Compensation Highlights: Employee Retention in Tight Labor Market Demands Merit Increases and Promotions

As a valued client, we want you to know that employee retention is essential to workforce stability and prudent compensation management regardless of labor market conditions. But when the labor market is tight in a robust economy – when employees are more likely to look for better paying or more satisfying employment elsewhere – employee retention is more critical than ever. Let’s examine some of the factors in play and see how employee retention can be strengthened with wise use of compensation budgeting and employee recognition:

Why Employee Retention Gets More Difficult in a Tight Labor Market

As I noted in this article, when unemployment drops as job openings rise, workers enjoy options and opportunities. This leads to increased “quits” as employees are confident they can find another job, and for more money. This, naturally, adds pressure for employers to become more competitive with employee compensation and total rewards – or face the consequences of higher employee turnover and its associated costs (more on that later).

Employee Retention Calls for Higher Merit Budgets

Most organizations will try to contain increases in employee compensation budgets even when market conditions make that task more challenging. As an example, in the tight labor market of 2018 when 2019 budgets were being planned, U.S. salary budgets were projected to rise by an average of just 3.2 percent, barely inching up from the prior year. This was according to the WorldatWork 2018-2019 Salary Budget Survey: Top-Level Results.

So, while overall salary budgets might remain relatively static in a tight labor market, individual compensation budget pools may need to be increased. The merit budget pool is a prime example and represents an opportunity for employers to recognize and reward top performers even when annual raises remain flat. In fact, in a labor market environment when top talent is more likely to seek – and secure – more lucrative outside opportunities, this would be a wise investment for most organizations.

An article at SHRM.org cited Empsight’s Policies, Practices & Merit Survey Report, which noted that “Some organizations said they have created additional, supplementary base and/or spot bonus budgets specifically designated to reward and retain high performers,” And this, according to Empsight, “suggests organizations are … gearing up for a competitive employment environment” and “changing timing to administer rewards to their top performers early, which has the impact of accelerating pay for top talent.”

Not all merit pay increases are created equal, of course. As can be expected, top performers earn the lion’s share, with WorldatWork’s survey showing merit-based pay increases for 2018 averaging 4.1 percent for high performers compared with 2.8 percent for middle performers and 0.6 percent for low performers.

Beyond Merit: Rewarding Employees with Promotions

Another way many organizations attempt to stabilize employee retention is by using promotions. While promotions are often accompanied by pay raises, this is not always the case. For some employees, their status on the organization chart has value on its own (although a better job title without a pay increase can work against the employer as it might position the employee to find a higher paying opportunity elsewhere).

Offering promotions as a means of providing rewards and recognition when compensation budgets are tight has been on the upswing. According to the WorldAtWork survey, for example, “more employees are progressing in their careers … with an average of 8.6% of employees receiving promotions in 2017 compared to 7.9% in 2016.” Growth in the number of promotions is attributable in part to the rise of younger workers as Baby Boomers retire, to using promotions to address internal equity issues, and, of course, to the possibility of employees leaving for greener pastures in a tight labor market.

Another Reason to Boost Recognition and Merit Pay: The Employee Turnover Factor

While raising merit budgets and offering promotions with pay increases might appear to be too costly for many employers, most organizations would be wise to factor in the cost of employee turnover. As I noted in this article, the cost of replacing employees can cut deeply into your compensation and employee rewards budget. In fact, replacing an employee could cost from 30 percent to 400 percent of an employee’s annual salary! It doesn’t take long for most organizations to conclude that retaining top performing employees by offering merit increases or promotions makes sound compensation sense.

The Bottom Line:

In a tight labor market, employee retention is more important than ever. And a 3% merit budget is no longer adequate for retaining your high performers. Whether you plan on using higher merit increases alone or promotions with lucrative pay increases, your top performers are more likely to stay on your team if they feel valued and fairly rewarded.

If you’re not sure where your organization stands in the marketplace or how to structure your compensation budgets to optimize employee retention and reduce turnover costs, contact Total Reward Solutions today at 317.589.8529.

Cassandra Faurote

About Total Reward Solutions:

Need an additional total rewards or compensation service from us? Total Reward Solutions is your trusted partner for compensation services. Led by Cassandra Faurote, professionally certified Human Resources expert and author of the book Compensation Sense 101, Total Reward Solutions offers a broad range of compensation, benefits, performance management, and reward/recognition consulting services to help your organization attract top talent, motivate employees and retain top performers. We can partner with you on a project basis, on retainer, or as your total outsourced solutions provider for compensation services.

Call us today at 317.589.8529 to discuss how we can help your organization develop and implement competitive and effective compensation and total reward programs.