Compensation: Getting the Most Out of a Smaller Budget

With roughly 50% of organizations reducing total pay in 2009 compared to 2008, companies are struggling to motivate employees to perform at their highest levels at a time when performance is most critical. To address this challenge, successful organizations are using communications to articulate the value of their compensation plans, creatively exploring lower-cost alternative incentives, and changing existing incentive plans where opportunities exist to increase their impact.

Nearly half of companies indicated they are paying employees 15% less in 2009 than they did in 2008, according to a recent poll conducted by the Compensation Roundtable, the Corporate Executive Board's program for compensation executives. This decline is evident in all typical components of a pay package.

Salary increases in almost all organizations were lower than in the past, and in some cases not given at all. For example, roughly 34% of large U.S. employers polled in March didn't increase salaries at all, and most others reduced salary increase budgets relative to their originally planned amounts. As a result, salary increases averaged below 2% in 2009 compared to more than 3% last year.

While less common, a small number of organizations even reduced salaries. Globally, although numbers vary by region and country, the same trend generally follows: Salary increases were lower in 2009 relative to 2008, with a significant number of organizations not increasing salaries at all.

Bonus payouts fared similarly. Based on a February poll conducted by the Compensation Roundtable, 50% fewer organizations paid out target bonus amounts to their employees in 2009 relative to 2008. In addition, given that bonus payouts are largely influenced by the performance of the organization in the prior year, this picture will likely be bleaker in 2010, based on business results so far this year.

Finally, the value of long-term incentives typically given in the form of equity has suffered as well. As of the end of 2008, stock options at more than 70% of the Fortune 500 were worthless due to stock price declines, making this compensation vehicle, which traditionally has been used to motivate higher performers and senior executives, ineffective. And although many organizations have considered repricing stock options or buying them from employees, very few—under 5%—have actually done so, given the shareholder implications.

Unfortunately, most don't expect this situation to improve in the coming year. Most compensation executives polled expect pay to remain flat or even decline further in 2010.

With employees' pay significantly lower than they have come to expect, the usual approach to motivating and retaining employees is in jeopardy. This, along with other workplace challenges such as reduced engagement, has driven a decline in productivity of an estimated 3% to 5%. This comes at a time when employee productivity is most critical to companies' success.

And although some experts argue that companies do not need to worry about retention in an employer-friendly labor market, almost all companies are worried about retaining at least one key talent segment where they still are competing intensely for talent or have skills that are difficult to replace. In addition, many companies are justifiably concerned about the implication of current reductions in pay once the economy turns around.

All this combines to make pay a real challenge for many organizations. To address it, organizations must act now—despite the remaining uncertainty of the impact of economic and political forces on compensation.

The Compensation Roundtable identified three primary strategies that more successful organizations employ:

Communicate to maximize the effect of compensation plans. Most organizations do not share enough pay information with employees, causing employees to seek information from other sources. Unfortunately, employees most typically receive inaccurate pay information from those sources (friends, web sites, recruiters, etc.).

Conversely, organizations that are transparent about certain elements of their company's pay plans could lead to an increase an employee's productivity by more than 15% without spending more. Employers can do this by ensuring key organizational constituencies convey specific messages so that each has optimal impact when they communicate:

Compensation or Human Resources staff should communicate how the pay system works and share any technical aspects that employees need to understand.

Direct managers should handle most of the communication and focus on personalizing the pay system to their direct reports.

Senior business leaders should clearly articulate how the pay system and any changes to it directly support the business's objectives and performance.

Communicating about pay is more important to do in times of uncertainty, even though pay-related news is usually not positive. In the absence of receiving communication during these times, the average employee tends to assume things are even worse than they are, affecting their motivation even more negatively.

Make changes to existing incentive plans where opportunities exist to increase their impact. While companies invest huge amounts in incentives, most—more than two-thirds of compensation executives that participated in a recent poll—do not believe their programs are effective. This causes almost 70% of organizations to examine their incentive plans and make changes to them, such as:

Increasing the level of differentiation based on performance (21%),

Raising the threshold for receiving a bonus payout (13%),

Decreasing bonus target amounts (13%), or

Changing the relative weight of organizational and individual performance in determining an employee's bonus (24%).

Interestingly, when it comes to this last approach, roughly an equal number are increasing the weight of organizational performance as individual performance in this determination. The Compensation Roundtable has found that the optimal mix of the two for increasing employee performance and retention is roughly fifty-fifty. For most organizations this implies a need to increase the individual component of bonus determination.

Creatively explore lower-cost alternatives to incentives, in particular reward and recognition programs. Reward and recognition programs cost a fraction of bonus and long-term incentive plans, which is likely why most companies have reward and recognition programs in place.

However, more than 80% of those who have these programs are uncertain how to measure their effectiveness. Further, there is definite curiosity as to whether this "soft compensation" vehicle can make up for some of the loss of pay that most companies and employees have experienced.

In fact, well-designed and implemented reward and recognition programs can significantly affect those benefiting from them directly as well as those who are simply aware of them. Because the average award amount is typically relatively low, this can be a much more cost-effective way to increase productivity compared to a more traditional incentive or salary increase. Further, individuals in the same working group who know their colleague received an award will also become more productive, even though they did not receive anything themselves.

When it comes to designing reward and recognition programs, understanding the characteristics of an organization's workforce is crucial. For example, awards tend to generate greater value for lower-paid employees, while higher-paid employees are influenced more by recognition. Given this, even within the same company there may be an opportunity to tailor program for different groups—a reward program in the call center, for example, but a recognition program for the engineering group.

As organizations address pay-related economic challenges in the short term, some are planning for a favorable emergence. It is not too late for others to do the same. Immediately, organizations should identify high-potential employees, and either increase their pay or plan for this compensation when the economy picks up. The decision to offer positive pay adjustments when recovery comes rather than waiting for the annual pay cycle should be considered. If you delay the compensation increases until the economic performance of your organization improves, proactively communicate to employees a promise to pay.

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