A Little Less in the Envelope This Week

With companies cutting back, something's got to give--and in this downturn, it may be your pay package

A decade ago, the deal didn't get any better than at IBM (IBM ). Big Blue's generous compensation packages offered medical coverage that was virtually free, cushy pensions, and salaries that rose dependably each year. Today, those guarantees are gone.

The convulsive change--in which IBM ripped out the ramparts of its entitlement culture and replaced them with more pay-for-performance and leaner benefits--began in the early 1990s and took on an added urgency during the late '90s war for talent. Cast as the crusty stalwart in the battle against all those cash-gorged startups coughing up options, IBM realized its compensation structure was about as appealing as its old Selectrics. A workaholic up-and-comer could exceed every goal and still wind up with the same raise as the incompetent in the next office. Worse, fewer than 1,000 employees had stock options. In a climate that was all about risk and reward, IBM was more about security and one-size-fits-all pay.

So the company instituted rigorous performance reviews, spread stock options to 70,000 workers, and made an average of 10% of employee pay variable--meaning it would swell and shrink depending on the worker's performance and that of the company. Benefits were also overhauled. In 1999, IBM announced its new cash-balance pension plan, which saved the company millions but earned it the ire of employees, many of whom complained of losing as much as half of their benefits. That's not to mention health coverage, which ended up costing as much as $157 a month. Says 37-year-old IBM engineer Jeff Zitz, who estimates his pension under the new plan could take as much as an 80% hit: "Halfway through my career, they changed the deal."

Now, blue- and white-collar employees across Corporate America are realizing just how much their deals have changed, too. Nowhere is the shift in risk more dramatic than at Enron Corp. (ENE ), where employees saw their retirement savings wiped out even as executives at the top cashed in.

But you don't have to work at a company that's bankrupt and under siege by federal investigators to feel at least some of the pain. In the first months of this year, for example, many workers at companies as diverse as Ford Motor Co. (F ) and Texas Instruments Inc. (TXN ) won't see a penny in bonuses--something that during the boom was a guaranteed slam-dunk, swelling pay by 10% to 70%. At Gap Inc. (GPS ), salaries are frozen, while at Bethlehem Steel (BS ) and Wyndham Hotels (WYN ), company matches to 401(k)s have been cut. At Lockheed Martin Corp. (LMT ), the squeeze comes in the form of soaring health-care costs: For some, the employee portion of premiums has tripled in the past seven years. Co-pays on doctor visits and prescription drugs have doubled. Robert M. Handshuh, a 45-year-old Lockheed Martin project manager, says his 2% raises won't begin to offset the spike. "I'm barely holding my own in the last two years," he says.

Even in a recession, there is still one big plus for workers in the new payroll fluidity: It gives companies other ways besides layoffs to deal with the turbulence of the global market. The growth in variable pay and options is also one reason why Federal Reserve Bank of New York economists Hamid Mehran and Joseph Tracy think the labor market is able to operate more efficiently than in the past: The new tools gave companies an end run around wage inflation. Says Phil Webber, IBM's vice-president of compensation and benefits: "Flexible compensation is good for our business in terms of controlling costs." During the boom, performance-based pay also enabled employees to pump up their bank accounts by hitting goals, which in turn helped companies boost productivity.

Still, it's hard to believe how fast--and drastically--things have changed. A decade ago, Corporate America prided itself on offering employees some insulation from the vagaries of the business cycle with a panoply of benefits and a steady, if slow, climb in pay. But handing out supersized raises to compete with startups during the boom would have wrecked profits and locked balance sheets into higher fixed costs. So companies started doling out stock options and implementing variable-pay schemes--bonuses and other cash incentives that have to be re-earned each year. The gamble paid off as everyone from secretaries to CEOs saw five years of dizzying, double-digit gains in stock portfolios, lavish bonuses, and a sizzling job market that made it seem like personal fortunes could only go in one direction--up.

This year, employees are seeing the dark side of the deal: vanishing variable pay, tougher performance reviews, cuts to 401(k)s, and shrinking health benefits. A year ago, Silicon Valley sales and marketing executives like Madeleine Xavier were making more than six figures. Today, Xavier, a 36-year-old University of California at Berkeley grad, works at online registration outfit Acteva.com--for a salary of nothing. Like many, she has taken a commission-only sales job to tide herself over during the bust. "Now a company's attitude is that you have to take a percent of the risk with them," Xavier says. Adds Hewitt Associates LLC compensation expert Ken Abosch: "There's no question that most corporations have turned away from fixed forms of compensation in favor of variable forms. There has been an abandonment of entitlement programs."

This quarter, for example, is turning into the bloodiest ever for bonuses. Salaries aren't immune, either. Nearly 30% of companies have cut or frozen pay, says Steven E. Gross of compensation consultant William M. Mercer Cos.--a number he projects could rise to 50% this year if the economy stays weak. That's not to mention the overwhelming majority of employee stock options that are deep underwater. What's more, almost half of the companies polled by Mercer, for example, said they plan on shifting greater portions of their health-care costs onto workers in the coming years. Kenneth R. Jacobsen, a consultant with benefits expert Segal Co., estimates that the percentage of an employee's paycheck going toward health care could spiral--in the worst-case scenario--to as much as 8.2% by 2005, up from 3.4% today.

Mix in the grueling performance reviews, increased workloads, and insecurity over jobs, and it makes most pine for the gilded days--or at least look forward to the end of the New Economy's meanest season yet. The problem is, this may be more structural than seasonal. The workplace that's emerging is a far different place from the office of the early 1990s. That's when most companies still subscribed to the peanut butter school of pay--spread the extra compensation thin but evenly throughout the company. Bonuses and pay hikes were often given irrespective of a weak economy.

Today, more than 75% of salaried and hourly workers have variable pay, up from fewer than half that number 10 years ago. The number of companies with pay-for-performance programs, some of which institute cutthroat quotas for "ranking and yanking" at least 5% of workers, also doubled in the 1990s. Moreover, more than 40% of companies now offer stock options to employees, up from just 8% in 1991. Compensation expert Gross estimates that in the late '90s, these awards amounted to as much as a 10% bump for low-level workers, 25% for managers, and more than 100% for senior executives (charts).

The boom-time bounty pushed nearly everyone up the ladder and made it easy for companies to get employees to buy in, especially since it masked some of the benefit takeaways. Now, though, the paycheck's volatility is leading to more uncertainty. Goldman, Sachs & Co. senior economist John Youngdahl estimates that the evaporation of variable pay alone, not including disappearing stock-option income, could subtract as much as $40 billion in compensation in the first and second quarters--a sum that's more than last summer's tax rebates combined. He adds that people in the upper-income tier who are losing the most in variable pay are also the ones who have slashed their savings rate in the past six years.

True, recent tax cuts, mortgage refinancings, and dropping energy prices will help mitigate the effects. But hitching pay to the profits roller coaster could cause more aftershocks at the macro level. Morgan Stanley Dean Witter & Co. chief global economist Stephen S. Roach thinks that the plunging of variable pay in the first quarter could cause consumption to drop 0.8% instead of the consensus estimate of a 0.8% rise. Other possible dents in a recovery: dried-up severance packages, record levels of overall consumer debt, and the fact that laid-off workers typically get new jobs paying at least 10% less. "We are going to see incomes weaken considerably over the next three to six months," says Mark Zandi, Economy.com Inc.'s chief economist. "Even if the corporate top-line numbers are stronger, this is going to ensure that the recovery is muted."

Michael Rawson is one man whose usual contribution to consumer spending has disappeared this year. During the boom, the production worker at Ford Motor did his share to give the economy a lift every March, when he got his annual cash bonus. Last year, it totaled $10,000. Rawson socked away two-thirds into a retirement fund and used the rest to splurge on a 56-inch Sony TV. He was already counting on putting some of his 2001 money toward a souped-up hot tub, complete with an underwater chaise longue. "I would have gone out and bought it the next day," says Rawson, 46. But Ford's earnings have tanked, and he and the company's other 100,000 production workers will take home a bonus of zero this March.

Still, it's not as if all employees deserve to moan. During the 1990s, in survey after survey, workers said they wanted more skin in the game, thereby opting for more measurements of their performance. "We take risks, and we can't whine when the economy goes south," says Intel Corp.'s director of consumer Internet strategy, David Nash, who, like Rawson, has seen his bonus shrivel to nothing this year. But many employees say they didn't realize that while they could be whipsawed by the ups and downs of variable pay, many executives would be insulated. At the same time that companies were cutting retirement benefits for employees, for example, some were also creating special supplemental plans for their highest-paid executives that guaranteed lush retirements.

For companies looking to preserve worker relations, September 11 adds yet another complication. The attacks created a slew of new corporate responsibilities to protect employees--if only physically. But the crunched pay and benefits, coupled with the harsh performance assessments, send the opposite signal. They also create more inequality. Employers are using variable pay to lavish financial resources on their most prized employees, creating a kind of corporate star system.

No doubt, dismantling the old entitlement culture is bound to create a whole new set of questions. "How do you communicate to a workforce that isn't created equally?" asks Jay Schuster of Los Angeles-based compensation consultants Schuster-Zingheim & Associates Inc. "How do you treat a workforce in which everyone has a different deal?" One way companies could start is by being clear about what that new deal is: Workers will have a greater chance to lap up the gains, but they'll also run a bigger risk of being left out in the cold.

By Michelle Conlin in New York, with Robert Berner in Chicago

— With assistance by Robert Berner

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