Presidio Pay Blog Providing Thoughtful, Strategic Advice for Critical Compensation Issues

Managing Compensation Costs

We are fielding quite a few requests for ideas on how to effectively manage compensation costs in light of the rough economic conditions. Below we’ve listed a few ideas we feel have merit and, in some cases, are a more strategic approach than simply cutting jobs. Feel free to comment or provide alternatives you’ve seen work.

1. Freeze Merit Increase Budgets - This translates to no base salary increases for 2009. Most surveys indicate companies have already revised their 2009 merit increase budgets downward from 3.6% to 2 - 3%. Some companies are taking this step further and freezing salaries altogether.

Presidio Pay’s Thoughts - Freezing salary increases is only slightly less demoralizing than a layoff, particularly for high-performing employees. We would suggest companies continue to provide some base salary increase to the top performers in the organization. This reinforces the importance of a company’s performance management process and further creates a link between performance and compensation. If companies can’t afford even limited increases, one practice we advocate is executive management taking a pay cut or foregoing bonus payouts to fund a merit increase pool for top-performing employees.

Examples - Bausch & Lomb, The White House, Yahoo!, a number of universities.

2. Mandatory Furloughs - This practice is structured very much like it sounds: A required unpaid vacation. Employees simply inform Human Resources or their manager of the week in which they will be taking their furlough. Companies may reduce the employee’s paycheck in the pay period in which the furlough occurred but will usually have payroll adjustments reflected in the first paycheck after the announcement of the furlough.

Presidio Pay’s Thoughts - We have found this to be one of the more palatable methods to trim payroll by about 2% (1 week divided by 52 weeks is about 1.92%). From the employee’s perspective, the sting of the reduction in pay is partially offset by the time off from work. Some companies choose to reduce the employee’s paycheck in the pay period in which the furlough occurred, giving the employees the ability to time their reduced paycheck. However, most companies prefer to have payroll adjustments reflected in the first paycheck or over the annual pay cycle. Note that there may be legal ramifications for making lump sum reductions in pay so always consult your labor lawyer first.

Examples - Gannett, Arizona State University, and the State of California.

3. Delayed Salary Increases - In a recent survey, many companies indicated they would delay the timing of salary increases by 3-6 months to postpone increasing fixed costs. These types of adjustments do not provide a retroactive “catch-up” feature to account for the foregone months of additional income had the annual salary increase happened at the regularly scheduled time.

Presidio Pay’s Thoughts - Companies considering this approach should model the financial impact to determine if the incremental cost savings will outweigh any negative morale consequences. As long as a company communicates to employees the revised timeline well in advance (and sticks to it) the impact won’t be as negative as an indefinite salary freeze, because employees can see a light at the end of the tunnel. Companies that continue to extend the delay after committing to a date or fail to address the situation with all employees in the form of a corporate announcement from senior management usually suffer significant employee engagement setbacks.

Regardless of how long salary increases may be delayed, we encourage all companies to continue regularly-scheduled performance reviews and manager feedback sessions with employees. This sends the message that the company values and recognizes employee development regardless of fluctuations in the economy. It also enables managers to differentiate salary increases by performance level once a merit budget becomes available.

Examples - Broadcom,  and a couple of local government agencies.

4. Layoffs and Pay Cuts Together - Another alternative to simply cutting jobs is to combine fewer layoffs with a slight reduction in base salaries for retained employees. Companies may find that the combination of the two events will have a similar net impact on the salary budget to laying off a greater number of employees.

Presidio Pay’s Thoughts - The combination of a smaller layoff and base salary reductions for existing employees may enable companies to maintain an acceptable span of control to continue effective operations. Often, in an effort to meet financial cost-cutting objectives, companies will cut too deep, limiting the company’s effort to execute against their short-term operational goals. Even more damaging may be the perception of remaining employees that they get to pick up the extra duties of their former colleagues and take a pay cut for doing even more work.

In addition, when demand for a company’s products or services begins to pick back up, the company may be faced with staffing up with external hires whose salary demands may exceed the long-term employees whose salaries were reduced.

Surprisingly, we’ve heard from companies that employed this approach that, in the long-term, retained employees demonstrated greater loyalty and engagement than new hires for having seen the company through the rough patch so long as management makes a concerted effort to recognize their contributions once the economy picks up.

Examples - Teradyne, IBM, Los Angeles Opera, and Time Warner/AOL.