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Salary increases are one of the most fundamental part of an organization’s ability to attract and retain talent. It’s a tool used motivate employees, reward commitment and loyalty, and encourage performance that’s beyond the call of duty. Usually organizations review employee compensation on an annual basis to ascertain who gets what, but where they differ at is the criteria and basis for those increases. While there is no hard and fast rule as to the right methodology to employ, there are a pros and cons to whichever you choose.

Here’s a look at some of methods various companies use to award salary increases.

1. Basic Increase Across the Board

Probably the safest way to award salary increase is to give the same percentage raise to all employees. A positive outcome of this is that there’s no disparity and no one gets singled out as earning lesser than the other. However, the downside is that high performing employees aren’t recognized for their efforts and contributions. As an outcome, those who’re going the extra mile may feel demotivated and morally hurt, leading to dissatisfaction and ultimately their exit. Also, it adds to complacency, particularly for those who are under performing as they see no incentive to up their game.

2. Tenure-based Increases

Loyalty matters a lot when you’re aiming to retain those employees who’ve been with you from the start or from the earlier days of your business. There’s much legacy riding on such individuals, and hence, retaining them becomes all the more important. Employing a methodology that awards salary increases particularly for those who’ve been around for a while encourages others to park their careers with your organization as well, boosting retention. However, because inflation does catch up over time, new recruits end up earning more than your long-time employees (a phenomenon known as pay compression). This of course would demotivate your long serving employees, making it important for you to adjust salaries to maintain them slightly higher than the new joiners.

3. Performance-based Increases

Probably the most commonly used method is the performance-based salary increases where performance ratings decide the percentage increase that’s awarded. The biggest positive that most organizations see with this is that healthy competition is encouraged and employees feel the drive to go the extra mile. However, some experts are quite against linking performance with salary increases. Their argument is that employees start focusing on monetary gains and overlook work quality. Plus, a weak performance management system can lead to manager bias which can demotivate those who aren’t close to their bosses. To tackle this, organizations choose the basic increase across the board method.

4. Skill Enhancement Increases

Rather than taking into consideration the tenure or performance of your employees, linking salary increases to skill enhancements is one way to ensure complacency is not part of your culture. The idea is to emphasize on your organization’s ideology to constantly be innovative and raising the bar. Employees who “invest in themselves” and enhance their skills just won’t be eligible for promotions and increased scope of work, but also higher salary increases. Of course, there needs to be systems in place to ensure the skills being enhanced are related to the job or relevant to the organization as well. Managers play an important role here to define competencies that they’ll be able to exploit and are in-line with the organization’s philosophy.

5. Market-based Increases

Organizations that operate in a competitive industry where specialized resources and skills are scarce often tend to participate in salary surveys to gain knowledge market compensation. This allows them to ensure they’re paying their key resources appropriately. Whether they choose to be at par with the market or above it, market-based increases help to retain your talent and increase your employer brand. If you’re just getting into a market-based increase strategy you’ll feel a larger pinch to your budget than you may be able to absorb. However, over the years you may be able to reduce the impact as you’ll be cruising at the level your organization chooses to be in terms of competitive salaries against the market.

Whichever methodology you choose (or a combination of them) to decide salary increases for your employees, make sure you have your sights on the objective. That means, you should be clear on what behavior you’re trying to encourage by the choice you make.

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