Do you know how amazingly costly it can be to deny a salary raise?

Do you know how amazingly costly it can be to deny a salary raise?  · 

While writing an article about asking a salary raise, I came upon very interesting statistics of the costs of employee turnover for companies. I have been part of a few hundred salary negotiations, decisions, approvals and review rounds on my career, and I have always wondered, why it is so hard for companies’ decision makers to pay well for the good people, and especially approve significant raises, when they would make sure that company would keep its top talent. It is amazing, that by rule, most companies generally “reward” their loyal and often essential employees with 3-5% yearly salary increases, while changing companies usually earns 10-20% bump in salary.

The numbers behind salary raises and why people leave their companies

So, let’s get to the numbers and facts to make this a bit more concrete:

Glasdoor did quite an extensive research in USA and UK and found out that 45% of the employees leaving their companies say that the main reason is salary. This is an amazing number, especially when we combine this to another research that states that it takes for a newly recruited employee 1-2 years to become fully productive. If the job is complex and requires deeply specialized company or product knowledge, this time can even be doubled to 2-4 years. When you think about these numbers, you probably start to figure out how expensive it is actually to lose an employee. These aren’t, however, the only costs that you will encounter. Let’s run through a short scenario to demonstrate what really happens and how costs start to pile up.

The case of losing and replacing Anna after she leaves the company

Let’s take a mid-level employee with $60.000 p.a. salary. Let’s call her Anna, she works on technical pre-sales that takes quite a bit of skill and experience to handle. She has done good work and is creating constantly valuable results for the company. Her position is definitely needed to ensure success of the operations.

  1. Anna comes in asking for 20% raise in January, telling that she has learned that this is the general pay rate in the area for someone with her skills and experience. Besides, she has been taking quite a bit more responsibility in the last year, so the salary raise should be warranted.
  2. Anna is denied the raise. She is told that while she has been doing good work, they do not give this big salary increases to anyone, and that she could maybe get a 10% raise in mid-year, if she proves that she can still improve. (This is just an example, but unfortunately a common one).
  3. Anna gets frustrated and disheartened, as she has been working extra hard the whole last year, getting new responsibilities, and now she did not see any reward for that. Her engagement starts to drop, and she starts to consider an option of changing companies.
  4. After 3 months of contemplation, Anna starts to look for new opportunities while doing her job on the decreasing level of engagement
  5. After 9 months, Anna gets a new job in a company that is willing to pay her the extra 20% from the start. She leaves the old company. For a better part of the year she has been working around 50% of the productivity that she had last year, when she was driven to get more responsibilities, and a raise.
  6. Company loses Anna and starts to look for a replacement. They realize that candidates on her level in general request $65-70.000 as a starting salary, as they need someone who is experienced, and can hit the ground running.
  7. The recruiting consultant working for your firm will take a 1.5 months’ salary of the recruit as her fee. On top of this HR department and hiring manager will go through 50 resumes and 15 interviews.
  8. After 3 months recruitment process, a new employee, Belle is found and starts with $68.000 starting salary. While looking for the replacement, Anna’s old manager is trying to manage somehow her job on top of her own. Company misses a few new sales because of the mishandling of the things.
  9. While recruiting, Anna is still in contact with her old colleagues, they go for a coffee, and she tells everyone that her starting salary in the new company is 20% more, and they are willing to increase it after the first year even more, they even offer free fruits and breakfast.
  10. Belle’s onboarding starts and the first years’ complete productivity for the new employee is around 35% compared to the full productivity of the previous employee. Company loses quite a few sales because of this. Belle, as any new employee, requires supervision and support from her manager and colleagues. She also needs a couple of additional external trainings that company will pay.
  11. 5 months after Anna left, another employee suddenly hands resignation. When asking for a reason, she tells that a recruiter from Anna’s new company contacted her on Anna’s recommendation, and they made an offer that is 20% more than her current salary. She also wants to work again with Anna, so she is set on leaving.
  12. The second year, Belle starts to get a hang of things and doubles her productivity to 70% throughout the year. She will ask for a 10% raise in the beginning of this year, as she has been making good progress.
  13. Finally, on the third year Belle is fully acclimated, and the company can fully depend on her. She comes in and asks for a 20% raise, because she is creating so much value, and company is depending on her so much. She also has heard about her predecessor, Anna, who is making a killing at a company X, and they are looking for new pre-sales managers. Everyone is telling that they are also paying really well…

I will not go to exact numbers following this sequence of the events, but I will give you a number, that you can look in correlation to the events: around $90.000. That is 150% of Anna’s annual salary, and it is a number that came up with a study “The Impact of the Family and Medical Leave Act” already in 1999. Unfortunately, there are very few other studies available, but I don’t think that the number has gone down from that, as complexity, and requirement for special expertise on many industries has gone only up since 1999.

The total sum of Anna’s initial raise request for these 3 years would have been $36.000. That is a bit over one third of the cost of losing and replacing her.  

The actual cost of her leaving vs. staying with increased salary is thus $90.000-$36.000 = $54.000

In our case the company actually made a good hire. How would the situation turn out, if they would have made a bad choice, and had to fire Belle after a year of disastrous performance? There are many opinions and calculations on the cost of the bad hire, but it is pretty safe to assume that a bad hire on a mid-level, but important position can cost 200-400% of the yearly salary of the bad hire. In some cases, it is argued, that a bad hire can cost over 1000% of the yearly salary in direct and indirect costs.

The cost goes up tremendously for the high-level or highly specialized employees and can reach 200-250% of their annual salary. And these salaries are usually starting from $120.000, meaning that it can cost $300.000 to replace such an employee. Some sources actually flash numbers like 400%, but I did not find any concrete studies confirming this.

I would like to see the decision maker or a manager who can justify spending $54.000 for replacing a trusted employee with a new recruit. If this is a recurring pattern and happens with several employees every year, you can see how the expenses start to accumulate.  

*These are off course rough estimations, but as you start calculating all the factors in, I think you will reach similar numbers.

The cost of denying the salary raise / underpaying in general attrition.

If you also remember the fact that 45% of the employees leaving their companies state salary as their main reason for leaving, you can roughly draw a conclusion, that for each important mid-level employee leaving, in the next 3 years you are roughly losing:

 (45% * 150% * yearly salary) – (Salary increase, that would have made them stay*3 years).

 In numbers this means for each $60.000 earner, who leaves because you did not give 20% raise they asked for, you will lose:

((1.5*$60.000) – ($60.000*0.2*3))*0.45 = $24.300

For a high-level employee with $120.000 yearly salary and asking for the same 20% raise:

((2.5*$120.000)-($120.000*0.2*3))*0.45 = $102.600 loss for each of your employees leaving

You may think, that you are not underpaying, but think of it like this: If someone else is willing to pay your employee significantly more than you, despite the risk of bad recruits, recruiting costs and the cost of onboarding period, the fact is: you are underpaying, and you will pay for it.

Reasons for this oversight by leaders and managers?

So enough for the numbers. I think you got the point. I hope that you also agree that something is not making sense here. Why are companies and decision makers so willing to let good people go, and in most cases join their competitions team with all their skills, experience and connections? When most things in the business world tend to be tediously measured and optimized, why is this one aspect handled with so much disregard?

I think that there are a few reasons for this:

  1. Ignorance: No-one really thinks (or doesn’t want to think) about the cost of losing a high-level employee. The losses can be significant, but as most companies do not have a proper process for calculating the loss & replacement costs, these costs are just wiped under the carpet. If you look back to the estimated costs above, it is clear that this is something that should not be ignored. I guess most companies and decision makers just don’t know or pay attention to this – or choose to ignore this because of the reason 2.
  1. Egos of the leaders: Giving a raise to someone who comes asking for it is too often seen as a challenge to the authority of the decision maker. Especially, if you add to the mix the threat of an employee leaving the company and the decision maker for a better salary.

This is too often taken as a personal insult against the decision maker, and his company, and it can cause a strange reversed logic, where the decision maker actually puts the blame to the disloyal and wayward employee not understanding the business reasons and thus being unreasonable. Meanwhile the decision maker sees himself only making logical business decisions, that are not driven by feelings, but facts and known salary standards, that the employee doesn’t understand.  This is off course complete fallacy, that leads to decisions that “save” a few thousands in a year in the employees’ salary and can end up costing 3-5 times more than that in the coming years.

Also, salary and job security are huge factors in every employees’ life, and being able to have such a control over people can have a negative effect on some thoughts and decisions of a decision maker. There is always the status and pride affecting the decisions: No one under me should come close to my own salary range, or challenge my judgement of the proper salaries, that I have chosen to give.

I believe, these attitudes are often not consciously thought and acted upon, but still they are there, otherwise I think we would see much more decision makers approving salary raises based on facts, not feelings.

  1. Culture & tradition

 This is probably the combination of the two above over time. Many companies have their salary standards and review processes based on a tradition that is decades old, and seem to be inherited directly from industrialization era of factory workers. If you view people as value creating machines, that can be easily replaced if they go “broken” and start demanding more money as maintenance, you are living in a wrong era, and you are in-fact a liability to your company, and can cause significant losses. I know for sure, that there are companies that are different, and decision makers that understand and care about this, but still there are many who keep up harmful traditions probably even not realizing what they are doing.

The whole salary topic is somehow still kept as an issue that should not be discussed in the companies openly. Companies want to keep their salary ranges secret, the decision logic for salary raises fuzzy, and they in general like to discourage people discussing their salaries.

This is also one of the reasons, why the salary discussions are one of the hardest and most scary discussions for employees to have. This is for sure partly because the logic behind decisions born out of of these discussions is too fuzzy to grasp, and outcomes are often less than satisfactory. When you add to this the fear of hurting your managers ego, and facing his rejection, contempt or even anger, and thus getting hurt yourself, it is no wonder that 45% of the people leaving the company do it for the salary reasons. It is strange, but true that it feels safer to ask more salary from an unknown company, than from your own manager. If that is not a sign of a bad culture, I don’t know what is.

Salary comparison services, such as Glasdoor.com have opened new possibilities for the employees, as they can now easily compare salaries between different companies, or even inside their own company.  If the companies don’t catch up on this trend, and start changing their attitudes and cultures, there will be still huge losses to be made in the future in form of employee attrition.

Suggestions to improve the situation in your company

Here are a couple of suggestions what you could do in your company to improve the situation:

  1. Create an actual calculation model for losing and replacing employees and use it every time when you are faced with a decision of a salary raise vs. risking to lose an important employee. If you dig into the facts and make educated estimations, you should be able to come up with proper numbers for your different level employees.
  1. Start building a reputation of paying very well (and pay well for those deserving it). Do this, if you want to keep your employees, and more importantly get the best employees. This will serve two main purposes:
  • You will get to keep most of those 45% employees, who would be leaving because of the salary.
  • You are not competing for the cheapest people, but you are competing for the best people. Who would you rather have working for the critical parts of your main product or service? A stable team of 8 highly skilled experts, or 15 employees that fill your minimum requirements, cost as little as possible, and who will leave you as soon as they get a bit better offer? The operational cost is roughly the same, but the results won’t be. When you factor in the cost of losing and replacing people, the expert team, that will stay with you, will end up being tremendously cheaper and more productive at the same time.
  1. Start creating a culture, where talking about salary and compensations is not frowned upon. 
  • Train your managers to handle properly the salary discussions and understand the implications of salary raises and denying them. Make people to use the calculation model from point 1 to understand the real costs of letting good people go.
  • Make sure that you and your managers know the going salary rates in the area very well, this way they can discuss them with confidence, and use them in negotiations.
  • If a (reasonable) salary raise is denied, make sure that there is a valid and logical reason for that, and that is communicated to the employee. If there is a gap between desired results on your side, and reward desired by an employee, create a plan and tracking for better results, that would grant the bigger rewards (meaning the desired salary raise).
  1. Revise your decisions: When you are about to let someone important go, because you aren’t willing to give them a raise, or even match the offer that they got from a competitor, think about the logic behind your decision. Consider the situation at least from these 4 different perspectives:
  • Company: Company is standing to make a huge loss in the coming years, and you are losing someone you know and can trust to make things happen
  • Competitor: Someone else is willing to pay him more than you, ready to pay the huge cost of the onboarding time and taking the general risk of a failed recruitment.
  • Your own ego: Are you just too proud or stubborn to give someone a raise because they were smart enough to realize their own value, and brave enough to challenge your authority on deciding how much they are worth?
  • Employee: What are their real reasons? Do they feel under valuated by their current salary? This will affect their engagement greatly. Think about how huge meaning does the salary have in a person’s life. If basically provides all the life’s necessities and luxuries for the employee and their family. They are willing to make tough decisions to get a bit more for their families if they are in a tight spot. Many will do this for their family, even if they loved working for your company and for you.
  1. Things to avoid 
  • To promote someone and tell her that salary increase attached to a new position will come in a year, after she has first proven that she can handle the situation. This does not only kill the joy and the huge engagement boost of the promotion, but also puts your own judgement in to question: If you don’t trust that she will manage the position, why did you choose her? In all honesty, many people will take this way too common practice as an act of mistrust and feel that the hard work they put in to get the promotion is not valuated at all. This is also an easy way to get your newly promoted prodigy to go looking for new appropriately paying opportunities as soon as she has a bit of experience to show for the new role.
  • Using the company’s tight financial situation or unclear future too often as an excuse to deny raises. If you are always tight on money, maybe your situation is somehow related to the fact that you are not able to keep the good people in?
  • Disconnecting effort and reward. People need to see the reward for their work and accomplishments. This gives meaning to the sweat and tears they shed for the company. The more and better you do, the more you get, should be a clear causal relation.

 The first thing that changed after writing this is, that whenever I am faced with a salary decision from now on, I will give it a much deeper analysis than before. How about you?

I am also very happy to hear comments that would dispute the numbers above. Maybe you have already made your own calculation and collected some data, that could improve the accuracy?

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