Many organizations have seen their operations significantly disrupted by the coronavirus outbreak. The virus outbreak is the fifth “Black Swan” event this decade.
For some, revenue has disappeared or has been reduced substantially. Not many organizations are hiring over 100,000 people like Amazon, to meet demand that has exploded. Does this dramatic, unexpected shock (aka, “Black Swan” event) require a substantial overhaul of your rewards strategy? The answer will be unique to each organization. And different strategies may be required even within organizations..
The Risk/Reward of Reductions
The need to modify business strategies and processes is hard to determine because the future is so uncertain. For an overhaul of rewards strategies to even be considered, it must be possible to forecast what will happen in the economy, which isn’t possible at the moment.
When short-term exogenous shocks destabilize operations and dramatically decrease available economic resources, tactical responses become the focus. Meeting the payroll, paying for employee benefits coverage and other people-related expenses are generally fixed costs, at least if the current workforce is still employed. Short-term cost reductions can be made by having hourly employees work fewer hours and by reducing salaries. There can also be a cessation of variable pay plan payouts for organizations using variable compensation plans. A few CEOs have reduced or eliminated their salaries for the present, as an attempt to limit the impact on those who have little discretionary income. Although there is very little being said about pay increases for employees since maintaining viability has become the focus, a few are volunteering to have their base pay rates or benefits reduced.
Reducing the headcount using terminations or temporary layoffs is another option for reducing the cost of operations. Although restructuring the workforce can be done instantly, there are complications relative to realizing a reduction in costs. Terminations may result in the need to cash out accrued time off and other vested benefits and may increase short-term cash outlays, which is the last thing the organization wants to do when revenues have collapsed. And, organizations that are viewed as serial downsizers damage their brand. If you seem to consider employees your most disposable asset rather than your most valuable asset, it will reduce your chances of receiving a “best employer” award. Some circumstances may preclude keeping people on the payroll and may require making them eligible for unemployment. But consideration must be given to avoiding the loss of tacit knowledge that only exists in the minds of employees, since this knowledge may be critical to continued operations.
An Eye on Pay & Benefits
When an organization makes variable compensation a significant component of its rewards strategy, a decline in performance will reduce total direct compensation levels. And, if employees have adjusted to living on their base pay, the absence of variable compensation payouts will be less damaging to their financial condition. Although the human tendency is to treat incentive compensation that has been received regularly as a base pay equivalent, that is on the employees, not the organization.
Many major organizations in Asian countries have as much as 25% of current direct compensation cost in the form of variable pay plans that are tied to overall performance. These “bonuses” are paid once or twice a year and employees understand organizational performance must be adequate to fund them. Since national cultures in Asia embrace employment security, organizations find it difficult to vary staffing levels as a cost control device. The use of variable compensation programs reduces the need to reduce base pay rates or benefits.
Most employees can understand that pay increases will not be forthcoming in the short run if their employer is in difficult economic straits. Keeping one’s job and income stream may be enough of a reward for some. However, some organizations have a different kind of challenge.
Booming business, increasing revenues and skyrocketing share prices make it seem possible for an organization to generously reward those who move the merchandise — at least for as long as current conditions persist. Netflix is seeing massive increases in the number of subscribers, so the organization is enjoying the same kind of revenue escalation as Amazon. But if these organizations loosen the purse strings and pay generously, what will they do when and if the gold rush ends? When the crisis is over, customers may have satiated their need for intellectual stimulation via a broadcasting network and replace it with trips to the ball fields and live events. And, if they have stockpiled a five-year supply of toilet paper, Amazon may find it difficult to keep all those new hires busy. It is in the best interests of those experiencing booms to remember that base pay increases and benefits improvements are career annuities; refunds are very difficult to get. And, if future revenues are uncertain, increasing rewards that are in the form of fixed costs is a dubious strategy.
The term “the Lord giveth and the Lord taketh away” does not apply to base pay and benefits. In fact, an organization may require a divine intervention to be able to get back what was previously given. Even though largesse during boom times seems harmless enough, management should understand that most people don’t want their lives to be like a series of trips to a casino, entailing wide variations in income levels. Mortgage holders expect payments to be made regularly, not only when times are good. If the good times are unlikely to last, it is wise to maintain a rewards strategy that is sustainable over the long run.
"When the connection between rewards and organizational performance is not well understood, the absence of something people have come to expect produces a shock."
– Robert J. Greene, CEO of Rewards Systems Inc.
Organizations must attempt to align costs with revenues. They might be happy to increase rewards during good times, as long as they do not become permanent obligations. If you pay a bonus two years in a row in Mexico, employees acquire a right to the bonus into the future. In the United States, employers should consider the impact of allowing annual base pay increases to seem like an acquired right. There are a large percentage of organizations that have given base pay increases every year for decades. The question each year in employee’s minds is not “if” but “how much?” When the connection between rewards and organizational performance is not well understood, the absence of something people have come to expect produces a shock. If pay increases and annual incentive awards seem to be based on whether senior management is happy (Santa got good reports on the employees), it is easy for employees to view a decision not to receive an increase or a bonus as unfair. Cognitive bias will work to convince them they have been good.
Case in Point
Changing strategies is always difficult and the process to implement changes should be given a great deal of thought. A division of a Fortune 100 company decided to reconfigure their total direct compensation strategy, from an “all base” to a “base-plus-incentive” composition. Realizing that it is difficult to add on an incentive potential when base pay is already at a competitive level, management elected to gradually phase in the program.
The objective was to add a 12% incentive opportunity over three years. In each of the next three years, the amount that would have gone into base pay increases was reduced by 2% and an incentive potential of 0% to 4% was added. At the end of the three years, base payroll was 6% less than it would have been and an incentive opportunity of up to 12% was in place. Adding an incentive opportunity of 4% for each loss of 2% base pay adjustments recognized that employees were sharing in the risk.
Each year, a performance standard was established and the incentive potential of 0% to 4% was determined by scaling performance against the standard. No matter the performance, base payroll would have been 6% lower than it would have been under the prior plan after three years. If performance had been poor all three years, so would total direct pay. If performance was exceptional all three years, base payroll would still have been 6% lower but variable compensation would have added cash awards of up to 12%. This type of plan positioned the organization to better face economic volatility.
Is It A New World Requiring Different Strategies?
The current context is volatile and uncertain, but perhaps we have mistaken a calm sea over an extended period for the natural state of things. There have been an increasing number of “Black Swan” events over the last decade, so maybe things that seemed so unlikely are not really that unusual anymore. The climate change has caused the environment to be less stable and a parallel effect may be occurring in the economy.
Rewards strategists would be well served to go back to the basic principles underlying their strategies. The “pay for performance” philosophy is one that produces large rewards when results are significantly better than expected, and one that produces smaller or no rewards when results are poorer than expected.
Each organization should assess their current conditions and establish a performance standard that is reasonable in the current climate. Business realities may change quickly and significantly. For that reason, the current rewards strategy should be continuously reevaluated, and programs fine-tuned to produce the appropriate level of rewards. Expecting the next improbable event and adopting an appropriate rewards strategy can produce awards that are equitable for both employees and the organization. And, by doing continuous environmental scanning, an organization may have the intelligence necessary to alert it to trends.
Making less dramatic changes over a period of time produces less shock than an abrupt change at a later date when the environment demands dramatic alterations.
About the Author
Robert J. Greene is the CEO of Reward Systems Inc.