This Simple Rule-of-Thumb About Annual Raises Will Reduce Employee Turnover If you're looking to keep your best employees, maintain morale and stay competitive in today's market, the secret might be in your approach to annual raises.
By John Boitnott Edited by Kara McIntyre
Key Takeaways
- Fair raises adjusted for inflation can prevent costly employee turnover and preserve productivity.
- Transparency and performance assessments play a key role in distributing salary increases effectively.
- Adapting raise strategies to current economic conditions can maintain staff morale and protect company reputation.
Opinions expressed by Entrepreneur contributors are their own.
A founder friend of mine recently gave an employee a raise. They thought they were doing something good — that this was a significant "generation" raise that would lift the spirits of the employee, giving them an increase in pay that would truly make a difference for their standard of living in the long run. As it turns out, my friend was mistaken and the employee was upset because the raise didn't amount to much after adjusting for inflation.
Times are tough for businesses everywhere, but giving employees fair raises can actually save you money in the long run. If you follow the right strategies, you can keep your employees happier and your organization running smoothly.
How to calculate a raise based on inflation
Inflation drives up the cost of goods and services and devalues your money. Even if you get a raise, it may not go very far if inflation rates are high. For example, in 2022, inflation rose as high as 8%. If employers keep pay rates the same as they were when inflation was closer to 4%, employees actually experience a kind of wage decrease.
But raises should not be based on inflation alone. You should consider basing them on the cost-of-living adjustment (COLA). COLA is based on the Consumer Price Index (CPI), the average price for goods and services. It is used by the Social Security Administration to ensure retirees don't experience a reduction in purchasing power due to inflation, and employers would be wise to use it as well.
In 2024, the expected adjustment for cost of living is 8.7%. So if you typically give an employee a $10,000 annual salary raise, consider an increase of $10,870 for the coming year.
Other considerations on raises
Many founders factor in the employee's performance when talk of a raise arises. For example, when exploring salary upgrades, you can divide your employees into three categories as follows:
- Below expectation
- Meets expectation
- Exceeds expectation
Then assign raise percentages based on annual assessments. For example, an employee who performs below expectations may receive a 3% pay increase. An employee who meets expectations could receive a 7% raise. An employee who exceeds expectations might get a pay raise of 10% or more.
Related: How Transparent Should You Be with Employees During Times of Uncertainty?Promote transparency when assigning raises
Transparency is a valuable tool you can use when giving raises so that your team doesn't feel they're being treated unfairly. For example, send out information to let employees know how much of a pay raise they can expect based on performance. That way, they don't think you're coming up with different figures for each person arbitrarily.
Supervisors or managers should also meet with employees when raises are due to review performance. You'd be surprised how often this doesn't happen. Let team members know what they are doing well and point out areas of improvement. This reduces surprises and potential disappointment when raises are assigned. One of the best times to inform the team members about the raise they're getting is during these annual or semi-annual reviews.
Written reports add to this sense of transparency. You should have documents available to demonstrate when employees excelled or fell short in certain tasks. This may seem like micromanagement, but it builds trust and accountability in the long run. It also helps workers recognize their shortcomings so they can improve and get a better raise next year.
The impact of not giving good raises
Generally, when employers hold back on raises, they are not doing so to "punish" their employees. They simply don't feel they have the budget to give one. However, not giving raises may cost you money in the long run.
2024 research shows hiring a new employee costs about $4,700 considering internal and external expenses. A standard formula to calculate hiring costs at your company is:
- (External recruiting costs + internal costs) divided by the number of hires
External recruiting may include expenses for talent acquisition, staffing agencies and other external services. Internal recruiting is what you spend on ads, hiring events, hiring software, interview processes and other administrative recruitment activities.
Generally, the cost of recruitment exceeds any raises you may assign. However, money isn't the only factor businesses must consider.
Related: What are Pulse Surveys, and How They Can Help Your Company?
Loss of productivity
Productivity may be the first to suffer if you lose an employee due to an underwhelming raise. Here are some of the ways that happens:
- If an employee leaves before you can find a replacement, you may be unable to complete many of their tasks. A temporary replacement may not be up to the challenge.
- HR may lose productivity due to more time spent interviewing or onboarding to replace the departed employee.
- New employees also need time to get up to speed which can slow down your processes and delay deadlines. They may also not be a good fit and quit early, starting the hiring process all over again.
On the other hand, when you give a good raise, happier employees may redouble their commitment and deliver on tasks well. You benefit from smoother operations and a more pleasant work environment.
Possible reputational damage
Higher turnover also leads to reputational damage. Disgruntled employees who leave your company may post negative feedback online impacting your ability to attract new talent, even making customers more reluctant to buy your products or services. The employees left behind may also feel more inclined to leave themselves.
Related: Why Empathy Is a Crucial Entrepreneurial Skill (and How to Develop Yours)
Real-life examples of companies giving raise increases to retain workers
If you're weighing the pros and cons of increasing raise amounts at your company, look to big corporations for inspiration. Most offer 3% annual wage increases, but in 2024, many bit the bullet and offered higher wages to keep employees and beat inflation. Here are some examples:
- Exxon: The oil and gas giant looked out for employees by expanding stock programs to twice as many workers in 2024. The corporation also gave employees a 3% bonus.
- Microsoft: The technology leader doubled its budget for merit-based raises, a strategy they hoped would increase employee commitment and create a more competitive internal environment.
- T. Rowe Price: Asset management company T. Rowe Price offered its global staff a 4% salary increase to reward worker commitment and ensure they continued to attract top-notch talent.
- Walmart: Walmart awarded wage increases to over 36,000 pharmacy technicians increasing average hourly wages to over $20.
Times are tough for everyone, but companies that adjust for inflation when assigning raises can save money in the long run. You'll spend less on talent acquisition, ensure high productivity and maintain a positive reputation in your industry.
