Thought Leadership in Action

Fifty years ago the compact between company and employee was practically written in stone: Show up every day, do your job well and lifetime employment and commensurate rewards will be yours.

A key piece of that unspoken agreement was the annual raise. Unless the organization was in serious financial trouble, raises were considered to be as reliable as the calendar. Some people got a small bump and higher-performers got more, but most everybody got something to cover the steady rise in the cost of living (COL).

However, like many timeworn hallmarks of the workplace, the automatic COL raise is rapidly becoming a thing of the past. This can allow companies to keep a lid on fixed costs, but also presents a challenge in retaining their top talent. Here’s what’s replaced it.

The Rise of Pay for Performance

The new philosophy behind annual raises is to pay for performance, contribution and capabilities, thus ensuring the market competitiveness of the company’s compensation program, according to Tom McMullen, senior client partner with Korn Ferry, a global leadership and personnel advisory firm.

Automatic COL increases are disappearing because companies have begun to question the return on investment, McMullen says. Instead of increases in base salary, they’re shifting to variable pay structures — incentives and bonuses.

Seeing Modest Wage Gains

But those gains have been modest. Korn Ferry’s December forecast said that, adjusted for inflation, employees in North America would see a smaller rise in their take-home pay in 2018. With the uptick in the economy, U.S. inflation rates are coming off the floor of the Great Recession, from 2.1 percent in 2016-17 to 2.5 percent expected for this year, according to the U.S. Labor Department.

Inflation was a key consideration in COL raises, with the goal to at least cover steadily increasing costs. But pay is no longer keeping up. According to PayScale, while wages have risen 14.5 percent overall since 2006, “real wages” have actually fallen 7.1 percent when you factor in inflation.

Because base salary increases are fixed costs, variable pay increases are done separately and are treated as a one-time payment for performance. “CEOs are willing to pay for performance, but only if they get that performance,” McMullen says.

Finding the Right Mix of Variable and Base Pay Raises

Variable-pay-only models run their own risk. An employee who receives sizeable bonuses but no COL raise over a period of 10 years will eventually realize they’re falling behind. In order to compete in the talent marketplace, McMullen says, some kind of base salary raise still needs to be in the mix.

“They key is to provide an appropriate balance to base and variable pay and make the increase meaningful and motivational for the employee and the organization,” he says. “To the extent this can be linked to performance — all the better.”

Rather than tying automatic raises to the rising cost of living, McMullen says, make them performance-based salary increases, then layer in a competitive incentive plan that has line of sight between individual and team performance. Recognition programs tied to specific organizational goals are also becoming more prevalent, since they can provide the worker with emotional satisfaction through a fixed base bump.

Also, McMullen says, “don’t forget the power of nonfinancial rewards — meaningful work, opportunities to collaborate, energizing work climate. We see these having a significant impact on employee retention.”