The New Normal in Compensation Programs

By Tom Burke, Buck Consultants

After a period of frequent fluctuations in compensation practices, things appear to be settling down as organizations adjust to a new set of norms. While the landscape of compensation programs may still look familiar, some elements are taking on more or less prominence in the post-recession economy.

Since the beginning of 2010, there has been a reduction in special cost-cutting actions including: pay or hiring freezes, temporary layoffs or furloughs, pay cuts, and suspension of company matches to defined contribution plans. During this period, Buck Consultants conducted two surveys: Recovery, Restoration and Retention: 2010 Compensation Trends (January 2010) and Compensation Planning for 2011 (August 2010). In January 2010, nearly two-thirds (64 percent) of organizations reported having implemented a pay freeze within the prior 18 months, a figure that dropped to less than half (48 percent) by August 2010. Buck Consultants’ most recent study, Reviving and Inspiring the Workforce: 2011 Compensation Trends Survey, shows a further sharp decline in pay freezes to 9 percent, which is more in line with historical patterns.

Typical pay increase budgets also have shifted gradually over time, from a long-standing four percent to the current norm of three percent. While increase budgets have rebounded from recessionary lows, they are likely to remain close to three percent for the foreseeable future, assuming no significant inflation changes. It’s not that organizations are unwilling to spend more; it’s that they want to make sure it is worth doing so without committing to additional fixed costs in the form of higher payrolls.

Pay for Performance Dominates

With pay increase budgets stabilizing, an even greater emphasis is being placed on pay-for-performance programs in order to motivate workforces and attract and retain top talent. Organizations are finding that with fewer merit increase dollars available, selecting the correct plan metrics is more critical than ever. At the same time, greater performance expectations are being placed on employees as organizations continue to look for ways to innovate and grow while containing labor costs.

Note that pay for performance is about more than just money. In Buck’s Reviving and Inspiring the Workforce survey, which contains information supplied in February 2011 by 105 U.S. organizations representing a range of industries and different sized organizations, the top strategy for retaining top performers is to provide new career development opportunities (41 percent). This is followed by three compensation-related strategies: market pay adjustments (30 percent), larger base pay increases (24 percent) and larger bonus opportunities (21 percent). These findings reveal the importance of rewarding top performers, both thoughtfully in terms of what the employee values and responsibly in terms of what is fiscally viable.

Continued Dependence on Variable Pay

During the past 36 months, annual bonuses have varied widely depending on performance, as should be expected. With limited ability to make fixed-dollar increases during the past several years, variable pay programs came to the rescue for many organizations. What has remained consistent during this period is the existence of annual bonus programs, even though payouts were zero in some cases. After all, there are no guarantees when it comes to bonuses, since they should be designed not only to encourage and reward desired performance when it occurs, but also to reflect financial realities.

According to Buck’s February 2011 survey results, 31 percent of organizations have paid or expect to pay bonuses that are within plus or minus five percent of last year’s amounts. An even larger number, 44 percent, expect bonus payments to exceed last year’s amounts by at least five percent. One-quarter (25 percent) expect bonus payments to trail last year’s amounts by five percent or more.

When looking at bonus payments versus targets, 44 percent of organizations report they have paid or expect to pay bonuses that are within plus or minus five percent of target. About one-quarter (27 percent) expect bonus payments to exceed targets by at least five percent, while 29 percent expect bonus payments to fall short of targets by five percent or more.

Attraction and Retention Trends

For some time now, organizations have been carefully watching for an uptick in turnover rates, which would begin to substantiate reports that employees are seeking new opportunities as job openings surface. While these indicators have yet to reveal sustained movement in the job market, evidence shows organizations are maintaining or implementing programs that will enable them to attract and retain employees as the competition for talent grows and intensifies.

Approximately two-thirds (63 percent) of organizations report using hiring bonuses, while 41 percent report using or planning to implement retention bonuses. Two-thirds (66 percent) report an existing employee referral bonus program, where employees are typically eligible to earn multiple bonuses. Such bonuses can have the dual benefit of attracting a strong performer while helping retain the recommending employee.

Among organizations with referral bonus programs, 79 percent rate their programs as "equally effective" or "more effective" than other recruiting methods. Similarly, 53 percent of these organizations rate their employee referral bonus programs as "quite valuable" or "extremely valuable" when considering both effectiveness and cost.

"Normal" has taken on new meaning when it comes to compensation programs. As a result of the recession, organizations have reduced their fixed costs by decreasing headcount and slashing pay increase budgets. As the economy slowly recovers, organizations are adopting a prudent approach to increasing fixed payroll costs. While there may be a general willingness to pay more, most of it will likely come in the form of bonuses and according to a scale that moves up and down with performance. Demand for top performers should remain strong and will likely increase as organizations begin to flourish.

Now is the time to ensure appropriate opportunities and rewards are in place to retain and attract the best talent. Making an investment today to revamp outdated pay and performance strategies should yield favorable returns as market conditions improve in the future.