Increasing The Use Of Variable Pay For Employees

Recent Hay Group research from several hundred organizations across all industry sectors indicates planned 2011 base salary increases for all employees are at a median of three percent. This reflects an uptick relative to March 2009, when salary increases were at a low point of two percent for most employee groups and zero percent for executives. Ten years ago, median salary increases ranged from 4.5 to five percent and then tracked fairly steadily at four percent from 2005 to 2008. While the past three years have seen the lowest base salary increases most employees have ever experienced, planned increases for 2011 are slightly higher versus last year, and are consistent across most employee groups.
a reprint from Hay Monthly Nesletter

The current economic outlook in the US continues to cause most businesses to exercise caution in growing their fixed costs, particularly base salaries and benefits. Organizations who survived the immediate challenges of a deep and wide-reaching downturn have emerged to a more cost-conscious and performance oriented business landscape. Fundamentally, the recession has caused organizations to get leaner and focus on activities that bring the greatest returns to the organization. Difficult choices are being made as available money has to be earned via performance and allocated to those areas (and people) most critical to business success. While the focus remains clearly on the bottom line, increased labor productivity and performance will be a core driver of profit growth going forward.

The performance-oriented, post-recession world in which organizations are operating has significant implications for line managers and HR professionals. Hay sees many organizations with a relentless focus on performance, as they seek to reverse some of the sloppy performance management practices that crept in during the boom years. Today, managers are looking for ways to balance the cost of reward programs and limited pay increases with the need to attract, retain and engage key talent. Because of this tension, many organizations are emphasizing both their variable pay and ‘total’ reward programs – engaging employees in non-monetary ways.

While there is not a significant change in pay increases for the coming year, the mix of pay is changing. As organizations emerge from the recession, they are shifting more of their focus from fixed compensation (i.e., base salary) to variable pay. In fact, recent Hay Group research reveals that organizations have increased (or plan to increase) the proportion of variable pay in their employees’ pay programs versus those who have decreased the proportion of variable pay in their employees’ pay reward package by a two-to-one margin. This change is partly cost-driven, as those organizations with higher proportions of variable pay tend to have more flexibility to cope with economic volatility.

This same research indicates that 66 percent of US companies (and 71 percent of companies globally) have recently changed or are considering to change the performance metrics in their variable pay programs. The top reason cited by organizations for making changes to their variable pay programs was to better align these programs with the changing business strategies (61 percent globally, 69 percent US). In the US, other top drivers were to create better line of sight between corporate and individual performance (39 percent), to improve organizational or team performance (37 percent) and to ensure market competitiveness (30 percent).

A significant legacy of the economic downtown has been a concentration on the bottom line and a trend away from ‘soft’ metrics, such as employee satisfaction, to hard, financial metrics. This is underscored by more than half (56 percent) of companies in our study reporting that they are placing increased emphasis on financial metrics such as revenue or profit in their variable pay programs. Another 21 percent plan to increase the emphasis on operational improvements such as efficiency and productivity measures. An emphasis on financial metrics can encourage employees to be focused on short-term financial gain without proper consideration of the risks to long-term sustainability, company brand or broader social concerns. The most successful reward strategies encourage an effective balance of short term and long-term goals, and recognize the need for a balance between financial, operational and human capital measures.
Approximately 40 percent of the organizations in the US and nearly half of companies globally have already increased or are planning to increase performance thresholds (which trigger a payout) in plans. But, during this time of change it is important that organizations are fully aware of the consequences that raising performance thresholds can have on employee engagement. Many employees have picked up accountabilities from colleagues who have been downsized, have seen limited or no pay increases over the past two years and if the variable portion of their compensation is even more difficult to earn, they may become further disengaged, just when companies most need them on board.
Hay's research found that while 80 percent of US companies agree that variable pay reinforces performance within the organization, only 55 percent believe that their variable pay programs are clearly understood by their employees. Recognizing this disconnect, 53 percent of US companies have already changed or plan to change the way they communicate variable pay programs to their employees. Variable pay programs can only work if they are understood by employees and managers. More often than not, a simple straightforward program aligned with business priorities is much more effective than a sophisticated program that is difficult to understand. We see many organizations seeking to distill programs communications down to core messages.
Hay sees many organizations working harder than ever to align their reward, performance and business strategies, either because their business strategy has changed or because alignment to the business strategy was not already optimized. In practical terms, this means ensuring that the right performance metrics are used and that reward programs are closely tied to those metrics, performance and rewards are appropriately differentiated, supporting performance management processes are in place and leaders have the capability and commitment to implement and communicate reward programs effectively.