Careful talk saves money

By David Wreford

The pay bill is usually the largest investment an organisation makes, yet most organisations believe they can manage compensation (base pay and variable pay) better than how they do it currently. Organisations typically claim to have a reasonable view of what they pay people, and why, but admit to having a hazier idea of what they should be paying them. As a result, most organisations both overpay (to the tune of around €1200 per person per year) and underpay their employees. The first is a straightforward waste of money; the second exposes them to the risk that people will be demotivated and/or leave, with the considerable knock-on costs of poor performance and/or having to recruit and train replacements.

Most organisations believe they can increase both the efficiency and the effectiveness of their pay strategies by doing things a little differently. A common mantra followed by many is: ‘We target salaries around the median, and reward upper-quartile performance with upper-quartile incentive levels.’ But unless they take a much more targeted approach to the way they apportion the pay budget, and improve the guidance to line managers on how these budgets should be distributed, there is no guarantee that they will get the best value for money from their investment.

To target pay effectively organisations need to understand the value that different employee segments bring to the business. They could segment their employees according to a range of factors, including:

personal – for example, do they need to target money at those with particular competencies, have higher potential or on an accelerated career path
geography – for example, do higher growth ambitions in one particular territory call for higher rewards?
job – for example, do they need to pay more for roles where there is a shortage of talent?

After critically assessing such factors, an organisation can decide how to position itself against the market and how to balance the different compensation components to best effect. Getting better value for money out of the compensation spend is always important, but it has become critical during recession when, in most organisations, budgets have shrunk. Even if pay reviews have been put on hold this year, now is an ideal time for organisations to think carefully about the way they manage and communicate compensation, so that when the upturn comes they will be in a better position to take advantage of it.

The governance and the communication of compensation are inextricably linked. In other areas of reward, such as pensions and long-term incentives, small numbers of people typically make big decisions periodically. But in compensation, large numbers of people (including line managers) are making regular, multiple, but smaller decisions. In the absence of strong guidance this usually leads to inconsistency, both between line managers, and between line managers and the company's overall approach.

Using Mercer's Compensation Management Index, we recently conducted research among companies in Europe to find out what aspects of compensation management they believed were more important, and how they ranked their own performance in those critical areas. Overall, companies' own performance lagged their aspiration in all six areas – strategy, organisation, design, process, technology and communication – but the discrepancy was by far the biggest in compensation communication. Organisations felt communication was the most important aspect of compensation management, but ranked their performance lower than in any other area.

Poor communication lies at the heart of inconsistent compensation management practices. Line managers tend to shy away from tough performance decisions, and are given little guidance in how to do it. They tend, therefore, to rank everyone 'above average' and aim to award them 'above average' compensation. This approach creates the very divisiveness that they are so keen to avoid, because it discriminates against the genuine above-average performers that the organisation wants to encourage. Employees in receipt of such mixed messages rely on the grapevine for information, leading to a decline in trust.

Organisations must develop and communicate to line managers the guiding principles for determining compensation. They also need to communicate directly with employees and encourage consistent communication from line managers. The value is clear: employees who understand the basis on which compensation decisions are made are five times more satisfied with their pay than employees who don’t understand what drives their compensation. This has a knock-on effect on job satisfaction and commitment to the organisation generally, and on attraction and retention.

But trying to communicate ineffective compensation strategies is clearly pointless. Only when you have more robust structures that encourage more consistent decision making can you can be more transparent about pay.

So how do you improve compensation management? You look at the six components listed above and try to get a better alignment between what you think is important and what you do. It might sound obvious, but if something is really important you should do it really well, and if you don’t think it is very important you should stop wasting time on it.

David Wreford is a prinicipal in Mercer's human capital business, focusing on compensation management in Europe. Based in London, he can be reached at +44 207 178 5598 or david.wreford@mercer.com. For further information on compensation management, log on to our dedicated website www.mercer.com/compensationmanagementEU