Why Your Compensation Philosophy Sucks

I was talking with a friend of mine recently and while the culture she described seemed terribly illogical and counter-productive in its results, it seems to be the prevailing philosophy when it comes to compensation and internal talent.  And it destroys engagement and kills your retention efforts.

Picture this:  [cue the peaceful harp fade music into the mist)

You have a high-performing, high potential employee…who you know is underpaid or at least well below  market mid-range for the position they are in.  Rather than adjust the compensation based on the value and out of recognition for their contributions, the company continues to only keep up with “cost of living adjustments.”  Yet, when this employee has another job offer in hand…you scramble to keep them and provide a hefty raise.

Uhh, anyone else see a problem?

A few things are going on here and the impacts of this mentality far outreach the above scenario and undermine your retention efforts, engagement, and trust.  I’ll outline the impacts more in terms of time than by category.

Before they get the offer

Employees are not nearly as naive about their salary compared to others around them (both internally and externally) as employers might hope.  While frowned upon by management, it is actually illegal to prohibit your employees from sharing their salary with their coworkers.  That’s right – illegal.  It is a violation of the National Labor Relations Act, section 7.  It is considered a “protected concerted activity” for employees to discuss the terms and conditions of their employment.  Go ahead, take a look, I’ll wait. (http://tinyurl.com/24hka3)  Or if you don’t want to read that and decipher it yourself, go here (http://tinyurl.com/2a24dkc).  And pretty much all of your computer savvy employees know about Salary.com or Payscale.com.  So if they are underpaid, they know it.

Whether you look at Herzberg’s two-factor theory or read Dan Pink’s Drive, both will tell you that while money is not a motivator towards better performance, it is most certainly a cause of demotivation if you are not paying enough.  If your employees know they are underpaid, they are not nearly as motivated to continue giving extra effort.  And in fact, it may motivate them in a direction you do not want…to look elsewhere.  Which, while we are talking motivational theory, Abraham Maslow‘s motivational theory holds we are “motivated to satisfy unmet needs.”  And my friend, your employees have a need to feel appreciated and to be treated fairly that you aren’t meeting.

This is all before they even start looking.  Your high-potential/high-performer is rapidly becoming disenchanted simply because they feel unappreciated.  This is why sometimes after their yearly compensation “raise” (if they even got one), your high performers actually decline in performance and engagement.  “Why those ungrateful bastards!”  (this is what you AND your employee are saying after the meeting)  So they go and see if another employer will appreciate them more.  Lest we forget, this is your top talent and time (and the recent recession) has proven that top talent is mobile in any economy.

So three months later, they have an offer.  Damn.  Here is where some employees have been waiting for you to ante up for too long and they just split; “Here’s my notice.  Best of luck to you.”  But some still like working for you, they want to stay, they just want to be appreciated, so they tell you they have another offer and so the negotiation to stay begins.

During the Opportunity Window

Don’t let that fool you.  You’ve already missed the opportunity.  That was four months ago.  But now here you are, so what do you do.  This is where employers take two tracts:

Tract A: We don’t negotiate with terrorists – Rather than engage in the discussion you call their bluff and say “okay, congratulations…now get out” and we cart them to the door on the day they give notice.  Now let’s think about this reaction a little more in depth.  How does this benefit you?  Chances are, under reflection, it is a much more emotional victory than a business victory.   From a business perspective here are your outcomes: you just lost a top employee, you now have a vacancy, you’ll need to recruit interview, train, onboard a candidate, and guess what, you’ll probably make an offer for more than what the exiting employee was getting paid.  You’ve cost yourself talent, time, and money.  This is where your prideful inside voice gets to say “yeah, but I disgraced them by having security walk them out.”  Really?  They just left you holding a poopy bag of a backfill situation, they are making more money, and you won?  You might want to think a little harder on that one.  I will admit that sometimes there are security risks regarding intellectual property and such but typically managers act out of emotion than logic in this scenario.

Tract B: Agh!!!  No, don’t go! – In this scenario you don’t wan to lose this person so you scramble and agree to “see what you can do.”  But most employers still operate from a sub-optimal perspective and myopic vision in this scenario.  Your motivation is to spend the least amount possible to get them to stay.  Well, guess what…that number would have been a heck of a lot less four months ago before they started looking elsewhere and you could have avoided this whole fiasco, and in a year, they still know they are underpaid and unappreciated.  Regardless of the number you come up with this is where you counter offer and they either accept or counter again.  In the end, let’s say you offer them enough and they say with a sigh “okay, that will work.”  Guess who won that one?  Nobody.  By its nature compromise equates to each of the negotiating parties giving up something and settling for less than they wanted.  But at least they stayed.  Whew!  Crisis averted.  But not so fast.

The Aftermath

Here is the hidden cost to what just went down.  An erosion of trust between boss and employee as well as the employee and the company.  The boss may now see that employee as “greedy” or “money hungry”.  The employee may now see the boss as an individual who only cares when they are about to lose and no longer trusts them as an advocate in their career.  The employee may also now regard the organization as unfair and again, not truly appreciative.

You may have also set up a jaded cultural message by providing a counter offer.  Now the cultural message is if you want a raise, look for another job.  A subtle disloyalty gets created.  Worse still is an organization I used to work for that encouraged people to quit and work for a competitor before they could get a promotion.  Talk about  promoting disloyalty…literally.  You may have inadvertently set yourself up to more threats of talent leaving and just set that as a permanent dynamic within the organization…which again costs you more than just the compensation adjustment.  You lost productivity, time, money, and engagement.

The Solution

Be Fair.  Sounds simple but many people see that as “be equal” and they are not the same.  Fairness is subjective and ultimately, if your employee thinks they are being paid unfairly then they will still seek out higher compensation.  If you are paying them fairly based on what the market provides and they come back with no offers, well, they just had a reality check.  But if you know they are getting underpaid and they know they are getting underpaid – try to balance out the fairness.

A bit of quick math on the cost of being fair (or rather unfairness.)  If you have a top performer with a salary of $80k and the average mid-point for that position is $100k with a range of 80k-120k.  First, what would it cost to replace them?  Even if you target 25% range penetration ($90k)…there is $10k more. Plus time for your recruiter to sort through candidates, interview, and schedule meeting.  Based on hours and difficulty of search you would probably pay an internal recruiter $500-$4000 for this one search…to say nothing of using an external agency which usually commands at least 20% of salary (so that’s $18k).  Lost productivity and on-boarding time/costs.  Figure an average of 75% capacity for the first 6 months (that cost you 25% of half year’s salary = $11k).  So for a total of $20,500 – $39,000, you finally replaced them.  And that is just the hard costs.  To say nothing of the cost of the vacancy.  (True, if the position is vacant for 3 months there is $20k salary you saved, but chances are the vacancy is costing you productivity that nearly offset that savings.)

Now, what if you just adjusted their salary to what you would pay the new person anyway (25% of market)?  $10k.  Can you imagine how much happier that employee would be?  No longer looking for another job, feels appreciated, you keep top talent, and for a bargain of nearly $30k less than losing them would cost you.  And before you say you can;t afford to do this for all  your employees, that’s not what I am saying.  I am talking about underpaid top talent you want to keep.  Chances are the costs of losing them far outweigh the net benefit of keeping them.

Stop being so short sighted with your compensation strategy.  In the war for top talent,  hold on to yours, be fair, and save your company money, time, and a negative culture.  By miserly controlling your payroll, you may actually be costing your company a good deal more than you need to when it comes to retaining top talent.


One thought on “Why Your Compensation Philosophy Sucks

  1. Pingback: 10 Things Good Bosses Do « Peak Alignment

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