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Compensation Survey & Salary Report Money Transfer

Loath to increase fixed costs, companies are keeping overall salary budgets static and funneling more dollars into distinct segments of the workforce to hold on to critical talent.

November 3, 2006
Related Topics: Compensation Design and Communication, Benefits
Compensation surveys for 2007 project the same flat U.S. salary budgets that have been seen for five years—a smooth, unchanging pool of merit increases averaging 3.7 percent and variable pay stuck at less than 12 percent of payroll. But at high-performing companies like Textron Inc., money is moving below the surface.

    Compensation executives at these companies adopt the flat overall budgets reported in the surveys but then sharply segment the workforce and push the cash around to retain critical talent. Multinationals are managing the top segments on a global basis and leaving the rest to local management.

    Segmentation puts employees in groups according to their potential impact on value creation and earnings and the full cost of replacing them. But it’s an empty gesture unless it is supported by a compensation structure that meets the needs of the critical segments.

    In the U.S., employers are channeling more money to the top and less to the bottom. Below the top segments, real wages are falling and performance pay is no longer a compelling issue.

    "Companies are still reticent about increasing fixed costs, and they can act on that reticence because labor markets are still not robust, except in some specific sectors," notes Steven Gross, global leader of the rewards practice at Mercer Human Resource Consulting.

    Textron is a good example of this cost-conscious but highly competitive stance. Best known for its Bell Helicopter and Cessna Aircraft business units, the multi-industry company operates in 33 countries, manufactures in 21, employs 37,000 people worldwide and pulls in $10 billion annually in revenue.

    Textron targets the market median for pay opportunity and easily blends into the aggregate numbers reported in the salary surveys. The company’s salary budget for 2007 matches the 3.7 percent average, and variable pay runs in the 10 percent to 12 percent range of payroll that most companies report.

    But a massive change in compensation at Textron began five years ago. That is when the Providence, Rhode Island-based company initiated a transformation from a traditional holding company with autonomous business units to a networked enterprise that could leverage the benefits of operating as a coherent whole with powerful global brands and common business processes.

Sharp segmentation
    Under direction from its board of directors, Textron segmented the work-force, shifted to a global performance management system for all professional employees and installed uniform incentive pay design and metrics for the top 1,000 executives and managers across all business units and locations. It also adopted a total-rewards perspective.

    "In our compensation approach, we must have enough continuity to reinforce the networked enterprise model for the top 1,000 executives across the organization, who may cross over industries within the company during their careers," says Jon Fliss, director of executive rewards. "We don’t want stand-alone business units, and compensation must reinforce that mentality."

    Annual incentives for this group are based on companywide earnings per share and return on invested capital, personal performance leadership initiatives and business unit profits. The incentives are directly tied to a global performance management process, which uses the same calendar and the same mandatory midyear and annual performance evaluations. Before the transformation began, Textron lived with a fractured performance management system.

    Approvals begin with manager recommendations for merit increases, annual incentive awards and stock-based incentives, including restricted stock. "Managers complete the performance reviews and then dramatically reinforce the evaluation with compensation," Fliss says. "They have some very powerful tools in their hands."

    A second workforce segment consists of the global group of 2,000 employees just below the top 1,000.

"The market tells us that other salaried employees make significant contributions to the success of the company," Fliss notes. But incentives based on earnings or return on invested capital hinge on factors that may not be within the line of sight of this group of employees. "So business units develop their own incentive plans and metrics for this group," he says.

    Incentive plans for this second segment are generally one of two types. For sales employees within this group, Textron uses commission plans tied to business goals and calibrated by different measures, including the type of customer, the nature of the relationship and competitors’ practices.

    For non-sales employees in the second segment, the company uses incentive plans that mirror those for the top 1,000 employees but use metrics relevant to each business unit, such as unit profits or revenue growth. The incentives may also be tied to profits or growth in divisions within the units if necessary to improve line of sight.

Designed at the top
    Textron’s explicit segmentation and rewards redesign puts it well ahead of other companies. In a 2006 rewards survey conducted by Deloitte, only 20 percent of the companies reported that they have explicitly defined their critical workforce segments. Forty-one percent said they have identified their critical segments, but only with implicit definitions that may not be widely understood.

    Within the group of companies that have explicitly or implicitly segmented the workforce, only half proactively design their rewards programs to meet the needs of the critical segment or give them significant consideration in program design.

    Fliss believes the role of Textron’s top executives in shaping compensation has been a critical element in tying the compensation plan directly to the success of the company. This leadership role consists of what Fliss describes as "bookends" for the design process.

"Every organizations has limited dollars and must determine where it must build institutional knowledge and where the knowledge is not specific to the institution and simply be bought."
--Steven Gross,
Mercer Human Resource Consulting

    The first bookend belongs to the board. "The board of directors is the driving factor in companywide compensation design," Fliss notes. In 2003, the board hired an independent compensation consultant to report on emerging compensation trends and design issues. The consultant attends every compensation committee meeting.

    The board has approval authority for compensation for the top six executives, but because these executives participate in the same plans as the top 1,000 employees, the board’s decisions reach far beyond the named officers.

    "All of the design elements and metrics are set at the board level, so the board’s influence is broad, which is as it should be," Fliss says. "We report back to the board on a regular basis on the results of their decisions."

    The other bookend belongs to HR leadership at Textron, organized on two levels—a leadership team and a technical group. The leadership team includes the top HR leaders and the heads of HR for each business unit.

    The leadership group is complemented by a technical group that Fliss launched in 2005. The rewards working group consists of compensation leaders from each unit. "We are truly a working group that shapes implementation," he says. "We strive to ensure that compensation is competitive relative to external markets and that we maintain internal equity."

    This technical group is now working though detailed analyses of the top 1,500 employees in the organization with a fact-based evaluation for each job. "Our task is to ensure that all jobs are aligned internally and that the company has correctly identified and captured the right 1,000 people in the global talent group," Fliss says.

Incentives down below
    For the 34,000 Textron employees below the top two segments, incentives are relatively minimal and do not follow the global design. "Market data indicate that not everyone should receive incentive compensation," Fliss says.

    Individual plants may use incentives to achieve their business plan. The incentives are based on highly tangible outcomes, such as safety improvements or output growth. "At the local level, incentives are not uniform," Fliss notes.

    "We try to ensure consistent design fundamentals, but we have to keep the details of the design, administration and communications local to build the relationship between employees and their managers or supervisors. The goal is the appropriate reinforcement of performance. It requires strong principles supported by strong local judgment."

    Textron’s flat overall salary budget and relatively modest amounts of variable pay below the top workforce segments reflect the broader trend evident in data ranging from salary surveys to the national income accounts. In Deloitte’s 2006 rewards survey, more than one-third of the companies reported they view performance pay as a critical tool for a limited group of key employees, but not the remainder of the workforce.

    Soft labor markets allow employers to identify critical employees and funnel money in their direction with little or no new money budgeted for the rest of the workforce. Mercer’s Gross reports that one large company recently posed the question, "We are the most desirable employer in the sector, so why don’t we pay below market? Then we can funnel more money into the pockets where we need greater recruitment and retention power."

    "The question for every company is always, ‘Where are we going to increase our HR investment?’ " Gross notes. "Every organization has limited dollars and must determine where it must build institutional knowledge and where the knowledge is not specific to the institution and can simply be bought."

    According to Gross, employers can segment the workforce into three groups: employees who are profit drivers; employees who are performance enablers or support staff; and legacy drivers, who made money for the company in the past but no longer do because the product mix has changed, production can be outsourced or the strategy has shifted.

    The portion of the U.S. workforce that belongs in the legacy segment is growing, but it is extraordinarily difficult to move people between the three workforce segments. Retraining is expensive, and downgrading workers is difficult.

    "Talent mobility is a workforce management and administrative nightmare," Gross says. "It’s very hard to cut wages when an employee is no longer part of the profit-driver segment but a legacy worker instead."

    Segmenting the workforce and then establishing the appropriate compensation mix for each group is the goal. "The key question most companies can begin with is, ‘Why do customers buy from us?’ " Gross says.

    "One retailer discovered that its customers no longer valued the high levels of customer service that its experienced sales force had traditionally provided. Instead, customers preferred lower prices. So the company shifted to a lower price model and cut out commissions for the sales force, which lowered wages overall. It was a successful move."

Pay levels abroad
    While real wages are falling and performance-based payouts are stuck at low levels for most U.S. workers, survey data show significant real-wage increases and higher levels of variable pay in countries outside the U.S., particularly in the developing markets.

    "We’ve seen much greater use of variable pay outside the U.S. since the late 1990s, with much more aggressive merit increases based on individual performance," says Ravin Jesuthasan, managing practice leader for rewards and performance management at Towers Perrin. "The rate of change toward more variable pay in these countries is faster than in the U.S."

    But in some countries, employers use a companywide bonus that is really a profit-sharing mechanism and based purely on company results, not individual performance, Jesuthasan notes. At these companies, variable pay is less about driving performance and more about sharing success—an after-the-fact plan.

    Employees have a real expectation that these bonuses will be paid out year after year. "There is almost an entitlement mentality and the bonuses are really what we call ‘salary in drag,’ " Jesuthasan says.

    Still, Towers Perrin’s 2006 total remuneration survey reports that variable pay as a percentage of payroll for an accountant, for example, averages 12 percent in Singapore and 9 percent in India, compared with only 4 percent in the U.S.

    Mercer’s 2007 global compensation survey reports that 2007 projected merit increases are higher in almost every country than in the U.S., with China posting a 7.2 percent increase—well above the 2.2 percent inflation rate forecast. Gross notes a steep rise in geographic workforce segmentation. "Instead of moving toward greater global pay alignment, a company may pay a premium in China, where turnover is high, and discount in Japan, where it is low," he says.

    The overarching trend in the U.S. and abroad, however, is that companies are becoming far more adept at segmenting the workforce along value-creation and geographic lines, managing compensation on a global scale and paying only what they must for each employee in each location. The result is a much more finely crafted tool for driving performance at a lower overall cost to the organization.

Workforce Management, October 23, 2006, p. 23-25 -- Subscribe Now!

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