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Small signs started appearing months ago: Jobless claims plateaued. Housing statistics improved slightly. Stock market averages gained ground. Productivity increased. The recession appeared to be bottoming out. Consumers seemed to be regaining confidence, and employers appeared ready to loosen tourniquets they had applied to stem their outlays when the economy was reeling.

As they prepare salary budgets for 2010, employers are signaling that they stand ready to award merit increases of about 3 percent—almost back to pre-recession levels, according to Watson Wyatt Worldwide (WWW), a human resource consulting firm headquartered in Arlington, Va.
And HR professionals have leadership roles to play in helping their executive teams navigate the many options available. Some compensation specialists plan to reformulate total rewards packages for positions at every level. Here’s how—and why.

Employers’ final 2010 compensation plans will hinge on the economy’s actual performance, of course, but prospects appear promising. The U.S. economy is expected to expand faster than previously forecast as consumer spending increases in the second half of this year and in 2010. Although job recovery may take longer—employment is typically among the last major indicators to turn positive at the end of a recession—many business leaders say their companies’ financial numbers have leveled off. A WWW survey of 179 companies reveals that as of last June, the number of respondents who reported that the worst had passed was nearly double the percentage that reported the same sentiment two months earlier, further boosting employers’ confidence for the future.

The Human Resource Agenda
Laura Sejen, WWW’s global practice director of strategic rewards, notes that results from the study show that for 2010 many companies are planning to:
• Cancel hiring freezes. Sixty-two percent of the respondents plan to do so.
• Restore salaries. Fifty-five percent of those surveyed who had reduced salaries plan to roll them back to previous levels.
• Resume matches to 401(k) and 403(b) accounts. While 70 percent of the respondents expect to start matching employees’ contributions at pre-recession levels, more than one-third were unsure when they would begin making matches again.

Naturally, experts caution, unforeseen events could push the economy off a recovery path, causing consumers to lose confidence and hold back spending. In that event, Steve Gross, global performance and rewards consulting leader for the Mercer HR consulting firm, headquartered in New York City, expects that business leaders "would continue their cost-containment strategies, such as low to minimal hiring, managing fixed base salary costs, and further adoption of furloughs or reduced work hours."

But even if the economy improves, it could be fragile for a while, which raises the question of why business leaders would now unlock their war chests. A major reason is that some industries remain profitable, and their leaders want to maintain the talent base, explains Bob Cartwright, SPHR, president of Intelligent Compensation LLC in Pflugerville, Texas. It costs less to maintain good talent via retention strategies than to attract new talent on the upswing. Cartwright estimates that it takes 1.5 to 3.5 times the pay to replace a good employee.

In addition, compensation specialists fully expect that as the economy improves and employers start rolling back their earlier decisions for coping with the recession, top talent will dramatically hike their expectations—especially their compensation expectations.

On the union side, employers’ negotiators may find opportunities for concessions during contract discussions. Justin Keating, an attorney specializing in union negotiations for Beins, Axelrod PC in Washington, D.C., recently negotiated a 15 percent pay reduction for a trucking company’s union employees. Unlike the pattern in previous contract talks, Keating notes, the downturn makes union officials more likely to believe company officials who say they can’t afford to meet union demands because doing so could put them out of business.

Some top managers may have no choice but to keep pay frozen until their businesses improve. While not desirable, "salary freezes are still preferable as an alternative to layoffs," says Rajiv Burman, HR vice president for North America of Jubilant Organosys Ltd., a life sciences company with headquarters in India.

Lane Transou, SPHR, manager of benefits and compensation for Parker Drilling in Houston, agrees but cautions that "salary freezes require a great deal of communication, and the longer the freeze, the more frequent the communication."

Regardless of the pace of the economy’s recovery, there probably will not be a return to business as usual in human resources, according to many experts. Some survival tactics adopted during the downturn appear to be here to stay. Sejen notes, for example, that many employers expect to see long-term changes in retirement decisions, staff sizes and health cost-sharing, which will affect compensation strategies:
• Employees will likely postpone retirement. Seventy-nine percent of the respondents to the WWW survey expect employees to work past their desired retirement ages as a way to recoup savings lost during the stock market decline. Companies with greater shares of older workers will likely have higher compensation costs because older workers with much experience often have higher salaries.
• Analysts also project dramatic increases in health care costs for 2010. To the extent that their health costs increase, employers may be less able to raise cash compensation. Gary Kushner, SPHR, president of Kushner & Co. in Portage, Mich., notes that health care costs for 2010 are expected to jump 10 percent to 12 percent for small to mid-size employers, and 8 percent to 10 percent for large employers with more than 500 employees.

As health costs increase, so too may employees’ share of those costs. In the June WWW survey, more than 73 percent of the respondents said they expect employees’ proportion of health insurance costs to increase. Furthermore, 46 percent of the respondents who had raised employees’ health insurance contributions during the recession said they do not plan to reverse those increases.

In addition, even when an employer begins to pay employees more in total compensation—figuring the value of benefits plus base salary and other cash compensation—workers may not be thrilled if their cash outlays for benefits premiums go up and their net pay goes down.
• Employers will keep staff sizes to a minimum and use contract labor to meet demand for goods and services as the economy grows. Fifty-two percent of the respondents to WWW’s June survey said they expect to decrease staff sizes in the next three to five years so their organizations won’t be caught with burgeoning headcounts should another downturn take place.
Hence, for 2010, budget lines for contract labor might increase quickly while the increase in total costs for compensation of regular full-time employees may not be so dramatic.

Revising Pay Strategies
In the aftermath of pay freezes and layoffs, many HR managers are weighing new compensation strategies. Researchers for Hay Group, a consulting firm based in Philadelphia, recently set out to study how rewards strategies and design would change during the next two or three years. Instead, they found that the attention of many business leaders was focused on the next three to nine months. The study of 760 respondents was conducted by Hay Group in collaboration with WorldatWork, an HR association headquartered in Scottsdale, Ariz. The researchers note that for many executives, there is just one issue: how to stay in business.
These executives focus on steps to:
• Align labor costs with economic realities.
• Align rewards with business strategies and performance
• Engage staff members with limited financial rewards.
• Leverage corporate scale, philosophies, processes and tech-nologies.
Yet by preparing for the next upturn, making necessary changes and investing in the future, many HR professionals can leverage these turbulent times to create long-term change in compensation strategies, according to Tom McMullen, Hay Group’s North American rewards practice leader. Variable pay programs—pay above base salaries—represents a notable area of change, McMullen says. These programs cover the entire workforce and range from short-term incentives for annual performance to long-term incentives for performance across two years or more. Variable pay includes cash bonuses, cash incentives or stock.

The Hay Group study indicates that the majority of the respondents plan to change their compensation philosophies to balance rewards for achieving short-term and long-term objectives. In practice, such philosophies would define what is measured and the time frames for measurement.
And they plan to shift the mix of variable pay. Rather than rewarding only for achievement of current-year financial performance, many business leaders want to reward employees for meeting longer-term objectives. For example, in addition to rewarding short-term profitability and productivity, variable pay will soon reward performance measures such as customer satisfaction, development of human capital and innovation, McMullen says.
Seeing executives reap large bonuses even when their companies perform poorly may diminish tolerance for rewarding short-term gains.

Enacting balanced compensation philosophies might, for instance, prevent rewarding a manager who cuts research and development spending to increase profit margins one year and is left with no new products to sell the next. Or, it might dissuade a mortgage broker from arranging a loan for a marginal applicant just to get the front-end commission.

Total Rewards
Since the bottom of the 2001 recession, HR leaders have been promoting the concept of "total rewards" to let employees know the full value of their compensation. In the Hay Group study, researchers found that 20 percent of the survey respondents report "total rewards" to employees and measure the return on their total rewards investments. Furthermore, 57 percent plan to use this approach in the future. This means that more organizations will add up benefits and even intangible rewards when figuring employees’ pay and determining the organization’s return on its rewards investments.

Hay Group research also indicates that when business leaders view pay as a cost, the goal is to minimize it, but when pay is seen as an investment, the goal is to optimize it, McMullen says. Thus, managers and HR professionals are likely to behave differently, depending on their views.
According to McMullen, business leaders who see compensation as a cost will match what others do, will respond to inflation and will calculate how much they can afford. But those who view compensation as an investment will look at rewards strategies and management processes to support their business strategies, align employees’ interests with organizational interests, and communicate the link between pay and performance.
For this reason, having internal consensus around compensation for 2010 will be critical.

Achieving Consensus
Human resource executives must take the lead with senior finance officials in making salary recommendations. WWW’s Sejen lists the components of those decisions:
• How much the company can afford, based on business results.
• Business leaders’ expectations for growth in 2010.
• How well base pay and total compensation will be positioned for markets within each industry.
Transou says the last point requires two elements: internal assessment of salaries to identify gaps by grade and position, and external comparison with salaries by industry. Benchmarks are available from third parties, consultants, professional chapters, government web sites and the Society for Human Resource Management (SHRM) Compensation Data Center.
In her book Solving the Compensation Puzzle: Putting Together a Complete Pay and Performance System (SHRM, 2008), Sharon K. Koss, SPHR, notes the following steps:
• Request last year’s budget and compare actual vs. planned expenses for the following year.
• Meet with the management team to determine its goals for broad compensation changes or enhancements.
• Review the organization’s strategic plans and goals, and check to see how HR requests line up.
• Have candid discussions with the management team about external pressures and influences on compensation budgets, including turnover, skills shortages and use of expensive outside contractors.
• Review internal issues with the management team, including financial challenges, business cutbacks and growth.

A Shifting Horizon
As this recession has reminded everyone, no matter how firm an employer’s compensation plans for the coming year may be, they are not set in stone. Economic conditions can change—for the better or for the worse—with little warning. And the most effective compensation plan may prove to be one that is the most flexible—the one continually examined and re-evaluated, and changed if necessary to ensure the organization’s survival.

Source: SHRM, volume 54, number 10.

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