Affording the Required Workforce
During turbulence in labor markets skill shortages force employers to consider raising the ante when attempting to attract and retain the people they need to succeed. The pandemic followed by the inflation surge contributed to the turbulence. Experienced people retired earlier than planned during the pandemic, creating gaps in skill/knowledge bases. The inflation surge created pressure on organizations to sustain employee’s real income levels. Technology advances have created demand for new skills that are in short supply. The sum of these external shocks has in some cases created a high price tag for the required workforce, making affordability a significant challenge.
For some organizations workforce costs (pay and benefits) are fixed. Once a base pay increase is granted it is like a career annuity… pay reductions are very rare and occur only under extreme conditions. Benefit costs have increased at a much higher rate than inflation for as long as people can remember. In capital intensive industries, such as an oil refinery with less than 5% of controllable operating costs in the form of workforce costs, this is a lesser concern. For an organization with more than half of its costs in the form of workforce costs it has had a severe impact on financial performance.
Skill shortages in the U.S. have been created by several factors. Jobs have increasingly required expertise in scientific, engineering and information technology. New cybersecurity and AI skill requirements are pressuring both organizations and academic institutions to increase the supply of people with those skills. Although additional candidates may be available in other countries the H1-B visa cap is a dysfunctional limit on the number of people who can enter the U.S. to lessen the shortages. Other countries aggressively court those with the skills, since they experience similar supply shortages. The result is often jobs being moved overseas where qualified candidates are available.?
Option 1: Have the work done by someone else
Over the last decade there has been an increase in the use of outside contractors to perform work for organizations lacking the skills and knowledge required to do the work. The “gig economy” was a popular topic for trend reporters. The use of outsiders to augment skills on one-time projects (e.g., the move to network IT systems in anticipation of the Y2K “crisis”) can prevent artificially staffing up to meet a temporary spike in workload. Many organizations waited too long to deal with the conversions, leaving insufficient time to retrain their existing employees. They were then forced to compete in a market with insufficient supply and very high price tags for those possessing the new skills. Even worse, once the conversion was complete, they were often left with overpriced and underutilized employees.?
Yet mixing outsiders with employees can present challenges. Employees may resent not being allowed to learn the new skills that would increase one’s market value. They may also operate differently. If they are used to working in teams and now must deal with individuals who perform their work independently it can cause a reduction in collegial and cooperative behavior. One of the biggest challenges is convincing employees that contractors are paid appropriately on a relative basis. If an employee discovers what a contractor is paid on an hourly basis (s)he may multiply that by 2,080 and use that for the comparison. Although an inappropriate comparison it can still contribute to resentment. When employees are required to come back to central locations after working remotely, they may compare to contractors who seem to be able to work from a beach shack far away and to perform the work under their own schedule.
Despite these challenges contracting out work that only needs to be done once may be a good decision. The reality that contractors are only paid their hourly rate when they are working on the assigned work may make them less costly than employees who are paid even when they are not. Using outsiders may also result in knowledge and skills being left when they leave that the organization would not otherwise have possessed for future use. Contract provisions can be used to ensure the employees are able to use the knowledge and skills after the outsiders have left.
Option 2: Redesign the compensation system
Base pay is fixed once it is established, as mentioned earlier. But rather than spending the entire budget on pay increases a portion may be reserved for cash awards. The table below illustrates a philosophy that reduces the compounding of fixed costs and increases the ability to reward current performance better.
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Performance by employees often varies over time. If a high-performance year results in significantly higher rewards, it can produce motivation to continue performing well. The 1% budgeted for cash awards seems a small amount but can produce significant amounts for a select group of employees. Cash awards can also be valued more than a base pay increase, since the full amount is available immediately, while to receive the increase the employee must wait for the entire year. This type of system requires a sound performance management system. One does not buy a historical landmark house and plug new, high-power appliances into old wires. The result might be a vacant lot. Effective and appropriate performance management systems can motivate better performance and can result in fewer departures by the most valued employees.
All direct compensation does not have to be in a fixed cost form. Variable compensation programs can be utilized that make workforce costs partially contingent on economic performance and the ability to pay. Profit/performance sharing plans have existed for decades, intended to share organizational success with employees. They are typically designed to align costs with revenues by making awards contingent on pre-determined criteria. Many private-sector firms use management incentive plans, both annual plans and long-term incentive plans. Some offer equity instead of cash. Direct sales personnel typically have at least some, if not all, of their current income in the form of commission and bonus plans. Trade and operations personnel may receive compensation contingent on mastering skills and may participate in productivity-based plans.?
There are also ways to make benefits partially variable. Organizations with defined-contribution retirement programs can make their contributions contingent on overall performance. For example, there may be a guaranteed 50% employer match for employee contributions, up to 6% of base pay. If the organization performs well that match may be increased to 75% or 100%. This can make the plan competitive with defined-benefit pension plans and avoid the accrued liabilities that occur under those plans. The use of flexible benefit plans can also increase the value of benefits coverage in the eyes of employees without altering the costs. For example, employees may be permitted to “sell back” vacation days at 1/260 (or another appropriate fraction) of their annual base pay rate. This can enable them to improve health care coverage or other plans they value more highly. Although it does not reduce costs it can increase the perceived value of the package by focusing expenditure on what the employees want the most.
The Bottom Line
Compensation strategies must fit the context within which an organization functions, its culture and its workforce. By designing programs that are more effective a better result may be achieved without increasing costs. By changing the mix of pay increases and variable rewards a better alignment of costs with the ability to pay may be achieved.?
About the Author:?Robert Greene, PhD, is CEO at Reward $ystems, Inc., a Consulting Principal at Pontifex and a faculty member for DePaul University in their MSHR and MBA programs. Greene?speaks and teaches globally? on human resource management. His consulting practice is focused on helping organizations succeed through people. Greene has written 4 books and hundreds of articles about human resource management throughout his career.