS) or Payscale. Employers typically conduct salary surveys, review industry publications and use salary software to gather benchmarking data.

Gathering information about these topics can help you attract quality candidates and negotiate more effectively with your current employees. Strong salary negotiation skills help you avoid common pitfalls and get better results for both the company and your employees.

Use objective criteria

When determining salary increases, using objective criteria can help reduce bias and ensure employees receive equitable treatment. Objective decisions rely on facts instead of feelings or opinions. 

For example, you might want to offer a 3% increase to team members who have been with the company for up to three years or have proven exceptional performance through project outcomes or skills acquired.

The length of an employee’s tenure is objective because it doesn’t vary based on a manager’s or HR employee’s opinion. You can easily check an employee’s hire date in your HR software and use it to determine how long they’ve been working for your company.

Train managers to have effective salary discussions

An employee’s manager is often the key decision-maker in the salary increase process, so it’s helpful to ensure they’re well-prepared and able to communicate effectively during negotiations. Consider training managers to use objective criteria and advocate for their team members during salary discussions.

Alternatives to salary increases

Offering salary increases isn’t the only way to reward employees or increase retention. If your budget doesn’t support permanent increases, consider adopting one of these alternatives.

Bonuses

A one-time bonus doesn’t have a lasting impact on your budget, so it can help you achieve the same goals as a salary increase without permanently increasing your compensation costs. Bonuses may boost motivation, enhance collaboration and reduce voluntary turnover. Consider offering these types of bonuses to your employees:

• Spot. A spot bonus is a one-time bonus that recognizes individual employees or teams for their achievements. For example, a manufacturing company might offer a $100 spot bonus to the employee who achieves the lowest error rate or the highest output during a shift.
• Profit-sharing. This type of bonus rewards employees based on the company’s overall performance. You might want to set aside a certain percentage of your profits each year for this purpose. For example, if you set aside 10% of $500,000 in profits, you’ll be able to distribute $50,000 in profit-sharing bonuses.

• Holiday. Typically given at the end of the calendar year, holiday bonuses are extra payments designed to reward employees for their contributions. Some companies pay a flat amount, such as $500, to every employee. Other organizations calculate their holiday bonuses as a percentage of each team member’s salary.

Flexible work arrangements

If you have a limited budget for salary increases, offering flexible work arrangements can help you motivate employees without significantly increasing your expenses. These arrangements give team members more control over their work hours and environment. For example, you might allow telecommuting or give employees the opportunity to set their own schedules. This benefit can be particularly helpful for working parents, caregivers or employees with disabilities. 

Additional PTO

Paid time off, also known as PTO, gives employees a chance to relax and attend to their personal needs. Offering adequate PTO can help you increase retention, reward team members for their loyalty and enhance job satisfaction. If you’re looking for an alternative to salary increases, consider offering additional PTO to your employees.

Enhanced benefits

Another option is to update your benefits package. Like increasing salaries, changing employee benefits requires careful planning. You might want to work with your Finance Manager to determine how a major change is likely to affect the company’s finances. If your budget supports a change, consider adding new benefits, such as upskilling stipends or certification reimbursements, or enhancing your current benefits:

• Health insurance: If your company offers health insurance, consider increasing the amount you contribute each pay period. For example, if you currently contribute 50% of each employee’s premium, you might want to raise your contribution to 60%.
• Retirement: Consider increasing the company match for your 401(k) plan, if applicable.
• Student loan repayment: If employees have student loan balances, consider offering repayment benefits. For instance, you could offer to repay $5,000 in loans for every year a team member works for your company.
• Commuting benefits: If many employees use public transportation to get to work, consider covering some or all of their transportation costs, such as bus passes or train fare.

Factors affecting salary increases

Salary increases are influenced by various factors beyond individual performance. External elements, such as economic conditions, inflation rates and shifts in the job market, can impact the amounts companies can offer. Internally, company profitability, budget constraints and organizational priorities play a significant role in determining the size and frequency of salary increases.

Additionally, industry standards and the demand for specific skills can affect how employers structure their compensation packages. It’s also important to consider the value of an employee’s contributions, changes in job duties and the need to remain competitive in attracting and retaining talent. By regularly reviewing these factors, organizations can ensure their pay increases are both fair and aligned with broader business goals.

Performance review and evaluation

Performance reviews are a vital part of the compensation management process. They provide a structured opportunity for employers and employees to discuss job performance, set future goals and address expectations around pay raises and salary increases. Regular performance reviews allow employers to assess employee achievements, identify areas for growth and make informed decisions about pay increases, bonuses and other forms of compensation.

For employees, performance reviews are an ideal time to ask for a raise, negotiate salary and align their career aspirations with organizational objectives. By linking pay increases to clear performance metrics, employers can foster a culture of accountability and recognition, ensuring compensation reflects individual and company success. Role-relevant and skills-focused metrics can help reduce bias. You might define them while setting goals during performance reviews.

How and when to offer salary increases

Consider these factors when deciding how and when to offer salary increases:

• Your budget: When salaries increase, costs for your company rise accordingly. Keep budget constraints in mind.
• The employee’s level of experience: It’s common to offer salary increases to reward employees for developing new skills and competencies. For example, you might want to offer a raise to a team member who has recently completed a training program. Salary increases can also reward senior employees who train other team members or serve as mentors.
• How many years the employee has worked for the company: Many companies choose to recognize years-of-service milestones with pay raises to improve employee retention.
• Industry pay rates: Salary benchmarking can help you determine if an increase is warranted based on recent market trends.
• The employee’s performance: Rewarding an employee who exceeds performance expectations with a pay raise provides recognition and positive reinforcement.
• The cost of living in your community: Consult the Consumer Price Index (CPI) for your area when determining pay raises. Changes in the CPI reflect increases and decreases in the average cost of consumer goods and services. During periods of high inflation, salary increases help employees maintain their purchasing power despite rising costs. When the CPI trends downward, cost-of-living raises may not be necessary, especially if your company provides regular salary increases.

Before you implement salary increases, think carefully about what you hope to accomplish. These are some common reasons for employers to give raises:

• Encouraging an employee to stay: If an employee has an excellent record, offering a raise can help ensure their continued commitment to your team.
• Recognizing an accomplishment: If an employee succeeds in overcoming a significant challenge or bringing in an impressive client, a pay raise might be the best way to show your appreciation.
• Rewarding exceptional performance: Employees are more likely to stay motivated if they have the potential to earn more money. If you consistently reward good performance, it’s easier to build strong relationships with team members. Salary increases can also help encourage new employees to increase their effort.

Consider timing when deciding when to issue raises, such as after a major accomplishment or during periods of company growth. Employers should not simply wait for employees to ask for raises. Instead, it’s helpful to proactively review compensation to ensure fairness and competitiveness.

Managing employee expectations

Effectively managing employee expectations around salary increases and pay raises is essential for maintaining trust and satisfaction within the workplace. Employers should clearly communicate their compensation policies, outlining how pay raises, bonuses and other benefits are determined. You might also include timelines for reviews and examples of merit increases, such as the matrix used.

Setting realistic expectations and providing regular feedback can prevent misunderstandings and disappointment while reinforcing the company’s commitment to fair pay and employee well-being.

How compensation management will remain key

As the job market continues to evolve, effective compensation management will remain a key driver of employee retention and organizational success. Prioritizing fair pay, regular salary increases and transparent communication can help attract and retain top talent.

Companies may need to adapt their compensation strategies to address changing employee expectations, rising inflation and new industry standards. Embracing flexible benefits, leveraging data-driven insights and maintaining a commitment to recognizing employee contributions can help you stay competitive and motivate employees.