Compensation Strategies for a Bad Economy

Pay for Performance: Compensation Strategies for Recessionary Times

By Staff Writer

Many companies will have modified their compensation and benefit plans during this economic recession in an effort to save money. They need to minimize costs now and, hopefully, get set to recover from the recession faster than their competitors.

You may have already reduced merit increases or even enacted a pay freeze. What are the trade-offs of cutting or freezing pay? Would an across the board pay-cut make sense or would it hurt certain key performers too much?

Let’s take a look at how the economic crisis has impacted compensation, and how you can maintain a pay-for-performance culture in recessionary times.

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How Has the Recession Affected Compensation and Merit Increases?

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According to their 2009-2010 survey, WorldatWork, a compensation professionals’ association, found that of the 1,000 U.S. companies they surveyed, employers actually gave a lower amount for pay increases in 2009 than they expected to. Instead of their planned pay-raises of 3.9 percent, they actually gave merit increases of about 2.1 percent.

Considering that inflation was virtually zero in 2009, an average merit increase of 2.1 percent is still not insignificant, and it means that some people were given a decent bump in pay, despite the economic crisis. Hopefully, those people were the companies’ top performers. As Al Lee, Ph.D., Director of Quantitative Analysis at said, “Why do you give employees a raise? Because you want to keep them. It’s still important to recognize when employees’ growing abilities means they are worth more in the market, or when their high performance means they are worth more to your company.”

Is an Across-the-Board Merit Pay-Cut Wise?

Dr. Lee brought up a key point to keep in mind as you look to trim the fat on merit increases. Pay special attention to your newer hires who are learning and growing professionally at a rapid rate. It’s important to compensate them appropriately for their greater and greater contributions.

For example, a software developer will gain a tremendous amount of knowledge and new abilities in their second year on the job, compared to a veteran developer in their 20th year. This sharply increased employee value is typically rewarded with, on average, 7 percent per year merit pay increases for software developers in their first five years on the job, according to Lee.

If, instead, this young developer gets only an increase of 2.1 or even 0 percent (salary freeze) at the end of their second year, they will significantly lag the market in pay before too long. If this employee is a top performer, the company with shrinking merit pay risks losing their talented employee to another company that is still practicing a compensation strategy that rewards increased experience and knowledge.

Beware the Pay Gap

Keep in mind, merit pay increases do not address the growing compensation inequity between top performers when one was paid below their worth at the time of hire. If Employee A was hired at a position’s minimum annual salary of $60,000 and Employee B at $66,000 and they both get a 5.3 percent merit increase every year, the gross earning gap between the two will be $33,000 after five years and $77,000 after 10 years. If Employee A is truly a top performer, it’s important to compensate them at or ahead of the market if you want to hold on to them – even in an economic recession.

A Forward-Thinking Approach to Compensation Strategies

Instead of merit increases, now may be a good time for your company to adopt a target base pay structure that keeps top performers on board and motivated for the company’s ramp up once the recession eases.

The three steps for implementation of this pay for performance compensation strategy are:

1. Target the salary that is warranted by the employee’s competency, performance, and potential. “If you differentiate pay, you need to do a good job of assessing performance,” says Larry Reissman, New England practice leader for The Hay Group. “That means everyone should know who’s doing the job, who’s outstanding and who’s not doing the job. Don’t micromanage shades of gray; get managers to really think about who it is in the company who deserves more–and who doesn’t.” Your company’s managers need to be trained on how to effectively perform employee  evaluations  in these areas.

2. Determine the gap between the current salary and target pay. Use solid compensation tools, such as ones found on, to determine the target pay for each employee based on their competency, performance and potential as assessed by their manager.

3. Make adjustments in salary based on gap analysis and budget constraints. When the target base pay system is implemented, you and the company’s senior management need to closely monitor the overall effectiveness of the compensation strategy and make salary adjustments based on the annual gap analyses and budget constraints.

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