2006 Base Salary and Merit Pay To Keep Pace with 2005; Is Merit Pay Merited?

12/01/05
By: Stephen Miller, Shrm.org

In 2006, the average employee base pay increase is expected to be 3.7 percent, the same as the 2005 increase and slightly higher than 3.5 percent for 2004, according to a yearend study by Sibson Consulting. The firm also notes how the misuse of merit pay (when handed out indiscriminately) can harm overall business strategy.

Likewise, a national survey of chief financial officers by staffing firm Robert Half International (RHI) also indicates that for most U.S. workers, salary raises and bonuses in 2006 will be in line with what they received in 2005. No surprise, but the researchers at Compensation Resources Inc. (CRI) come to a similar conclusion, providing a breakdown by position and industry type.

Before taking a look at why merit pay increases often lack merit, let's go to the numbers.


Base Pay Increases, Projected and Actual: 2000—2006
	*2000*	*2001*	*2002*	*2003*	*2004*	*2005*	*2006*
Projected	4.2 percent	4.2 percent	4.3 percent	3.9 percent	3.5 percent	3.6 percent	3.7 percent
Actual	4.2 percent	4.4 percent	3.7 percent	3.5 percent	3.5 percent	3.7 percent	--
Source: Sibson Consulting

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Merit/Salary Increase


	2004 Results		2005 Results
Group	*Actual 2004*	*Projected 2005*	*Actual 2005*	*Projected 2006*
Executive	4.3 percent	4.3 percent	4.5 percent	5.1 percent
Management	3.8 percent	3.8 percent	4.1 percent	4.4 percent
Exempt salaried	3.6 percent	3.7 percent	4.1 percent	4.0 percent
Non-exempt salaried	3.5 percent	3.6 percent	3.6 percent	3.7 percent
Hourly/production	3.5 percent	3.5 percent	3.8 percent	3.8 percent
All groups average	3.7 percent	3.8 percent	4.0 percent	4.2 percent
Source: Compensation Resources Inc.

CFOs Concur; Financial Incentives to Hold Steady in 2006

The majority of the nation's employees won't be receiving higher raises and bonuses in 2006 than they did in 2005, the RHI survey finds. Less than one-third (29 percent) of CFOs polled said they will give bigger salary increases in the coming year, and just 20 percent anticipate boosting bonus amounts.

The independently conducted survey includes responses from more than 1,400 CFOs from a stratified random sample of U.S. companies with 20 or more employees. The CFOs responded as follows when asked:


*For 2006, do you anticipate offering higher raises* than in 2005?**
Yes	29 percent
No	64 percent
Don't know/no answer	7 percent

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*For 2006, do you anticipate offering higher bonuses* than in 2005?**
Yes	20 percent
No	67 percent
Don't offer bonuses	7 percent
Don't know/no answer	6 percent

CFOs who expect to increase raises and bonuses in 2006 were asked by what percentage these forms of compensation would rise. The mean responses: 5 percent for raises and 7 percent for bonuses.

"Many companies may be hesitant to increase employee compensation because of other expenses impacting the business, such as rising healthcare and energy costs," says Max Messmer, chairman and CEO of RHI. "But an overly cautious approach can be detrimental, particularly as the competition for top candidates intensifies. Firms that fail to reward good performance risk losing their best talent."

He advices that "Organizations unable to offer higher raises and bonuses should look for other ways to recognize and motivate their teams, such as offering professional development opportunities and enhancing the work environment. While employees value financial incentives, they also place great importance on their company's corporate culture."

What's the Matter with Merit Pay?

"Although some employees will get higher raises next year based on merit and performance, the problem is that, with modest pay increase budgets, most companies hate to give anyone less than 3 percent," reports Jim Kochanski, senior vice president at Sibson. "Thus the top performers only get a little more than average performers."

He points out that the 3 to 4 percent "merit" increase has been the norm for so long that many employees and managers have never experienced anything else, and Sibson's projections indicate that this level of increase is likely to continue. "The challenge for organizations seriously interested in talent management is to figure out how to make merit increases reflect superior employee performance and productivity," Kochanski says. "When everyone gets the same 'merit' increase, we've come full circle and are now approaching the 'cost of living' increases that merit was designed to replace."
Some ways to make merit pay matter include:

• Set aside a special pool of money for the highest performers. If the overall budget is 3.5 percent, earmark 5 percent for the top 15-25 percent of the population.

• Calibrate performance ratings and merit increases between managers and units. Make sure managers really differentiate employee performance.

• Calculate merit percentages after performance ratings are performed. This eliminates the incentive for managers to "puff up" performance ratings in order to provide merit increases.

• Hold leaders accountable for merit budgets. Especially for groups of employees of 30 or more.

• Link the merit budget to the performance of the units. High-performing units should have more to reward their highest performers.

• Make sure low performers get no merit increases. This isn't being a scrooge; it's providing a clear indication they need to show better performance—or search for a new job.

Kochanski concludes that merit budgets may be relatively small, but they still represent a large amount of money, even before annual compounding. A company with 5,000 employees and average pay of $50,000 per person per year and a 3.5 percent merit budget adds almost $9 million to its cost base.

So, although merit pay increases may keep an organization competitive in the labor market, if used indiscriminately they may do little to support good execution of business strategy and business success by rewarding and retaining top performers.