CIPD - Salary review process

Pay and reward

February 2009

This factsheet gives introductory guidance. It:

defines the aim and stages of the salary review process
examines how employers plan and set budgets for salary reviews
summarises different approaches to determining individual pay rises within an overall salary review budget
gives a checklist to assist employers in choosing and using salary surveys
looks at methods for communicating the outcome of the pay review process to employees
identifies issues for consideration during the evaluation of the salary review process
includes the CIPD viewpoint.

Purpose of the salary review process

The aim of the salary review process is to set an overall pay bill budget and to determine individual pay rises within that budget, typically on an annual basis.

The process involves a number of key stages, some of which may overlap:

planning/setting a pay bill budget
determining individual pay rises within the overall budget – which may be based on internal factors (such as employee performance) and/or external factors (for example, a comparison with pay levels in similar organisations)
communicating outcomes to employees
reviewing and evaluating the outcome of the process.

Planning and setting a budget

For employers setting out on the salary review process, effective planning – including obtaining relevant data and starting to build the business case for the pay outcome – is an essential first step.

In practice, given that the finance function is likely to make some pay bill growth assumptions for say one to three years ahead, the business case usually needs to be set against an existing assumption about the budget available. Hence it is critical early on for HR to attain some influence over this budget assumption, or at least to understand the degree to which the business would be able to vary budgets if market conditions subsequently suggest this is necessary. Establishing a close working relationship early in the planning process with the finance function should help ensure that not only are key financial metrics correctly stated but that eventual proposals fall within the budgets set in the corporate business plan.

Pay practitioners need to gather information on a number of relevant issues to help influence the overall level of the pay award budget. According to our latest annual reward management survey, the key factors used to determine the size of the overall pay review among employers were as follows:

Organisational performance	53%
Inflation	44%
Movement in market pay rates	32%
The going rate of pay awards elsewhere	27%
Recruitment and retention issues	27%
Level of government funding/pay guidelines	15%

See the results of our reward management survey

When assessing the performance of their own organisations, HR practitioners may need to gather data from a range of internal sources. Key measures might include, most obviously, profit levels but possibly also more qualitative measures such as customer satisfaction levels. Issues of corporate governance should be kept in mind, for example, the need to take into account how results are achieved as well as absolute performance versus target.

For external influences on pay, practitioners can get up-to-date information from a range of official (government) and non-official sources. A wealth of official data is freely available via the UK Statistics Authority website (see Useful contacts below) which gives trends in the various measures of inflation, as well as other relevant indicators (earnings, unemployment, GDP and so on).

Employers need to consider which measure of inflation is most appropriate as an influence on the salary review process in their organisations. According to the 2008 survey of pay prospects from IRS¹, employers in the UK use the various measures in the following proportions (with some drawing on more than one measure):

the retail prices index measure of inflation – this is the most popular measure, with more than eight in 10 employers (81.7%) saying they would refer to this measure during forthcoming pay reviews
the underlying inflation (RPIX) measure (cited by 34.6% of employers)
the consumer prices index (used by 14.7%).

Turning to market pay rates, a wide array of salary surveys is available from private companies (see below). Additionally, data on pay review trends and forecasts are available from several commercial providers. Guidance on the type of basic pay settlement data provided can be found in our factsheet on that topic.

Go to our factsheet on Basic pay settlements: data sources

When gathering all this data, HR practitioners need to consider whether they wish to focus on recent developments and/or intend to try to incorporate forecasts of future trends. For example, they may decide to use actual ‘point in time’ inflation prior to pay reviews for a particular month or look at average inflation over a recent period – or they may choose to take into account predicted trends in inflation levels during the months or year ahead. Similarly, it is possible to make use of predictions of market movements in salaries in addition to a more retrospective exercise. The use of forecasts should though be undertaken with some caution given that their accuracy can be variable.

However diligent the process of data gathering, difficulties may still arise in practice, for example if salaries end up some way behind market rates, hence some companies allow for say a 0.5 to 1% budget pot to cover the smoothing of any anomalies (although this may be less of an issue during times of recession).

Once adequate data has been collated, an important step is likely to be the presentation of recommendations in respect of the budget and its distribution, perhaps to the board or some other level of internal management. Where an individual company recognises a union or unions, practitioners may also need to enter into negotiations or consultations with the relevant union representatives at this stage.

It is also worth considering at an early stage what else might be up for review or might rise as a consequence of salaries rising, for example, most basic pay rises will result in higher employers’ national insurance contributions and will often also incur additional pensions costs. This is particularly relevant where union negotiations are involved as it is rare in this scenario to discuss base rates in isolation – usually there would be a whole menu (including items such as overtime, shift rates and benefits) which in turn complicates the cost modelling.

It may be helpful to try and agree the likely level of ‘on-costs’ with the finance team to enable HR to present proposed cost increases both with and without those ‘extras’. It is also useful to identify the costs in the relevant fiscal years if the annual rise spans more than one financial year.

Thanks to increasingly sophisticated technology, a range of tools such as specialist software and spreadsheets are available to help employers plan and undertake the pay review process. For example, specialist modelling technology is available to illustrate the outcomes that would arise from a range of potential decisions on pay rises and distribution strategies. This may be particularly helpful in ensuring that individual rises ultimately remain within the overall pay bill budget.

Timing of reviews

Also at the planning stage, employers may want to consider the timing of the salary review process (and whether any adjustment is necessary). Many pay reviews take place in either January or April, typically in order to follow the financial, tax or calendar year.

A position needs to be adopted on whether to use the same review date for all staff or to operate a rolling review process based for example on each employee’s anniversary of joining. During difficult economic times in particular, there may also be an argument for flexible timings of individual pay increases according to performance. Under such arrangements, the standard review date stays the same but the effective pay increase date for top performers can be brought forward (but using a lower rate of increase) whilst poor performers would have a delayed increase. This can over time significantly improve the pay benefit for top performers (for example, by giving the equivalent of four increases in a three-year period). However, the use of differing salary review dates inevitably brings with it an additional level of complexity.

During difficult economic times, of course, some employers will defer the effective pay review date for the entire workforce or even freeze pay levels altogether.

Determining individual pay rises

Within the overall pay bill budget, there generally needs to be some means for determining individual employees’ pay rises. While no such mechanism is needed in organisations that award an across-the-board increase giving each employee an identical percentage pay rise, such systems are declining in coverage. Almost half of organisations no longer award employees an across the board annual pay rise or cost of living adjustment, according to our annual reward management survey (see link above).

Rather, there is a growing focus on the desire to ensure that the behaviours, attitudes, performances and values the organisation needs are recognised and rewarded by the pay review process. There is also a need to pitch individual salaries at the appropriate level to support the recruitment and retention needs of the organisation – and even during an economic downturn certain occupations will still be in high demand.

Set against this background, pay rises for individual employees may vary according to both internal and/or external factors:

internal factors – these may include some measure of individual or group employee performance or contribution and/or length of service
external factors – most notably, these include salary levels for comparable employees in competitor organisations (often assessed by the use of salary surveys – see below).

Internal influences on pay: performance

In organisations where assessments of employee performance or contribution are linked to the level of salary increases, it is usual to hold review meetings with individual employees, often involving the use of written assessment forms. Employers need to consider a number of issues, such as whether to keep the salary review process separate from the performance development review or to integrate the two processes.

Additionally, some employers choose to set specific distribution patterns for performance ratings when linking performance to pay in order to help ensure consistency and/or stay within budget. For example, each divisional head is restricted to ranking 10% of employees as ‘outstanding’. Under such arrangements, there may also need to be a ‘calibration’ stage to ensure the correct proportion of employees end up in each category. It is also possible to set an increase budget per manager or division.

A degree of common sense and flexibility should be exercised in using distribution curves, particularly for smaller departments, as this process often causes considerable tension and friction.

Alternatively or in addition, some employers create a ‘merit matrix’ which gives a guideline increase to the line manager, depending on an individual’s performance/position in pay range (possibly in combination with an assessment of external rates – see below).

The usual challenge is whether to allow line managers wide discretion in allocating the budget at the expense of consistency of approach or to permit only limited discretion which may be seen as a straitjacket. A robust system is needed for tracking spend versus budget in this respect and for dealing with disputes among managers competing for funds. This should be backed with adequate governance to ensure the right people review and approve at the right time together with a clear audit trail.

More information on assessing the performance of individuals or teams can be found in our factsheets on those topics.

Internal influences on pay: length of service

In the UK, length of service is generally declining in influence as a factor affecting individual pay rises. However, it retains a stronghold in parts of the public (and voluntary) sectors – albeit within certain limits to avoid concerns over potential age or sex discrimination.

Indeed, there are some quite distinct issues facing reward professionals involved with the salary review process in the public sector and, under that broad umbrella, within differing organisations in the sector. In the civil service, for example, the unions are reportedly frustrated by the way pay is governed compared with other parts of the public sector, with no separate funding for the cost of progression – meaning that there is “less money available to fund any basic increase, which often results in staff at the top of their pay band receiving no consolidated increase.”²

More detailed analysis of the ways in which both internal and external factors affect the pay review process can be found in our factsheets on pay structures, pay progression and market pricing.

Using salary surveys

Employers wishing to take account of external labour market pressures and trends when reviewing salaries often find it helpful to make use of the wide range of salary surveys that are available from commercial producers, consultants and other organisations. However, HR or reward specialists need to allow adequate time and resources – which can be substantial – for involvement in such surveys (especially as participants). The workload encompasses everything from completion of questionnaires to the analysis of survey results – although the latter in particular may be helped by the use of specialist software or the services of consultants. It is moreover important to remember that surveys are not infallible and unerringly accurate sources of information – equally important is having a firm reward strategy and policies to guide pay decision-making.

In making comparisons with the external labour market, there is also a need to distinguish between percentage increases and absolute rates of pay as, if salaries in an organisation are ahead of or behind the market, the ‘percentage game’ will exacerbate rather than address this.

Several issues need to be considered when choosing and using salary surveys. The following checklist sets out the sort of questions that employers need to bear in mind:

Who are the publishers of the survey? How, when and why do they produce their figures?
For example, there is a need to consider whether the sample size is large enough to be reliable and whether the participating organisations are stable over time, whether the figures are up-to-date and whether the analysis is objective.
Which employers are your competitors in the labour market? Are they represented in the surveys under consideration? How can you make sure that you are matching like with like in terms of company – for example, should you benchmark solely against your own sector?
While survey responses are usually anonymised, many include a list of participants. It is also worth noting on this point that there are frequently differences between firms that are competitors for business and those that are competitors for staff.
Is the regional, national or occupational labour market most important to the salary setting process in your organisation?
For high-level IT staff or accounting staff, for example, the occupational labour market may be more important whereas for unskilled jobs in cleaning or catering, a very local area survey may be more relevant.
Should the job-matching process make use of sampling or rank all jobs in the organisation? How do you ensure that you are comparing like with like in terms of job size?
The use of sampling may reduce accuracy while the process of all-job ranking inevitably involves a heavier workload. There will moreover be instances of roles that are unique to a particular organisation, rendering them incapable of direct matching. In such cases market pricing would often take place based on the perceived internal worth of the role using the nearest equivalent job that can be surveyed as a reference point.
What elements of earnings are covered by the figures?
Salary surveys may, for example, set out details of basic salary only or encompass other aspects of direct compensation such as regional allowances, cash bonuses and long-term incentive plans – as well as possibly encompassing the wider benefits package. While these types of data may be useful for purposes other than the salary review, it is important to be sure that like is being compared with like.
How many surveys are needed?
It may be that one survey is sufficient to cover the whole organisation or several may be needed for differing occupational groups or for specific analysis of particular aspects of the reward package.
What is the cost of the survey(s)?
Many are expensive, though discounts may be available for participating organisations. Some survey results are available only to participants. CIPD Library has a range of salary surveys for use by members – see ‘Further reading’ below.

Further guidance on using salary surveys is available from a range of sources including a People Management article ‘How to get the most out of salary surveys’.

Go to the People Management article

As well as choosing an appropriate survey, practitioners need to consider more specifically how to feed the data into the pay setting process in their own organisation. They may need to define a reference point specifying which external market rate(s) are to be used to help determine internal pay levels. This might well be the median, when compared with competitor organisations, although it is sometimes argued by HR that there is a need to maintain internal pay rates at, say, the upper quartile level with the aim of recruiting and retaining higher quality staff. However, while boosting pay rates in this way may well yield an immediate return on recruitment, it may have more mixed results in respect of retention, for example, by potentially locking in staff who are disengaged.

Employers may have to devise some mechanism to allow them to take into account a combination of factors when determining individual salary increases, for example, individual employee performance as well as external market rates for comparable employees. HR practitioners may therefore need to draw up a matrix, combining factors such as ratings of employee performance together with reference points extracted from external salary survey data, in order to determine individual salary rises. The distribution often also takes into account employees’ current salary position relative to market or target rates of pay, with those below market rate receiving proportionately more (assuming their performance reaches the required level).

Further information on the mechanisms used for determining performance-related pay rises can be found in our factsheet on that topic.

Go to our Performance-related pay factsheet

Links with bonuses or total reward

While the focus of this factsheet is the process for determining consolidated salary increases, it is important to keep in mind the link between this process and the total reward picture, particularly the awarding of non-consolidated cash bonus payments.

Some employers, for example, recognise contribution partially or wholly via the payment of cash bonuses in place of consolidated salary increases, and it may be that the only way for salaries to increase is if the market rate has increased.

A variation on the theme is to use a mix of consolidated salary rises and cash bonus payments to position pay differently for employees who are deemed to be performing at different levels. Hence consolidated pay rates for employees “meeting expectations” might be positioned to take their salary to the median level for their occupational group while, for “exceptional” performers, cash bonuses could additionally be paid to take their total annual earnings level up to the upper quartile level.

CIPD members can find more information on this issue in our tool on bonus and incentive payments.

Go to Bonus and incentive plans: a development guide

Throughout the salary review process, there is an enduring need to remain aware of the total reward picture so that practitioners look at positioning the level of cash (fixed salaries plus variable bonuses) within the context of the wider rewards and benefits package – especially against the background where changes to salary levels can have a direct impact on associated costs.

More information on total reward can be found in our factsheet on that topic.

Go to our factsheet on total reward

Communicating outcomes to employees

Good communications are essential to the salary review process, as employees may be left demoralised or resentful if the process is insufficiently transparent or seems unfair. The operation of a robust appraisal and pay review timetable, clearly communicated and with good project management, are imperative to the whole process.

It is also necessary to ensure clarity over the details of what is being rewarded, how and why, as well as setting out clear guidelines over what the HR function communicates and what line managers communicate. HR and line managers additionally need to reach a mutually agreed position on how much information should be disclosed on issues such as budgets and the setting and distribution of increases according to performance rating.

HR practitioners and line managers need to choose an appropriate communication strategy for their own organisation, taking into account factors such as the size and culture of the company. Smaller employers may be able to announce results face-to-face, whereas communications may need to be via email in larger or more geographically dispersed firms. Some large employers provide a video for employees to watch, although these need to be well-produced to maintain credibility and can therefore be costly to resource.

If the pay review involves a consideration of individual performance then it is likely that an individual conversation would be an essential part of the process to avoid jeopardising the hoped-for outcomes of transparency and fairness.

Whichever combination of methods are used, it should be remembered that, for the employee, this is one of the most important pieces of communication he or she will receive during the year and, from the organisation’s perspective, this is one of the biggest investments in people it will make during the year, hence the aim should be to maximise the impact.

Further information on how pay is communicated and how that communication is received can be found in our recent employee attitudes survey.

Go to Pay management survey (UK): employee attitudes

Additionally, the HR function will probably need to arrange the dispatch of letters to individual employees confirming key details of the pay review outcome such as the level of the pay rise, the new individual salary and the effective date of the new rate.

Problems sometimes arise at the administrative stage of the salary review with various documents or spreadsheets containing sensitive salary and bonus award data drifting across the organisation between HR and line managers. Attempts could be made to reduce such difficulties by emphasising the need for care in management communications and/or enforcing data protection rules. It may also be possible to use web-based software to avoid a plethora of spreadsheet printouts.

Additionally, consideration should be given to the existence and operation of any appeal process relating to the salary review process, with clear guidelines in place for its operation.

Evaluating the salary review process

The salary review process is not invariably a wholly rational or scientific affair. HR may for instance have to negotiate with line managers and departmental heads (who may want more cash for their ‘stars’) over whether this is appropriate and, if so, how this can be achieved. This could involve sensitive discussions, say, over whether any problems in employee turnover are necessarily due to uncompetitive salaries rather than other factors such as line manager behaviours.

For this and other reasons, it is important to evaluate the salary review process and identify lessons that can be learned for next time. This process should ensure that the pay budget has not been exceeded (for example, employees receive a 3% rise to salaries, but the pay bill actually increases by 3.5% once other costs are considered).

There is also a need to be wary of the scenario where HR holds the line to a strict budget for the purposes of the pay review but then loses control or visibility of awards that may be made through the rest of the year. Hence it is also important to monitor any ad hoc pay awards made outside of a formal process, as these can have the effect of circumventing the formal system and, most troublingly, increasing costs beyond the initial budget.

It is additionally important for practitioners to check that awards have been effective in the aim of supporting business objectives. And, from the point of view of both the law and good practice, employers need to be confident that the pay review process has not discriminated on the basis of personal characteristics (such as race and gender) which often involves monitoring of pay awards for different groups. They should also ensure that the needs of any employees on long-term leave (such as maternity leave) have been accommodated by the process.

CIPD viewpoint

The salary review process review should be closely aligned with the business, HR and reward strategies of the organisation. The use of metrics and measurement is important in enabling HR to evaluate the results of the salary review to ensure it supports the needs of the business effectively. An evaluation of the process is also essential to check that it recognises individual and/or collective contribution rather than prejudice and that the budget set aside for the salary review is not exceeded.

Useful contacts

UK Statistics Authority

References

ATTWOOD, S. (2008) IRS pay prospects 2008: summary. IRS Employment Review. No 908, 24 October.
SHARP, R. (2008) Public sector pay 2008. IRS Employment Review. No 912, 19 December.

Salary review process