Is Three Percent the Right Merit Budget for Your Organization?

By Stacey Carroll, PayScale.com I get the phone call a lot. It goes something like this, “Stacey, my CFO wants to know what the average increase other companies are giving this year so we can determine our merit budget. Can you tell me?”. I can. The short answer is from everything I’ve seen and read recently, most organizations are planning on giving anywhere between a two to three and a half percent increase in 2012. But, the better way to answer the question is: “Why is ‘what everyone else is doing’ our approach to compensation”? In reality, what your organization should pay as a merit increase for 2012 is going to depend on many factors – but here are just three.

Factors to consider when determining your merit budget:

1. What is happening in your market?

An average is only as good as the information that it’s based on. For example, if the average increase for companies in your area is two and a half percent but you are in IT services, the average for your industry might be three percent. Even more complicated is what if you are not in IT services, but you have IT employees in your organization? If those companies are looking for the talent that you have, and they are staying competitive with the industry but you are not, you risk losing your talent to a competitor down the street. The competitor might only be in competition with you for your IT talent – but they are a competitor nonetheless.

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2. What is the demographic of your workforce?

Generally speaking, earlier in your career there is a stronger positive correlation between higher pay and each additional year of experience. So, for an accountant with one year of experience the difference between one year and two years of experience may be four percent but for an accountant with 14 years of experience the difference in pay with one more year of experience may only be one percent. If you have a workforce dominated by employees at the beginning of their career – you may need larger merit budgets to account for the maturity curve, the correlation between pay and experience.

3. How is your organization different than the norm?

If your company has performed significantly better or worse than your competitors, it may indicate that the performance of your employees is significantly better or worse than the norm. This may warrant an increase budget that is different than the average. Another example, if the average is based on organizations that are already paying competitively with market – but you have some work to do to bring employee’s pay within the range of norm, you may need more of an increase budget. It’s important to evaluate information about the average against how closely you feel your organization is aligned with average.

I’m not going to criticize anyone who is interested in collecting information for the purpose of making decisions. After all, great decisions are made on the foundation of reliable information. However, I think we need to help our organizations to understand the difference between using one number that represents too many variables, and therefore assumptions, as the basis for our decision making.

The best answer is that the organization establishes a compensation philosophy that supports the business objectives, builds a compensation plan with relevant, timely market data, and then executes with increases that are based on rewarding those things that your organization values. This approach will help your organization stay ahead of the pack instead of hanging out with the average.

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