Upfront: Looking Beyond the Annual Pay Raise

How companies are compensating star employees while keeping salary increases low.

Despite the economy's increasing vigor, most companies remain cautious in their budgeting of pay increases for this year and next, according to Mercer Human Resource Consulting's "2004/2005 U.S. Compensation Planning Survey," a study of nearly 1,600 employers in a wide range of industries. Companies plan to raise pay by an average of 3.3 percent this year, the same level of increase they granted in 2003. For 2005 the compensation picture is only a little brighter, with employers planning average raises of 3.5 percent.

"2005 will mark the fourth consecutive year that pay increases have averaged less than 4 percent," says Steven E. Gross, leader of Mercer's U.S. compensation consulting practice in Philadelphia. "From 1994 through 2001, annual pay increases ranged from 4.1 percent to 4.4 percent, but they dipped below 4 percent in 2002 and have remained there since. Employers are seeing some signs of an improved economy this year, but they're not ready to commit to higher pay increases yet."

The improving economy is challenging companies to focus once again on attracting talent -- but with a twist. "Employers learned an important lesson in the late 1990s when the labor market was so tight," Gross says. "Today, instead of attempting to grow revenue by 'buying' the right talent on the market, companies are focused on building talent from within. They are taking a long-term-development approach."

The survey's data on rewards supports that claim. Although nonmonetary recognition awards and spot cash awards are far more prevalent today, the practices respondents are most likely to adopt in the future relate to performance management and employee development. For example, 19 percent said they are considering offering formal career planning. "Employees have clearly emphasized the importance of career development and advancement in their decisions to join or stay with an organization," says Gross.