Should we go high or low ? Salary increase vs cost of replacement


  • “Maybe it’s time we start to think about managing our talent a bit differently“.
  • Is your organization managing the recruitment budget very differently from the salary review budget ? In this episode, learn why it’s important to make cost comparisons across different budget lines in order to be more efficient in spending on people.
  • “When you recruit somebody external because one of your employees is leaving, you’re going to pay 10 to 15% more for the new person to do the same job as the old employee was doing, while to keep the original employee, you would give them only 3% as merit increase. So why would an employee be incentivized to stay at your company ?”
  • Watch the video to get the full training, or read the transcript below.


Merit increase or bonus, how do you reward performance ?
Reader question : “When shall I review salaries for staff on fixed-term contract ?”
Recruiters and the pay compression challenge



Hello and welcome to this episode of Compensation Insider. About a year and a half to two years ago, I read an article from Peter Capelli who is a renowned professor of Human Resources. I’m very proud because a few years ago I had the chance to meet him, and he signed me a copy of one of his books, Talent on Demand, which was written back in 2008, and which was really, really in advance in seeing some of the situations that we’re facing today, and that big corporations are starting to implement, like internal talent markets and even inter-company talent markets, and so on.

As I was looking for some information in the book, it reminded me of an article that I read from Peter Capelli writing about something which is dear to my heart as a Comp & Ben : the cost of a salary increase versus the cost of hire.

I will paraphrase what he was writing.

When the company needs to replace an employee

If a company is looking to recruit somebody to do the same job as an existing employee, they would pay a premium for that.

I think we’ve all seen that during recruitment. The company would pay 10% to 15% more for somebody to come and do the same job, while for an employee to stay in the job at the same time, in the same year, the merit increase budget might be just 3%.

3% is a number which has been prevalent in the US market in the last few years. I’m going to exclude COVID here, obviously, but in most cases it has been stuck at 3%, in Europe it was even sometimes less. Here in the GCC, we’ve had sometimes more, but let’s say 3%.

So he’s saying, when you recruit somebody external because one of your employees is leaving, you’re going to pay 10% to 15% more for them to do the same job as the old employee was doing, while to keep that original employee, you would give them only 3% as a merit increase.

Let’s imagine that is for taking on a bigger job. You would probably give a premium to somebody of 15% to 20% to come and join you, do a bigger job than what they were doing, while internally you might give employees 8% to 10% salary increase for a promotion.

So why would an employee be incentivized to stay in your company? That’s what we all see all the time :  employees say that they’re open for new job opportunities, because they know that if they want their package to increase, they have to go outside the company. They might love your organization. Their loyalty might keep them in place for a while, but it’s not necessarily going to keep them for a long period of time.

When budgets are handled very differently

The salary increases mentioned above are based on administrative budget rules and ways of thinking that are coming from a finance point of view, and sometimes, money pots are very siloed. I’ve already mentioned that in some of my trainings and maybe even here on Compensation Insider. For example, the money pot for recruitment is separate from the money pot for salary increases. The hiring manager has a lot more power and control over how much he or she spends when recruiting, than they do have when they are doing salary reviews and making sure that they’re trying retain their best people, because “we have a set of rules”, “we want to maintain equity”, blah, blah, blah. So we put more control on managing salary increases.

Often, the CFO will tell us, “Why should I give a 10% salary increase for somebody or put them on a retention scheme? I don’t need to, I’ll just go outside. Let’s play the numbers game. I don’t want to spend more money on employees.”

Think about it, when you’re replacing somebody, we usually say that the cost of replacement for professionals is about one year of salary and maybe six months for less-skilled positions. That means that in the first year, replacing the employee who left is going to cost you one year of their salary, 100%, plus 10% to 15% above and beyond to attract the new candidate, so let’s say 12.5%.

So it’s costing you 112% of that employee’s cost in the first year, just to replace the person who left.

Then every year it’s going to cost you an additional 12.5%, which is how much more you’ve had to pay for that new person in the job, instead of keeping the old employee. Let’s imagine if you have an employee turnover of 8% of people who are in positions that you want to keep and people who have the skills that you want to keep. So each year the cost of replacement of these valued employees is going to cost you 8% X 112.5%, which is 8.9% of this whole population’s salaries. It’s costing the company 9% of all the top performers’s salaries to replace those top performers who leave.

It’s time to think in a more purposeful manner

Peter Capelli was making a comment : maybe it’s time that we start to think about managing your talent a bit differently. I agree. If we are able, as Comp & Ben people, to show to the CFO and the CEO what is the cost of people who are leaving but that we don’t want to see leave, and compare it to the cost it would be to replace them, we can more easily convince them to put in place either a special salary increase for them if they’re lagging behind the market, whether that’s the median or some other percentile, or to put in place a specific retention scheme targeting those employees.

I hope that you find this way of thinking interesting, and it brings value to you, and that you will have an opportunity to implement it. I know that with the pandemic, not all organizations are facing this kind of situation, but as much as there are some organizations that have been very negatively impacted by COVID since 2020, other industries have actually had to struggle to find enough people to fill in the positions because their market has completely boomed. These might be in a more competitive marketplace, in terms of talent, and they need to think about how to minimize the cost of replacement, by making sure that the right ways of keeping people inside the organization are put in place.

Obviously, I don’t want to say that increasing the salary or giving a retention bonus is the only way to keep people. Give them opportunity to grow, giving them flexibility in terms of how and where they work, if that is possible in your organization. Making sure that they’re in an environment where they get frequent and honest feedback, where there is no unconscious bias, or it is reduced as much as possible, is going to be important too.

But as one of the tools in your arsenal to keep the people that you want to keep, getting management to be convinced, from the numbers, to do something special for those populations, is going to help. That’s it for today. Thank you for listening. I hope to see you soon.

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