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January 7, 2002 Issue

The Impact of the Recession and the Impending Recovery on Current Compensation Strategies - Part I - What Doesn't Work

A headline this past Saturday from the Associated Press reads "Unemployment Reaches Six-Year High." The article states that unemployment reached 5.8% in December. The US economy has now lost more jobs in 2001 than in the past two decades.

The same article discloses that the Dow Joes Industrial Average rose 87.60 to 10,259.74. In 2001, US businesses cut 1.4 million jobs, 1.1 million since September 11. In 2001, the employment level peaked in March, the same month the National Bureau of Economic Research ruled the recession began.

In recent issues of Business Week, editors write about signs pointing to a full recovery by the fall of 2002. They point to the relatively quick recovery of the stock market after 9/11 and polls showing a less than expected decline in consumer confidence. Preliminary holiday season sales figures show sales at the same or slightly less than 2000. Unless there is a complete stalemate over the Economic Recovery Act pending in Congress, the US economy should be fully recovered by 2003.

Despite this optimistic report, many organizations are implementing short-term reactive compensation strategies.

According to recent research by WorldatWork, 77% of employees in the US are eligible for some form of profit sharing, bonus, or variable compensation program, up from 52% in 1997. The idea is to link employee compensation to financial results and not to commit to set pay adjustments based on market or performance.

Morgan Stanley Dean Witter is predicting that after-tax corporate profits will fall 21% in Q4 2001. This will dramatically decrease variable compensation payments. As a result, consumption of durable and non-durable goods may fall 1% in Q1 Of 2002. The move to more variable compensation may backfire and prolong the current economic recession.

There is a natural tendency for organizations to move their compensation programs towards variable rather than fixed ones during slow economic periods. Astron Solutions always advocates the alignment of compensation with organization success. We also suggest the linkage be in the form of a "Balanced Scorecard" addressing all aspects of organization success, not just financial.

The current trend to align compensation programs only to financial aspects of the organization may focus employee efforts on short-term measures at the sacrifice of customers and future growth. True, compensation programs can only be effective as they are affordable, but having all decisions based solely on the financial scorecard will leave the organization at a deficit when the economy recovers. They will reinforce and retain employees that are successful only in saving the organization money today. They may have lost forward thinking, customer oriented employees needed for future growth.

Effective variable compensation programs are used in conjunction with a sound base pay program. Organizations that replace base pay strategies with variable pay strategies soon find they are not competitive at the base level. Their ability to attract and retain the talent required is diminished. This becomes a serious issue when the organization is ready to respond to an upturn in the economy. They find themselves unable to pay market rates required and end up increasing their base salary costs to catch up. It also sends the message to current staff that it was the market, and not their efforts, which drove base pay decisions.

Another questionable strategy is the wage freeze or minimal adjustment. This strategy's premise is that it is better to freeze wages than to face a layoff. For those with labor contracts, you understand the difficulty of this strategy. One would think that unions are there to protect the jobs of the membership. But in reality, they are there to continue to push for economic gains. In most cases, when faced with a wage freeze or layoff, the union will take the layoff, as layoffs are governed by contract based seniority protections. Therefore, the more junior, recently hired employees will be let go first, protecting their loyal membership base.

An additional issue with this strategy is the potential talent loss. Highly competent and performing employees will tolerate a wage freeze or reduced pay adjustment for a very short period of time. These employees are ambitious and want recognition, reward, and advancement opportunities to continue. If an organization cannot provide this, they will look elsewhere and will more than likely have a short-term search. There are many organizations doing well in this recession and willing to pay for talent. As with the variable pay strategy, the wage-freeze strategy has the same issues of quickly falling behind the market.

Astron Solutions supports a comprehensive, total rewards focused strategy where all aspects of total rewards are reviewed and realigned based on current economic conditions with an eye towards upcoming strategies.

Many clients ask if and how they should modify their current compensation programs. They also question reported market levels for jobs in new salary surveys. Many CEOs and CFOs challenge HR to control or cut salary expenses. In the next issue of Astronology, we will explore some of the "Best Practices" that we have observed or recommended to organizations for 2002 and 2003. These strategies will focus on those organizations that have moved from a centralized compensation system to a decentralized one, and visa-versa.

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ISSN Number 1549-0467