As compensation professionals, the sad truth is that we have relatively few tools in our kit when it comes to delivering cash compensation to employees. Basically, we have salaries, incentives, bonuses, commissions, and spot bonuses. Everything else (such as Gainsharing and profit sharing) are variations on one of these themes. Used properly, these are sufficient. Unfortunately, many companies fail to distinguish properly between them and as a result everything blends together into a confusing mess.
In many companies, when an employee does something exceptional, s/he receives a hefty base salary increase, a large bonus or incentive, and possibly even a spot bonus; all for the SAME performance. Not only is this confusing to the employee, it is also costly, wasteful and inflationary. And it stems either from confusion over what each pay element is intended for, or sloppy salary administration (or both). Because this is fundamental to my notion of The Perfect Pay Plan, I am going to clear it up now. Future blog entries will build on the concepts introduced here.
The purpose of a base salary is to purchase a specific set of skills in the marketplace. Every person brings with them a certain body of knowledge, skills, abilities and experience which they have acquired during their career. This body of knowledge has a certain value to you as an employer and it also has a certain value to your competitors. (NOTE: These values are not always the same, which is a topic for a future discussion). We all know that it costs more to purchase the knowledge of an engineer than it does to purchase that of a drafter. If you want to attract and retain the engineer you must recognize the value of their knowledge and pay accordingly.
If you accept the premise that base salaries exist to purchase (and retain) a particular body of knowledge, then there are only three reasons why a person's base salary should increase:
1) Because their body of knowledge has increased, making it worth more to you and/or your competitors.
2) Because the market value for their body of knowledge has increased making it worth more to your competitors, even though the knowledge itself has not changed.
3) Because their body of knowledge is worth more to you, even though the knowledge itself has not changed.
The key to understanding base salaries lies in the way they work. Base salaries only go up; they rarely remain the same, and almost never go down. Therefore, once a base salary increase is granted, that increase will be paid over and over again for as long as the employee remains with the company. What's more, if an increase is granted for a specific achievement, you will continue to pay for that achievement forever; even though it may never occur again.
Because base salaries only go up. you should only increase a person's base salary when they have done something that increases their value to you for as long as they remain with the company. In most cases, this means they have acquired additional knowledge, skills, abilities, competencies or experiences that they can continue to use year after year to accomplish results. By increasing their body of knowledge, not only are they worth more to you, but also to your competitors. If you fail to recognize this you may loose them. Take the example of the computer programmer who learns how to be a network administrator. This new knowledge has value, and if you can't (or don't) use it, s/he is likely to go somewhere that will
When you pay a base salary, you are purchasing the knowledge, skills, abilities, competencies and experience that a person will use to achieve results. But you are not paying for the results themselves. A person can have all the knowledge in the world and accomplish nothing. Similarly, a person can have relatively little knowledge and accomplish great things. The base salary exists to recognize the value of the knowledge. We have another tool available to recognize the achievement itself -- that is where incentives come in.
THE BOTTOM LINE
So, in The Perfect Pay Plan, I would do away with merit increases and so-called pay-for-performance systems that reward people for having a good year. Instead, I would focus my base salary increases on people who enhance their knowledge, skills, abilities, competencies and experiences making them more valuable to me, forever. I would encourage this by having specific developmental plans for each employee that clarify exactly what knowledge they lack, what knowledge I desire, how they should go about acquiring that knowledge, what support I will provide in that endeavor, and how much it will be worth to them (and to me) when they acquire it. This is really what people are talking about when they refer to a "learning organization." Unfortunately, they rarely understand how this connects with The Perfect Pay Plan and how The Perfect Pay Plan can help to bring it about.