Pay Key Employees More — or Lose Them and Pay Even More

Today’s higher inflation and salaries spur the need for equity pay increases — but it’s a persistent issue, and owners must choose their targets wisely

Inflation remains high despite the interest-raising efforts of the Federal Reserve, and salaries are rising substantially as well, with employers “budgeting an average of 3.8% for merit increases in 2023, compared to the 3.4% delivered in 2022.”

But merit increases don’t tell the whole story and aren’t necessarily enough to keep longtime, valuable employees during a solid job market. Forward-thinking owners and managers should consider equity (external market corrections and internal comparability adjustments) raises for star performers to avoid the much greater cost of losing them. This tactic must be deployed carefully in light of limited resources, however.

Here is a look at the issue, including the potential cost of losing key employees and tips for deploying equity raises smartly.

New hires are almost always paid more, and most employees know it

Hiring is starting to slow, but the competition for many jobs is still fierce, and employers have already paid significantly more to fill roles during the post-COVID-lockdown boom. And while salaries may be confidential, almost everyone knows about this paradigm—either because people talk or after assessing competitive pay on job boards.

An excellent or essential employee often makes far less than a recent hire. Proven, loyal performers are penalized for failing to job hop, creating a situation where some might consider it irrational for them to stay. Money isn’t everything, of course; many workers enjoy their job, like the people they work with, or value specific benefits. But other longtime employees feel the pinch of inflation and the lack of proper recognition employers give them for their skills, reliability, and diligence.

These factors can easily send someone on a job hunt and into the arms of a competitor, leaving their old company to pick up the pieces. And if an individual is truly essential, the impact can be devastating. Unfortunately, many companies, often large ones with rigid HR policies such as a maximum annual raise, ignore this issue while paying new hires significantly more, even though it routinely harms the organization. In fact, it can become a maxim among employees: “If you want to make more money at this place, you’ll have to leave and come back.”

But smart businesses — especially small to mid-sized ones — can’t put up with or afford such waste.

The cost of losing good performers and hiring replacements

A Society for Human Resource Management (SHRM) study found that the average cost of finding and training a replacement for a lost employee is equivalent to six to nine months of their salary. A Center for America Progress study argues bigger numbers: “the cost of losing an employee can be anywhere from 16 percent of their salary for hourly, unsalaried employees, to 213 percent of the salary for a highly trained position.”

In a hypothetical example of a white-collar position making $80,000 per year, the expense is $40,000 to $170,400 — and that’s just the cost of hiring someone new and getting back to the status quo. Other impacts, including lost productivity, the effect on morale, possible errors, inferior customer/client service, and lost institutional knowledge, can send deeper shockwaves through an organization, depending on its size and the value of the former employee.

Among the direct and indirect costs, some elementary math considers the existing employee’s pay, a recent hire’s pay, and a direct replacement’s pay. Using our example of a good performer making $80,000 a year, here’s what often happens in a strong hiring market: a new hire is paid $100,000. The existing worker leaves because they make 20% less than the newbie, and the employer is then forced to hire another person at $100,000. That incremental expense is more than the salary difference; retraining costs and the lower productivity of the new worker while getting them up to speed make this trade expensive and disruptive to the employer.

In retrospect, giving the former high-performer a 15–25% equity raise that shows respect and keeps them around doesn’t look so bad.

Tips for providing equity pay increases

Businesses have limited resources and must operate within healthy margins, and employee pay and benefits make up the lion’s share of expenses, of course. So, while employers might want to provide everyone equity bumps to match the market, it’s usually not feasible. Thus, it’s crucial to choose the opportunities to do it carefully, and employers must assume some risk with the rest of the workforce.

Here are some basic tips:

1. Realistically assess the company’s key performers. You may have to risk some turnover — but identify the people you really can’t afford to lose.
   
2. Devise and offer a proactive raise based on the position and current market conditions. It doesn’t necessarily have to match the going rate or be all at once; a commitment to incremental increases can work. But the number must be significant enough to get the individual’s attention and show they are valued.
   
3. Don’t just speak with dollars; use words, too! Explicitly tell the worker they are valued and respected and that you are doing your best to keep and assist them through this inflationary period. Human connections based on honesty and respect go a long way and are sometimes more important than money, as is the attractiveness of an organization’s work environment and culture. Take the opportunity to show some love, and employee loyalty may follow.
   
4. As always, explore alternative and flexible benefits with comparatively low costs that may have outsized value to the employee. They aren’t usually a substitute for some form of pay raise amid rising prices—but they can help keep someone if you can’t keep up with the market. For example, some individuals may prize flexible remote work above all else or deeply appreciate childcare benefits. Understand what motivates your key people and attempt to provide it.

Equitable pay is a persistent issue, regardless of the economy

At this time of writing, inflation is still high. But while the overall job market remains competitive, hiring is slowing down, some companies are laying off staff, and hiring is expected to fall further in 2023 if a recession takes hold. So, considering equity pay raises may seem like less of a priority.

But it’s important to understand that turnover due to disparities in pay and perceived disrespect remains a problem in most economic and hiring environments. New people often make more than individuals with years of loyal employment. And at a certain point, it always makes sense to catch up the great performers, as losing them harms the organization and has a negative ROI.

It’s wise to keep these issues and pay dynamics in mind — and always make decisions based on what’s best for the business. Fortunately, a well-considered equity pay bump is also usually what is both fair and best for the employee.

Karp HR Solutions helps businesses master the mix of finance and human resources. Contact us today for a free consultation.