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Special Report on Compensation: Cracks in the Ice

After two years of dormant pay, or at best paltry raises, the compensation pendulum appears to be swinging in the other direction as more companies prepare to boost salaries and dole out bonuses and other incentives.

“In 2008 and 2009, companies were taking four, five, six—in some cases seven—different actions all targeted at managing or outright reducing costs associated with human resources,” says Laury Sejen, rewards global practice leader at consulting firm Towers Watson & Co. “Now that we’re through the worst of that and business conditions in general are better, we’re seeing better funding for the annual salary increase.”

Surveys show pay increases running as high as 3 percent in 2011. Towers Watson says its survey of 1,046 U.S. companies indicates an average increase of 2.7 percent. Human resources consulting firm Mercer surveyed more than 1,100 organizations and forecasts an annual increase averaging 2.9 percent compared with 2.7 percent in 2010. And the Conference Board, a private research group, predicts a median increase of 3 percent, as does the consulting firm Hay Group Inc.

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“It’s a glass half-full if you compare it to where we were 12 or 15 months ago, when people said the average that employees could expect was a 2 percent increase,” says Tom McMullen, North American reward practice leader for Hay Group. “Relative to most of 2000 to 2008, when we saw increases of 4 percent to 5 percent, 3 percent is lower.”

Still, pay hikes should comfortably outpace the inflation rate next year. Based on Consumer Price Index projections by Georgia State University, a 2.8 percent wage increase would equal a “real” salary increase of 1.1 percent. “The 2011 number appears to be a more positive story than we’ve had for quite a long time,” says Dave Van De Voort, a partner at Mercer.

Only 2 percent of companies plan across-the-board pay freezes in 2011, according to Mercer. That’s down from 13 percent in 2010 and 31 percent in 2009. “There really is a mindset that you can only do that for so long,” says Jeanie Adkins, a partner with Mercer. 3M Co., for example, ended a pay freeze this year that had begun in 2009. But that was just one of several cost-cutting steps affecting compensation taken by the company, which is based in St. Paul, Minnesota. Employees of the maker of Post-it notes and Scotch tape were given until Dec. 31 to use “banked” vacation, ending the tradition of being allowed to carry days over year to year. Those hired after Jan. 1, 2009, participate in a defined-contribution retirement plan instead of a defined-benefit plan. And in October, the company said it will phase out offering health insurance to retirees.

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Beginning in January 2013, 3M will deposit money into an account that retirees eligible for Medicare could use to buy Medicare supplemental insurance, spokeswoman Jacqueline Berry says. Starting in January 2015, retirees not eligible for Medicare will receive money in what 3M calls a “health reimbursement account” to buy insurance. Despite the overall compensation improvements forecast for 2011, some workers have agreed to pay cuts this year or future pay freezes.

Members of the Sheet Metal Workers International Association, for instance, accepted a contract in October with Wolf Appliance Inc., a manufacturer of ovens based in Madison, Wisconsin, to cut wages 20 percent and to freeze salaries for five years. The pay cut will be phased in 5 percent per quarter.

Also, union workers at Harley-Davidson Inc. factories in Wisconsin approved a contract in October that cuts about 275 jobs, freezes wages and allows the company to hire lower-paid seasonal workers when the agreement goes into effect in April 2012. Harley-Davidson and Wolf Appliance both had warned the unions that the companies might relocate to lower-cost regions if their unions didn’t accept the concessions.

Keeping the keepers
Despite unemployment remaining at 9.6 percent in September, some employers are beginning to worry about retaining top talent. “Employers have been anticipating that when the economy turns they’ll have a hard time attracting and retaining their key talent,” Adkins says.

That concern has led some companies to veer from their traditional calendars and to give raises sooner to employees whose pay was frozen during tough times. For example, Dallas-based AT&T Inc., which had frozen pay for managers in January 2009, gave them raises in November 2009 after business bounced back rather than waiting until March 2010, the traditional month for increases. “The company wanted to thank the managers for their hard work and to acknowledge that the sacrifices they had made resulted in a healthier company,” AT&T spokesman Marty Richter says.

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With tight budgets, companies continue to strengthen the link between pay and performance. The highest-rated talent will receive pay increases averaging 4.5 percent in 2011, according to Mercer, compared with 4.3 percent in 2010. Average performers will receive a 2.7 percent increase, and the lowest-rated workers will receive 0.5 percent. But fewer workers get sizable raises. The number of workers rated in the middle has dropped to 35 percent in 2010 from 52 percent in 2007. The number of workers who are at the top has remained relatively steady. Fourteen percent earned the highest rating in 2010, up from 12 percent in 2007. The number rated as low has grown to 20 percent in 2010 from 6 percent in 2007. The bottom-rated talent has more than doubled, up to 7 percent in 2010 from 3 percent in 2007.

The trend reflects more companies adopting forced rankings, where managers evaluate employees’ performance against that of other workers rather than against preset standards. Jack Welch popularized the strategy during his tenure as CEO of General Electric Co. At GE, Welch famously categorized employees as “A” players for the top 20 percent, “B” players for the middle 70 percent or “C” players for the bottom 10 percent.

Employers also want to spend their limited dollars on the most deserving. “That’s one of the most significant changes over my career that we’ve seen in the numbers—the significant shift to more people being rated in the lower categories,” says Van De Voort, who has been at Mercer for 22 years and has worked in the human resources field for 36 years. “It’s tougher to get rated high and you don’t get as much [as you used to] for getting that rating when you get it.”

Companies also want to slow the growth of fixed costs such as salaries and benefits, Hay’s McMullen says. “Companies are saying, ‘We’re quite happy to pay compensation when performance is there, but we’re going to make sure that it’s effectively leveraged in variable pay rather than base pay.’ ”

Rockwell Collins Inc.’s compensation strategy includes several tools to drive performance.

After freezing wages in 2009, the Cedar Rapids, Iowa-based aerospace electronics company awarded merit raises in 2010. And in December its employees will receive cash bonuses, the first the company has offered in two years.

Employees know how large the bonus could be if the company achieves all of its objectives. Because of the economy’s drag on its commercial markets, Rockwell Collins told employees at the beginning of the 2010 fiscal year, which ended Sept. 30, that they would receive only 40 percent of the amount for which they’re eligible even if the company achieved all of its goals. But because the company ultimately did better than expected, it recently told employees that the firm may be able to pay them as much as 60 percent of what they would receive under normal business conditions.

With conditions improving in its commercial markets, Rockwell Collins anticipates revenue totaling between $4.8 billion and $5 billion for fiscal 2011, up from $4.7 billion in 2010 and $4.47 billion in 2009. Because of the brighter outlook, the company plans to fully fund its bonus pool in fiscal 2011.

“We are all in it together in terms of our incentive program,” says Melodee Webb, vice president of compensation at Rockwell Collins.

To help maintain employee engagement, Rockwell Collins doubled its budget to $5 million this year for its two employee-recognition programs: “instant compensation,” which awards checks of $1,000 to $7,500, and “alternative awards,” which are gift cards of $25 to $500. “We tracked it and made sure that people weren’t holding back on using those tools,” Webb says.

Besides creating a direct connection between above-and-beyond performance and compensation, spot bonuses don’t encourage a sense of entitlement. “The beauty of spot bonus awards is that there is no expectation in general on the part of the employees that everybody is going to get some form of spot bonus,” Towers Watson’s Sejen says.

Companies still unsure about their 2011 finances should focus on total rewards—flexible hours and skill building—when money for raises is lean, Sejen advises. “We’re advocating a strategy that builds in as much flexibility as possible. Avoid to the greatest extent possible huge commitments that can’t be scaled back if business conditions take a turn for the worse.”

Workforce Management, November 2010, p. 30, 32, 36Subscribe Now!