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Annual Pay Increases – What Is “Fair”?

I recently received an e-mail from a client.  They’re in the service industry with about 250 employees and multiple departments, located in the Pacific Northwest.  The COO was frustrated because the board of directors, at the urging of some department heads, wanted to give all employees the exact same percentage raise.

Here’s her question:

Can you reach out and try to explain the downside of across the board raises just because someone lasted another year.  One or two departments are trying this approach and it may undermine the salary and wage plan we are trying to implement with top performers getting more, average performers getting less and non-performers getting zero.

Someone has to be a #1 and someone has be the bottom of each department.

And here’s my response:

One of the first things a business must do is set a compensation standard for the entire organization.  It is counterintuitive to have one department doing one thing and other departments doing another.  It lacks cohesion but more importantly it lessens the overall culture and direction you’re trying to establish for your organization..

So my first recommendation is that it’s one overall compensation and workforce strategy and plan for the entire business.  Successful businesses are run this way; unsuccessful businesses are not.

The second recommendation takes more time.  And it is essentially – should we do across-the-board raises – the same percentage – for everyone or should it be a merit-based program?

The rationale for across-the-board raises is that everyone is treated the same; we’re all one team and, candidly, it’s a lot easier for lazy managers to implement.  There isn’t any complaining, no thought needs to go into it, and we can get it over with.

This was the thought of businesses until the late 1980’s, and it worked until then.  Treating everyone the same created harmony and dis-incentivized weaker performers from complaining to their lawyer, or anyone else around them.  Also there was thought that it increased the “we are all one big team” mentality.

This theory is now widely discredited by forward moving organizations and by leadership thought leaders globally.

We are in an era of “one size fits one”, not “one size fits all”.  Across-the-board raises discourages your top performers and encourages mediocrity among the team.  Businesses are trying to do more with less, and implementing pay-for-performance, or merit pay, is the principal way of accomplishing this.  Progressive organizations identify their top performers then find out what they want and give it to them.  And they weed out poor performers.

A great deal is made of the employment practices in Silicon Valley – Google, Netflix, Yahoo! and all of the others.  We read about flexible workplaces, catered sushi lunches, and free dry cleaning on premises.  But what you don’t see is the expectations associated with all of those perks.  The Netflix Culture Code – a document I recommend to every business owner, CEO and future leader – is a perfect example of this.

Do you know what Netflix’ thinks of mediocre performers?  It’s on page 22 of their code: Adequate Performance gets a Generous Severance Package.  They don’t even pay average performers less than top performers – they get rid of them.  In this way, they maintain their standards of excellence.

I know lots of CEOs who regret keeping marginal performers on too long; I know none of them who regret letting them go too quickly.

So in ‘the real world’ today, poor performers aren’t just paid the same as everyone else – they’re eliminated from the organization!

Merit pay incents top performers; it motivates marginal performers to either improve or find employment elsewhere.  And most importantly it sets a standard that you expect excellent performance at all times.

I would like to find out from the department heads what their compelling reason is to do across-the-board raises.  I’m willing to bet it’s a self-serving reason, from “we’re just one big team” to “I don’t want to create discontent.” That’s yesterday’s thinking and a guarantee that mediocrity will continue.

We talk all the time about eliminating an entitlement mentality and creating a culture of accountability.  How on earth can that take place under a one-size-fits-all mentality?

And the “one team” argument is ludicrous.  Look at professional sports teams.  Do they all get paid the same?  No.  Do they all get the same percentage of raises each year?  No.  Everyone knows who gets paid what, and everyone knows that the best players get the most pay.  That’s the way it works.  And somehow those “teams” still have that “team mentality”.

Focus on moving forward.  Leadership takes courage.  But the drive to be great needs to be self-evident.  Right now, the evidence is that your managers don’t really want to lead.


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