One of the companies where I worked as an executive was a private equity-owned turnaround. When the PE company was initially evaluating buying the business, one of the things that came to light in due diligence was that the company paid salaries significantly below market rates. In a financial review of the company’s income statement, this was viewed as an asset because the company was performing at such a high margin. What I quickly came to realize after joining the company was that paying below market-rate salaries was not only not an asset, it was a huge liability. The company’s compensation strategy left us hamstrung in our ability to hire and retain great talent and, despite realizing we needed to increase the team’s salaries, we were stymied by our budget, which had been set based on the original salary structures. My experience managing this company taught me the only compensation strategy which makes sense to build a winning business is to pay at or above market rate salaries. Here are the top 12 reasons why:
- You will get more high quality applicants: Assuming you include a salary range in your job ads, if you’re advertising a job at or above market rate salary you will receive far more resumes for consideration. Even if you don’t include a salary range in your job description, once your company has a reputation for paying at or above market, which is easy to accomplish thanks to sites like www.glassdoor.com and www.comparably.com, you will still get more resumes. It goes without saying that the more resumes you get the more likely you will be to find a great candidate.
- You will get pick of the litter: After you wade through the crush of resumes, create your shortlist, and go through interviews, some candidate will rise to the top. They’ll be the chosen one. You’ll be excited to work with them. In fact, it’ll seem like the job description was created just for them. You’ll extend your offer and wait with bated breath to find out if it was accepted. It’s far more likely it will be if it’s at or above market. I’ve been on the flip side of this scenario and have had some fantastic candidates turn down offers and slip away. It’s a huge bummer. You don’t want the good ones to get away.
- You won’t be rushed to make hiring decisions: Due to the increased volume of resumes we just discussed, the likelihood will increase for you to have a qualified candidate pool soon after you post a job. This makes it easy to extend an offer to the right candidate. On the other hand, when you don’t have a sizable candidate pool and you have a business urgency to fill a position, you can be forced to rush into hiring a substandard candidate. While it’s obviously never our intent to hire the wrong person, when we find ourselves in this situation sometimes we are forced to gamble.
- Your employee retention will be far higher: When your team members are satisfied with their salaries they will be less likely to start looking for other jobs. Additionally, when contacted by recruiters looking to poach your employee, they will be far less likely to listen to the recruiter. Even if they do, the recruiter will have to offer a substantial package in order to get your employee to jump ship and leave your company.
- It will be easier to work with recruiters: if you want to engage a recruiter to help you fill a position, they will find it far more appealing to work with you if you’re paying on the high end of the salary scale. They know the more attractive compensation package will make it easier for them to fill the position and get paid promptly. Additionally, if you’ll be doing a substantial amount of hiring volume with a recruiter and they know your positions are appealing and fast to fill, they may be willing to offer you a lower fee. This is less likely if you’re paying below market and they know it will be a lot of work to fill your position. If you’re far enough below market, some recruiters will even refuse to work with you.
- Employee morale will be higher: Look, I know there is plenty of data which talks about how little compensation has to do with employee morale in comparison with culture, learning opportunities, verbal recognition, and having a great boss. I’m certainly not minimizing any of those things. In fact, I agree they’re often more important than compensation. Regardless, it’s still common sense that companies whose teams earn more money will be more likely to have higher morale than companies which pay less. There may be a point of diminishing returns, but there is no doubt companies which pay far below market will inevitably have morale problems when their employees realize they’re being paid less than other people doing the same jobs in competing companies.
- Top talent ramps into full productivity faster upon hire: when you allocate the money to pay for top talent, you’ll quickly find that they reach peak efficiency far faster after their date of hire than less qualified employees. This can actually save you some of the higher salary expense in the form of increased productivity. As an example, if you hire someone with deep experience who hits the ground running and reaches peak efficiency 30 days after hire, in comparison to a more average hire who might reach peak efficiency 90 days after hire, you’ve gained more than 15% productivity from that role in year one.
- Top talent is easier to manage: not only does top talent perform better early on in their role, they take less management time and attention for the duration of their employment. This makes your life easier and frees up valuable management resources to focus on other tasks.
- There is an arbitrage opportunity: If you’ve ever managed a software engineering team you’ll know that a top end experienced engineer may offer three times the productivity and/or value of one of your more junior developers. Despite the massive disparity in contribution, it’s unlikely the senior engineer earns a full 300% of the more junior developer’s salary. Therefore, the peak productivity of your very best team members is actually cheaper in terms of dollars per contribution. The more senior team members you have, the more you are able to take advantage of this arbitrage opportunity.
- If you don’t pay at or above market, you will have more aborted hires: For all the reasons discussed above, if you’re paying below-market you will inevitably be extending offers to riskier candidates. While you may win some of these gambles, probability dictates that some percentage of these hires won’t catch on and will need to be terminated. This is tremendously costly, especially when you consider it probably took you longer to find these candidates and, since you knew they were more junior, you gave them extra time and support to ramp while hoping they would figure things out.
- If you don’t pay at or above market, the overall quality of your team will decline over time: If good employees stay in jobs when they’re well compensated, it’s equally true that poor employees stay in jobs regardless of their compensation. Lower performing employees tend to be less motivated, recognize it will not be easy for them to find a higher-paying job, and frequently become adept at doing just enough to stay employed. Over time, in this scenario, you will see your top talent leaving for more lucrative positions while your lower quality talent stays put and drags down your company performance.
- If you’re paying below market, prepare for budget variances: When you decide it’s time to replace an under-performing, under-compensated employee, you’ll need to either hire a similar employee at the same salary or increase the salary in order to attract a higher quality candidate. The need to replace an under-performing employee rarely raises its head in a polite and timely manner during the annual budget cycle, so most of the time you’ll need to bump up the compensation spontaneously, creating a negative budget variance.
After reading this list, it’s easy to nod and think, “Yep, this is all common sense. You get what you pay for. Why pay for a lower quality team?” But you’d be surprised at how much effort goes into figuring out how to cut salary expense. It’s almost always the largest expense in the company so it’s normally the first place leadership looks when forced to cut costs. If you’re ever put in this position, I urge you to resist adopting a compensation structure below market rate. Building a company is about assembling the best, brightest, most motivated and engaged team possible. If this is indeed the key ingredient for business success, paying at or above market rate salaries is a key strategy to help you recruit and retain the best possible team. Conversely, doing the opposite is a virtual guarantee your company will accomplish less.
Now I know all you folks in startup land are thinking, “That’s nice and all but I simply don’t have the cash.” I hear you and I’ve been there. What I can promise you is that the long-term benefits in productivity, quality, and culture far outweigh the expense. The quality of your team is 100% correlated with the quality of your results. If you’re committed to building a successful company with a strong foundation, the only way to do this is to invest heavily in your team. If you’re complete cash strapped, consider delaying some of your other hires to carve out the necessary budget to keep salaries at or above market. Pay people what they’re worth and let them shine. You’ll never regret it.
As a final thought, recognize that much of the cost of higher salaries will be recouped due to lower turnover, higher productivity, and faster hiring cycles. It may not end up completely cost neutral, but the total cash impact of paying high salaries will be far smaller than the simple variance between an above-market salary and a below-market salary.
What do you think? Is paying at or above market salaries the right approach? If you agree, please share this article!