General, Time-Based Pay Increases…A Waste Of Scarce Resources

The economic crisis that began in 2007 had a profound impact on the rate at which average pay levels increased in the U.S. labor market. For several years market averages moved little, if at all, and many organizations froze and even reduced base pay levels to offset the drop in revenues. The organizations that best managed the economic realities were those who used a strategy that selectively adjusted employee pay rates based on relative contribution and that considered how well individuals were already paid. Those using merit guide-charts that based pay adjustments on both performance ratings and position of the pay rate in the range allocated the limited budgets optimally. Those that gave automatic, time-based pay increases not only did a poor job of allocating budgets but also exacerbated out of line pay rates.

When allocating a pay increase budget the philosophy should be to give the largest increases to those performing at a high level and whose current pay is low relative to the market and their contributions… these are the people competitors would love to have. The smallest (including zero) increases should go to those paid above market and/or above the level warranted by their contributions… these are the people who could not replicate their current pay elsewhere. No system appeals to everyone. Lawler once said “whatever you do 15% of the employees will hate it… just make sure it is the right 15%.” So the system used should motivate and satisfy the employees the organization wants to keep and that it needs the most.

Some public sector entities still use automatic, time-based step increase programs. These systems are most common in collective bargaining units. If there is little or no opportunity to vary performance in a role this approach is less disastrous. But “pass-fail” jobs have become rare. So why do these systems continue? I worked with a large municipal water utility that used steps… until a Board member challenged the system during the economic crisis. He had been accosted by a neighbor, who wanted to know why the payroll of the utility was increasing each year when there supposedly was a hiring freeze and the labor market rates were not increasing. His only answer was that the utility had promised increases would occur every year. The neighbor pointed out that was contrary to everything known about motivation and perhaps it was a time for the utility employees to be treated more like the rate payers were being treated in their organizations. The Board member made it clear to the utility’s management that the “pay for aging” system had come to an end.

During the crisis the President told the public that U.S. Federal employee pay had been frozen for two years. That sounded good but it was not true. The pay structure had been frozen but employees still were getting their 5% step increases… irrespective of their performance or how well they were already paid. While consulting with several federal contractors during that time I was aghast that their pay had really been frozen for two years by the Dept. of Energy. This across the board approach disregarded the competitiveness of contractor pay levels and increased the difficulty of convincing newer employees paid low in their range that they would be rewarded for their performance. Since most were highly educated in STEM fields this damaged recruiting and retention efforts during a talent shortage. But the government personnel responsible for contract oversight were still receiving automatic increases.

For employees learning the skills and acquiring the knowledge required by their jobs an automatic progression can be appropriate. It is difficult to differentiate pay actions based on performance when the employees are not competent to perform. Someone starting as an apprentice in a skilled trade is mixing training with on the job application and being assigned work consistent with his or her qualifications. Their pay grows along with their mastery. This makes sense but this is a very small portion of the employed.

The public sector has been moving from step rate systems to merit pay systems. When I designed a survey of water utility compensation some fifteen years ago over 2/3 of the utilities reporting used steps. Today less than 1/3 do for non-union employees. At least half of the federal employees are in agencies that have abandoned the GS system and its automatic steps. They did so because they were unable to attract and retain high performers and because there was no control over the expenditure on pay adjustments. So the trend is clear.

I have been told by executive management in some organizations that their employees prefer the step system. But if the context within which the organization must operate makes automatic escalation of payroll costs untenable it seems management should explain to the workforce that this cannot continue if the organization is to survive and/or convince investors or the public that their money is being spent appropriately. Time for general increases and automatic time-based progression to become a lot rarer.

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