A man smiles and pumps his fist in response to something he reads on a piece of paper. Pay raises make for happy and motivated employees, but business owners must apply them carefully to avoid breaking the bank. — Getty Images/fizkes

There’s a simple way to boost your employee retention rate: Pay your team more. Bonuses, raises and above-average salaries are the most compelling reasons for a person to stay in their job long-term.

Most employers would love to give their workers a raise every year. But financially, that’s simply not sustainable. For small business owners seeking to find the right mix of compensation while keeping an eye on their bottom line, here are some things to consider when offering raises.

Raise, bonus or another benefit?

The first step in considering whether or not to offer a raise is to establish some criteria for pay increases. Raises are just one way to show your employees that you appreciate their hard work; therefore, clarify from the outset what types of compensation you are able to offer.

A compensation mix will generally involve some of the following incentives:

  • Pay increase (raise): Usually a set percentage based on the employee's pay, raises result in a permanent increase in payroll expenses.
  • Bonus: A variable cost (one-time payment) tied to sales or production volumes, for example.
  • Benefits: Flex hours, a travel stipend or tuition reimbursement are examples of incentives that can be easier on your bottom line while still showing employees you’re invested in their success.

The fact is that most employers won't always be able to pay their employees more on a long-term, permanent basis. A tough business year might call for bonuses rather than pay raises, for instance. In your compensation policy, outline how you will reward employees with a combination of these incentives according to business conditions.

Create pay raise criteria

There is a time and place for pay raises. Many businesses offer small pay increases every year, but for small businesses, raises can be used to reward specific employee achievements. Consider offering raises for the following reasons:

  • To reward loyalty: Traditionally, businesses offer a pay raise to employees who stay at the company through thick and thin. A 10-year anniversary, for example, is a good time to give a raise.
  • When cost of living increases: This type of raise is company-wide, or applied to individuals if, for instance, you have an employee moving to open a new location in a more expensive city.
  • When an employee develops a new skill: “Merit raises are given when an employee earns a new skill set: I.e. becomes a Certified Public Accountant or obtains a Human Resources certificate,” wrote the experts at Timesheets.com. “Merit raises are typically only given to employees based on performance and company goals.”
  • To reward great work: Of course, if someone is consistently working hard, achieving results and contributing to the success of your small business, they deserve a raise.

Tying raises to performance reviews may have an inverse effect.

If you’re not sure your business can consistently pay higher salaries, opt for performance-based bonuses or an alternate incentive. “The variable cost structure of a bonus package helps business owners during times of low sales or production volumes. Pay raises are permanent, but bonuses keep payroll costs lower when the revenue isn't there to pay them,” wrote Investopedia.

[Read more: 5 Ways to Get Promoted in 2021]

How much should you offer in raises and bonuses?

Most raises fall in the range of 3–5% of an employee’s salary. When you compare this number to the cost of replacing an employee—estimated at 20% of their annual salary—raises seem pretty affordable.

There are different types of bonuses and, as a result, bonuses range in value. Some can be combined with others: For instance, an employee could receive a holiday bonus in addition to a signing bonus. Generally, though, performance-based bonuses are around 1–5% of an employee’s base salary.

Timing considerations for pay raises

Conventional wisdom suggests that the best time for pay raises comes during performance reviews or at the end of the year. However, tying raises to performance reviews may have an inverse effect.

“Consider moving away from annual salary reviews. They encourage staff to work harder in the months leading up to the review. A better option might be on-the-spot raises. Not only does it keep your staff on their toes, it gives them immediate feedback for a job well done,” said the experts at Xero.

[Read more: How to Ask for a Raise During a Pandemic]

Moving away from annual raises also removes the impression that pay increases are a “given.” “Showing up and doing your job earns you a paycheck, not a raise,” wrote Chris Ronzio in Inc. Raises and bonuses should reward your top performers when the company is doing well. Enforce raise criteria, proactively offer raises outside of performance reviews and offer alternate compensation when you can’t afford long-term pay increases to show your employees you value their time and effort.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published March 30, 2021