We’re planning to give our hourly employees a cost of living pay increase next month. What should we use as the benchmark?

Pay for performance (or merit pay) is the compensation program I recommend – regardless of the employee’s status in the company. Unless you’re planning to hire according to the Woody Allen theory (“80 percent of success is showing up.”) I suggest you avoid across the board COLA (Cost of Living Allowance) pay increases.

COLAs are often found in public sector and unionized organizations. Quite honestly, I’m not sure why a profit oriented business owner would want to pay/reward people for keeping the seat warm for another year. Without having some specifically measurable expectations most businesses will end up with employees who (sometimes begrudgingly) hang around for the minimal pay increases in lieu of working elsewhere and having to demonstrate their worth.

An ideal merit pay program would include the following:

  • Overall organizational strategic goals for the year
  • Departmental/Division goals that are specifically tied to the strategic goals
  • Individual performance goals that are tied to the departmental goals
  • Periodic review of the individual’s performance to goals
  • Merit pay increases based on the employee’s achievement of the goals and his/her contribution to the organization

Of course, the employee’s goals do not have to be elaborate or lengthy. I recommend no more than 2-3 goals for non-management employees. More than this tends to confuse and dilute the employee’s focus. Goals are ideally set up in the SMART format (Specific, Measurable, Acceptable, Realistic, and Time-based) and are mutually agreed between the manager and the employee at the beginning of the fiscal year.

Everyone works toward the achievement of the company’s goals when they are focused and rewarded based on their contribution. In order to establish a company culture that retains and rewards contributors you’ll want to: 1)Meet to set up the goals at the beginning of the review period with each employee; 2) Meet periodically to review how the employee is doing in achieving the goals, and; 3) conduct a year end formal evaluation and tie merit pay to performance. If this is done well, the “Woody Allen’s” will be weeded out well before it’s merit pay time.

Salary surveys will likely include a cost of living component in the merit percentage increase. But avoid handing out COLAs across the board. There are a number of salary surveys available that will include salary budgets for your area. The standard budgets for merit increases for 2004 are running under 4% for overall payroll.