Compensation Strategies For Today: Creating Order Out Of Chaos

"if you keep doing what you have always done you will get what you always got" is a popular bit of wisdom. But that is true only if the context stays the same. If it changes you might get something else. Most believe the pandemic has altered the context.

Many of the outcomes we could have done without. A lot of organizations did not anticipate and plan for another “Black Swan” event (like the economic crisis a decade ago). Perhaps they thought they could react quickly and adequately if one showed up. Yet many organizations can provide grim tales of their inability to anticipate, assess and adapt as quickly and as effectively as was needed.

Done is done… what happened happened. Organizations must plan for the short and the long term. One of the most critical decisions to be made is how they will manage employee compensation. What worked before the labor markets were totally disrupted by the pandemic and subsequent inflation surge may not be a good fit to the turbulent environment that now exists and that may persist.

Three principal decisions related to compensation management need to be made each year:

1. How much to adjust the pay structure(s),

2. How much to budget for pay adjustments, and

3. How to allocate that budget.

Each of these will have an impact on an organization’s ability to attract, retain and motivate the talent needed for success. Strategies must be economically sound and must convince employees/contractors/candidates that the organization provides competitive, equitable and appropriate pay opportunity and pay rates.

Pay Structures

Adjusting pay structures should be considered when they are determined to be out of line with pay levels prevaling in the relevant labor markets and the organization's desired competitive posture. The increased turnover rate during the last few years seems to have increased people's willingness to consider a change of venue, so compoetive pay ranges are one of the keys to discouraging employees to act on that willingness. Pay ranges establish the pay potential for employees in the roles they are currently playing and for other roles they may progress into. Yet an employee's pay range is typically less of a concern than their current pay rate and recent pay adjustments.

In the many years I have been consulting I have not found people to be emotional about what their pay range was, unless they were at the maximum and a policy prevented any further adjustments. Employees often believe that pay ranges are not internally equitable and/or externally competitive. But if pay rate and pay adjustments that are deemed adequate keep coming the pay range is an abstraction to employees.

There may be reasons to overhaul pay structures. I recently reviewed a structure that had only a 4% difference between successive range midpoints and had ranges that were 70% wide. In addition, actual pay rates were bunched in the lower part of the ranges. This can cause people to feel grossly underpaid, because their rate is so far from the maximum (a human tendency is to view the maximum as a realistic and even near-term target). The only reason pay range minimums and maximums exist is to act as control parameters which ensure pay adjustments do not result in employees being paid too much or too little for serving in a role.

When ranges are 70% wide it allows people to be paid pretty much anything and does not instill discipline in managers making pay recommendations.? Wide ranges are of limited use in determining how to best allocate the available funds for pay actions, particularly in times of limited budgets. Range widths of 40 - 50% are more typical and provide a balance between flexibility and control.

Some organizations, more often those with collective bargaining units, believe pay structures and/or pay rates should be adjusted by the current year inflation rate. This practice is based on the mistaken assumption that adjustments should track the cost of living rather than the cost of labor. This is an economically unsound basis for managing employee compensation. For example, if an employer gave inflation-based adjustments the last few years they would have increased (permanently) their fixed cost payroll by double digits. Now that inflation has returned to historical levels they must be able to afford that inflated payroll. Since market pay levels only increased by half the inflation rate the adjustments,were unjustifiable. Some organizations granted cash inflation offset awards, which did not inflate the fixed cost payroll, and as a result are better aligned with market. It is puzzling why most compensation strategists missed a PR opportunity. Taking the initiative by communicating "we know you are being impacted by inflation" and awarding everyone one or two weeks of pay in cash as an "inflation offset" would have provided a platform for educating employees that compensation management must be done in a sound business manner. What makes the large base pay adjustments even more dysfunctional is that adjustments going forward are now going to look inadequate even when inflation is down (a fact employees will overlook).

A serious evaluation of the pay structure(s) should be on each organization's "to do" list now.

Pay Budgets

It is rare to find an organization that has difficulty finding things to spend their financial resources on. There is an annual competition for available resources and each item in a budget receives an allocation. Budgets for pay actions are competing with all other potential expenditures. The pandemic and subsequent inflation have contributed to a major destabilization of labor markets. This puts even more pressure on decisions about pay budgets. Those budgets need to be adequate to do what needs to be done relative to employee compensation.

Some organizations are not in a position to budget anything for raising the pay levels of current employees. They may in fact be forced to reduce payroll to offset dramatic drops in revenues. As happened in prior economic downturns this requires a choice about how to reduce costs. Yet this may put them at a competitive disadvantage and cause an increase in unwanted turnover. It is therefore prudent to at least focus on ensuring critical talent is not in danger of leaving, and if it is find some funds to disburse on a targeted basis.

Base pay rates are in effect a career annuity. Base pay rate reductions are not feasible, except under dire circumstances. Benefits costs are also fixed and are likely to go up if the current workforce is retained, no matter what management does. So how can fixed costs that are too high be adjusted? Reducing headcount may on the surface reduce payroll, but at the same time it will probably increase current costs because vested entitlements need to be settled immediately (for an excellent treatment of this see Responsible Restructuring by Wayne Cascio).??

The potential costs of not providing an adequate budget for pay actions must be considered, no matter what the economic circumstances are.? The number of vacant jobs increased dramatically as lockdowns eased and employers began competing for talent aggressively. Research suggests the working conditions during the pandemic convinced a number of people to reflect on their career plans. Ads promising much higher pay rates became numerous, potentially nudging more people to think about at least exploring other employment options. All these realities put more pressure on organizations to consider pay adjustments, despite the challenge of affording them. Retaining talent without tools do do it is a major challenge.

Although it may seem prudent to emulate other organizations when creating budgets, it is a perilous decision. The contexts within which other employers operate are all different from each other, and any strategy should be a good fit to the context. There are annual surveys that report on pay budgets for other organizations, but given the turbulence in the market the overall averages they offer are not good guides. Survey data that is several months old has limited credibility and averages are often a meaningless combination of diverse values. The only way to get a clear picture of the organization's competitive position is to survey a select group of principal competitors for talent and to evaluate both their current actions and future plans.

The budget decision should be based on the context within which the organization must function currently and in the foreseeable future, not what other employers do.

Pay Actions

There should be careful consideration of how to allocate whatever budget an organization can justify economically. Some organizations (more in the public sector) give everyone the same increase, irrespective of individual competence/performance or the organization’s ability to afford it. Many collective bargaining contracts mandate the same amount be given to everyone, and to do so for extended periods of time. General increase systems result in some people already overpaid for their competence and/or contribution being treated as well or better as those who are underpaid. When the same % of current pay rate is used in calculating adjustments this further magnifies the misallocation of available resources. Higher paid incumbents receive more dollars and get further ahead of those who are lower paid. When budgets are very limited the primary principle is not to waste any scarce funds. “Same for everyone” often means "appropriate for no one.”

Paying for compoetence and performance has been shown by scientifically sound research to motivate people to perform and to develop. Despite occasional claims in the practitioner literature that extrinsic rewards lessen the intrinsic motivation to perform the evidence supporting this claim is not credible. There is a body of scientifically sound research that suggests the opposite is true... economic rewards can reinforce self-efficacy and provide motivation. Recent research also shows that if performance ratings are discontinued performance will tend to decline, so suggestions that performance appraisals be discontinued contradict what empirical evidence suggests.?Before replacing current performance management systems it would be prudent to determine how current systems could be managed better.

Culture must be considered when deciding about budget dissemination. No matter what kind of culture exists it is important to make it clear that contribution is valued and the right things are rewarded. There must also be a perception that performance is defined, measured and managed appropriately. If changes are to be made to past practice how people will react should be considered. The impact of changing from a “same for all” to a “winners get the gold” philosophy can be highly disruptive for an organization that has disbursed pay actions in an egalitarian manner, unless accompanied by a cultural shift. The current systems must also be able to deal with dramatic changes in philosophy or policy.

Adopting a pay for performance strategy when the performance management system is unsound can produce a result similar to what would happen if an old house were to be purchased and new appliances were then plugged into the old wires… the action would be likely to create a vacant lot, available for building a new home.

Setting pay rates for new entrants into a role (whether new hire, transfer or promotion) should be guided by a strategy that fits the turbulent conditions in the current labor market. This is best done by defining who should be paid in the zones within a range. The range can be segmented into thirds (or fourths) and descriptions written that suggest where an employee's rate should be set. People with minimum qualifications and who must develop the required skills/knowledge should probably be paid in the lower portion of the range (which could be labeled the “Developing” zone). Those who have become fully competent and who performed adequately should be paid in the middle portion (which could be labeled the “Market” zone). Only those who are fully competent and who consistently perform at a level that substantially succeeds expectations over time should be paid in the upper portion (which could be labeled the “Premium” zone).

There are times when it is operationally expedient to hire someone who is exceptionably competent. This may require an entry rate that is in the middle or upper part of the pay range. Those who have been in the role might believe a newcomer should be paid less than they are. But the rate should reflect the competence level and as long as clear criteria justify the rate the organization should be prepared to defend its decision.

One strategy that may be a good fit to today’s level of uncertainty is to deliver individual pay actions partially or totally in the form of cash. Variable compensation programs (a.k.a. incentive or bonus programs) do two things. First, they deliver a single sum rather than a smaller increase in increments throughout the year, making them more visible. Second, they do not inflate fixed cost payroll, since any subsequent awards will be contingent on future conditions. This also provides flexibility for continuously aligning practice with current realities in the future.

This is a time when experimenting with something new may be advisable. Pay is not the only consideration when people evaluate their employment conditions. Recent cohorts entering the market value career opportunity very highly, meaning they expect their employer to invest in their development. Current employees may be thought of as potential "gig-ers" and considered for stretch developmental assignments, which can expand their range of capabilities. This enables the organization to avoid staffing to peak work load levels, since those with a wider set of skills may be shifted to where they are needed. It also provides evidence that the organization is willing to invest in its people and to support their growth. Some managers may be less than enthusiastic about sharing their best people. That can overcome by making it clear that the talent is the property of the organization, not managers.

As work assignments become more varied it may also make sense to consider basing at least a portion of an employee's pay on the skills and knowledge they possess. Learning new skills involves both some risk of failure and also additional effort, so by acknowledging and rewarding employees for acquiring what the organization is short of using legal bribes can make a lot of sense.

The direct compensation package can also be used as a retention tool. For example, replacing or augmenting annual cash incentive plans with restricted stock plans can help to moderate the current cash outflow and provide an incentive to stay until the shares vest. When working for a privately held consulting firm one-half of my annual cash incentive award was paid in stock, until I reached a stock ownership level that met the established standard based on my level in the firm. This served as a strong retention device. Additionally, people who are owners are likely to think and behave like owners... who washes a rental car?

Most organizations view benefits as a cost that keeps going up, no matter what they do. They are usually right. They also believe that employees undervalue all the organization does for them. They are right about that as well. Research shows that employees often estimate their employer's cost of providing benefits is something less than one-half of what it actually is. That is a communication failure.

Providing "total compensation" statements each year, individualized to each employee, is a powerful way to not only get more credit but also to remind people of what is available to them. An additional step is to provide employee choice when they select their benefits. The ability to shift costs around can allow employees to have more of what they value the most by giving up things they care less about. Given the diversity of employee populations having a single package for everyone seems inappropriate. By realizing the value of all they receive may cause employees to be more realistic in comparing what other employers offer to what they have. Jumping for more base pay can still be the right choice for some, but it can lead to leaving behind valuable benefits that will be less generous in the organization recruiting them.

A Different Strategy?

The environment is volatile, bordering on chaotic. A new planning model that does not pretend organizations can predict the future accurately is needed. The type of scenario-based planning and preparation that SEAL teams go through can be a guide. All feasible conditions are anticipated, and alternative strategies are prepared for coping with anything that may happen. The plan fitting the most likely scenario is adopted first, guiding initial actions… an assessment is made continuously of how well the strategy fits the current reality… adaptations are then implemented to modify or replace things that did not work… assessments are then made of how the adaptations worked… actions that realign plans and realities are taken… etc.

During my first night parachute mission I felt like Indiana Jones, making that step first based on faith. Uncertainty can cause organizations to freeze in the door. There is no going back, because what worked acceptably well before or that works for other organizations may be exactly the wrong thing to do. Understanding the internal realities of the organization and anticipating the external realities that will be faced is the first step for formulating a strategy. Surviving and even prospering will depend on the quality of the scenarios that are defined, rather than the correctness of a single prediction about a highly uncertain future. How well a strategy works depends on how well it fits the current context of each organization.

You better start swimming or you will sink like a stone… the times they are a changin' Bob Dylan

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.

• Strategic Talent Management: Creating The Right Workforce
• The Most Important Asset: Valuing Human Capitol
• Rewarding Performance Globally [with Fons Trompenaars] ?
• Rewarding Performance: Guiding Principles; Custom Strategies? (2d Edition)