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Ask Our Expert: Aftermath of the Recession on 2009-2010 Compensation Spending

Ken AboschWe've asked our expert, Ken Abosch, Aon Hewitt's North American Compensation Practice Leader, to answer your questions from our recent 14-city Compensation Planning Briefings and HCI Webcast "Budget to Win: Retain Critical Talent Through Competitive Compensation." Unprecedented economic changes are impacting how companies approach compensation and talent management this year. If you'd like to ask a question about these changes or any other compensation challenges you may be facing, e-mail us and we'll share responses to selected questions on a regular basis.

Question: What are Hewitt's recommendations of checking market competitiveness during this time? Can we believe the numbers?

Answer: Currently, many organizations are experiencing reductions in staff and budget reductions, making market competitiveness assessment considerations challenging. Now more than ever, it is a logical question to be asking in order to determine how best to leverage scarce resources.

In 2009 we observed one of the most significant reductions in the workforce ever experienced, and the economy is still at a record high level of unemployment. We also saw unparalleled actions to reduce costs, including the slowing of salary increases, record numbers of salary freezes, and the first ever wholesale reduction in pay. We also observed some very unusual behavior regarding salary structure movements.

With all this as a backdrop, the question compensation professionals are being asked, and to which they need to be prepared to respond is — what was the impact of all these changes on our competitive landscape as an employer?

This is one of the most critical times to analyze the latest market data results. This analysis will help determine whether actions taken at our company were the right ones. More importantly, it will inform us as to what we should be doing next. Are we being too aggressive and could we get by with less? Are we in danger of falling behind because our labor competitors took different approaches than we did? A market analysis, even a paired back one, is highly suggested to be able to advise our organizations about what happened and how we should position ourselves in the future. As most survey information was collected late in the year, they should be a reliable indicator of current pay practices and levels.

Question: Have companies considered moving money from base pay to variable? Comment: There is a fear that more money will go to the low/average performers since low or zero increases last year. Managers will feel obligated to provide something.

Answer: In 2010, companies are projecting to spend only 2.7% of payroll on salary increases — the second lowest ever recorded (the lowest recorded was last year). These same companies also are projecting to fund variable pay plans at 11.8% of payroll — very close to the record high level of budgeting we observed for variable pay in 2009 (12.0%). We also were able to dissect variable pay practices for companies who either froze salary increases or who reduced salaries in 2009. These companies also funded their bonus plans at near record levels.

One of the most logical explanations for the high level of variable pay funding is occurring through a shift in both philosophy and budgeting behavior away from fixed costs and toward non-recurring expenses such as bonuses. Yes, in fact, organizations have recalibrated how they want to spend their payroll to reward performance — away from base salary growth and toward variable pay funding.

Regarding the concern that managers will try to allocate more base pay dollars to low/average performers, two factors make this less likely. First, cost of living is very low — employees who did not receive a raise last year were not as disadvantaged as they might have been in prior years. Second, with such a small salary increase budget (2.7%), if dollars are channeled to low/average performers that will put organizations at a high degree of risk for their top performers. This is a risk very few organizations can afford.

Question: What is the definition of variable pay? Does it include commissions?

Answer: Variable pay describes any form of compensation that is performance based, usually focusing on a 12-month performance period, and which must be re-earned each year. Base salary increases do not qualify, as once an individual receives a salary increase it is an annuity that must be paid into the future. Instead, a bonus is paid in a lump-sum form and does not carry over into a subsequent compensation plan year, making it a variable expense.

There are many forms of variable pay including:

  • Business incentives;
  • Cash profit sharing;
  • Gainsharing;
  • Team awards;
  • Individual performance bonuses;
  • Special recognition;
  • Equity; and
  • Commissions, which are typically reserved for sales roles in most organizations, and by definition, do also represent a form of variable pay. When we report statistics on variable pay from our Salary Increase Survey, we exclude any impact of commissions since sales roles are analyzed separately.

Question: How can my organization retain top performers and keep them engaged during economic crisis (salary freeze, bonus reduction, 401(k) match elimination)?

Answer: Watch for more from Hewitt in the months ahead on this topic.

Question: What should my organization do about retaining and motivating with very low or zero salary increase budgets?

Answer: From a base salary standpoint, it will be very difficult to recognize and reward employees with a salary increase budget below 3%. For organizations that decide to freeze salary budgets again in 2010, it will be impossible to motivate and retain employees if base salary growth matters. Instead, organizations are focusing on other avenues to send a differentiated performance and reward message.

With record numbers of organizations providing variable pay programs to their broad-based employee populations (90% of U.S. companies), and with near-record high levels of funding (11.8% of payroll), and with a strong trend to push participation in these programs lower into the organization, it is clear that many have shifted their focus to variable pay as the basis for pay for performance. Other organizations have widened the spectrum of rewards to go beyond cash compensation, considering training and growth experiences, mentoring, special projects and initiatives, and more direct access to leaders as ways to recognize and reward employees. In particular, we can expect to see more preferential treatment in the future for high performers and high-potential employees as organizations do everything they can to motivate and retain these critical contributors.

Question: How are companies who froze merit budgets in 2009 planning for increases in 2010?

Answer: According to the responses from the 48% of companies in our study who froze salaries last year, most are planning to have a salary increase budget in 2010. Against the backdrop of a 2.7% average salary increase for all companies in 2010, companies who froze salaries last year are projecting to spend 2.9% of payroll on salaries in 2010. We know we are not out of the woods however, in that 13% of companies are still planning to freeze salaries in 2010. That level of zero base salary increases is still significantly higher than what we would see in a typical year — with less than 1% of companies freezing their salary budgets in a more normal economic environment.

Question: What may companies be doing for those employees that received no increase in 2009 to reward them in 2010? Should we treat them differently than those that received increases?

Answer: The answer to this question depends on a number of factors about why employees did not receive an increase in 2009. Were they poor performers? Were they already more highly compensated than comparable roles in the market? Were business results weak and is this expected to continue?

To control the universe of possibilities, let's restrict the answer to above average employees who are paid within a reasonable range of the market, and were not given increases in 2009 due to tough economic conditions. Many organizations will be taking a close look at this segment of the employee population and determining if they can provide them with somewhat stronger base salary increases. Overall salary increase budgets are not expected to be robust in 2010 (2.7% of payroll on average), so it will be very difficult to make up much ground. As a result, more organizations are introducing an individual performance component into their variable pay plans as a way to channel more money to select groups of employees. And, we also are seeing some use of special use incentives (funded outside of typical structured bonus plans) that can be used for special allocations. These special use bonuses are most often provided to top performers, high potentials, or employees in critical skill positions. So for the majority of employees, there probably will not be much relief.

Question: We continue to fall behind market on pay. How do we catch up in this environment?

Answer: If by falling behind market on pay means base salaries specifically, that could be a challenge. Organizations just fought very hard to reduce their fixed costs in order to better compete in a global economy. Very few companies are going to be willing to increase costs for what is in most organizations a top three expense category. The most likely scenario will be for organizations to focus explicitly on their high performers and channel what scarce resources they can afford to make sure they are not vulnerable for those employees. For the rest of us, the name of the game will be either total cash compensation, or the broader category of total rewards that attempts to leverage other employer-provided resources such as benefits, training, work-life balance, and work environment. This will take the form of more education to employees about the value of what the employer already provides them as part of the employment deal, enhancements to some of the more valued rewards categories, or more targeted allocation of rewards to specific employee segments (high performers, critical skills, retention risks, etc.).

Question: What are some innovative ways companies are attempting to retain employees when there are salary freezes and questionable incentive pay amounts going forward (because forecasting is challenging in this economy)?

Answer: Watch for more from Hewitt in the months ahead on this topic.

Data Sources
Hewitt 2009 Variable Compensation Measurement™
Hewitt 2009-2010 U.S. Salary Increase Survey

About Our Expert
Ken is a Principal consultant with Aon Hewitt Associates and is the North American leader of Hewitt's Broad-Based Compensation (BBC) practice. He is located in Aon Hewitt's Lincolnshire, Illinois headquarters and has over 20 years of experience consulting in all facets of human resources including linkage to business strategy, globalization, engagement, incentive design, broadbanding, and employer branding. Ken has worked with numerous organizations to help them achieve breakthrough value creation through their people, and is a frequent speaker on the topic. Ken is regularly quoted in a variety of media sources including The Wall Street Journal, USA Today, Crain's Chicago Business, CBS Radio, WGN Radio, CNN, and The Osgood File. Prior to joining Hewitt, Ken worked for a major pharmaceutical company in the areas of compensation, employee relations, and pharmaceutical sales. Ken holds an M.B.A. from the J.L. Kellogg Graduate School of Management at Northwestern University and a B.A. in psychology from Northwestern University.