Measure Compensation’s Impact

An analysis can reveal the effectiveness of your compensation strategy.

By Joanne Sammer Sep 1, 2012
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September CoverPay represents most companies' largest expense—and their most powerful performance tool. The need for compensation structures and programs to work as intended cannot be overstated. Therefore, a periodic impact analysis of pay programs is vital to answer three questions, says Myrna Hellerman, senior vice president of Sibson Consulting in Chicago.

First, although corporate leaders may think they pay competitively, "is that actually the case?

"Second, the organization is spending $X on these programs, but are the dollars going to the right people?"

Third, "is the organization getting the right kind of outcomes for that investment?"

A compensation impact analysis shows how pay programs, including pay philosophies and strategies, positioning, and base pay and incentive design, are playing out in reality in terms of financial costs and returns as well as organizational impact.

Such analysis can help leaders "understand the implications of the decisions that they are making relative to compensation," says Stacey Carroll, director of professional services at PayScale Inc. in Seattle.

Gauging the impact of incentive investments is a key driver for Hilton Worldwide's annual analysis of its bonus plan, particularly the plan for each hotel's general managers and the functional directors.

"We want to make sure our highest-performing hotels are getting the highest payouts," says Michael Janninck, vice president of compensation for the Americas, in McLean, Va. Each year, following bonus payouts, he looks closely at who got what and why. For example, if hotels in one brand consistently outperform or underperform hotels in the other brands, "we look at certain metrics, like customer satisfaction and revenue per room, to see if this is a one-year blip or an ongoing issue," Janninck says.

How often should companies conduct a compensation impact analysis? It depends. Some compensation specialists incorporate their analysis into their annual reviews of pay programs. Others conduct an impact analysis for a reason. For example, they may want to address problems related to competition, recruiting or retention, or internal equity, or they may want to identify the best use of compensation dollars, says Andrea Averill, a principal with Strategic Rewards Consulting Group in Philadelphia. Merger, consolidation or major change in business strategy could also prompt analyses. "Look at your compensation structure at least every three years," Averill advises.

Measuring Risk

Philadelphia-based Lincoln Financial Group, with about 8,500 employees, conducts an impact analysis of its compensation programs every year, including a risk assessment of its incentive plans. The analysis examines pay levels relative to the market using benchmarks for more than 25 percent of its jobs. "We develop compensation program recommendations based on a fairly in-depth look at the marketplace," says George Murphy, senior vice president of employee experience and services.

Instead of increasing salaries by whatever percentage surveys are showing, corporate leaders use the benchmarks to see how far pay for those jobs has moved compared to merit increase percentages published in the most recent surveys. "We look at how quickly pay for those jobs has moved in the course of the year because you can have jobs that are moving at a faster or slower rate than that 3 percent" the surveys are showing, Murphy says. "We are then able to go to senior management in the fall of every year and say, 'This is how far the market has moved, this is what we recommend to increase pay, this is what we recommend for the annual incentive program, and this is what we recommend for long-term incentives.' "

Lincoln Financial's risk assessment grew out of its compliance with the federal Troubled Asset Relief Program. Regulators initially required the company to conduct a risk assessment to make sure its incentives were achieving expected results. Executives found the assessments so useful that they still conduct and review them, even though doing so is no longer required.

Researchers use the assessments to develop a "heat map" with red, yellow and green areas to show levels of risk associated with incentives and related metrics. For example, if the assessment shows that 80 percent of an employee's pay is based on sales to one vendor, "that would reveal three hot spots—too much pay via one pay vehicle concentrated into one result that is related to one vendor," Murphy explains.

Although corporate officials are concerned about excessive risk in incentive programs, they do not want incentives that create a completely green heat map, or one that shows no risk. "We accept a certain amount of risk," Murphy says.

"We make sure that we address all of the red spots," Murphy says. "When it comes to the yellow areas, we want to know what the risk is and whether it is overweighted in any particular critical areas." Murphy and his staff do not work to eliminate all yellow areas, but managers monitor those areas with greater scrutiny.

Make It Pay Off

Conducting a compensation impact analysis can help generate important insights. Here are some ways to manage the process.

Determine the goals. Before beginning a compensation impact analysis, “be clear on the organization’s compensation philosophy and what the organization wants to reward,” says Stacey Carroll, director of professional services at PayScale Inc. That means considering the role of each element of rewards, including base pay and variable pay, and how they fit into the organization’s overall value proposition.

Identify the market. Organizations compete for talent in different ways and among different populations. By identifying the markets for talent, HR professionals can get a sense of where they need to set pay levels relative to those markets. Then, review the internal strategic value of specific jobs. For example, a consumer products company might benchmark marketing jobs at a higher percentile than companies in other industries to reflect the importance of those jobs to the company and the competition for that talent. Technology companies might position software development jobs higher.

Gather tools. An impact analysis requires strong and credible market data, job descriptions for benchmarking, and the internal or external expertise and time to follow through.

Share findings up and down. Share the results with senior management and the board as well as with line managers and employees. Doing this keeps people informed. It also sparks healthy dialogue about pay programs and whether and how they are serving the organization.

Changing Market

Recognizing the changing nature of pay programs and the market for talent, particularly key talent, many compensation specialists conduct impact analyses consistently to keep up with their markets. For T-Mobile USA, a compensation impact analysis goes beyond numbers. To make sure corporate leaders are pricing jobs appropriately to the market, compensation specialists consider whether they need to modify the defined markets for talent. Each year, they also evaluate and change thepeer group against which the company is competing for talent as needed.

"A specific challenge for us is having so many large entities wanting to play in the wireless space rather than just traditional telecom companies and manufacturers," says Bruce O'Neel, vice president of human resources in Bellevue, Wash. "Other players in the wireless space include Apple, Amazon, Google and Microsoft."

At the same time, T-Mobile's operations are changing, thereby fostering changes in compensation. For example, the company may increase hiring to gain deeper market penetration in a particular sales channel that requires a particular type of sales team. "To become competitive, we use real-time, ad hoc market evaluations," O'Neel says.

Because many T-Mobile competitors pay more for the right talent, this can lead to hyperinflation in pay for some jobs—and these pay scales require careful monitoring.

When it comes to the analyses, T-Mobile focuses on questions such as: Are there concerns about the compensation programs? Are jobs priced appropriately in the market? Are there indicators of gaps between attraction and retention that are cause for concern?

Making the Business Case

An organization does not have to be in the high-tech industry to find its compensation misaligned with that of its market. As Wickenburg Community Hospital in Wickenburg, Ariz., has grown quickly—from 110 employees to 175 in a few years—officials have made major changes to its compensation system. When Bill Horn joined the hospital staff as human resources director two years ago, he conducted an impact analysis that revealed a compensation structure that rewarded employees based on longevity rather than performance. Further, compensation specialists were not casting a wide net for market data to price specific jobs.

Horn began by matching all positions to jobs in the marketplace to determine whether the hospital was paying market value.

A key part of this process was involving supervisors and executives and convincing them of the need for change. Although completing an impact analysis in a smaller organization can be a challenge because of the cost of obtaining and evaluating market data, Horn notes that the people involved can easily build the close working relationships necessary to implement change. "I sat down with every manager and asked them to rate all of their people on a scale of one to three based on proficiency and performance," Horn says. "It became clear that some people were not being paid at the correct level." However, because the hospital did not have the funds to bring everyone's pay up to an appropriate level right away, the management team committed enough funds to get everyone within 15 percent of target.

As Horn's experience suggests, a compensation impact analysis can help HR and compensation executives make a business- and data-based case for change.

"Rather than focusing on fixing the squeaky wheel, you are gathering facts to see what is actually happening and if there really is a disconnect," Hellerman explains. "Sometimes, the squeaky wheel involves more than just pay."

H.J. Heinz Co. annually assesses its total rewards program "to identify opportunities, emerging competitive issues and possible compliance concerns," says Randy Keuch, vice president of total rewards in Pittsburgh. The results and data from this analysis help Keuch build a business case for any changes. The review focuses on:

Metrics such as turnover, offer acceptance ratios, workforce composition and employee engagement survey data.

Market positioning as measured by the percentage of employees with target compensation above or below the market median.

Changes to regulatory, tax, accounting and other requirements.

Whether the total rewards program needs adjustments, such as new delivery vehicles to replace equity awards with cash incentives to comply with country-specific requirements.

Most of the salaried positions within Heinz's global operations are assigned to a global pay band—based on competencies, size of business and other considerations—that helps to determine base salary and the percentage of pay for each additional element of compensation. If officials in a region decide to increase bonus targets, for instance, this analysis would consider whether this is a permanent change and calculate the cost, people and business impact of the increase, including the impact of higher bonus payouts on retirement arrangements and other elements of pay. "We would also explore other performance-based approaches to deliver compensation, with the additional cost borne by the improved business performance upon which the incentive is based," Keuch says.

In conducting an impact analysis, HR and compensation executives should make sure the process is relevant and useful to their internal customers. "I am always concerned that the compensation team be perceived as having value added to the organization and not as a bureaucratic black hole," Murphy says. "We work very hard to make sure we are doing all the right things to help move the business forward and in the right manner."

The author is a New Jersey-based business and financial writer.

Web Extras

SHRM article: Analyze Compensation to Reveal Business Risks (Benefits Discipline)

SHRM article: Align Pay with Business Priorities to Reap Rewards (Benefits Discipline)

SHRM article: As Economy Improves, It’s Time to Revisit Pay Structures (Benefits Discipline)

SHRM video: Stacey Carroll, director of professional services and education at PayScale, says a mistake companies often make is not doing an impact analysis of their compensation strategy

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