Can You Afford to Pay a Raise?

Can You Afford to Pay a Raise?

 More than ever, as rising inflation chips away at disposable income, a pay raise can help plug the gap. The 2023 Social Security cost-of-living adjustment is 8.7%. When times are tough, some extra dollars can remind employees that management has not forgotten them.

A raise versus a bonus

One central question is, should you provide a raise or a bonus? A pay raise is generally a set percentage of salary increase and is almost always permanent. A bonus, however, is theoretically a one-off payment, sometimes linked to sales or production volume. For many businesses, a bonus, while not guaranteed, is an expected part of an employee's overall compensation.

Companies may also deliver other types of perks and fringe benefits as a sign of appreciation and encouragement. These perks run the gamut, from flexible working conditions, travel stipends, tuition reimbursements, gift certificates and entertainment tickets to partnerships, profit sharing and stock. Employers can even provide a combination of raises and bonuses.

How much should a raise or bonus be? You may want to follow the lead of your competitors for the answer. Be rigorously fair; at least, incorporate the same criteria for all your staff based on explicit guidelines. Follow equivalent principles for part-time workers or teams if similar performance factors apply.

Or you may wish to benchmark against market averages. Businesses and economic conditions vary widely. According to the U.S. Chamber of Commerce, average performance bonuses are calculated at 1%-5% of base salary. As a rule of thumb, firms tend to pay support staff between 3% and 5% in raises, 10% and 12% to managers and even higher percentages to senior executives, taking into account that the latter receive much of their compensation through bonuses.

When is the ideal moment to schedule the payment? Firms may pay annually, semiannually, when it has been earned or after an employee's specified time with the company. Also, they may use a bonus as a short-term incentive for, say, a new sales campaign or for reaching specified goals or milestones.

Bonuses, which can be reduced or eliminated, can be preferable for adjusting variable costs in line with company profitably. This is especially true if payroll is your largest expense — your business must generate sufficient revenues and cash flow to meet higher payroll. Since unpredictable pay fluctuations may be disruptive to employees, be careful to explain to them how they ultimately help preserve jobs.

What are you rewarding?

Whether a raise or bonus, companies look at key factors for deciding to increase compensation, such as:

• Rewarding loyalty — for example, marking a 10-year employment anniversary.
• Accommodating for higher costs of living — either firmwide or only for employees living and working in more expensive locations.
• Acquiring additional professional licenses and skills.
• Performing exceptionally.
• Adding responsibilities.
• Taking on more autonomy — some companies raise salaries, starting at about three to 12 months from the original hiring date.
• Improving efficiency and performing tasks faster.
• Proving reliability, particularly for critical day-to-day operations.
• Keeping up with your industry and market.

The underlying drivers are to both demonstrate appreciation and incentivize. A raise or bonus can boost motivation and encourage retention. Keep in mind that a modest bonus costs firms less than does hiring and training a new worker. Performance merit increases are often linked to established goals that create a "stick and carrot" situation, as employees will intensify their efforts to earn monetary recognition.

Sharing the good news

It is best to communicate the good news of increased compensation to your employees personally and privately. Relay the dollar amount, rather than a percentage. Thank them for what they do and follow up soon after with a formal letter. It may be appropriate to explain to them how the increase was determined in order to discourage any perception of bias.

Should you communicate the good news at an annual salary review? An on-the-spot revelation may work better for offering immediate feedback and gratification for superior performance. You also want to dispel any sense of entitlement or complacency. There may be lean years in the future, so it is sensible to manage expectations for the long term.