How to Determine Employee Pay Rates & Raises for Maximum Productivity

February 6, 2020

Table of Contents


Most people work to earn a living and that living is defined as the compensation employees receive in exchange for providing an employer with labor. Compensation generally consists of salaries, bonuses, commissions, and fringe benefits, such as paid vacation, health insurance, and retirement plan contributions. 

The pay rate is the price per unit of labor. In the U.S., that unit of labor can either be an hour (for employees paid by the hour) or a year (for employees who receive an annual salary). The pay rate is an important factor in employee and management relations. Employees are concerned with their pay rates as these rates directly impact their standard of living. Management is concerned with pay rates since paying higher wages will increase production costs and negatively impact the bottom line.

In this article, we’ll discuss how to determine employee pay rates, when pay raises are warranted, and non-cash ways to reward employees for exemplary job performance.




Factors That Determine Pay Rates


A company’s compensation package generally includes base pay, incentive pay, and benefits. To determine employee pay rates, companies must strike a balance between what they can afford and what will motivate employees. It’s important that this balance is achieved because the ramifications of mediocre pay rates are reduced productivity, poor performance, and high employee turnover. 

There are other social, economic, legal, and political factors that can influence pay rates and make compensation management a complex part of doing business. 

The eight factors that influence the determination of pay rates are:

  1. Ability to Pay 
  2. Supply & Demand
  3. Cost of Living
  4. Bargaining of Trade Unions 
  5. Productivity
  6. Government Regulations
  7. Training
  8. Prevailing Market Rates


Ability to Pay

The wages paid to employees will depend upon the employer’s ability to pay, i.e. the profitability of the company. If the company is marginally profitable or experiencing losses, it likely can’t afford to pay a competitive salary and may not be able to recruit top talent. If the company is profitable, it can afford to pay at least a competitive wage and attract and retain premium employees. During periods of prosperity, employees are generally paid higher wages as management’s way of sharing profits with them.


Supply & Demand

It’s crucial for companies to be aware of the availability of relevant talent in the geographic area where they’re recruiting. When the unemployment rate is low, job openings are plentiful. This causes employers to fight hard to attract and retain candidates with certain skill sets and experience.  In this “job seeker’s market”, employers have to pay a competitive wage or find candidates bypassing their organizations for more lucrative opportunities. Employee satisfaction is a key contributor to a company’s success so offering a compensation package that attracts and motivates highly desirable candidates is essential.  

During periods of high unemployment, employers have a larger candidate pool to choose from. Candidates aren’t as selective regarding wage rates as their primary objective is to simply find some form of employment. In this scenario, employers can often pay lower wages.


Cost of Living

Most people work to earn a living, which they do by providing labor in exchange for money. The cost of living is a major factor in determining compensation and is largely dependent on location, more specifically, the cost of housing. That’s why you’ll often find that salaries in large urban areas are higher than salaries for similar positions in more rural areas.

Wages are also affected by the Consumer Price Index (CPI). An increase in the CPI will decrease the purchasing power of employees and they will demand higher pay. When the CPI is stable, regular pay increases may not be warranted.


Bargaining of Trade Unions

The bargaining power of trade unions has a direct impact on wages paid to employees. The stronger the trade union, (determined by its membership, financial position, and type of leadership) the more likely employees are to receive favorable working conditions and higher wage rates.





Productivity largely depends on the availability of capital assets such as machinery and automation, and on the availability of natural resources, which are required as inputs in the production of products and services. A company’s effective and efficient use of these inputs to produce socially desirable outputs impacts the level of wages employees receive. When production levels are optimal, employees can be paid more and those who are most productive receive pay that’s at the upper limits of the pay scale. To get the most from employees and, thus, increase productivity, compensation is often based on productivity. If productivity increases beyond a certain level, it’s common practice to issue bonuses to employees.

Another factor that affects productivity is the political and social climate of the country or region in which the business is located. Especially in corrupt countries, many governments interfere with business activity or try to receive bribes from businesses for the benefit of specific government officials instead of using the money as tax revenue for the benefit of the entire nation. This mismanagement of the country can reduce the productivity of its people.

Many businesses with strong unions are often less productive, since they’re constrained by the unions’ demands or by union contracts. For example, unions often resist automation, and other cost-saving changes to project jobs. 


Government Regulations

In order to not only improve the working conditions of employees but the wages they receive, the federal government will pass legislation such as minimum wage laws which are part of the Fair Labor Standards Act (FLSA). Minimum wage laws protect the interest of employees by mandating that wages can’t be set below a predetermined level. Companies are liable for paying employees as instructed by the government. 

In underdeveloped countries, the bargaining power of the labor force is weak so employers exploit workers by paying them dismally low wages. However, India’s Minimum Wages Act of 1948 was passed by government to ensure employees a living wage.



The amount of education or training that an employee has attained also has an impact on how much the employee can earn. After training, it’s presumed that the employee will be more productive and more desirable to employers who compete for employees through the wage rates they offer. If a considerable amount of time was invested in training or education, then it should lead to higher-paying jobs. If not, people would pursue easier work or work that doesn’t require extensive education or training. 


Prevailing Market Rates

The prevailing wage rate for a particular position in a particular market (location) will influence the rate that candidates will expect to receive. When asked for salary expectations, savvy job seekers will conduct research to find out the “going rate” in their area for a position that’s most similar to that for which they’re applying. Employers would also be wise to conduct similar research to ensure they’re prepared to offer a wage rate that will not only entice candidates but motivate them to stay once hired.


What if You Can’t Afford to Pay Market Rates?

Fortunately, it’s possible for employers to attract top talent even if they can’t offer the most competitive salary. In this case, employers need to come up with creative ways to supplement their compensation packages. Non-monetary forms of compensation such as professional development and technical training can go a long way in retaining a qualified workforce. Employers can also actively recruit from areas where pay rates are lower or let employees work from home or from an office that’s closer to where the employees live.




Non-Monetary Forms of Compensation


In a 2019 survey conducted by Forbes and market research firm Statista, 50,000 employees at U.S. companies and nonprofits were asked: “How likely would you be to recommend your employer to a friend or family member?” This question was posed along with more than 30 detailed questions.

When the survey results were compiled, Trader Joe’s topped the list with an impressive score of 9.59 out of 10. Although employees found remuneration to be favorable (employee pay is not only competitive but minimum pay is based on the market a store is in; crew members also qualify for raises every six months), there were other factors that likely contribute to employees being satisfied and highly motivated.

Crew members feel valued and part of a team in which each member contributes to the company’s success. Trader Joe’s accomplishes this by honoring their commitment to eliminate bureaucracy and take the input of all employees into consideration. Crew managers can evaluate their managers so everyone is held accountable and the abuse of authority is minimized.

Employees also have a say in how much time they spend on tasks. For example, Trader Joe’s management understands that crew members may not want to spend an entire workday on a single task. As a result, employees enjoy coming to work, are friendlier, and are willing to go the extra mile. 

Trader Joe’s is also generous with paid time off (PTO) and offers flexible hours. The company credits its attention to employees’ needs for their high employee retention rate.

The takeaway? Trader Joe’s has focused on creating a supportive work environment in which all employees feel they’re an integral part of the company’s success. And, this is something that doesn’t cost anything. This shows that a company can make employees happy in ways that don’t involve money.

Here are some more non-monetary forms of compensation offered by high-ranking companies on the Best Employers list:

  • Diversity program
  • Pet-friendly workplace
  • Remote work option
  • Reduced or flexible hours
  • Decompression capsules – Little soundproof pods for taking a nap
  • Recreation room with pool table, ping pong table, Foosball, arcade games, rock climbing, onsite volleyball, and roller hockey
  • Free onsite daycare
  • Free onsite gym/gym classes
  • Personal and professional development


Reasons to Give Employees Raises


A hot topic in the workplace, money is one of the top reasons employees leave jobs. The lack of money, that is. Employees have come to expect an annual pay increase and if they don’t get it, employers could have some “unhappy campers” on their hands. 

If you’re finding that you and your team aren’t on the same page regarding how frequently they receive raises, here are some non-tenure-based reasons to increase an employee’s compensation. They’ll help you keep your team happy without hurting your bottom line.


Employee Takes on More Responsibility

If you have an employee who has been with the company since its early days, he/she is likely tackling numerous tasks. As your company grows, that employee’s level of responsibility may increase significantly. It’s not uncommon for early employees to offer the benefit of their experience by taking on the responsibility of training new hires. 

For the sake of employee morale and in the spirit of fairness, the senior employee’s contributions should be recognized by way of additional compensation.


Employee Is More Autonomous

A brand new employee may require more oversight and not be able to “hit the ground running” from day one. The time that the owner or manager expends in providing guidance to the new employee has a cost.

As the employee becomes more comfortable and confident in performing her job, management doesn’t need to monitor her as often. She becomes more autonomous and is, therefore, more valuable to the company and deserving of a raise.

 During the hiring process, increased autonomy is anticipated with promising candidates so an employer may introduce the idea of “planned raises”. These planned raises can be scheduled at regular intervals from the date of hire. This is a great way for new hires to “prove their worth” before they’re offered a higher pay rate.


Employee Is More Efficient

Similar to autonomy, employees who can produce more during a workday by increasing efficiency are getting more done for the employer. For instance, if they’re able to produce the same amount of work that used to take them twice as long, they’ve become more valuable to the company.

While an employee might be producing the same output as before, by completing it in half the time, he’s able to move to a new project more quickly. Once an employee can work more quickly than they could, say six months ago, it’s time to reward him with an increase in pay.


You Want to Keep Up With the Market

If you find yourself needing to hire more employees for the same position that you filled five years ago, you can’t expect to offer the same salary today that you offered five years ago. If the market rate for the position was $55,000 five years ago and today the rate is $70,000, it’s a good idea to bring your current employee’s pay up to the current market rate of $70,000. If not, the employee may seek that rate with another employer.

If you belong to a trade organization, ask other business owners what they pay for similar positions. You could also use online tools like, Glassdoor, or Indeed to get pay rate information for your area.


Cost of Living & Pay Increases

Although the cost of living is a major factor in determining pay rates, it shouldn’t directly affect pay increases. For example, the inflation rate and the Consumer Price Index (CPI) could increase by marginal amounts. Employers should aim to give raises that are representative of an employee’s increased performance which means the pay rate increase needn’t match the inflation rate and CPI increase.


Mutually Beneficial Raises 

If your employees feel they’re not being fairly compensated or recognized for their hard work, they’ll leave. If you treat your employees well, they’ll work even harder for you and genuinely enjoy doing so. Recognition and compensation don’t always have to be monetary. Be creative and offer perks that employees find valuable. You don’t want to create an environment where solid employees start to leave because of money alone. This could be problematic for the health of your business.  



Impact of Employee Performance on Pay Raises


While there are several reasons to reward an employee with a pay increase, employee performance primarily drives an employer’s decision to do so. Employees who perform at a higher level and demonstrate greater commitment to the company are rewarded with higher pay. High performing, superior employees can expect to receive as much as 4.5% to 5% and, in some cases, up to 10% based on their performance.

What factors in an employee’s personal performance rating? Employees are rated based on how they met, didn’t meet, or exceeded the goals set forth by management. They can also receive pay raises for using soft skills (leadership, effective communication, problem-solving, and successful collaboration) that had an impact on the company’s performance.

There’s a good reason for basing pay raises on performance. If high-performing employees were compensated the same as low-performing employees, where’s the incentive for the latter group to step up their game? The lure of a financial reward can serve to motivate under-achieving employees to be more productive and dedicated.  

If you, as a business owner or manager, are faced with a situation in which an employee shows considerable displeasure over the amount of a pay increase, provide feedback. Sit down with the employee and make sure there’s a mutual understanding of how pay increases are determined and what constitutes outstanding performance. Let the employee know what he/she can do to improve performance and contribution so that he/she can qualify for the highest possible pay raise in the future.


Talent Management Strategies

If your company effectively employs talent management (TM) strategies, you should experience fewer complaints from employees regarding pay raise percentages. Johns Hopkins University defines TM as, “a set of integrated organizational human resources (HR) processes designed to attract, develop, motivate, and retain productive, engaged employees.”  Simply put, it involves matching the right people with the right jobs to achieve the goals set forth by company leadership.

TM requires the HR department to collaborate with managers/supervisors to put the strategy into action.  A solid TM strategy will address four critical areas (often referred to as the Four Pillars of TM):

  1. Recruitment – Attracting talented candidates
  2. Performance Management – Once hired, talent is expected to perform at a high level. Performance reviews, one-on-one meetings, and reward and recognition programs are common procedures for measuring and improving performance.
  3. Learning and Development – This pillar allows employees to further develop the skills needed to meet their performance goals and help the company meet its strategic goals. It includes everything from ongoing training to workshops. 
  4. Retention – Retention involves keeping high-performing talent with the company for as long as possible. This leads to increased productivity and the successful achievement of the company’s strategic goals.

The aim of a TM strategy is to attract ideal candidates to the company and further develop them once hired. These employees are expected to exhibit a high level of personal performance which helps improve business performance. Since reward and recognition programs are a part of the TM strategy, these high-performing, highly motivated employees are expected to be compensated (via pay raises) in accordance with their performance ratings. 


Do Employers Have to Give Raises?


If you’re a business owner who hasn’t given your employees a raise in years, shame on you. Although pay increases above the minimum wage aren’t required by law and, as a business owner, you have the right to change your mind about increases, rewarding employees for outstanding performance is the fair thing to do. You shouldn’t need the Fair Labor Standards Act (FLSA) to mandate that you treat your hard-working, loyal employees well. 

So, to answer the question “do employers have to give raises,” they’re not required to do so by law. But, if they want to retain highly qualified employees, then the answer is “yes”. Otherwise, their employees will abandon them for greener pastures.



What’s Considered a Good Pay Raise?


The attractiveness of a pay raise is largely a relative concept. The same pay increase can make some employees giddy, yet cause others considerable distress as they wonder why they didn’t receive more. This raises the question:  “What’s considered a good pay raise?”


Average Pay Raises

To answer the question, let’s first look at the average U.S salary increase in 2019. According to Aon’s annual survey which is based on responses from more than 1,000 companies, the average pay raise was expected to be 3.1%, the highest since 2008. However, the amount that companies budgeted for variable pay (which includes incentives and bonuses) decreased by its largest margin since 2010. As a result, total cash compensation was actually expected to decline slightly, from 15.5% of payroll to 15.2%.

Nevertheless, companies expected to pay their best employees an average raise of 4.6% according to a survey by risk management and advisory firm Willis Towers Watson. Employees with an average performance rating were expected to only receive a 2.7% pay increase.


Salary Increase Budgets

In the U.S., employers’ salary increase budgets rose by 2.3% for the 12-month period ending in September 2019. In September 2018, the increase was 2.6%.

The WorldatWork “2019-20 Salary Budget Survey: Top-Level Results,” predicts that 2020 salary increase budgets will rise by 3%, an increase from budgets of 2.9% in 2019. Less than 21% of U.S. employers are expected to increase their salary increase budgets for 2020. The majority of employers plan to keep merit increase budgets the same.

In Mercer’s 2019/2020 US Compensation Planning Survey, the average merit increase budgets for 2019 and projections for 2020 also indicate a salary budget increase of 2.9% for 2019 and projected increase of 3% for 2020. These findings are consistent with the past five years. According to Mercer, “All employee groups saw a year-over-year promotional increase, with average promotion salary increases (as a percentage of base) at 9.3%, ranging from 8.3% (Support) to 11.1% (Executive). However, while the promotional budget amount has slightly decreased, the average promotion salary increase received by an individual has increased by 1.5%.”

These projections reflect the average increase that employees received in 2019 and can expect to receive in 2020. However, they’re not the percentage increases that employees can expect across the board. Even when employees perform similar roles, employers are differentiating pay based on performance at an increased rate.


Pay Raises Vary by City

While the average performance-based pay raises across different industries or job types don’t change significantly, there are minor variances. According to Aon, employees in industries like education and transportation were expected to receive a below-average raise of 2.6% and 2.8%, respectively. Workers in the construction industry were expected to see a higher pay increase of 3.4%.

Across the U.S., the average expected pay raises vary from city to city. While most employees expected to receive raises consistent with the national average, employees in two of California’s largest cities were projected to receive an above-average pay increase. According to Aon, the average worker in San Francisco and Los Angeles will see an increase of 4% and 3.7%, respectively. 

The Consumer Price Index (CPI) increased 2.2% over the 12 months leading up to end-of-year 2018, so the average worker fared only slightly better than he/she did a year ago. Therefore, those who depend on bonuses and raises may not be able to keep up with inflation. 


Job Switching & Pay Raises 

Employees usually need to change jobs in order to maximize earnings over a long period. At one time, employees could expect an average salary increase of 10% to 20% if they switched jobs. While increases of that magnitude are no longer commonplace, switching jobs is still considered to be the most common route to the best pay raises.

If an employee stays at the same company, pay increases may be limited by current base salary because companies often have a narrow range within which they can raise pay. However, by considering employment elsewhere, the employee isn’t bound by those limitations. 


Other Ways to Raise Pay 

If you’re thinking about raising an employee’s pay, keep in mind that increasing base pay isn’t the only way to reward employees. In some cases, an employee may actually come out ahead with a generous bonus in addition to a moderate raise.

For example, if you have an employee with an annual salary of $70,000 and you offer a meager 1% raise, base pay would only increase by $700 which isn’t enough to keep up with inflation. But if you also offer a bonus of $3,500, the employee’s total compensation would increase by 6% (1% base pay increase plus 5% bonus). Based on Aon’s survey, this total compensation increase is better than what most top-performing employees would receive. 

Again, you could also emphasize any non-monetary perks that you offer such as professional development. While this reward won’t immediately put more cash in the employee’s pocket, it can boost the employee’s future earning potential. 


So, What is a Good Pay Raise?

A 3% to 5% annual pay increase may not sound like much but in today’s economy, it’s the norm. The size of a raise will vary greatly by an employee’s experience, tenure with the company, geographic location, and the company’s industry. When determining the amount of your employees’ pay raises, also take benefits and non-cash benefits into consideration as they’re part of the total compensation package.


The Cost of Employee Benefits Increases Total Compensation 

Some employees may be disappointed with the amount of their annual pay raises without realizing how the cost of their benefits adds to the total compensation provided by the employer. 

According to the U.S. Bureau of Labor Statistics, employer costs for state and local government employee compensation averaged $51.66 per hour worked in September 2019. Wages and salaries averaged $32.19 per hour worked and accounted for 62.3% of total compensation costs, while benefits averaged $19.47 and accounted for the remaining 37.7%. 

Among state and local government occupational groups, total compensation costs ranged from $35.85 per hour worked for sales and office to $62.08 for management, professional, and related occupations. Among industry groups, total compensation costs were $54.10 per hour worked in the education and health services industry and $49.71 in public administration.


Total benefit costs ($19.47) include paid leave ($3.87), supplemental pay ($0.51), insurance ($6.07), retirement and savings ($6.17), and legally required benefit ($2.85) costs. The average total benefit costs in the public administration industry were $20.95 or 42.1% of total compensation.


Do you want to see an average of the cost to employers to offer employee benefits? Mercer’s Quick Benefit Facts flyer contains the annual limits through 2018 for various employee benefit purposes, including figures for 401(k) and 403(b) contributions, annual retirement plan limits, the definition of highly compensated employees, and Social Security taxes and benefits.



Final Thoughts – How to Determine Employee Pay Rates & Raises for Maximum Productivity


The topic of employee compensation can be a touchy one. Employees want to receive as much pay as possible while companies try to strike a balance between keeping employees happy and maintaining the financial health of the company. Employers need to keep in mind that the financial health of the company depends on having a stable, motivated workforce.  If employees are put in the position of having to resign in order to receive adequate compensation, this can be problematic for companies. 

Highly-skilled and motivated employees are responsible for a company’s success. Therefore, they should share in that financial success by way of pay raises or bonuses. Employers who realize this and put it into practice will reap the benefits for years to come.


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