As a business leader or an HR professional, one of the crucial planning cycles for the upcoming year is upon you. Compensation budget planning is one of the most impactful factors on an organization’s bottom line and you need to be strategic in how you approach it. Now is a good time to revisit your compensation budgeting practices and determine which will best lead you to organizational success.
COMPENSATION BUDGETING FOR BUSINESS LEADERS
For C-Level executives the top priority is creating growth for their organization. A huge factor in that growth are your employees. Additional priorities that impact the bottom line include building a great team, retaining the strong team that you have and staying competitive.
According to The Predictive Index’s 2019 CEO Benchmarking Report, employee-related costs are 55 percent of the average organization’s total costs. Your employees are often the organization’s biggest expense – while simultaneously being your biggest asset. Additionally, the loss of employees (turnover) can cost employers 33 percent of an employee’s annual salary.
The stakes are high and C-Level executives should expect their HR leaders to provide a compensation budget based on talent optimization to protect their assets. Talent optimization is an approach that aligns your talent strategy with your business strategy. Key components you should expect from the HR leaders in your organization include clear job descriptions, clear interviewing structure, expertise on compensation strategies and standardized interviewing strategies.
Build a Compensation Budget That Drives business Growth
Your compensation budget strategy and plan will answer questions such as: how does pay align to our business goals – are you hiring in the key areas that will contribute to fiscal growth in your organization? What do we value and how do we want to reward those values? What pay choices will help us retain, motivate, develop, and attract top talent – in other words, does your HR team have their finger on the pulse of what is driving engagement for employees and do you have variable pay built into the budget to reward employees who drive growth and enhance operational efficiencies?
Finally, do we want to prioritize pay for the jobs that are mission critical? The typical compensation plan is complete when it has a philosophy, strategy, guidelines for pay, policies and processes. A comprehensive plan will be your guide when bottom-line impacting decisions need to be made.
The War for Talent
The war for talent is and has been fierce in the last several years. And signs show the pressure is on for the foreseeable future. In the last three years, demand for workers has been strong and has reached levels where workers are feeling empowered to make moves. Workers were job-hopping in record numbers in 2018. The Bureau of Labor Statistics (BLS) pegged the annual number of hires in 2018 at 68.9 million and the number of employee quits at 40.1 million.
The job market is experiencing a record period of low unemployment and organizations are finding it difficult to fill all of their open positions. In fact, 46 percent of the organizations we surveyed believe the strong job market has increased their turnover rates. More than half of these organizations said that less than 25 percent of their turnover was “good” turnover, meaning the exit of low-performing employees.
According to PayScale’s Compensation Best Practices Report 81 percent of organizations planned for base pay increases in 2019. However, the average increase didn’t change much from 2018, with 69 percent of employers estimating an average increase of 3 percent or less.
How Will You Adjust Your Compensation Strategy?
When we asked organizations to tell us the top reason they have adjusted their compensation strategies and budgets, a whopping 32 percent said the move is to support retention efforts. Another 28 percent adjusted their comp strategies to make themselves more competitive to attract new hires; 19 percent made changes to better compensate employees who have “hot skills” in the job market. For example, making an effort to hire top salespeople, can produce impactful results on an organization’s growth. Top-performing salespeople sell between 4 and 10 times more than the average salesperson
Gone are the days when everybody in an organization received a standard raise percentage across the board. Organizations today understand the importance of recognizing high performers and invest disproportionately in them. Although a three percent annual raise is still the most common, 42 percent of organizations said they have given at least one employee a raise of more than 10 percent.
How Do You Differentiate Yourself?
So, how do you attract new employees, keep your current high value employees happy and balance your fiscal and operational responsibilities? Organizations are differentiating pay based on performance in order to retain high performers and they are using a variety of tactics to do so. The most popular retention tactics organizations planned to use in 2019 were the merit- based pay plan (used by 61 percent of organizations), learning and development opportunities (59 percent), and the discretionary bonus plan (34 percent).
It is crucial that C-Level executives work with their HR leaders to ensure that core values are embraced by employees – and that these values guide your compensation decisions. Organizations who want to attract and retain the best people need to make sure their values and purpose as a company are clear and communicated well both inside and outside of the organization. The values you hold dear as an organization and the key business growth strategies should be embedded in the organization’s compensation philosophy and reflected in all pay decisions. When the core organizational values and growth strategies do not match with the compensation philosophy, it will seem disingenuous to both current employees and prospective employees.
COMPENSATION BUDGETING FOR HR PROS
As an HR professional you need to create a budget and be able to sell it to your organizational leaders. So, what are the steps you should take to create a compensation budget that ‘everyone’ loves – including your business leadership?
Five Key Steps for Your Salary Increase Budgeting Process
- Identify and manage pay inequities (by completing a market study and a gender/racial pay audit)
- Develop solutions for your pay inequities
- Calculate how much addressing your pay inequities will cost
- Present your budget request to finance and leadership for approvals
1. Identify and Manage Pay Inequities
Pay inequities can exist at multiple levels, from the organizational down to the individual level. You’ll want to start at the organizational level to determine 1) whether your organization is paying fairly to the market, 2) whether your ranges are competitive with the market.
The way to identify pay inequities is to do a market study (or to benchmark your jobs to the market). To ensure relevant results in your market study, you’ll need to keep three things in mind:
- Price to the job, not the employee. Pricing by the job requirements will help you identify the midpoints of your ranges; employee skill sets and experience will determine their positions within the range.
- Make sure your job descriptions are up-to-date. You need to know your positions really well in order to get reliable market data to appropriately benchmark your jobs. Go beyond just title matches to match the key responsibilities and tasks for your benchmarking jobs.
- Use reliable sources of data. Make sure the data is not only fresh, but also covers your appropriate competitive set. It should also have transparent
- To determine if you’re paying fairly to the market, you’ll compare your pay for your full organization to the market (at the targeted percentiles you’ve determined in your compensation strategy).
- The key metric to look at is the market ratio. This compares employee pay to the market values for a position to which they’re assigned, at the target percentile. A market ratio of 1 says you’re paying at market values. A market ratio below .8 says you’re paying low to the market; a market ratio greater than 1.2 says you’re paying too high to the market.
- Then, you’ll want to check how your current structure is holding up relative to the market. For example, see how close or far your range midpoints are from the market values for your positions.
- Key metric to look at: If your range midpoints are, on the whole, more than 3 percent different from the average market values for your jobs, you may be out of alignment with the market.This can mean that some jobs have shifted significantly over the past year.
Departmental Level Inequities
- Next up, you’ll want to examine if you’re paying fairly across departments.
Position Level Inequities
As a next step — check for position level inequities. In other words: Have some of your positions moved faster in the market than others? In today’s volatile market, from year to year some positions may move as much as 10 percent or more, while others may stay still and yet others may decline.
The key metric to look at is the comparison between the range midpoints and the market values for each position. Make note of positions where there is a large spread between the figures. For these positions, you will need to consider ways to adjust employee pay in those roles. In today’s hot job market, employees know when they have in-demand skills and they will pose flight risks to your organization if they aren’t appropriately compensated for the skills they have.
Individual Level Inequities
To identify Individual level inequities, the questions to answer are: Are we paying our employees fairly based on our compensation strategy and their Equal Employment Opportunity status?
Typically, individual level inequities show up in two ways. First, organizations can lose track of their pay strategy when they bring in newer incumbents who are paid at or near the wages as longer tenured employees. For more details, read this article for a guide on how to address pay compression.
Second, check on a regular basis to make sure you’re paying fairly across gender, race and ethnicity. In other words, you need to be able to answer these questions:
- Are all females / people of color are paid similarly as males / white workers when both groups are doing comparable or similar work?
- If you have male and female workers with similar profiles who are doing similar work, are both groups assigned to the same pay grade / job level?
If the answer is “no” to either question, you have a potential gender/racial inequity that should be addressed right away.
For more guidance on how to identify pay inequities, check out these resources:
- Your Pay Equity Action Plan (whitepaper)
- How to Identify Gender Pay Equity Issues with PayScale Reports
2. Develop Solutions for Your Pay Inequities
At each level of the organization, and for each inequity you identify, you’ll want to determine a way to resolve the inequity.
The biggest concern is the legal one. If you have identified any compliance-related inequities, the only solution is to resolve them immediately. Beyond that, you’ll need to determine the impact pay inequities have on retaining top talent and employee engagement and morale.
Be sure to develop multiple strategies for how you intend to resolve the inequities. For example, is it possible to absorb the inequities into this year’s increase budget, or is the amount so large that may take multiple years to resolve? Consider how critical it is to resolve the inequities immediately.
3. Determine How Much the Solutions for Your Pay Inequities Will Cost
Now, you’ll want to calculate how much it will cost to rectify the pay inequities you’ve identified. The three key numbers to look at include:
- Range adjustments – do you need to adjust your comp plan ranges to stay current to the market? If so, by how much? To stay competitive in your market, you’ll want to examine your ranges on an annual basis to confirm that they remain relatively aligned to market values on the whole. Typically, ranges move every 2-3 years. However, how often you want to adjust yours will depend on your org size, industry and compensation strategy.
- Market adjustments – how much do you need to budget to give pay increases for jobs that are moving fast in the market? Do you want to do a semi-permanent change (adjust the pay range for these positions) or a more temporary fix (market premium bonus)?
At the position level, the way that you would correct inequities would be to make market adjustments. You’ll need to think about which approach works best for your organization. On one hand, you can make a market adjustment by moving a position to a new grade. In that case, the budget question to ask would be the cost of ensuring that all incumbents are within range for the new grade.
Alternately, you could keep the position in the same grade and offer that employee a market premium, or a bonus payment. This could be the better option if the employee is in a job that may be temporarily high relative to the market (but may come down in the future). This way, you can both encourage retention of those employees and mitigate the risk of overpayment in the future.
Add Your Base Pay Increase to the Budget
After budgeting the pay inequities that you may have identified in your organization, you’ll then determine the pay increase amounts. Typically, your CFO has already provided high level guidance on this figure. It’s usually a percentage of the total salary budget (often 3 percent or 4 percent).
A note about red-circled employees:
In the past, HR professionals have asked us whether they should accounting for red-circled employees (workers with pay above the range maximum) in their budget.
For employees whose pay is already at the top of the range, there’s no hard and fast rule as to what to do. What you do will depend on how you budget, how you want to handle these employees and how closely you follow your budget. For example, some organizations allow managers more discretion to allocate their budget as they see fit. In that case, it would be up to the manager to decide if they want to reward someone in the red. Alternately, you may decide to simply keep the 3% (or whatever amount that came from your CFO) in your base pay increases line item, and then for those in the red, convert their increase portion to a results-contingent bonus when it comes time.
4. How to Present Your Budget Request to Finance for Approval
If you would like to ask for a bigger budget so that you can get every employee within range, fulfill your compensation strategy and give certain high performers greater than typical merit increases, you’ll need to be prepared to present your case.
The key here is to give your finance leaders multiple options — the one you want and the one you don’t want. And you need to prove to them that you have their mandate (to control costs) in mind when you present your alternatives. Before you even talk to Finance, think through the following:
In a worst-case scenario, are the “underpaid” employees worth retaining?
- What is the likelihood that this person is going to leave if they don’t get a raise?
- If the likelihood of this person quitting is high, what are the consequences for the team/department/business if the person does quit?
Make sure you explain the consequences in terms of hard costs and soft costs. Hard costs include loss of productivity during backfill phase, getting the new employee ramped up and productive, and recruiting costs – all of which impact an organization’s profitability. Soft costs include things like lower employee morale and engagement and opportunity costs for the team and manager.
How is your organization approaching compensation budget planning season this year? Let us know in the comments!