Salary Increase Budget vs. Compensation Strategy

Key Takeaways

• Effective compensation planning goes beyond establishing an annual salary increase budget. Organizations need a clear strategy for distributing available funds that considers employee contributions, business priorities, and long-term organizational goals rather than relying on standard percentage increases.
• Salary increase strategies should balance employee needs with organizational objectives. Factors such as performance, market competitiveness, internal equity, critical skills, and position within salary ranges should inform compensation decisions, helping organizations recognize employee value while working within budget constraints.
• How organizations allocate their compensation budgets is just as important as the amount available. Whether using a top-down or bottom-up budgeting approach, HR teams need a structured process that aligns salary decisions with company priorities, supports consistent decision-making, and provides a clear rationale for how increases are awarded.

Determining a budget is key to your compensation planning cycle, and developing the strategy for that budget is critical. Employees want to feel appreciated and that their contributions are valuable. However, if they know everyone is receiving the same 3% increase this next cycle, then why would they stretch themselves to receive the same reward as someone putting in minimal effort? Let’s explore why simply applying a 3 to 4% budget doesn’t solve all pay decisions for your organization.

Median compensation salary range of the recent past

The 3% merit salary increase is the standard rate in corporate America. The article “3% Salary Increases Put Greater Focus on Variable Pay,” from the Society of Human Resource Management (SHRM) dated from 2017 indicated that 70% of employees fell in the median range and were those expected to receive the 3% increase.

This research is almost 10 years old, prior to the global pandemic that affected supply chain and everyday life. Since this article, inflation in the United States hit a 40-year high in 2022 when it reached 8.6%, according to Associated Press. There have also been spikes in grocery and gas prices throughout this time, making the 3% merit salary increase standard of yesteryear not as desirable as it might have once been.

This standard is not a one-size-fits-all approach either. More companies were predicting a 3.6% increase for 2026, which is a noticeable decrease from the prior year’s budget according to the WorldatWork article 2026 Salary Increase Budgets Project U.S., Global Caution. This decrease was due in part to geopolitical issues and trade concerns that left companies uncertain.

Data from that WorldatWork article showed a 10-year-high increase in both 2022 and 2023 with average salary increases reported at 4.2 and 4.4%, respectively. WorldatWork reports that predicted and actual models are often closely aligned, however, the slip in recent years back to the 3.6% model is reflective of cautious strategies and budget pressures.

Differentiate your compensation salary strategy

The 3.6% increase addresses the impacts employees are feeling on a personal level. It’s a better increase than the 2021 reported average mean of 3.0% by WorldatWork, however, not everyone in the organization will achieve that rate. There are different strategies at play and it’s dependent on your organizational goals how to award this monetary amount. A few ways we suggest assigning increase is by: performance, the employee’s position in their pay range, market position, critical skills, or internal equity.

The strategy you choose is the strategy that the managers or people leaders in your organization need to support and be clear in their communication and performance evaluations.

Evaluating based on performance needs to follow an objective criteria. During the performance reviews, that is the perfect time for people leaders to review job descriptions and hear from their individual team members on how their work is contributing to the duties assigned, quality of that work, and identifying areas of opportunities. Teaching employees to quantify their experience and tell their stories of success will be a moment of professional development and opportunity to advocate for their projects. This will also give them the chance to shine a light on projects they might not get to share on larger team calls or highlight behind-the-scenes work that is making tasks easier for others, even if it’s not front and center.

If choosing to assign increases based on an employee’s position in their pay range, you might need to consider their tenure, performance, and eligibility for promotion. Considering how their pay range aligns to a potential promotion, such as from software engineer II to a senior software engineer, might also affect your strategy decision. Be mindful of pay band changes between roles and the growth potential of the employee.

Similar to the performance-based increases, you might consider the critical skills assessment. In this, evaluate industry expectations and create a matrix that shows where employees’ potential in developing or strengthening those skills might lie. With AI being at the forefront at most technology company conversations, you might evaluate how teams are using AI to improve processes and in what way it’s improving project productivity. Only your team and your company leadership know what technical or critical skills are needed for success, so take the time to research and be clear in your findings. Having the cover of “because of AI” isn’t enough any more. Employees want clear targets on how they can improve and where they should focus their energy, and be rewarded for such.

Make the most of your compensation budget

In most cases, you are not the team setting the budget but the one expected to work with what resources are provided. You face the brunt from unit leaders or even the individual contributors when they are looking for some wiggle room in their increase because the larger population might assume you control the budget. Knowing what you can actually control is the power you need in planning the next compensation management cycle.

You understand your company’s values and culture best as part of the HR team. You might even have rebranded your team to include “people” in your title. At the heart of your work is the people in your organization, and the compensation management cycle should reflect the work of your people and the culture you want to emulate. The budget tells you what you can spend, but you decide how it is spent.

This is why it’s necessary to define the increase strategy and two hierarchical strategies you might consider are top-down and bottom-up.

Top-down salary increase budget strategy

The top-down budget strategy is an allocated strategy that assigns the budget by hierarchy, distributing the amount down through the position tiers. With this model, you distribute the budget at the top level by leader. This provides the opportunity to award company units based on performance, strategic goals, and other criteria you and your team establish.

Once you split the budget across the top, you then essentially create a budget for each unit that can then be allocated across the teams in the unit. For example, if you have a budget of $100,000 for the Engineering unit, you can then split that $100,000 between the three teams that make up that unit as appropriate.

This top-down strategy isn’t based on a standard percent increase across all units, instead it evaluates performance outcomes and their alignment to company strategy.

Bottom-up salary increase budget strategy

The bottom-up budget strategy is a formulaic strategy that looks at every employee record and works up through the hierarchy to distribute the budget. With this model, more time is needed as you evaluate each employee and how their performance is aligned to department and organization strategic goals.

The bottom-up budget strategy provides individual departments to determine how their performance is aligned to the overall company, whereas the top-down strategy is giving teams less flexibility but more objectivity. The bottom-up budget requires more time to give personal evaluations while the top-down strategy is a quicker approach.

Determine your strategy

We know you are also living the reality of inflation increases and global impacts. You understand, just like everyone in your organization, are facing the changes in real time and having to make adjustments as needed. That 3% standard increase for median-rated performance won’t cut it long term in our evolving economic landscape.

When given the salary increase budget, consider what you can control and what is best for the next phase of your company. Consider the company strategic goals, values, and culture. Then, develop a budget strategy that meets your people where they are at and where they can go.