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Why Compensation Planning Matters More Than Ever Right Now

The coronavirus pandemic has upended 2020 business plans. With social distancing forcing people to stay home, many businesses have had to shut down. Furloughs and layoffs have rippled across the country, with a record-breaking 6.6 million Americans filing for unemployment benefits at the end of March. Some economic advisors are warning of a massive impending recession to rival (or even exceed) the Great Depression of 1929, but given the uniqueness of the situation, others aren’t so sure. With the economy careening uncertainly over a precipice, payroll is one of the few things that employers can control to keep businesses afloat.

A mature approach to compensation planning is critical in this situation, perhaps even more critical than when the labor market is tight. Although there will be plenty of displaced workers available as unemployment rises, strong workforce management is crucial for a company to thrive during a recession. You must do more with less and rely on the best and brightest remaining in the company to work harder with fewer resources. Turnover and employee disengagement can be the death of a company during tough economic cycles. You need every competitive advantage you can get to manage the workforce productively and incentivize employees to work as smart and as hard as they can for you.

If you remain unconvinced, here are just a few detailed reasons why compensation planning matters more during an economic downturn.

Determine who you’re underpaying and overpaying

In a booming economy with low unemployment, underpayment is dangerous because it can lead to disengagement and high turnover as employees seek better opportunities with higher compensation elsewhere. When the market takes a turn for the worse, employers sometimes assume that underpayment becomes less of a concern as jobs are scarce and workers plentiful, but this isn’t actually true.

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Underpayment is always a concern. An individual’s perception of their value is tied to their pay. Underpaying employees signals that you don’t value them. Although some employees may find it harder to change jobs when unemployment is high, not feeling valued leads to disengagement and resentment. During a tough economy, you can’t afford this. In addition, the best employees will always be able to find opportunities, especially in competitive fields where there is a lack of skilled resources regardless of the state the economy is in. In a down economy, unproductive turnover can be even more expensive and damaging to business operations than in a strong economy.

In other words, just because an organization is tightening its belt to make it through a difficult season doesn’t mean that it can stop valuing its employees. If anything, an uncertain economy is precisely the time that employers should be looking more closely at employee satisfaction and evaluating what to do with red circled (overpaid) and green circled (underpaid) employees to make sure that the organization is being as thoughtful and judicious as possible in how they are spending their payroll dollars.

Overpaying employees is obviously also a concern in a down economy. Many organizations who undergo a market study for the first time or after not having done one for awhile are often surprised to discover that they are overpaying in many areas. This is particularly true when organizations have been relying on “free” online salary data that is not location or industry specific and can inflate compensation averages.

For example, a Google search for “software engineer salary” is going to return results that are weighted toward geographical areas where software engineers are more heavily populated, such as the San Francisco Bay Area, which has a very high cost of living. If the searcher is actually located in Cary, North Carolina, the going rate for that position is going to be lower. Online crowdsourced data from PayScale is cultivated, validated and controlled so employers can trust that the ranges are based on compensable factors. PayScale also utilizes company-sourced data and third-party market data to offer the most robust data solution on the market.

Organizations that rely on intuition or negotiation to determine compensation are also at risk for overpaying. For example, PayScale’s research on the gender wage gap has shown that women are often shortchanged in organizations that rely on self-advocacy to set compensation. This is because unconscious bias and gender norms can result in punishing women for putting themselves forward. Organizations that rely on negotiation to set pay are more likely to overpay good negotiators, which puts them at high risk of unintended inequity. To apply principles of pay equity, you need to look at market data for defined roles in your industry, and set pay ranges based on the role, not the person.

In summary, understanding how total payroll costs are distributed is crucial during times of uncertainty. This is true even if an organization chooses to make no changes to current employee compensation.

Use market data to inform pay ranges and maximize payroll spend

Creating a compensation plan based on data-driven pay range structures can help your organization attract, retain and motivate employees without overspending. It can also help you manage current payroll dollars to maximize spend by understanding how workers are currently paid to market and what disparities may exist within job families.

Organizations that have grown quickly often rely on internal valuation for job positions with just a dash of market data reference to make pay decisions. Operating this way over the course of several years lands the organization in some sticky situations.

For example, tenured employees might be underpaid compared to new employees who joined the company when the market was paying more for the same positions. This can be true even if tenured employers are receiving regular wage increases. This situation can cause employees who have been with the organization a long time to become discontent, resulting in employees choosing to leave for other opportunities or putting in less effort into their work.

There may also be employees who are stuck in the middle (in between the tenured employees and new employees) who don’t know what to expect from their salary.  For example, they may wonder if they should make as much (or more) than a new employee because they are doing the same job and have been with the organization longer. Even a 3 percent annual increase might feel insulting or discouraging to an employee who knows they are paid less than newer teammates in the same position.

During a down economy, the reverse situation can occur. As previously mentioned, some employers view a troubled market as a reason to extend lower offers to new hires. If the compensation extended is less than what current employees are making, you again have a pay equity problem that will come back to bite you as soon as the market improves – and perhaps before.

A better way to manage pay is to set pay ranges for job positions based on market data with deliberate intention to target a defined percentile within that range. What percentile the organization targets may vary according to the value that a specific position brings to the business. This is part of the organization’s compensation strategy.

Reliance on strong market data to set ranges will position the company to respond confidently when candidates and employees ask for more pay — as some inevitably will, even when times are tough, especially high performers. Employees are more likely to respect decisions about pay that are made based on facts and data rather than bias and appeal, especially if the company can explain its pay philosophy and commitment to pay equity, which can also help build trust in HR.

With hiring freezes currently slowing down typical HR functions, now might be a good time for HR departments who have not invested in a compensation philosophy and strategy to start building one.  Survey participation season is also upon us, offering an opportunity for employers new to strategic compensation planning to become participants and start building out compensation structures based on multiple sources of highly qualified market data.

Correct instances of over-compensation

A key benefit of benchmarking, reviewing market data, and setting pay ranges is that once you have uncovered which employees are underpaid and which are overpaid, you have some options to address the situation.

Option 1: Update the role with a reset pay range 

It’s very common for high performing or long tenured team members to start taking on more responsibility and special projects while still being tied to the pay of their original job description. For an employee who has grown tremendously, small pay increases of 1 to 5 percent a year are not enough to meet the value the employee is contributing, but may be enough to take the employee to the far end of their range, resulting in them becoming red-circled.

The employee likely wants a promotion, but a promotion is not always on the table, especially in an organization with limited hierarchy where promotions are limited to managerial positions. This can be frustrating and is likely a leading cause of employees resigning to seek more professional development (and a bigger pay check) elsewhere.

If you have high-performing employees in this situation that you don’t want to lose, you can resolve it by re-scoping their job description and re-benchmarking the range of their pay to include the additional skills they have learned and the responsibilities they have taken on. This might necessitate a title change and a pay bump if previously denied. Or it might merely reset the range of an overpaid employee who now has more headroom to grow within their newly structured position.

At the end of the day, taking a proactive approach to restructuring the role of red-circled employees you want to keep will show them that you value their contribution while also giving you an opportunity to set new expectations. With a newly scoped job description, you can establish new stretch goals for the employee that will align to greater impact for the business.

While this strategy does not directly save you money or cut costs, it does enable the business to “redeploy” a strongly performing asset. In many cases, the value that a hyper-engaged, strongly performing employee brings to the business will offset the cost of increasing their compensation or extending their pay range.

Option 2: Freeze pay

In times of economic uncertainty, it is extremely common to freeze pay raises, especially for red-circled employees who are already outliers for their position in terms of compensation and a threat to internal pay equity.

If you are considering freezing pay, it is critical to understand that employee morale can take a hit and that high performers may choose to leave the company. To mitigate this risk, transparency and pay communications are essential. You are likely considering this option because the organization is going through a financial hardship. If you don’t explain these circumstances to employees, they are more likely to take a pay freeze as a personal slight rather than the hard decision of a business going through a difficult financial period.

If the decision is being made as a result of an impending recession, it is also important to acknowledge that recessions are temporary and that the freeze to wage increases is likewise temporary. This communication will have more credibility if you clearly define the employee’s role, responsibilities, current pay range, and contributions to the organization and impress upon them that they are tremendously valued and what you would like to do for their compensation when the financial situation improves. This is also a good time to remind employees what the organization already invests in them in terms of total rewards and that you appreciate their continued contribution to their current role.

If the employee understands that the freeze is not a reflection upon their performance and that they will be rewarded if they can stick it out for a certain amount of time — even if that time is undetermined — they are more likely to feel recognized and valued and remain with you.

Option 3: Reduce Pay 

Reducing employee compensation is the least desirable option, but it may be necessary depending the severity of the impact the business is facing due to external market factors. In some situations, it may even be what employees prefer if it means other employees will keep their jobs and if the situation is guaranteed to be only temporary and reversed once market conditions improve.

Nevertheless, pay reductions are not a fun option to communicate. As with pay freezes, pay reductions require deft handling of compensation communications by well-trained managers. Don’t skip any steps, but you should probably start the conversation with an overview of the company’s current financial health and projections. If you have a high level of transparency, you might walk the employee through what will happen if pay reductions are not enacted.  Typically, this means showing a timeline to bankruptcy if costs cannot be cut significantly.

Although conversations of this nature are sobering, some businesses find that bringing their employees into the decision-making process builds camaraderie and actually boosts morale. Although times are tough, employees who are trusted with the vulnerability of the business may be inspired to work harder than ever to protect that business and may even volunteer to take pay cuts to ensure that the business survives. This will depend a lot on your company culture as well as the size of your organization.

The most important thing is to come to an agreement with employees on what a pay reduction will look like and why it has to happen. You should also be clear on when the decision will be re-evaluated, and make sure you honor promises made to restore compensation —hopefully with additional rewards — when the financial burden is lifted.

Conclusion

During the coronavirus pandemic, HR has become a critical and strategic function of the business. The decisions made by HR today can make or break a business in the troubled times ahead. Compensation is an enormous and indispensable part of this responsibility. Although many organizations are issuing layoffs or thinking about having to do so in the future, the remaining workforce must still be managed, and employee retention and engagement will be more important than ever. It is therefore essential that HR leaders and compensation professionals seek to utilize up-to-date market data from multiple sources to inform their compensation and benefits strategy and planning.

Interested in how compensation management software can help you build compensation strategies in an uncertain economy? Contact PayScale for a demo.

Amy Stewart
Sr. Content Marketing Manager at PayScale
Read more from Amy

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