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Compensation & Benefits

Published September 2008

Doing Compensation Right: The Winning Spread

 

  Erik Berggren and Christopher Lozaga

Companies talk a lot about compensation planning and pay-for-performance, but even organizations that consider themselves progressive on compensation fall back on the old peanut-butter approach to pay: allowing managers to spread the budget for merit increases somewhat evenly to their people.

It is conventional wisdom that peanut-butter pay just doesn't work; yet, it still is a ubiquitous practice. If a company was to find out its manufacturing process wasn't producing the results required, chances are it would tackle the problem immediately. Organizations should tackle flaws in their people processes with the same urgency.

Is the Peanut-Butter Approach Really That Bad?

When using the peanut-butter approach, typically the majority of people will get a 2-5 percent pay increase. According to Manpower Professional, a staffing firm and collector of labor statistics, the average tenure for an employee is down to 3.6 years. The difference between 2 and 5 percent is almost meaningless given the short tenure of today's worker. Therefore, how can companies expect this approach to motivate and retain their best people? When top performers get a 5 percent raise when they could demand a 10 percent higher salary at a new company, they leave for the better opportunity.

Spreading pay around also means lower performers and average performers still might get a pay increase. This has two consequences. First, high performers feel they are getting a raw deal. They think, "Why put in extra effort when the weakest link on the team gets almost the same increases that I do?" In this scenario, reward is not commensurate with performance.

Second, peanut-butter pay keeps company payrolls fat with low performers, who tend to stick around when they cannot pull their weight but still get a raise. Instead, managers should increase the spread difference between raises for low and high performers.

Clearly the peanut-butter approach is bad, but is there any proof that increasing the spread is better? To help determine the answer, SuccessFactors Research recently conducted a study of 157 enterprise and mid-market companies to see if there was a relationship between peanut butter and performance and to see how compensation management makes a difference in their organizations.

The study found compensation management does matter. In the test sample, the 41 companies using compensation management experienced better revenue growth (33.8 percent more) and net income growth (8.5 percent more) than those that don't. Compensation management had the clear value proposition, but research also delved into those companies to find out what makes them the best of the best.

The hypothesis was simple. Companies with the biggest difference would do better. To test this, the spread in merit increases for each organization was compared to each one's financial performance.

Specifically, research examined the percent increase relative to employees' base salaries across the 41 companies and then calculated the standard deviation in the percent increase in pay to show the spread for each company — and the higher the standard deviation, the bigger the difference evident in the average annual raise.