Special Report Compensation & Salary ForecastMoney Talks

January 12, 2010
Companies that froze salaries at 2008 levels should unfreeze them as soon as business conditions allow and grant merit increases in 2010, top compensation experts now advise. Companies that cut salaries in 2008 or 2009 should restore them as soon as possible and add merit increases in 2010. Without these measures, the already dramatic decline in employee engagement may undercut the potential for revenue growth and profitability.

Surveys indicate that 50 to 75 percent of employers froze or cut base salaries during the recession; many also report an unprecedented drop in employee commitment and loyalty. Watson Wyatt Worldwide’s 2009/2010 U.S. Strategic Rewards survey found that engagement has dropped 9 percent among all employees and 23 percent among top performers—those who ranked in the top 10 percent in their last performance review. More than 40 percent of top-performing employees report that their employer’s pay and benefit cost-cutting actions have had an adverse impact on work quality and customer service.

    “The drop in engagement is directly tied to the pay and benefit cuts,” says Laura Sejen, global director of strategic rewards consulting at Watson Wyatt in New York. “Engagement is related to the experience at work. It is not a broader response to external events.” Watson Wyatt’s 2009-2010 rewards report concludes that employers have created significant attrition risk among top-performing employees.

The retention risk is real for top performers, who retain mobility even in soft labor markets. But with unemployment now forecast to peak at more than 10 percent in early 2010 and remain above normal levels until 2013, many employees will be forced to stay on the job despite high levels of pay dissatisfaction. Their ongoing demoralization reduces the prospects for improved corporate performance.

“The disengagement issue is a prime concern for employers in the context of pay freezes and cuts,” notes Loree Griffith, a principal in Mercer’s New York office. “The myth is that employers can put in reductions without consequences.” In 2010, the central compensation task will be to reverse freezes and cuts and address the disengagement that followed in their wake.

Unfreeze, restore
Watson Wyatt has closely tracked employer actions in response to the recession with bimonthly surveys since the crash in the fall of 2008. The strategic rewards survey reveals the full cumulative effects of a year of cost-cutting actions. Seventy-two percent of employers have restructured or laid off employees since the recession began. Firms have cut headcount by an average of 9 percent. Even high-performing firms—companies performing above their peer group—have laid off an average of 7 percent of their workforce.

Sixty percent froze salaries, including 54 percent of high-performing companies; 15 percent cut salaries, including 15 percent of high-performing firms. Twenty-four percent cut bonuses; 17 percent cut or eliminated the 401(k) match; 13 percent reduced other benefits. The Watson Wyatt survey results demonstrate that the drop in employee engagement is closely correlated with the number and type of cost-cutting actions that companies implemented during the downturn. In organizations where companies took a number of restructuring actions, engagement dropped precipitously.

“The drop in engagement is a significant downward shift,” Sejen says. “Normally, we might see a 5 percent swing in engagement levels from year to year. The 23 percent drop in engagement among top-performing employees is a warning to employers that they must reverse pay and benefit cuts, starting with base pay. Base pay is always among the top five factors that high-performing employees cite when they report the reasons why they would leave their company, and now base pay is the No. 1 reason.”

Tinkering with career development or recognition programs will not suffice for employees who have swallowed outright pay cuts or faced freezes representing the permanent loss of the average 3 percent pay increase that would have occurred in 2009 if employers had left pay programs intact. When the workforce is soured over pay cuts, only money talks.

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Sejen advises employers to take decisive action to reduce rampant disengagement. “Restore base pay first, and then add merit increases,” she says. “But don’t leave benefits restoration far behind. Health care and retirement benefits are among the top five reasons that top-performing employees join a company. Employees want job security and core rewards.”

Watson Wyatt advises employers that cut salaries to reinstate them as quickly as business results will allow, to return merit increase budgets to pre-recession levels in 2010 if possible and to differentiate increases based on employee performance. “2009 was a very lean year for employees for core rewards and particularly for salaries,” Sejen says. “Companies will make it a priority to fund salary increases even if they can’t restore other elements of the rewards package—for example, the defined-contribution benefits match.”

In the October Watson Wyatt survey of HR leaders, 54 percent of the companies with a salary freeze said they will reinstate salaries within the next six months; 26 percent said they will reinstate within the next 12 months. A Culpepper survey of 835 high-tech companies found that 23 percent of those with frozen salaries plan to unfreeze them by the end of 2009 and an additional 28 percent plan to unfreeze them in 2010, but 45 percent are still uncertain about their plans. Among companies that cut salaries, 53 percent report that they will restore them in 2009 or 2010, but 40 percent remain undecided.

“There is no monolithic model for restoration,” Sejen says. “But two methods are prevalent: full restoration as soon as possible, or partial restoration and then full restoration when business results allow it.”

In a partial restoration, a company with a 10 percent across-the-board cut may restore pay to 95 percent of the previous level, for example, and then 100 percent in the following quarter. Companies will not grant retroactive 2009 increases. “We’re talking about payroll, which is typically the largest line item in expenses,” Sejen says.

“Companies need to take a long, hard look at the pay issue,” Griffith says. “We’re seeing clients take a segmented approach, looking at targeted populations with phased-in restorations or market adjustments to ensure that high-potential employees will stay on when the market improves.” She advises employers to plan a salary increase budget for 2010 and use the entire allocation if possible. If a company needs to scale back, it can continue with a freeze or phase in restoration for high performers or employees in certain salary grades.

Griffith notes, however, that if the restoration is phased in, it must be carefully orchestrated and communicated and tied to business needs. “For example, if one unit is doing better than others, a company can phase in increases beginning with that unit and explain the reasoning to employees,” she says. “We’ll see a mix of practices.”

2010 increases
“The 2010 increase will be a separate decision from the decision to restore pay,” Sejen says. “For companies that cut pay, the inclination to grant a 2010 increase will be based on business results and whether the companies are confident that results are stable.”

The Watson Wyatt survey reports a projected median merit increase budget of 2.8 percent for 2010, and Sejen expects that projection to hold despite the wide gap that appeared between projected and actual increases in 2009. She notes that from 2003 to 2008, projected and actual increases remained relatively closely aligned, and in strong years companies actually made selective salary adjustments above the prior year’s projected salary increase.

Despite the less stable environment for projecting 2010 increases, several factors raise the likelihood that projections may hold. “Companies will commit to a 2.8 percent increase only when results are improving, and half of companies report that they expect results to improve before the end of 2009 and half report that results will improve in 2010,” Sejen says. “But if we have another dip, all bets are off.”

"The disengagement issue is a prime concern for employers in the context of pay freezes and cuts. The myth is that employers can put in reductions without consequences."
—Loree Griffith, Mercer

Hewitt’s survey of 1,156 large organizations found that base-salary increases for salaried exempt employees in 2009 were just 1.8 percent, the lowest in 33 years. They are expected to inch up to 2.7 percent in 2010.

Salaried nonexempt employees can expect an increase of 2.6 percent in 2010, up from 1.9 percent in 2009. Mercer’s survey indicates that actual increases for 2009 averaged 2.7 percent for all employers and 3.2 percent for employers who granted increases. “The difference between projected 2009 increases and actual 2009 increases changed every month,” Griffith notes. “Companies should now use just-in-time planning. They should go ahead and budget for 2010 but be ready to make changes. They will be planning carefully and will be very reactive to the market.” For 2010, the Mercer survey reports projected increases averaging 2.9 percent, excluding companies with zero increases. Eleven percent of employers expect to freeze pay across the board.

Although most employers plan to unfreeze or restore base salaries, the recession has fueled deeper doubts about common pay practices.

“This is a good time to look back and consider which pay actions should remain in place,” Griffith says. “Companies can look at pay policies and consider whether the company should give increases only every other year, or only with changes in job responsibilities. It’s an opportunity to rethink the annual increase. There is a lot to learn from this recession.”

Workforce Management, November 16, 2009, p. 27-31 -- Subscribe Now!