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A Small Business Guide to Giving a Raise

An employee asks for a raise—now what?

In 2020, economic uncertainty prompted many companies to freeze salaries. As businesses bounces back, don’t be surprised if employees come knocking. It might be a headache for managers, but it doesn’t have to be. If your decision is guided by a broader compensation strategy, you can proceed with confidence.

What to Do When an Employee Asks for a Raise

When an employee plucks up the courage to ask for a raise, a manager’s immediately reaction is all important. It’s natural to feel a little irritated or even offended—that’s okay, what matters is that you don’t show it. The employee needs to know that you’re on their side.

Instead of making promises or explaining why it isn’t possible, ask the employee for more details. Show that you want to understand their position, but don’t allow your conversation to become about comparisons with other employees. When an employee has stated their case, tell them that you’ll discuss the matter with HR and get back to them soon.

How to Justify a Raise for an Employee

There are a lot of factors that go into deciding whether an employee deserves a raise. Here’s a big mistake many companies make: basing decisions on why, according to the employee, they need a raise—mounting bills or a wedding approaching, for instance. If you start basing decisions on need not merit, you set a dangerous precedent: another employee can always come along with a better excuse.

Instead, you’ll want to focus on an employee’s performance, how crucial they are to the organization and, most importantly, how fair you judge their current salary. Does their pay level fit with company and industry averages for someone with their skills, experience and length of tenure?

You should also consider where an employee works; how does their salary fit with local Cost of Living indices? Watch out, though: if you operate a remote-first workforce, employees who earn less in ‘cheaper’ locations may feel hard done by.

The Cost of Turnover

Ultimately, an employee’s worth comes down to how hard they are to replace. Are there candidates of similar experience and skill are available for a similar salary? Don’t forget intangibles: long-serving employees could play a big role maintaining company culture or might simply an important cog within their specific team. That’s not easy to replace.

Finding and training new recruits isn’t cheap—it costs an average of $4,129 to replace just one employee, according to SHRM. And then there’s the risk that they won’t be a good fit. Ultimately, if it’s between an employee leaving or offering a small raise, it’s almost always financially smarter to give them the money.

Even if an employee doesn’t threaten to leave, rejecting their request for a raise risks leaving them disengaged, especially if you don’t go about it the right way.

Judging Performance

Giving a raise is often the right call but for a small business, it doesn’t take many raises for labor costs to sky-rocket. Employees need to earn raises, which means you need to judge by performance. Don’t be fooled by short-term success: employees are smart enough to ask right after they’ve played a key role in a big project. Judge performance over the long-term, ideally as part of a regular schedule of performance reviews.

How Much Should a Raise Be?

Deciding to offer a rise is often the easy part—the challenge is deciding how much to offer. It needs to be enough that an employee feels rewarded, without jeopardizing your compensation structure and labor budget. Annual raises tend to average out at around 3%, with slightly more for top performers.

The simplest way to decide how much a raise should be is to implement an organizational compensation policy, where achievement (like promotion) guarantees a certain salary increase. There may be flexibility within certain bands, but an overall structure can help ensure fairer results.

How Often Should You Give a Raise?

The cadence of salary increases is another question that keeps business leaders up at night. Make raises too infrequently and you’ll have a disengaged workforce where top talent is easily picked off by competitors. Frequent increases boost engagement but add a bigger financial burden.

To inform your decisions, use the Social Security administration’s Cost of Living Adjustment. In 2021, this will be 1.3%. If employees’ salaries increase by less than this percentage, this will in effect feel like a salary reduction, although local inflation rates can offer more accurate guide.

Investing in People

Companies may feel that they already invest highly in learning and development. Here’s the kicker—the more you invest in an employee’s training, giving them new skills and experience, the more their earning potential rises. They’ll be more likely to request a raise, and they may well deserve it. The good news is, they might cost you more but you’ll have more productive employees who can boost business profits.

If a company is doing well, leaders may consider an across-the-board salary increase. If everyone has contributed to a recent project, it can be a great reward. It can seem like the fairest way, but be warned, it might hurt company culture. Inevitably, you’ll have employees who contribute more, and they might become disgruntled to receive the same increase as those who aren’t pulling their weight.

What to Say When Declining a Request

If you’ve done your research and are making a decision based on an official compensation strategy (rather than just gut instinct), an employee will be more likely to accept your decision without complaint. Let them know you have bad news, explain the reasoning behind the rejection and lay out concrete actions they can take to earn a raise in future. However, don’t turn it into a performance review—and don’t make guarantees you can’t keep about future raises.

Creating a Compensation Strategy

A great compensation strategy goes hand in hand with performance management—hard work and top talent will be rewarded. Regular raises mean your best employees are paid at the right level before they ask and when requests are made, managers will be armed with data to make informed decisions.

The good news is, Paycor can help. Our compensation planning software gives you the tools you need to reduce turnover and boost recruitment by reducing complexity and automating compensation events in one system.


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