Reactive Compensation Management Leads to "Pay the Squeaky Wheel" Philosophy

There's a temptation that some organizations fall prey to in compensation management.  It's the temptation to let the pay program - essentially - manage itself.  Rather than working diligently, or putting the tools in place, to actively monitor and update pay practice, these organizations seem comfortable allowing things to slide - not completely, mind you, but just enough so that pay activity slips from a proactive to a reactive mode.  Salary ranges and grade assignments are reviewed in response to employee departure or hiring issues.  An increasing proportion of salary actions take place outside the regular increase cycle, when employees or managers complain or bring issues to the attention of HR.  The continuing activity can create a false sense of security that pay is being managed and problems are being dealt with, but it can mask a significant underlying issue.

The issue is this:  As an organization, you've essentially moved to a new compensation philosophy.  What it is: something I'd characterize as "Pay the Squeaky Wheel".  What it isn't is pay for performance.  Your compensation dollars are being spent fixing problems, not motivating people, driving improvements or focusing attention on important goals.  It may seem like a subtle difference, it may even seem like just semantics, but it isn't.  My experience in talking with employees and managers inside organizations that have fallen into this pattern, usually inadvertently, is that this message comes across loud and clear, and sets a strong precedent.  Want to get ahead here?  Want to make more money?  Then your best bet is to:  1) Complain, 2) Get your manager to complain, or - most effective of all, 3) Resign, but be willing to be talked back for a bigger paycheck.

If effective compensation management is about return on investment, what kind of return do you get for your pay dollars in a scenario like this?

The Importance of a Written Pay Philosophy

I had the opportunity earlier this week to attend a presentation by Rich Sperling and Dana Martin of Hay Group on Best Practices in Reward Design.  The presentation highlighted findings from recent research on reward design and management that Hay conducted in partnership with WorldatWork. 

One of the research findings that I though worth noting here was on compensation philosophy.  (As covered in earlier posts here and here, a compensation philosophy represents the consensus of organizational leaders regarding what should be accomplished - and how - with the dollars spent on employee compensation.)

Research participants were asked to respond with either "true" or "false" to the statement:  "My company has a compensation philosophy."  91% responded with "true"; that their companies do indeed have a compensation philosophy.  When asked in another question whether or not the compensation philosophy was "written", only 62% said "yes".

Surprised?  I'm not.  In fact, I run into this all the time.  The management of nearly every company I talk with assures me that they do, in fact, have a compensation philosophy - but very few of them have it documented.  What does this mean?  As far as I'm concerned, it means they don't really have a compensation philosophy - or at least not one that leadership has come to agreement on.  This is a lesson that I have learned the hard way.  Let me share an example.

A medical services company has hired me to review their compensation program.  Employee turnover is at an all time high, employee satisfaction is low, and management believes that compensation is a key contributing factor to these issues (employee opinion survey results would appear to confirm this).  Before I can review their compensation program and tell them whether or not it is accomplishing what it should, I first need to know what it is they want the program to accomplish.  How competitive should pay be?  What is their compensation philosophy? 

Management spurns my offer to sit down and discuss compensation philosophy with them, assuring me that - although it is not documented anywhere - they are "very clear" on their philosophy and what it means.  In fact, there are a couple of staff meetings coming up where top management (the Chairman of the Board for one meeting, the President for the other meeting) is going to be speaking with employees about compensation philosophy and announcing the kick-off of this compensation review project.  Perhaps I could attend, and then I could learn first hand what their compensation philosophy is?  I agree to do this.

Well, I attended both sessions and (as some of you have already guessed), the compensation philosophy explained by the Chairman was completely different (and even at odds with) the one presented by the President.  Bottom line, not only did we have to sit down as a group and discuss (and come to consensus on) the company's philosophy, but now we also had damage control to do.

I could probably share a dozen other versions of this example, just off the top of my head.

My point, of course, is that documenting the compensation philosophy is very important, if for no other reason than it forces discussion and agreement on what that philosophy really entails.  The Hay research confirms this, as it looks more closely at organizations that write down their pay philosophies versus those that don't.  A few examples of their findings here:

• Hay, as you may know, conducts the annual "America's Most Admired Companies" research that is published in Fortune magazine.  When they looked at the prevalence of written compensation philosophies among the "Most Admired" versus all other respondents, they found that:
  • 76% of "Most Admired" companies have a written pay philosophy
  • 61% of all other respondents have a written pay philosophy
• Hay also separated the responding companies into quartiles by their financial performance, using TSR (Total Shareholder Return) as an indicator.  When they looked at the prevalence of written compensation philosophies among the top versus bottom performing companies, they found that:
  • 71% of the companies in the top quartile for financial performance have a written pay philosophy
  • 53% of the companies in the bottom quartile for financial performance have a written pay philosophy
• And not surprisingly, when Hay asked respondents how well they believe their employees understand the company's compensation philosophy, they found that:
  • 44% of the companies with a written compensation philosophy responded that most employees understand it
  • 21% of the companies with a compensation philosophy that is not written responded that most employees understand it

I think I've made my point.

Is Outside the New Inside? Trends in Recruiting Outside the Industry Have Implications for Compensation Philosophy

A new study released by Salveson Stetson Group, a Pennsylvania executive search group, confirms a trend that I have also noted among my clients: organizations are more often purposefully recruiting management and executive talent from outside their industry.

According to Sally Stetson, firm co-founder and principal, the industries most often searching beyond their own for leadership talent, and the reasons that they are doing so, are as follows:

Hospitals and health-care systems. “They are recruiting finance executives, in particular, from other industries as a result of tighter government regulations, increasing financial demands, and the need to manage investment portfolios, think strategically, and adopt fresh approaches to chronic problems,” said John Salveson, co-founder and principal with Salveson Stetson Group.

Pharmaceutical companies. “Typically, pharmaceutical companies have focused solely on recruiting managers and executives from their competitors. However, many of the larger companies have started to concentrate on candidates from consumer products and retail companies such as PepsiCo, Frito-Lay and The Limited. Executives from these types of companies are perceived as being more progressive, and more accustomed to working in a fast-paced environment,” said Stetson.

Manufacturers. “The more progressive industrial manufacturers are also looking for talent with consumer products experience because these types of executives are accustomed to operating in leaner organizations, which are better able to respond quickly to changing business needs,” said Stetson.

Banks. “More banks are hiring managers and executives with retail experience as they change their cultures to become more customer-oriented,” said Salveson.

Non-profit agencies. “Non-profits have become more open to looking for candidates who have for-profit business experience. This supports their desire to operate more efficiently and effectively. Many non-profits also are seeking managers and executives close to retirement age who want a change in their careers and are interested in meaningful work," said Stetson.

As organizations seek access to different talent pools to fill management and executive openings, it will be critical that their compensation philosophies and packages are reviewed and re-aligned accordingly.  This will impact not only the competitive pay data they use to set compensation levels, but also -- potentially -- the very nature and make-up of the compensation plans offered to leaders.

Yet one more reason why it is important for staffing and compensation professionals to be talking to one another.

More about the Salveson Stetson study here.

Compensation Philosophy: More Aggressive for Executives

There is an interesting piece of information in WorldatWork's recently published 2006/07 Salary Budget Survey regarding the compensation philosophies (specifically, how they intend to pay in relation to market rates) of participating organizations.

Although most organization's report compensation philosophies that are intended "to pay at the market rate", participants are about twice as likely to have an "above market" compensation philosophy for executives than for any other employee group.  Detailed statistics on compensation philosophy across the different employee groups are shown below.

Nonexempt Hourly Nonunion

To pay below the market rate:  4%

To pay at the market rate:  81%

To pay above the market rate:  7%

No formal compensation philosophy:  8%

Nonexempt Salaried

To pay below the market rate:  3%

To pay at the market rate:  83%

To pay above the market rate:  8%

No formal compensation philosophy:  6%

Exempt Salaried

To pay below the market rate:  3%

To pay at the market rate:  80%

To pay above the market rate:  10%

No formal compensation philosophy:  7%

Officers/Executives

To pay below the market rate:  3%

To pay at the market rate:  71%

To pay above the market rate:  18%

No formal compensation philosophy:  8%

To learn more about the WorldatWork Salary Budget Survey click here.

More on Compensation Philosophy

I can't help but follow on to the previous two compensation philosophy posts with this.

In an article published in the June issue of workspan entitled "New Rules: Paying for Performance, Part Two", my former colleague Brad Hill (now a principal at Tandehill Human Capital) and his co-author Christine Tande cite an example of a particularly powerful pay philosophy:

A major steel producers offers a pay philosophy that states, "We will hire five people to do the work of ten and pay them like seven."  This philosophy is fresh, vibrant and communicates an above-market pay practice closely tied to demanding performance standards.

Well said on all counts.

Compensation Philosophy - Part 2

We return to the key questions involved in articulating a compensation philosophy.

The primary question

What do you want your compensation program to do?  Try to drill down beyond the standard "attract, retain and motivate" to identify the (1 to 3) critical things necessary to push the organization forward on its path to success.  Examples of compensation objectives might be:

Driving and rewarding cross-division collaboration

Directing all discretionary pay dollars to the top individual performers

Encouraging employee learning and development in the technologies critical to the future of the Company

The secondary questions

Nailing down the critical objectives is the first step.  Then, it is important to detail how these objectives will be accomplished through the compensation program.  That brings us to some secondary questions, such as those below:

What do you see as organization's labor market or markets (other local employers across all industries?  other heavy manufacturers of similar size across the region?)?  Where do you intend to position compensation opportunities relative to this market or markets (at average or median levels?  higher?  lower?)?

What different pay elements are included in your compensation package (base salary?  profit sharing?  spot bonuses?  what about benefits?)?  What role does each of these play in accomplishing your primary objectives?

A compensation philosophy is simply a document (one page, please) which captures Leadership's agreement on what the compensation program should accomplish and how.  Don't just file it away.  Think of it and use it as an annual performance appraisal for your compensation program; let it be the statement of intent (what should be) against which your current compensation practices (what actually is) can be regularly measured.

Compensation Philosophy - Part 1

Are your compensation dollars being well spent?

How do you know?

At best, organizations struggle to answer these questions.  At worst, they never ask them to begin with.

Whether its called a compensation philosophy, reward strategy, or something else, it is important that an organization's leadership come to some agreement on what should be accomplished - and how - with the dollars spent on employee compensation.  For most organizations, employee compensation represents a significant portion of the cost of doing business.  It deserves to be managed with the same focus and attention as any other important investment.

How to develop a compensation philosophy - or revisit one that's been gathering dust on the shelf for several years?  It can be as basic as getting the right people together to answer some fundamental questions, starting with the big one:  What do we want our compensation program to do?

More on compensation philosophy questions in tomorrow's post.