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I was having a semi-hypothetical discussion with someone here about the recent Annual Review and Compensation podcast. He asked a question that I can't begin to form an answer on.

How is it that companies report returns of 7, 8 or 9%, but only give salary increases of 2, 3 or 4%? Doesn't this leave employees behind and encourage even top performers to leave when their raise performance is less than division or corporate performance.

Brian

stephenbooth_uk's picture

Just a guess but:
* Tax
* Executive Bonuses
* Share premiums
* More Executive Bonuses
* Contingency (money put aside for when things aren't so good)
* Different ways of reporting profits (the "Make us look good for investors" figure might not be the same as the "How much we actually made" figure)
* Bonuses for the C-suite and premiums for the shareholders
* Paper profit vs cash flow and bad debt
* Political contributions
* Bonus for the CEO

Not sure about outside the UK but here in the UK there are various different ways of reporting profit and loss (including pre-tax, post-tax, above the line, below the line and many others) that are all entirely legal and can give different answers. Generally the one you have to report to the tax authorities gives you the best of idea of whether you have actually made any money or not. This is one of the reasons it's often important for managers to be able to at least read a balance sheet.

Stephen (happy that he finally found a use for his Higher National Certificate in Business and Finance)

bflynn's picture

Say the company returned 8% that year. You propose something like: "You're getting 4% so that the CEO can get a good bonus. Remember that the company average is only 2.5%, so you can see that we really value you."

That doesn't work. Neither does an explanation that the 8% is an accounting mirage. Even the one that is most likely the truth (return funds to shareholders) rings hollow.

Why does it seem that the rate of increases for salaries is so far below the rate of increase for revenue?

Brian

jhack's picture

First, take a look at your company's income statement, balance sheet, and statement of cash flow. They explain where all that revenue goes. This is not necessarily easy or fun. Every MT manager should know how to do this. M&M have referred to it, but have yet to do "finance for manager tools managers" so you may have to turn to other sources if you are not familiar with these critical company documents.

Those statements will explain where that revenue is going: capital investments, shareholder dividends, stock buybacks, etc. Since those activities are typically aligned with your company's strategy, you should know it.

Your cost structure might be growing too, so revenue growth is no guarantee that more cash is available for salaries and bonuses.

So, if it turns out that profits are going to shareholders instead of employees, then you have a teaching opportunity for your team. Welcome to corporate capitalism: the investors get a return for risking their money on your company, and their return is greater than the growth rate in salary. Show your team how to read those three critical statements, and to relate that to strategy. And if the money is going to the investors and senior executives, the lesson is: When you own the company, you get the rewards.

It's no different than explaining why the top salespeople get paid so much more than the top technical people. Or why finance and marketing make it to the CEO level more often than info tech folks. This is the way business works.

So yes, you're only getting 4% so the CEO can buy another airplane. You want the airplane? Become CEO. To do that, well, it's all about people and...you know the rest of the story.

Seriously, this is a chance to teach about corporate finance and strategy, along with the realities of capitalism.

John

terrih's picture

How does one get hold of the balance sheets if one works for a privately-owned company?

stephenbooth_uk's picture

[quote="terrih"]How does one get hold of the balance sheets if one works for a privately-owned company?[/quote]

Talk to the finance director or equivalent.

Stephen

jhack's picture

and often they won't share every detail. But then how do folks know that revenue is up 8%?

You can ask the finance head to explain some of the basics. Tell them that your team knows revenue is up whatever percent, and ask where that revenue is being invested, if cash is being moved to the balance sheet, etc. They may not share all the details, but they'll typically provide the kind of overall info you need to give your team an understanding of how the pie is being carved up.

John

stephenbooth_uk's picture

[quote="jhack"]and often they won't share every detail. But then how do folks know that revenue is up 8%? [/quote]

It's often not easy to get the information and you tend to have to build trust and to make it clear why you want the information and what you intend to do with it. Unless you already have a good relationship with the finance head/director (Networking cast?) you're unlikely to get much (if any) information at first but with work and time you can get what you want.

Just showing an interest in what they do can go a long way. One company I was at (privately held, 70 employees of which I was the most junior) I just got chatting to one of the directors late one afternoon and happened to mention that I was studying a HNC in Business and Finance. He pulled out a copy of the company's accounts and spent about 40 minutes talking me through them, what they meant and how that fitted in with the company's strategy and business model. I think I learned more in those 40 minutes than I did in 3 months of evening classes. I also became a lot more confident about the company and was able to use some of the knowledge to improve our IT procurement (part of my job was to plan and execute replacement of IT equipment, everything from desktops through network infrastructure to servers). Prior to this procurement had tended to be panic buy when we needed the kit. Knowing how our sales and cash flow worked (we made most sales around March/April and the money mostly came in during July, slowing to a trickle by by September, due to the purchasing models of our customers) I knew when the optimum time to put in a capital budget request was (May) and when the best times to buy kit would be (September, October and November) and when the worst times would be (March, April, May and June). Management may not have liked spending money but I think that knowing in May when they were likely to need to spend big chunks of it helped a lot, although obviously moving away from panic buying meant the chunks were a good deal smaller as I could now shop around.

Stephen

juliahhavener's picture

I think that one of the really valuable things M&M talk about over and over is the sharing of information. In some companies, you may have to move up quite a few rungs before you see your own group's financials, much less the company's.

With some recent changes in leadership, we are seeing more of the financials that are behind our group's goals and budget items. This is powerful stuff. Good stuff. I know not only that *I* am contributing, I know what my department is doing and how that fits into the entire picture. It's a wonderful thing.

So not that this adds anything to the current conversation except that it's good to have the information, it's better to have someone spend a little time and show what different parts mean, and it's great to have a clear picture of where you happen to stand in that money-driven world.

bflynn's picture

[quote="jhack"]Seriously, this is a chance to teach about corporate finance and strategy, along with the realities of capitalism.[/quote]

John, I agree its a great chance to teach. There are problems, such as getting financials in private companies. And even in public companies, once you've done a cash flow assessment, that is still historical. A budget document for the coming years is really where the reasons for not giving larger raises would be revealed.

I'm not sure I like the implication of teaching this either. Remember that we're talking about a top performer and trying to convince him to stay with our company instead of creating his own 15% raise by going somewhere else. Talking about capitalism and how owners and CEOs get the biggest reward would only encourage him to jump to a new position. There's not a lot of data points, but my experience is that changing jobs will create a raise about 8 times larger than staying put. I can't believe a lesson on capitalism and corporate structure is going to be effective in keeping someone in place.

I don't know the answer yet. I'll have to keep looking....

Brian

jhack's picture

If someone is just looking for 15%, and if all you can give is 8% (from your 4% bucket), then you will have a retention issue regardless.

I like to teach (and coach, and delegate...) and my top performers love to learn. I can't always compete on price, but I can differentiate by making my team a better team than most. Rare is the employee that cares only about money (and I don't mind losing them).

If your top performers aren't interested in understanding your company's strategy and what that means for resource allocation, are they long term assets to the company?

I really don't see the downside. Even if you work for a private firm where the owner uses the free cash flow to buy a fleet of race cars, why not be upfront about it? "Stick with me kid, and I'll show you how to have your own fleet!" (I'm not kidding - this was exactly a situation at a company I worked for long ago).

If you're not on board with the strategy, then you have a decision of your own. And if you are, then share your enthusiasm for it.

and you're right: do include the budget in your analysis.

John

stephenbooth_uk's picture

[quote="jhack"]Even if you work for a private firm where the owner uses the free cash flow to buy a fleet of race cars, why not be upfront about it? "Stick with me kid, and I'll show you how to have your own fleet!" (I'm not kidding - this was exactly a situation at a company I worked for long ago).[/quote]

One of my friends told me a few years ago about a meeting he'd had with his manager (who owned the company). He told my friend that there would be no payrises that year for anyone (despite the company doing very well and current salaries being well below the industry average) as he had just bought himself 3 new cars (all Porches) and a boat. Apparently he was such a nice person and so good at the people management side of things (definite High-I) that no-one left or got overly upset. Indeed when my friend left a couple of years later (not having had any pay rises, the owner being up to 8 Porches and 2 boats) it was only because he literally could not afford to work there anymore because of how much his mortgage had risen.

Stephen

jhack's picture

Great story! The key is being honest about what's really going on. If you try to hide it or make up a story or just refuse to talk about it, it will be more damaging than telling the truth.

John

cwatine's picture

[quote="bflynn"]I was having a semi-hypothetical discussion with someone here about the recent Annual Review and Compensation podcast. He asked a question that I can't begin to form an answer on.

How is it that companies report returns of 7, 8 or 9%, but only give salary increases of 2, 3 or 4%? Doesn't this leave employees behind and encourage even top performers to leave when their raise performance is less than division or corporate performance.

Brian[/quote]

Hi Brian-

Maybe it is a translation issue, but I cannot see the link between the company return and the salary increase (except they are both percentages) ?

A return of X% means that the share holder gains X Euros when he has invested 100. It does not mean that the owner gets a salary increase.

A better comparision would be if the dividend was increasing by X% from one year to another ... But still, a salary increase is "permanent", not a dividend increase! A Dividend can be compared to a bonus ... You get it if the company made a profit ... And if it has not been reinvested ...

It reminds me of a conversation with one of my employee claimed he wanted to have a salary increase of 10% because the company was "making" a 10% profit (on sales)... It was very hard to explain him what each figure meant ...
And in the end he was still not satisfied, and said something about the banks, the stock market and the share holder! I think he was mixing what he heard on the radio and the life of our small company...

Communication about money and wages is not always easy, because you hear all kind of creazy things on the radio and TV. Things that have nothing in common with the reality of a medium sized company.

Céd.

maura's picture

There has to be a balance between making an investment in your employees (in the form of salary increases and/or bonuses, training, or anything else staff-related the business can spend money on), and protecting current and future profits.

If profits are a function of what you bring in minus what you pay out, then it makes good business sense to keep your costs as low as possible while still spending what's necessary to ensure that you keep good people around that can make you money next year. Raise your salary budget too much and you have to bring in that much more next year in order to break even. Raise it too little, and you risk good people leaving for greener pastures.

That's just the nature of the beast - it's the gamble that companies make when they set the increase percentage. If any employee feels that they are being compensated unfairly, they are free to make the call on how to handle that - stating their case and asking for more, working to deliver better results next year, or choosing to move on.

bflynn's picture

[quote="cedwat"]
It reminds me of a conversation with one of my employee claimed he wanted to have a salary increase of 10% because the company was "making" a 10% profit (on sales)... It was very hard to explain him what each figure meant.[/quote]

Actually Céd, this is almost exactly the way the question was phrased. However, it was not profit on sales, but an increase on net reveue.

I think I mostly agree with John. I have another answer this morning that pay raises are linked to the market of other pay raises. They are not linked to how the company actually performs (until of course, the company isn't doing well).

So this is proof that top performers don't stay for money? But they surely will leave for it.

Brian

ccleveland's picture

I'm with Cédric,

Company return has no direct correlation with salary increases. A company can post a negative return and still give salary increases.

Sure, in the big picture, a company cannot give [u]years[/u] of increases while showing [u]years[/u] of losses...except maybe some airlines. ;) However, trying to argue that the salary increases should be higher just because the company has been very profitable in a given year is like trying to stop a stampede with a trombone... and you'll probably walk away with a headache in both cases.

CC

jhack's picture

bflynn, great point: the price of labor is determined by the market, not by a company's revenue.

John

ccleveland's picture

John/Brian,

BLUF: It isn't a worthwile use of energy to try comparing one year's salary "bucket" with any single external measure, including company returns AND the labor "market".

In a "perfect" market, price of labor is determined by the market; however, there are many barriers that prevent a perfectly open labor market. There are usually salary distortions (usually salary compression) that do not accurately reflect "market" changes. The distortion is caused by several factors, such as the high risk of changing jobs.

Overall salary budget increases are usually based on a very wide variety of factors including such things as past returns, labor market, future company expectations, industry trends, strategic plan, cost of capital, etc.

CC

jhack's picture

I agree that there can be no tight coupling of your raise bucket to market value. And yes, the labor market isn't perfect (few are).

Knowing the market value of your people is still worthwhile. It may not allow you to change your buckets, but it will tell you if you're paying above or below the market, and if that creates a potential retention issue.

Maybe you're paying above market average, and you could draw talent from a competitor...

John

cwatine's picture

[quote="ccleveland"]
Company return has no direct correlation with salary increases. A company can post a negative return and still give salary increases.
Sure, in the big picture, a company cannot give [u]years[/u] of increases while showing [u]years[/u] of losses...except maybe some airlines. ;) [/quote]

In hard times (market down, crisis, etc.), you can have two kinds of behaviours in companies :
- stop investing in machines, marketing and people, cut costs, etc.
- invest even more in machines, marketing and people to make a difference on the market

In my opinion, the second solution is most of the time a winner, because this is in hard time when you make a durable difference on competition. This is the perfect time to increase the gap. You invest much more than average.
Of course, you can only do it if you have reserves. Reserves you have made during easy time.

This is one of the reasons why you cannot link directly profit and salaries. You may have a decline on turnover and profit and still give salary increase and bonus because :
- you want your people to stay
- they still have done a good performance compared to the market

jhack's picture

Ced,

That's a great point, and it's why the conversation has to be about company strategy and direction, not just about revenue or costs.

How powerful is this statement: "Profits are down this year due to [credit crunch, whatever] but we're investing in you to build the future."

John

Mark's picture

I'm sorry this has taken me so long. I regret my absence.

Lots of good stuff here. A couple of thoughts about the concept, and then, I think more importantly, effective manager behavior.

First, of COURSE any individual's salary is not tied directly to corporate performance. I would wager that there are 20 things that affect one's salary. The only BIG lever to the direct is their performance.

Companies ALSO GIVE RAISES IN DOWN YEARS, because of the cost of living. That attenuates their ability to share ALL of an up year's 'winnings" in a good year.

Companies DO NOT exist to enrich their employees. Companies exist to serve society with greater efficiency than individuals could alone. This is the heart of the "specialization of labor" concept so crucial to modern large organizational capitalism.

There ARE organizations that DO exist to share EXACTLY what the market gives to the firm - ones that individuals own (private firms). Just be careful what you wish for - owners suffer in down years.

The specialization of labor also creates what amounts to economic friction - the loss of value due to the inefficiencies of people working together. This degrades the value of a company's earnings.

Further, if someone were to ask me this question, I'd assume that I had bigger issues with them.

I'd probably respond with an interest in having a longer discussion and learning opportunity with them regarding corporate economics (they would do the research by asking some of the questions in posts above). I would EXTEND the conversation by saying something like, "Great point. Let's use this as a chance to learn as much as we can about how the company works, and we can work back and down to where we fit in." This is based on an assumption that the company is ethical and forthright, which the vast majority (95%+++) are. And, it's also based on the fact that other companies are much the same...meaning that WE'RE NOT AT A COMPETITIVE DISADVANTAGE in the marketplace because of the lack of linear causality in corporate performance and salaries.

And, you're always going to have this tension! Relax when it gets asked. It's ... normal.

It's good to be back.

Mark