As a small business owner, employees are one of your most valuable assets; attracting new hires and retaining existing talent is vital for helping your company grow, thrive, and succeed.
And the way to attract and retain that talent? Offering competitive pay raises.
Let’s look at the importance of offering competitive pay and what you can do to make sure your raises stay competitive.
What Is Competitive Pay?
Competitive pay is a compensation package that's better than other small businesses' in your industry and region. Typically, competitive pay is the average salary for a role in a given geographic area plus a percentage that puts the salary above average for that area.
But competitive pay isn’t limited to an initial hourly wage or salary. For pay to remain competitive, you need to offer raises to your existing employees throughout their tenure with your company.
What Are Competitive Pay Raises?
Generally, giving your employees an increase in pay that’s above the average rate would be considered competitive. In 2022, the average annual salary increased by 5.1%—a significant increase from the past two decades, where employee raises stayed consistent, hovering in the low 3% range.
In 2023, a competitive pay raise would be more than 5.1% of an employee’s regular pay. However, this percentage should only serve as a baseline; you need to take into account other factors, such as your location and job description, to determine if a pay raise is, in fact, competitive.
Why is it Important for a Pay Raise to Stay Competitive?
Now that you know what competitive raises are, let’s jump into why it’s so important that those raises stay competitive.
Attract and Retain Talent
Many companies aren’t paying their employees competitively. For example, according to data from CNBC, 74% of workers claim their current wages aren’t sufficient to keep up with rising costs or the pace of inflation.
Because so many companies aren’t paying their employees competitive wages, it presents an opportunity for your business to stand out as a place people want to work; offering competitive wages can make it easier to attract top talent to your company—and then regularly offering raises in pay can help keep them there.
Benefit Your Bottom Line
Because offering competitive raises can help you retain talent, these raises can also help your bottom line. For example, the average cost of hiring a new employee is $4,700, according to the Society for Human Resources Management (SHRM).
However, the true cost of recruitment can amount to as much as three to four times the position’s salary when you account for “soft costs,” like screening applicants, holding interviews, and the productivity loss of a position going unfilled. By doing what you can to keep employees with your company—including making sure their wage or salary raises stay competitive—you can lower or, in many cases, eliminate those hiring costs.
The point is, competitive pay lets small businesses attract and hire new talent fast. It also helps retain existing employees, avoiding the cost of turnover and other issues, like low morale from employees being overworked when the company is dealing with staffing issues (which can lead to diminished productivity or employees leaving their roles).
Top Things to Consider
Making a raise competitive isn’t quite as simple as tacking on a percentage to an existing wage. So, what else should you think about? Here are some top things to keep in mind when figuring out how much to boost team members’ salaries:
- Competitors’ pay ranges: Similar small businesses hire employees from the same talent pool. Competitive pay can be the differentiator between an employee taking your offer (or remaining employed at your business) or choosing to work for a competitor. Search through local job boards and job listings to get a sense of what your competitors are paying for similar roles. Then, offer more competitive pay raises based on your financial situation and other research.
- Inflation: Inflation is the rate at which prices increase for products and services. As inflation rises, purchasing power decreases. This means your employees’ wages don’t stretch as far as they once did. During periods of high inflation, you can offer raises that surpass the inflation rate—which measured 6.5% in December 2022—to help offset the decline in purchasing power and keep your small business competitive in the job market.
- Seniority: To ensure increases in pay stay competitive, you need to determine who qualifies for higher pay. Offering a higher base salary to new hires without increasing pay for current employees can lead to wage compression. Avoiding wage compression—and all its downsides—requires determining which positions command higher salaries and which, if any, are still competitive.
- Job specifics: The criteria for competitive compensation differs for each position in your business. For example, competitive pay for an entry-level position might be considered a few cents over minimum wage, whereas highly specialized roles command much higher salaries. Consider the job description, responsibilities, title, and required experience when calculating increases in pay to ensure you remain competitive within the labor market.
- Budget: Your budget plays a significant role in determining and offering pay increases. If your budget is tight, it might be difficult to ensure raises stay competitive. Take a look at your revenue and expenses to find out how you can increase pay without threatening your bottom line.
- Cost-benefit analysis: A cost-benefit analysis is a process in which you compare the benefits of an action to the cost of taking that action. For example, you can conduct a cost-benefit analysis to determine if it’s worth increasing the price of some of your products if it means you can afford to offer higher salaries for open positions, resulting in more competitive pay.
How to Calculate Competitive Increases in Pay
It’s a delicate balancing act to ensure raises stay competitive without harming employee morale or compromising the financial well-being of your business. Follow this step-by-step guide to help you figure out what, exactly, competitive pay means in your area and industry.
Step 1: Research the Local Labor Market
Before you can calculate competitive pay, you need to research and analyze your local job market. In many cases, the national average salary doesn’t accurately reflect your area’s cost of living, the number of available job seekers, or your state’s minimum wage.
Fortunately, this information is readily available through the U.S. Bureau of Labor Statistics (BLS). BLS wage data can help you narrow down average salaries by occupation based on your specific geographical data, such as your state and metropolitan area.
For example, the national mean hourly wage for a plumber in May 2021 was $30.46, and the mean annual wage was $63,350. In contrast, the mean hourly wage for a plumber in the Boston-Cambridge-Nashua, MA-NH metropolitan area was $41.03 (or $85,340 annually). In other words, plumbing companies in the Boston-Cambridge-Nashua metropolitan area would need to pay hourly wages that exceed $41.03 if they intend to offer competitive pay raises.
From there, you can reference the BLS Consumer Price Index (CPI) to track the impact of inflation on your area and determine its cost of living.
This data can be used alongside your market research into competitors’ salaries to establish a solid baseline for competitive increases in pay.
Step 2: Determine How Many Open Positions Are Available
You need to do well by your employees by offering them competitive raises—but you also need to protect your bottom line. This means avoiding overhiring for open positions or taking too long to fill a vacant opening.
Hiring more employees than necessary increases your labor costs, potentially prompting eventual layoffs. On the flip side, taking too long to fill a position can hamper productivity and increase stress on your existing employees. As a result, they might start looking for work elsewhere or causing workplace issues.
Determining your staffing needs can help you maintain consistent productivity without overburdening—or losing—your existing workforce. It also ensures that your labor budget goes towards competitive pay for your existing employees—instead of using that budget to hire additional employees you don’t actually need.
Step 3: Establish a Budget (and Stick With It!)
Competitive pay rates need to fit into your budget. Before you begin increasing base pay and offering competitive increases in pay, figure out if your small business can afford to do so—and if so, by how much.
In some cases, this depends on the financial strength of your business and the local economy. Though you should prioritize remaining financially solvent, it might make sense to reduce other expenses or dip into your discretionary funds to offer pay increases and reduce employee turnover.
Remember, too, that some positions demand higher salaries than others—so make sure your budget allows for specialized and in-demand roles that you may need to support a healthy, thriving business.
Step 4: Evaluate Compensation and Raises Across Your Company
Based on your situation, it might make sense to increase entry-level pay beyond the minimum wage or to hire a new manager with a higher salary than your last hire.
But these situations can cause resentment among your existing staff, especially if older, loyal employees aren’t earning as much as a new hire.
In other words, consider offering pay increases to your existing employees as you increase the base pay for open positions. This can require some budgetary ballet, but it helps avoid dissatisfaction, low morale, and turnover.
How Often Should You Offer Pay Raises?
Annual increases in pay, often after favorable performance reviews, are common. However, some human resources professionals recommend decoupling reviews from compensation to, instead, offer on-the-spot increases in pay:
- To reward loyalty
- When the cost of living increases
- When employees develop new skills or surpass expectations
- After a promotion
- If your company outperforms its goals
Alternatives to Raising Pay
Sometimes, it’s simply not possible to offer competitive increases in pay without jeopardizing the financial health of your business.
Even in these situations, it’s possible to offer competitive compensation that can help you fill open positions and retain employees by:
- Increasing bonuses and commissions: Incentive pay, like bonuses and commissions, are independent of an employee’s base pay. Incentive pay plans are often based on an employee’s performance and promise a portion of the revenue they generate. Increasing the size or percentage of an employee’s bonus or commission can be a viable and cost-effective alternative to a competitive pay bump.
- Providing other bonuses: Other bonuses, like retention and discretionary bonuses, are lump sum payments on top of an employee’s base pay. These bonuses are used to reward loyalty or celebrate success and can contribute to an effective compensation strategy.
- Improving benefits and additional PTO: Employee benefits can contribute to competitive compensation packages in lieu of salary increases. When an employee asks for a raise you’re unable to provide, suggest positive changes to their employee benefits, like better insurance coverage, an improved retirement plan, more paid time off, or access to professional development opportunities.
- Offering workplace flexibility: Did you know 59% of employees consider workplace flexibility more important than salary and other benefits? Options like flex time and remote work can give your small business a competitive advantage on the job market and improve employee morale without eating into your bottom line.
- Giving employees equity and stock options: Offering your employees free or discounted stock options can incentivize them to work harder and have some skin in the game without impacting your budget. At the same time, these employees reap the rewards of your company’s success through a tangible financial benefit.
Best Practices to Ensure Pay Increases Stay Competitive
As a small business owner, it’s important to continually reassess employee pay increases to ensure you’re remaining competitive. These best practices can help you maintain a competitive advantage in your local labor market while attracting and retaining the best talent.
Maintaining open lines of communication between you and your employees can mitigate discontent and avoid turnover. During meetings and performance reviews, be candid about your pay scale and incentives. Make sure both new hires and existing employees understand when they qualify for an increase in compensation and how those raises are calculated.
Employees like to feel appreciated. Personal milestones, like work anniversaries, present great opportunities to reward an employee for years of loyal service—especially when paired with a competitive increase to their salary or wages or a one-off celebratory bonus.
In addition to celebrating personal milestones, significant achievements—like surpassing a sales quota or landing a huge client—offer opportunities for you to recognize and reward employees for their hard work with higher pay or other competitive compensation.
For example, you can offer a high-performing salesperson an incentive like an improved base salary or an increase in commissions. This encourages them to drive additional revenue while recognizing their hard work and recent accomplishments.
Your employees deserve to know when and how to qualify for a competitive pay raise. However, they also deserve equal compensation relative to their role, job description, experience level, and skill set.
This is called internal equity, which entitles employees of the same or similar role to equal compensation. In other words, every employee that shares a job title should earn compensation within a predetermined salary range, as well as similar benefits—like insurance coverage and time off.
Frequently Asked Questions
Still have questions about how you can ensure increases in pay stay competitive? Let’s look at some common questions small business owners have.
Is competitive pay a red flag?
Competitive pay isn’t a red flag, though there’s a caveat. When you write or approve a job description, explain why and how your pay is competitive—and what it’s competitive toward, like the industry, local job market, or cost of living.
In other words, be transparent.
What is a good yearly raise?
A good yearly raise is over 5.1% of an employee's annual salary. Why is that? Because the average wage increased by 5.1% in 2022, which means to be competitive in 2023 and beyond, you should consider offering more than that.
You'll also want to consider factors like your local cost of living, the effect of inflation, and what other businesses in your industry are paying employees and new hires.
Is a 5% raise every year good?
A 5% raise is slightly below the recent average pay raise in the U.S., which was 5.1% in 2022.
While experts predict salaries will go up by a little less in 2023 (by 4.6%), 5% might still not be enough if other small businesses in your area and industry take the inflation rate and other factors into account when offering competitive pay raises.
How can raises to compensation stay competitive if I don’t have the budget?
If you can’t afford to pay higher wages, consider alternative forms of compensation, like increased commissions, more time off, or workplace flexibility. These methods can improve employee morale, retain employees, and entice new hires without a significant impact on your bottom line.
Use These Tips to Ensure Pay Raises Stay Competitive
As a small business owner, maintaining your bottom line and offering stellar compensation packages is a delicate balancing act. Competitive raises help attract and retain loyal employees, but they also need to make sense for your budget.
By planning an effective compensation strategy that considers both average salaries and other incentives, like bonuses and benefits, you can offer great raises that help your business—and employees—thrive.