In a business where staff churn is costly, should I let employees lead and request their salary increase?

Question

I've asked the same question on the Economics Stack Exchange here to get answers from the perspective of applied economic theory.

I'm the managing director of a company in which we run appraisals every 6 months. Each time we negotiate salary I have in my mind's eye this picture...

Assuming the 'correct' salary for an employee is 70k, there's an incentive to offer slightly more. 'Slightly more' because there's some error in estimating the market rate and the costs of getting this wrong are high. I've added a staff churn costs of £20k/yr for getting this wrong based on loss of knowledge, morale, recruitment costs and what I refer to as a 'change incentive' for the replacement employee. The change incentive is the amount you must offer a new employee beyond their current rate (market rate?) to discount the loss of familiarity and to take on the risk of joining a new employee.

Belief 1 - Underpaying employees is much more costly over the long term once staff churn is taken into account.

Belief 2 - the employee has better information about their value - based on them being nearer the information about their skills, positive contributions and self interest in the literal sense.

Belief 3 - salary expectation in job adverts are positively skewed to discount against the risk and transaction costs to the employee of change. Nobody switches to an identical salary unless it's a sideways move. Anecdotally, I've heard advice to change jobs every few years in order to raise your salary faster. Humans tend to be unnecessarily risk adverse and you can give yourself a competitive edge by overcoming this bias.

Belief 4 - primary information source for market value are job adverts and job offers. These overvalue for the reasons in belief 3.

Belief 5 - Protracted and/or aggressive salary negotiation is costly in itself. If there's a big discrepancy it can create feelings of being undervalued.

Belief 6 - Employees will be content and thus likely to remain with the company if they feel they are receiving the market rate.

Assumptions: the company is otherwise a pleasant place to work.

In my particular industry, I'd consider low staff churn rates and high staff morale as being a distinct and powerful competitive advantage. The figure of 20k churn cost is probably conservative.

In England, where I live, the cultural norm is for the company to either start the negotiation or more commonly simply state what the pay rise is going to be. This is followed by a period of watching how much they squeak squirm with dissatisfaction. Given the beliefs above and an industry where staff churn is costly, I'm inclined to lean in the other direction and either let them begin the negotiation or even more radically, simply request what their salary should be; as is common for sellers of other types of good. Salary negotiation seems to me to be unique in that the buyer of the good (their labour) dictates the price and then watches to see if the supply vanishes (resigns).

Is it an optimal strategy in salary negotiations to let the employee decide?

Answer 1

I think this is a bad idea.

• It actually places the employee in a difficult position. Now they have to try to guess what you might think is a "reasonable" raise. Asking for too much will make them look bad (or at least that will be their assumption). Asking them for too little will sell themselves short. This artificially creates a very stressful situation. An initial offer of a pay raise from you actually provides useful information about what raise you might consider reasonable. By withholding this information, you make things harder for the employee.
• It won't necessarily reduce protracted/aggressive salary negotiations or hard feelings that come from them. By making it open-ended, you invite very high suggestions, which you will then have to ratchet down. This may be worse than just offering a reaonable raise in the first place, and negotiating from there. Who will be more satisfied: someone who was offered 5% and negotiated that up to 10%, or someone who proposed a 20% raise and was talked down to 10%?
• It won't necessarily make employees happy. It will create a lot of variation in raises, based on employees' guesses about how much they asked for, and this will create unhappiness for some. If I requested a 5% raise, but then I find out Bob got a 15% raise just because he asked for it, I'll be unhappy. It seems like my workplace arbitrarily rewards people, based mainly on who is boldest and who guessed correctly.
• It won't necessarily reward the best employees. Instead, it will heavily reward those who were most aggressive in the negotiations.

If you want to retain employees, and think it is therefore worth paying an above-market rate:

• Make a generous initial offer.
• Offer especially generous raises to the employees you value most.

Answer 2

When I hire people, I do ask them to set their salary. "What do you want to be paid?" I ask them. Only if they refuse to name a number (having believed those people who claim the first to say a number "loses") do I offer one. [Do I always pay people what they want? Well, I don't always hire them, and wanting far more than what they are worth to me is one reason I might not.] Then once aboard, I tell them, "I want you to be happy and that includes with your pay. I will give you regular reviews and raises, but any time you feel you are not being paid properly, come and tell me and we'll see what we can do about it."

In operation, what we can do about it is often "I see. Well to pay you that, I need you to X, Y, and Z consistently. Do you think you can get to that in 3 months? Let's meet then and confirm you have, and we'll raise your pay."

The major downside to this is that employees rarely believe their employers genuinely want them to be happy and want to retain them. They believe the employer is trying to pay them as little as possible and that any statements about wanting to be nice are a trick to get the employee to relax and accept less than they are worth. They worry about "leaving money on the table" and being bad negotiators. This is most strong with new hires, who don't know anything about you and have no reason to trust you. If you wanted to implement an approach like this, you would need to "walk the walk" in a lot of other aspects (training, office décor, upgrading hardware and software, flex hours, etc etc) so that people come to understand "this company is built on us and when we love our jobs, the owners make money, therefore the owners work at ensuring we love our jobs." There are people who will never set aside an adversarial mindset. The good news is your company improves when they leave.

Answer 3

You really are trying to solve the wrong problem. If you have decided turnover is 20k a year value, just set your "midpoint" salary at 85k instead of 70k.

Or alternatively, instead of making compensation review a once/year thing, make it part of a regular ongoing feedback cycle. The reason that this:

This is followed by a period of watching how much they squeak squirm with dissatisfaction

happens is because most of the time, the way raises are decided is something like:

• Employee works for 11.5 months with no feedback (apparently 6 in your case)
• Employee gets yearly review
• Employee raise gets set based on yearly review
  • Employee has no chance to correct performance which might impact their review
  • Employer provides feedback infrequently enough to allow any actual adjustment
  • Normally, reviews are not negotiable - they are set by management and the employee is simply recipient

This is why yearly reviews suck for employees. If on a regular basis throughout a year employees are receiving feedback, understanding what they need to do in order to raise their performance, they are far more like to either:

• Be ok with their "meets expectations" review
• Not be dissatisfied with their yearly salary increase

Naturally it is considerably easier to do a once/year review than it is to be good at management. A good manager provides regular feedback.

Another alternative is just to make a formula for salary that employees plug their numbers into. Stack Overflow does this.

Anecdotally, at a previous employer, this all worked to my advantage that the company did NOT do this - I was able to ask my manager and basically understand exactly what amount of my work would be required for increasing my review the various levels. Ultimately I decided it was not worth it for me to "aim for the highest" rating given the amount of work required. But this was my decision, in light of the information I had. Not a black-box.

Unfortunately most employees are not going to do this.

Is it an optimal strategy in salary negotiations to let the employee decide?

Let me give you my personal experience.

My current salary is basically exactly the number I gave the hiring manager, upon similar conditions to what you are saying - they wanted me to pick a salary I felt was fair.

Now this required me to:

• Meaningfully understand the pay range of my position (though I just directly asked, most employees won't do this)
• Play a mind game. Do they want me to pick a reasonable number? Should I ask for as much as I can get?
• Lead negotiations

A few observations from this process. First, and perhaps most importantly, by giving the employee the stipulation to set the number you put them into a variety of awkward situations, discussed well in other answers.

However, a more insidious problem which may work against you is that ambitious or good employees now will always wonder, "could I have gotten more?"

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I think several of your assumptions are also misguided:

Nobody switches to an identical salary unless it's a sideways move

This isn't technically true. People do this for companies that have better benefits, culture, worklife balance, more interesting work, better career options, stability, etc.

Belief 2 - the employee has better information about their value - based on them being nearer the information about their skills, positive contributions and self interest in the literal sense.

This isn't true.

My value that I decide isn't my market value. It's what companies are willing to pay me. I could pick $1,000,000 a year. But I'll never get it.

So you really end up with employees feeling even more uncertain about their worth than before, because now they are setting the thresholds - if the employer rubber stamps it, then they fairly naturally will feel underpaid. "If they accepted X% raise, why wouldn't they have accepted X+1%?"

Answer 4

I'm not sure why I have a different experience, but here in France I'm regularly asked how much I plan to earn during the interview, and I'm not reluctant to give a number. A few times I was told I'd be too expensive for them, and a few times I was told they would pay me 5% over the sum I asked for.

If your business model is based on hiring good people who bring in a lot of value and paying those people competitively, I don't see why you shouldn't let them make the offer. If you can accept their offer without negotiating it, there's a good chance you will be the employer they chose.

This said, keep in mind that some great people just aren't good negotiators. If your company doesn't have a system to adjust their salary based on their performance, you might lose them as they grow unhappy over the fact that they are paid less than others.

Answer 5

I worked at a (small) company where my salary increases were preempted by my manager. Every year (at a relatively random time), I was informed that my salary was increasing, sometimes fairly significantly, sometimes not much. This was something I appreciated, as it avoided the awkward raise discussion (which I absolutely hate) and also made me feel really appreciated. This company was quite the commute for me and I always intended to stay less than a year but ended up staying for 5 years. The thing was, even the 1 year I thought I could have gotten a higher increase, I didn't feel like bringing it up because they had already bumped me up.

Completely anecdotal I know, but by pre-empting the discussion, it really saved a lot of awkwardness and thoughts of leaving.

Answer 6

There are already excellent answers to this question, but I want to add that by leaving it up to the employee to assert his/her worth, you're playing into the fact that women are often taught, both subtly and overtly, that they should sit tight and wait for their worth to be recognized.

In other words, Women Don't Ask. By making people assert their worth and trusting them to get it right, you're likely to end up with a gender-skewed payroll.

Answer 7

If I am at the receiving end of these "open" negotiations, i.e., the employee, probably I would hate the idea. As much as I can drive a hard bargain, it is not my best virtue. As long as I have the facts, I can haggle till the cows come home, but is it really in my best interest ? For instance, when I am or my significant other, is buying a car, or say a close and valued family member doing the same, I wouldn't mind going to the dealership and make the salesman and the sales manager squirm. Why, because, I know the factory price for the vehicle. I know the dealer markups. I know the current sales incentives manufacturer offers to the dealer and I know what I can afford. Everything is just a google search away. Before I start the haggle fight, I know at which point I will be happy to stop, because I understand that, making a bone headed move and trying to drive the dealer to a price, where he will not be making enough money to cover the cost of selling that car, is not fair.

When I am negotiating for my salary raise, I do not have any solid data. All I have is a few "range" type salaries for people who may or may not be at my skill level and who have the same or similar job title like mine. So there is nothing solid to haggle on.Let's say my current salary is 100K and it is raise season. I checked the relevant data and see that people of my caliber, or whom I think are my caliber, are commanding an average of 110K salary. When my boss asks me "what do you think your raise should be" the logical answer would be 10%. Right ? But at the same time I know that, since the last raise, company revenue growth was a measly 2%. I will feel like s#!+ if I ask for 10%, for two reasons. If I am denied, I will feel that company doesn't realize my value. If I get it, I will know that someone is getting shafted to compensate my salary increase. Maybe rightfully so, because they were under-performing, but still, especially if they know me, it will be a point of animosity. If I am working with this under-performing person and once the raises are known (and they will be known by everyone due to the office gossip or a loudmouth at certain point) this uncomfortable situation is inevitable. Very bad working condition in my regard.

At this point, if the company or my boss came forward and said,

Okay guys, you know the company growth since the last raise was 2%. So, the raises will be no more than 5% this time around. Hopefully we can do better next period as a company and maybe we can compensate for this period.

Now, even I know I am worth 110K, I also know that. I can not go any more than 105K. Do I really want to leave the company for that 5K difference which I may get at another place but I will not know what their work style, or, management style is, and for all that I know I may be miserable. Whereas, here, at my current workplace, I know what to expect and it really doesn't bother me and in the words of original poster, it is quite a pleasant place to work. But, the boss had better stick to his word and do not give raises more than 5% to some other employees, because they drive a hard bargain at this point. If he or she does, it is the same as driving a dagger into my heart. I believed what you said and you deceived me. That "upto 5%" figure was a total BS. And you can be sure that, I am jumping ship at the first opportunity I find. Honesty goes a long way, is what I am trying to say here.

Of course, there is a 3rd angle that not everyone might be paying attention to. This is a sales position. And you do not want the mellow, go with the flow kind of person to be your sales person. You want someone who drives a good bargain. So, haggling for his or her raise might give you the clues about to which point this person can go to get what he or she wants. A kinda-sorta performance evaluation on the sly.

In the grand scheme of things, the method of bargaining for your raise, is quite controversial and in a heterogeneous environment where sales and marketing people have to coexist with introverted personalities, it will not bode well for obvious reasons. But if you are using it to measure the expectancy of your type-A personalities, it might be a tool to use for performance evaluations as well. All in all it is very environment dependent in my opinion, to be praised or poo-poo'ed, right off the bat.

Answer 8

Is it an optimal strategy in salary negotiations to let the employee decide?

No, it's not, there is a reason why norms are 'norms'

When dealing with people you cannot pigeonhole like this across the board.

It's viable and is actually done, but on a case by case basis, usually with long term well known employees, rather than en masse. Even then a whole lot more factors including intuition are involved.

Giving this much negotiating power to an employee is a terrible idea in general.