Human Capital & Careers

Salary Increases Give Way to Variable Pay Hikes

Companies are allocating more of their payroll budgets to compensation vehicles that don't add fixed, ongoing costs.
David McCannAugust 26, 2015
Salary Increases Give Way to Variable Pay Hikes

Most people are all too aware that annual salary increases have flattened out since the most recent recession. In fact, following each of the past several recessions, salary hikes normalized at a lower level than they had previously.

So it may come as a surprise, to some, that companies’ spending on employee compensation hit record levels in 2015, according to Aon Hewitt. That is, for this year companies allocated a greater percentage of their employee-compensation budget to increases than they have since the consulting firm began tracking compensation data 39 years ago.

What gives?

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It’s simply a result of the cost-management mania that has gripped the corporate world for the past six years. A salary increase is a fixed expense that carries forward in perpetuity. On the other hand, compensation vehicles like merit bonuses and incentive-based pay are variable expenses that revert to zero the following year and are also attractive because they generally go only to high performers.

In Aon Hewitt’s new compensation survey of 1,214 organizations, most with annual revenue between $500 million and $10 billion, among those that did bump up compensation spending salary (i.e., they didn’t freeze salaries), increases accounted for 2.9% of this year’s budgeted payroll costs for salaried, exempt employees. That’s down from a consistent 3.6% to 3.7% in the several years before the recession. At the same time, the amount allocated for variable pay hit a record 12.9% of budgeted payroll for such employees, compared with 10.8% in 2008. Altogether, then, 15.8% of overall payroll costs, also a record, was allocated to increases.

Of course, everyone does not share equally in the bounty. A majority of variable compensation is paid in large chunks to executives and other high earners. Variable pay is on the rise for other non-exempt workers too, but the amounts are far less; the share of 2015 payroll costs was 6.7% for salaried nonexempt employees and 6.4% for nonunion hourly workers.

Meanwhile, the flatter salary increases are not just the new normal, but possibly a permanent normal.

“Prior to the most recent recession, the salary increase number had never been below 3%,” says Ken Abosch, leader of the broad-based compensation practice at Aon Hewitt. “The question that keeps coming up is, ‘When will we return to 4%?’ Because there had been a 10-year run of closer to 4% [before the recession]. But all the indicators we track suggest we won’t be normalizing to 4%, because of the pressures companies are under to minimize their fixed costs.

He adds that while the salary spectrum isn’t responding to changes in the economy like increasing GDP and productivity and decreasing unemployment, the typical company has “made a conscious decision to reward performance through variable pay.” Finance executives at other companies “need to be cognizant of that fact for competitive purposes.”

Despite putting the brakes on salary for the existing work force, companies continue to pay more when hiring from the outside. “We call it a recruiting premium,” Abosch says. “Most people will not switch jobs unless there’s at least a 10% increase in compensation. It’s a risk premium for leaving an organization that you know something about and going to a new one that you don’t.”

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