2011-04-18

The changing face of reward

Drake Editorial Team

 

This excerpt of a study by the Hay Group examines how the business drivers of reward are changing due to the impact of the global economy downturn and other macroeconomic trends. The study is based on face-to-face interviews with senior HR specialists from over 230 companies in 29 countries, which collectively manage more than 4.7 million people and generate annual revenue streams of about US$4.5 trillion.

Across all sectors and regions, organizations are struggling to rebuild profitability following the recession. With revenue growth hard to come by, they are focusing on cost containment and performance improvement as the paths to profit growth. This requires them to balance four often conflicting challenges: cost containment, performance improvement, talent engagement, and risk management.

The tension between cost containment and talent engagement was a strong theme in the research. Organizations are very concerned about retention and motivation, particularly for top performers, high potentials, and those with scarce skills. However, the option of paying more for retention or performance is often no longer available, and companies are focusing more on intangible rewards – such as motivational leadership, challenging work, and career development – to boost engagement.

 

Reward is on the board agenda

Representing up to 70% of a company’s total costs, reward is now a top management issue, with the CEO and board getting closely involved. The study shows that reward is now, more than ever, under the microscope, with CEOs asking:

• What performance are we getting in return for what we pay?
• What is the effectiveness of all the costs allocated to reward?
• What is the return on investment?

Getting reward right is mission critical for all organizations. The challenge lies in developing and delivering reward programs that are cost effective, drive performance improvement, build talent, and avoid risks.

 

Performance is the new mantra

Performance is the fundamental focus of most organizations. They want to demonstrate a verifiable return on investment from any activity; and with employment costs representing up to 70% of an organization’s cost base, this includes reward,

The dominant theme from most respondents is ‘doing more with less’. As well as addressing organizational structures and increasing the efficiency of systems and processes, there is a very strong focus on aligning team and individual performance to corporate goals. Leadership has also come under the spotlight as organizations ensure that their management has the strength and skills to lead the organization out of the recession.

 

Targeting top talent

The emphasis on retaining and rewarding high performers emerged as one of the strongest themes of the study. Organizations of all sizes in almost every sector cited recruitment and retention of key talent, along with the development of good internal candidates, as a dominant strategy.

The relentless focus on cost-cutting during the recession has resulted in many organizations stripping out poorer performers. Organizations have emerged with a leaner workforce but with a correspondingly greater reliance on their best people, many of whom have taken on wider roles as a result of restructuring, often for limited or no incremental increase in compensation. Retaining these people is a key priority.

At the same time, the market for those key roles and talented individuals has scarcely abated. Many organizations in emerging economies are looking for future leaders who are able to work within the existing organization and cultural background and also work effectively in a global context. Increasingly they are competing for those same talented individuals with other global organizations looking to expand.

Many respondents to the survey proposed more stringent succession planning was needed. With the baby boomer generation reaching retirement age, identifying and preparing the best leaders for the future is a concern for many organizations.

 

Don’t forget to manage the middle

A word of caution has to be offered about over-reliance on high performers to deliver business results: The majority of people who work in most organizations fall into neither the poor performer nor the star category, but are good, competent, average performers. Shifting performance in this middle category will make a difference to surviving the present recession and performing in the upturn. Organizations should make an effort to keep this critical set of staff motivated, engaged, and adequately rewarded for the positive contribution they make.

Organizations are very concerned about retention and motivation for top performers, high potentials, and those with scarce skills.

 

Engagement is no longer optional

In a challenging global economy where organizations are running lean, tapping into the discretionary effort of engaged employees is imperative. The Hay Group research shows that organizations in the top quartile on engagement have revenue growth 2.5 times that of organizations in the bottom quartile, and those that score high for both engagement and enablement have revenue growth 4.5 times higher.

 

Engagement is not enough

Hay Group research shows that employee engagement alone does not guarantee an organization’s effectiveness. Many organizations enjoy high levels of engagement, yet still struggle to translate that into performance.

What is often missing in organizations that are struggling to see the results of engagement is ‘employee enablement’. In an enabled workforce, employees are effectively matched to positions to ensure that their skills and abilities are put to optimal use. Enabled employees have the essential resources – information, technology, tools and equipment, and financial support – to get the job done. They are able to focus on their key responsibilities without wasting time on non-essential tasks or navigating procedural restrictions.

Unfortunately, most organizations employ a sizable number of ‘frustrated’ workers – capable, engaged, but not enabled. In the short term, these motivated but poorly enabled employees may carry on and suffer in silence. But over time, many can be expected to turn off and disengage – or tune out and leave.

The ultimate aim is that engaged and enabled employees produce their best possible performance for the organization.

 

The best system is not a substitute for management

Organizations are also investing in ensuring that their performance management systems and processes work to drive the performance they define. In some cases, this means introducing more efficient systems and processes, and centralizing or automating performance management. But most recognize that those systems and processes will work only if they have the right culture and management skills to support them. The focus for many, as a result, was on building management skills around performance management, and on ensuring the transparency of the performance management process.

Recognition is growing that a performance management system is not a substitute for management. Responsibility for defining performance rests with leaders; and responsibility for managing performance in accordance with that definition rests with line managers. Provided line managers are supportive of senior executives, they are ideally placed to foster high levels of confidence in the organization’s leadership and direction, and to help employees understand organizational expectations.

There is also an increasing need to address low performers – to lift them up or manage them out. Low performance may have been tolerated in the past, but few organizations can afford to ‘carry’ anyone anymore. Addressing poor performance is often a more challenging task than dealing with high performers, and again organizations are looking to better equip line managers to have those difficult conversations.

The impact on reward

Performance is the key driver in the post-recession world. Reward – and a new focus on total reward that is closely tied to performance – will play a crucial role in allowing organizations to compete in this new environment. Variable pay, differentiated reward, and performance metrics all play a vital role in this new strategy.

 

Aligning reward with the business

The survey confirmed that many organizations are working to align their reward and business strategies, either because their business strategy has changed or because alignment was not optimal. In practical terms, this means ensuring that:

• The right performance metrics are in place
• Reward programs are closely tied to metrics
• Performance and rewards are appropriately differentiated
• Supporting management processes are in place
• Leaders have the capability and commitment to implement reward programs effectively

The reward risk audit

The increasing globalization of business has created an enormously complex environment for managing reward, with organizations juggling the demands of local regulation, market conditions, culture, and tax structures. This complexity is a concern for compensation committees struggling to come to grips with their expanded responsibilities.

Many will need to begin at the beginning, identifying and assessing the risks inherent in their reward programs. A risk audit should be conducted across the organization to provide senior management and the compensation committee with the information they need to make informed decisions.

Those decisions, however, should not focus solely on reducing risk at the cost of innovation and competitiveness. An overly risk-averse approach to reward can be just as damaging to performance as an unmanaged, unrecognized risk. The answer lies in transparency and clarity from leadership about why the organization is doing what it is doing, and how reward strategy will drive performance.

 

A delicate balance – global versus local

A desire to cut costs and reduce risk has led an increasing number of organizations to centralize their reward decision making and policy, and sometimes even administration.

Centralization has the potential to allow organizations a clearer line of sight over their reward programs, so that they can ensure local schemes align to global priorities and policies. This increases return on investment and reduces the risk of potentially damaging inconsistencies.

For many, the concern is striking the right balance between global consistency and local adaptability, and allowing for proper recognition of varying local practices under tax legislation, social benefits, and regulation.

 

Think globally, implement locally

The most frequent point of conflict in implementing a global remuneration strategy lies between the corporate philosophy and design components, and the different country operations. Local regulations and cultural expectations play a significant role in reward but can be lost or ignored in a centralized strategy.

Imposing a global policy on variable pay without understanding the different markets is not workable. Hay Group’s research has identified these key steps to successfully implement a global reward strategy:

• Form a global total remuneration strategy that is more than a mission statement and has clarity around non-negotiable areas
• Explain the global philosophy to management in all countries and test it with them to identify in advance any unintended consequences that may result from local taxes, culture, and employment practices
• Translate the global philosophy into local implementation plans
• Clearly spell out the rationale for employees
• Continually measure and test the results on an employee satisfaction

Differentiating reward

Organizations in all sectors are striving to forge a closer link between performance and reward. While this aspiration is nothing new, the difference now is that the challenges it brings can no longer be placed into the ‘too hard basket’.

Many survey respondents talked about a general shift from a culture of ‘entitlement’, ‘paternalism’, and ‘comfort’ to one of ‘performance’. In practical terms, this is leading to a greater differentiation of reward based on individual performance. The limited budget that is available is being put behind high-performers and key roles seen as critical to the business.

Hay Group’s research into the reward strategies of Fortune’s Most Admired Companies has shown that the best organizations carefully target their use of differentiated reward. When bonuses are taken into account, senior managers in the world’s top organizations can earn 20% more than their peers. These people are being rewarded for their ability to deliver and ensure that their organizations stay at the top of their sector – they are driving the strategy and motivating their people.

 

The false security of ‘hard’ measures

It is clear from the survey that some organizations are placing more emphasis on financial measures in rewarding performance. Times are tight, and organizations want to know that they are going to get a return on the money they invest in their reward programs.

However, this emphasis on financial goals and metrics is at odds with what Fortune’s Most Admired Companies do. While peer companies apply performance metrics to executives that focus on operational excellence, profits, or revenue, the Most Admired go further by adding measures around long-term thinking, teamwork, building human capital, and customer loyalty.

Whatever goals are set, it will never take away the need to arrive at a ‘holistic’ view of an individual’s performance over a given period that takes into account financial impact, behaviours, and values. Responsible reward, in other words, is the key to a truly successful reward strategy.

 

Variable pay comes into its own

An increasing trend as organizations emerge from the recession is a shift in balance between fixed and variable pay. The best organizations use variable pay not purely as a cash flow tool but as a support mechanism for their performance management strategy.

 

Five common trends in variable pay

• Linking bonuses to medium- and longer-term targets that support sustainability and organization performance over the longer run
• Ensuring bonuses are properly funded, with a focus on growing the bottom line as the main driver
• Balancing individual and enterprise performance in designing bonuses
• Simplifying programs, in particular by reducing the number and variety of bonus schemes
• Clarifying and communicating the intent and design of variable pay

Say what you need to say

The new trends in reward strategy cannot succeed without a solid foundation of good communication, based on strong leadership. At every stage – the drive towards variable pay, a closer link between performance and reward, differentiation of high and low performers, retention of talent, and a trend towards total reward – there is a risk that the return on investment will be lost because leaders and managers have not clearly communicated the organization’s intention and strategy.

Hay Group’s research into Fortune’s Most Admired Companies revealed that the best organizations do not necessarily offer more intangible rewards than their peers, but do a much better job of communicating what they do offer and of making employees understand their value.

 

Top 6 pay-for-performance actions

1. Introducing differentiated reward structures where available rewards increasingly go to the top performers and high potentials – those critical to the survival of the business, now and in the future.
2. Building line management skills in setting goals, coaching performance, and recognizing and rewarding performance.
3. Clarifying definitions of performance.
4. Balancing individual and enterprise targets for bonuses.
5. Aligning individual targets to overall strategy.
6. Making greater use of multiple rewards, mixing short and long-term incentives with the motivational stimulus of better career development and varied work.

The best organizations develop a course of action that weaves the reward program messages into the fabric of the organization, ensuring core messages are clearly communicated and reinforced frequently, using total reward statements, and engaging line managers early and often.

 

The keys to effective reward

Follow these principles to ensure their reward programs effectively support business strategy:

• Create a performance culture. Use your reward programs to help you move from an ‘entitlement’ to a ‘performance’ culture. Look at how to differentiate reward for high performers so that it acts to engage not just your ‘stars’ but all your people.
• Think in terms of total rewards. The Hay Group research has consistently shown that intangible benefits such as career development opportunities play a vital role in employee engagement. This is one of the many reasons that organizations should not lose sight of total reward – the total benefits employees receive from working for a company.
• Consider all costs. While many organizations closely focused on reward costs during the recession, this was sometimes at the expense of a wider contextual consideration of cost. It is too easy in the current climate to overlook the total cost of reward – benefits and allowances can account for as much as 40% of reward costs.
• Build in flexibility. Bonuses not only focus attention on key goals but also provide a cost buffer in downturns. Increasing the proportion of total pay delivered through bonuses provides employers with greater flexibility in their cost structures and helps to protect jobs.
• Make a thorough assessment of risk. Risk is inherent in reward programs – not least the danger of encouraging risky behaviour through variable pay, which has been sharply highlighted by the financial crisis – and should be frequently and thoroughly assessed.
• Balance global and local requirements. With centralization of reward strategy on the increase, the challenge for multinational companies is to ensure they hit the right balance between global consistency and local autonomy.
• Reward effectiveness. Reward programs need to deliver a clear return on investment. Clarify what you expect your reward programs to deliver – engagement, retention, performance on critical success factors, or some other measure. Make sure you have the means of measuring progress, such as employee satisfaction surveys.
• Nurture innovation. The survey highlights the tension between the need to reduce risk and meet compliance requirements and the desire to develop new reward policies and programs that better support the needs of the business.

The reward ‘To Do’ list

• Review reward strategy to ensure that it supports business strategy.
• Reassess performance criteria so reward is linked more closely to goals that clearly reflect the vision and strategy of the organization.
• Review the balance of variable and fixed pay to ensure it is right for the company culture and for business needs.
• Use reward differentiation where appropriate to focus limited resources on those most successful to the business – high performers, high potentials, and those with skills that are in short supply. 
• Closely assess and measure the return on investment from reward programs and strategy.
• Communicate the true value of your reward package and how it supports the goals of your business.

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Excerpt reprinted with the permission of the Hay Group, a global management consulting firm that works with leaders to transform strategy into reality. To learn more about the Hay Group visit www.haygroup.com. The complete research study can be accessed at www.haygroup.com/ca/downloads/Details.aspx?ID=24561 or email [email protected].