Establishing a
Salary Increase Budget
Purpose of Process (see below how HRSource™ can help):
To control the salary increase expenditures and the impact it has on the financial performance of the company. This process is market driven and pay-for-performance oriented.
Recommended Steps in the Process:
- Analyze the salary survey data and determine the actual market
pay position. (See Salary
Survey process and sample Salary
Survey Analysis worksheet.)
- Note the average salary increase budget as reported in the
salary survey (the components of salary increase budgets are
typically listed in salary surveys such as merit increase
budget, promotion budget, adjustment budget, cost of living
increase budget, etc. Definition of these terms
appears under process tips).
- Determine your preferred market pay position (For example,
does your company want to pay equal to the market average as
reported in the salary survey, 5% above the market average in
the salary survey, or 5% below the market average, etc.).
- Recommend a merit increase budget based on the difference
between the preferred market position (step 3) and the actual
market pay position (step 1).
- Create a separate adjustment/promotion budget equal to 10% to
20% of the merit budget, depending on the anticipated number of
promotions and adjustments.
- Most salary surveys include an average merit increase budget.
Compare the survey average merit increase budget with your
recommended merit increase budget (step 4). If there is a
significant difference, you may want to adjust your merit
increase recommendation. For example, if your recommended merit
increase budget is 2%, and the survey average merit budget is
5%, you may want to adjust the recommended merit increase to
some point between the two numbers such as 3% or 4%. Otherwise
employees may perceive the company to be a low payer, because
their friends at other companies are getting bigger salary
increases. Also, the best of market pay position calculations
are only accurate to the nearest 5%.
- Calibrate the recommended merit increase budget, as adjusted,
with the company's ability to pay. Request input from the
Finance department. The financial position may require that the
recommended merit increase budget be lowered. If the employees
are aware of the financial condition of the company, often they
will accept a zero, minimal, or delayed merit increase as
opposed to job cuts or similar drastic actions.
- Obtain top management approval for the salary increase budget.
- Multiply the salary increase budget percentage by the base payroll of each division. This allows you to express the salary increase budget as a dollar amount, which may be more understandable to your managers than a percentage budget. Provide this budget number to each division director/manager.
The next steps illustrate how that budgeted increase can be allocated to individuals. The goal is to give the larger salary increases to the better performers. The two general approaches are: more structure and less structure. Typically smaller companies opt for less structure, but this depends on the organization's culture.
Less Structure:
- Generate a simple merit increase
guideline.
- Instruct managers to spend within the salary increase budget.
A manager of one department may get permission from higher level
management to spend above the guidelines if, for example, that
department had many outstanding performers and the performance
of the department as a whole was outstanding.
- Provide the following additional instructions:
- Refer to the evaluation of the employee's performance as documented in their Final Performance Management review (see Performance Management process).
- Select an appropriate merit increase amount as indicated in the Merit Increase Guidelines chart.
- A manager may raise this recommended increase if the employee's salary is low in the range or decrease it if the employee's salary is high in the range.
- A manager may change the merit increase recommendation based on the employee's salary relative to peer ranking.
- Employees at the top of the salary range are not eligible
for a merit increase. If they are an outstanding performer,
they may be eligible for a lump sum merit payment. A lump
sum merit increase is calculated by multiplying the
employees annual salary by the percentage salary increase
suggested by the merit increase guideline. A lump sum merit
increase can provide financial recognition for outstanding
performance without further inflating a salary that is
already high.
- Collect the salary increase recommendations from managers and
calculate the projected spending.
- Review spending anomalies, if any (there's always some), with
the managers.
- Obtain final approval from top management.
- Instruct managers to inform their employees of the salary increases. Providing employees with a simple salary increase letter is a nice touch.
More Structure:
- Generate a detailed merit increase
guideline.
- Instruct managers to allocate salary increases based on the
employee's performance (see Performance
Management process) and the merit
increase guideline.
- Collect the salary increase recommendations from managers and
calculate the projected spending
- Review spending anomalies, if any (there's always some), with
the managers.
- Obtain final approval from top management.
- Instruct managers to inform their employees of the salary increases. Providing employees with a simple salary increase letter is a nice touch.
Process Tips:
Choosing a more structured approach or less structured approach depends on the culture of the organization (do managers want/need structure, are employees accepting of structure), the capacity of the organization (generally more structure takes more resources of the human resources staff), and the training of the managers (untrained managers need more structure).
Salary reviews are typically conducted annually.
Also see the section entitled A Classic Approach to Compensation.
Focal Versus Anniversary Reviews:
Focal reviews (all employees are reviewed at the same time) are
generally more popular than anniversary reviews (employees
reviewed on the anniversary of their hire date) because budget
tracking is easier and managers only worry about salary reviews
once per year. With anniversary reviews, managers often have to
conduct salary reviews every month. Both approaches have
advantages and disadvantages. Under a focal review schedule, the
first salary increase of new hires is prorated, based on the
number of months between the date of hire and the focal review
month.
Merit increase is a pay adjustment given to an employee based on his/her job performance. This is the most common type of salary increase.
Adjustments are salary increases typically provided to an individual employee or members of a specified job family when the average pay rate of the individual employee or members of the job family is significantly behind the average paid by the market, such that the merit budget alone will not sufficiently close the gap.
Promotions are salary increases to recognize the assignment of an employee to a job in higher salary range.
Cost of living adjustment (COLA) is a salary increase given to all employees (the same percentage increase to all) designed to bring pay in line with increases in cost of living. These were popular many years ago, but are now rare.
HRSource™ can help establish and monitor salary increase budgets:
