Pay rise or bonus?
Wednesday, 26th September 2007 by Peter Hollingsworth
Anne and I were looking at the annual salary review. As it had been a good year for the business she was keen to be generous with the salary increases, but I wasn’t so sure.
“Peter, we have had such a great year; everyone has worked so hard and I know we have cash in hand so I want to be more generous with the salary increases,” said Anne.
“I’m sure you agree.” It was clear what answer I was expected to give, but I wasn’t sure it was the right one.
I managed to give a non-committal reply so I could sit down and think. Anne is not what most people expect in a business director. She has no formal qualifications, little interest in formality and is almost completely non-hierarchical.
Despite this, she has developed a growing, profitable business. In the circumstances, those of us who hanker after a bit more structure just learn to accept that her way works and try to catch any stray balls that may drop.
I have learnt over the years that Anne’s instinct is pretty reliable so I wanted to make sure I had reason to be dubious of her recommendation before I challenged her. I soon saw that the numbers showed that my gut feeling was reliable on this occasion.
Anne runs a people business. It is selling services that mostly relate to hours worked. While there are some economies of scale, the relationship between employment cost and revenue – assuming similar levels of occupation of staff – is relatively fixed.
So, all things being equal, a generous pay award was going to mean erosion of margin. I was pretty sure Anne was looking at the salary award as a reward and didn’t understand what the consequences would be for next year’s trading.
I showed Anne the numbers. Fortunately she was in a receptive mood and took time to study the spreadsheet I had put in front of her.
She soon saw that the increases she had proposed, once National Insurance and pensions had been added, increased the costs rather alarmingly. “Can you increase your selling prices to reflect the increased cost?” I asked.
“No way,” came the immediate reply. “We are already at the top end of the price range. But everyone is working so hard. They deserve the reward. There must be another answer.”
Fortunately I had anticipated this reaction. “Yes, I think there is.” I explained that as we were rewarding the strong performance of the team during the past 12 months, I felt we should be paying bonuses instead of salary increases.
The salary levels were already competitive with rates elsewhere so we didn’t need to increase them from that perspective.
There was also two other strong advantages of bonuses: firstly they would be paid as a lump sum: a £2000 bonus will probably have a much greater impact on an individual than if it is spread over 12 months, secondly, as this year has been a good, profitable one, the payment of a year-end bonus will reduce the corporation tax bill.
“And if we don’t have such a good year next year, we haven’t burdened ourselves with extra costs that we can’t get away from.” Anne was clearly warming to my idea. “You are right, but there are issues we need to address now as well.
The first time you introduce a bonus it has a great impact. A year later two things happen: firstly people expect a repeat, so if you do pay one, the impact is reduced – and if you don’t there can be a feeling of de-motivation.
Secondly employees start to see that their basic pay is eroding, so if that is used for overtime, pensions etc, they feel they are losing out.”
“I think we can manage that. We might even pay a modest salary increase and a bonus alongside. I am sure I can get selling prices up to compensate for that. I think there are ways we can sell more hours without it costing more too.”
As far as she was concerned that was it, issue finished. She was soon on to the next topic and, as usual, she would leave the rest of us to sort out the detail.
It was a lesson learnt. When running a business ‘selling hours’ you need to be very careful you know what you are doing when it comes to changes in what you pay for those hours. Fortunately, there are alternatives that keep staff happy and retain financial flexibility.
