Companies Rethink the Annual Pay Raise

Will doing away with automatic raises improve performance or destroy morale?

By Dana Wilkie Jun 9, 2016
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No more annual pay raises? It’s a move that companies increasingly are considering, most recently General Electric (GE). 

And if this becomes common, the change could either redefine rewards systems in a way that motivates employees and attracts high-quality candidates—or it could prove to be a demoralizing switch that leaves many workers’ wages lagging behind the cost of living. 

“This is the future and it has only just begun,” said Jason Averbook, a 20-year HR veteran and former CEO of TMBC, a global provider of engagement and performance solutions based in Los Angeles. 

Kris Duggan, CEO at BetterWorks, an information technology and services provider in the San Francisco Bay Area, called the idea “revolutionary.” 

At BetterWorks, he said, “we’re looking at salaries every couple of months to make sure we’re paying fairly. An annual [raise] is an old-school way of thinking based on the assumption that employees plan to stick around for five to 10 years. If you wait an entire year [to review compensation], you might lose employees who don’t want to wait for a [raise]. If we hire an engineer at a certain price point, we evaluate how much we’re paying our other engineers to be sure we’re always paying fairly.”

There’s no guarantee that this method of providing more-frequent opportunities to earn a raise is what GE has in mind, though. GE didn’t offer specifics June 6 when Bloomberg News asked what would replace annual pay raises, other than to say that it is “being flexible and rethinking how we define rewards, acknowledging that employees and managers are already thinking beyond annual compensation in this space.”

GE’s media department did not respond to a SHRM Online request for an interview. A decision on the issue may come within the next several months, a GE spokeswoman told Bloomberg News.

Rationale for Rethinking Raises

“In general, companies spend considerable amounts of money on the annual merit increase, typically about 2.5 percent to 3 percent of payroll,” said Mary Ann Sardone, a partner with HR consultancy Mercer LLC and Mercer’s North America Workforce Rewards Practice Leader. “Merit increases not only add to fixed costs but also increase the cost of other linked benefits, such as [paid time off] and disability, over time.”

Sardone said there is growing concern at companies—not just at GE—that the annual raise does little to motivate and reward for performance.  “So like any large business expense, companies are starting to examine the return on investment they are getting out of this significant expenditure,” she said. 

Only 1.2 percent of U.S. companies use a discretionary timeline for increasing base pay, according to this year’s compensation survey by Mercer. About 90 percent of companies have a fixed date when everyone receives their raise, assuming one is granted, while about 5 percent make the change for each employee on the anniversary of his or her hiring or move to the current job. 

Hurting Morale—and the Wallet 

Stephen Balzac, president of Stow, Mass.-based 7 Steps Ahead LLC, an organizational development consulting firm, said GE has “failed the first lesson of successful organizational change: They announced a major, fundamental change to how they relate to their employees, and left the future extremely unclear.” 

“When that happens, people are far more likely to assume the worst than the best, and thus become more resistant to the entire concept,” he said. 

Workers tend to embrace the annual raise, he said, because “it’s a tangible sign that the company recognizes that expenses increase over time.” 

“[Raises] represent a point of financial stability in a world that can be very unpredictable,” he said. “Providing annual raises means that employees are unlikely to feel they need to compete with one another. Internal competition is extremely destructive to teamwork and cooperation.”

Justin Black, director of organizational science at Redwood City, Calif.-based Glint, which sells a cloud-based employee engagement tool, said workers are apt to become disillusioned if companies that scrap annual raises fail to produce a clear, understandable explanation for how they plan to reward workers financially in the future.  

“It won’t take long for employers who do this with the wrong intentions or insufficient commitment to see the negative effects: frustration, distraction, attrition,” he said. Companies that may be considering this route need to carefully plan how they will monitor the impact of various compensation schemes on their employees, Black added.

Balzac said workers are certain to become demoralized if companies begin finding reasons for not providing raises—for instance, by making pay-for-performance goals nebulous or impossible to achieve. 

“A very real problem with the decision to remove raises … is that once the money is not being handed out [on an established basis], it is very easy to find excuses to not hand out the money,” he said. “Money always feels safer in the bank.” 

Workplace experts acknowledged that some workers who don’t get annual raises may see their wages fall behind the cost of living. But Averbook said that just because an organization eliminates its annual raises doesn’t necessarily mean it needs to eliminate cost-of-living adjustments. 

“It is important to separate performance and achievement of goals from cost of living,” he said. “For too long, organizations have blended these together and it has hurt the high-performers by not rewarding them for what they have achieved. It is key to make sure that performance compensation is not blended with cost-of-living adjustments so people realize they will be rewarded for outstanding achievements.”

Replacing Raises with Perks 

One way to soften the blow of doing away with annual raises, experts say, is to provide other perks that workers value—such as more time off or paid parental leave. 

Balzac cautioned, however, that “not everyone wants the same perk.”

“How do you determine equivalency between different perks? How do you make sure you have the right perks for everyone? I think a lot of new parents would not view paid parental leave as a perk so much as a necessity. It's certainly not fun in the way that a perk such as a paid vacation might be. This has the potential to only increase resentment and competition between employees.”

Communication will be the key to creating a new structure for awarding pay increases, Averbook said. 

For instance, he said, total rewards statements—those that show workers the financial worth of their wages as well as their benefits—will be “more important than ever to show the value that a company is providing an employee.” 

Dominique Jones, chief people officer at  Ottawa, Canada-based Halogen Software—which offers cloud-based talent management solutions—said managers will need to let employees know that their salary is based on a wide range of factors and behaviors and not limited to a specific performance score given at the end of the year. 

“Managers must be accountable, with honest and open conversations around compensation—which means they need to be given the training, tools and resources to do this well.” 

And company leaders, Duggan said, must “have frequent calibration meetings with managers to remain in sync and make sure” raises are awarded fairly. 

“It’s also vital to have transparency,” he said. “If you keep everything behind the curtains, your employees might assume the higher-ups at your organization are still receiving their annual raise, which could kill morale.”

Dana Wilkie is an online editor/manager for SHRM.

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