Commentary: Thinking Beyond the One-Size-Fits-All Pay Cut

Three decades ago, General Electric Co. (GE ) nearly made a half-trillion dollar mistake. A young Jack Welch, having spent a year working overtime to distinguish himself from the pack, was handed the "standard" $1,000 raise. As Welch tells it, in Jack: Straight from the Gut, he was on the verge of quitting--a move that would have deprived future shareholders of billions of dollars in wealth. It wasn't until an executive slapped an additional two grand on the table that Welch decided to stay. "In bad economic times, you have to take care of your best," Welch said recently. "Go hug your best. Give them a raise while you're laying other people off."

GE no longer uses "standard" raises, but many other companies do. Now, as the economy weakens, a new trend has emerged: standard pay cuts, pay freezes, and reduced bonuses. Agilent Technologies (A ), Tribune Co. (TRB ), and DiamondCluster International (DTPI ) have all used this approach. Undoubtedly, they believe it's more egalitarian than cutting jobs.

STARK DIFFERENCES. But if layoffs are the unkindest cut, across-the-board pay reductions may be the most foolish. Treat the company stars the same as the laggards, and you risk losing your future Jack Welches. Instead, employers need to do the hard work of truly differentiating among their staff members. That means giving performance reviews with teeth and making it clear to one and all who's at the top of the heap as well as who's at the bottom. Most of all, it means giving your best people--the ones you'll need for the rebuilding effort when the economy bounces back--much, much more. To do that, some people (let's call them the deadwood) will have to make do with smaller raises, or none at all. "Never be afraid to overpay your overperformers and underpay your worst performers," says Buck Consultants' Randy Ramirez.

The results can be dramatic. Towers Perrin recently surveyed 721 North American companies and found that the most successful all had one thing in common: They were nearly three times as likely to give their best employees massive raises. Of course, leaving unproductive people out in the cold could result in many of them moving on. But as long as they're the bottom 10%, why worry? It's probably the right move for them as well as the company. Janet Fuersich, rewards-management principal at Towers Perrin, says the best companies viewed turnover as a chance to weed out laggards. Says Fuersich: "All companies have their back to the wall right now. It's survival mode. In survival mode, you keep the people who are going to keep you healthy."

Some companies have already learned that lesson. At Electronic Data Systems Corp. (EDS ), in any year, less than 40% of employees get a bonus, and only 75% get raises. At Wal-Mart Stores Inc. (WMT ), bonuses paid to store employees are based solely on the performance of their store. And at Gateway Inc. (GTW ), some employees may get 15% raises next year, while others may get nothing. Says Jack Van Berkel, senior-vice president for human resources: "If you get 15%, you're a star. And everybody is going to know that you're a star."

To be sure, companies that trim payroll costs through across-the-board pay cuts or freezes think they're doing the right thing. Melvyn E. Bergstein, CEO of DiamondCluster International Inc., a Chicago consultant, cut cash compensation for partners 15% in an attempt to remain cash-flow neutral without layoffs. It didn't work: he ended up cutting 10% of his workforce. CEO Edward W. Barnholt of Agilent Technologies Inc., faced with weakened demand and canceled orders, cut pay 10% in May as a matter of survival: "We just couldn't keep burning cash forever and stay in business."

That's the problem. Too many CEOs view salaries and bonuses as fuel for the corporate furnace when they should be looking at them as a tool to shape a better workforce, and more important, build a deeper bench of future leaders. Pay everyone the same--in effect telling your top performers they're no more valuable than the deadwood--and your best people will bolt. Treat them like the stars they are, and you'll win their loyalty forever. It's a Darwinian approach, but it works.

By Louis Lavelle

With Michelle Conlin in New York

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