The shifting purpose of base pay

March 02, 2020

Year after year, market data shows merit-based salary increases have a negligible impact upon employee performance.

It turns out, though, many companies haven’t gotten the memo.

According to the 2019 Mercer Compensation Planning Survey, 90 percent of companies report offering salary increases based upon individual performance.

But due to stagnant merit increase budgets, the salary increases offered by companies do little to motivate and retain top talent.

Merit pay budgets remain unchanged

Regardless of industry, company size or region, the 2019 Mercer Benchmark Database (MBD) shows that merit increase budgets have remained flat at 3 percent over the past five years.

As a result, the average pay bump received by top performers is 66% greater than that of the average salary increase of typical employees.

This may seem like a fairly significant increase at first glance, but in reality, it doesn’t amount to much more money than for most workers.

Take for example a top performer who earns a $50,000 annual salary. This employee’s merit increase would come out to an additional $2,400 per year, while a counterpart would receive an additional $1,450.

That’s a meager $80 extra per month that the top-performer takes home — it just doesn’t cut it.

So, what are the alternatives for companies to signal value to their top employees?

Alternatives to merit increases on salary

Mercer consultants recommend that companies make use of short-term incentives or bonuses for rewarding their top contributors.

Bonus pay is an attractive option for companies because it offers a distinct advantage — it’s flexible.

Rather than incurring a fixed cost, companies can deliver bonuses as they please throughout the year, for example, when a worker meets a specific benchmark.

As a result, employees are incentivized to deliver top results — a stark contrast from across-the-board salary increases of little variation that can create a culture of apathy.

As noted in our 2019 Global Performance Management Study, the practice of tying compensation directly to specific objectives motivates employees by demonstrating how their own contributions feed in to the company’s overarching goals.

Not only do performance-based bonuses cultivate a highly motivated workforce, they also free companies from the burden of additional expenses tied to salary increases, such as retirement plan contributions.

What’s the optimal bonus target when determining the level of compensation?

The 2019 MBD reported average bonus targets of 5%, 10%, and 15% of base salary across the career streams of support, professionals, and management, respectively.

Adding transparency to the mix

The trend toward undifferentiated base salary increases supplemented with performance-based bonus pay is made more complex in the modern era of pay transparency.

Today, crowdsourced data on your competitors’ pay levels is readily available online for workers. That being said, even when offering highly competitive bonus pay, your company’s base pay level needs to be just right.

When workers know your company is paying competitively, equitably, and based on performance, it strengthens trust on both sides and allows for greater alignment of goals and values.

And with this information all readily available online from external sources for current and prospective employees, your company can establish trust by being fully transparent on the matter within your own organization.

According to Mercer Global Talent Trends 2019, top-performing employees are four times more likely to work for a company that ensures equity in pay and promotion decisions.

By offering pay transparency to employees within your organization, both parties benefit from a culture of trust.

The path forward

Rewarding employees for performance using tools other than base salary and broadening employee expectations (and in some cases rights) for pay transparency and pay equity means companies have no choice but to get base pay right.

Here are three ways you can get pay right:

1. Make use of reliable data to better understand your labor market and what competitors are paying.

As simple as it sounds, having robust sources of market data that underpin a logical, defensible pay strategy is essential for remaining competitive.

2. Be honest and fair.

When defining a pay strategy, consider what your organization actually values and pays for versus what your organization thinks it pays for. The data show that real pay for performance is not delivered through base salary, so be honest in your pay strategy.

In addition, ensure that all compensation is fair by using robust statistical analysis to review pay equity at least once a year.

3. Build a plan to correct market gaps.

In a world where base salary increases have been flat for years, no organization can afford to pretend that pay for performance will resolve any market gaps that might exist.

If your organization relies on bonuses to smooth over the gaps, have a plan that’s grounded in the realities of market data, and an expectation for pay equity at every element of pay.

Need more advice? Take a look at Mercer’s incentives tools or reach out to us at 1-866-605-1031.