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July 2008

Allocating Scarce Pay Dollars in Challenging Times

by Pat Zingheim & Jay Schuster

How much grit does your organization have during challenging business and economic times? There are problems of talent shortages in specific skills, concern about sustaining achievement of business goals, and problems of not having enough pay increase dollars to go around. Selectively scarce talent and increasing pressures on pay budgets—precipitated at least in part by rising healthcare costs—continue to consume total compensation dollars. From a strategic perspective, organizations have some alternatives ranging between the following to consider:

  • Less for all: The “time-tested” solution is to reduce the amount of pay adjustment dollars available across the board. Everyone, for every reason, gets less, and the logic is, “leaner year—share the pain.”

  • More for some: Giving some people less and others more based on some variable, most likely a measure of scarce or critical skills, rewards those with the most needed skills and the most value added at the expense of others in the workforce.

For example, our study of compensation practices at a sample of America’s Best Hospitals (as determined by U.S. News and World Report) focus their retention, pay and reward dollars on the professional talent who are key to providing excellent healthcare—e.g., registered nurses, medical technologists and physical therapists (see our article and study on Schuster-Zingheim and Associates, Inc.’s website, "Workforce Retention and Pay and Reward Practices in America’s Best Hospitals").

What do we know about retaining, paying and rewarding the superkeepers—the top 20% of the workforce in any job category in terms of performance, skill and competency? We know the best people with strong contributions to business performance and the scarce skills and core competencies want to have their excellence matter in terms of career growth, development, pay and the other rewards of work. If they don’t, they will go elsewhere to find what they want. Further, no CEOs are saying, “Give me all the average to below-average performers you can find; I can ‘make do’ with them.”

The “Knowing-Doing Gap”

Few sponsor talent retention, pay and reward strategies that treat everyone the same—nearly every leader and HR professional testify in favor of doing your best to keep the best people with the most essential skills. But when the topic of “paying for performance” or “paying scarce/unique talent” comes up, HR asks, “How do we get managers to stop giving the same pay and rewards to nearly everyone?’ Or, “Our managers don’t want to acknowledge differences in the value of employees because they must work with them in close proximity all year, and it creates hard feelings.”

Education on the Business Case

Everyone involved must understand the logic of doing this. It is easier to distribute pay and rewards evenly and not make decisions based on preference for the top performers in each job category who have the most essential and scarce skills. The business case, however, is clearly established because people who have the scarce/critical skills and add the most value to an organization expect to be rewarded for the value they add.

The business case is that leaders in many organizations believe that the top 20% of the workforce in terms of performance provide about 80% of the value and the work the organization needs done. These people are in demand. Other organizations are targeting the best people you have, so you need not only to keep those you have but also to attract more. The case is organizational survival, growth and success—if the organization needs people to make it a success, then a business case can and should be developed for retaining the best talent.

Provide Tactical Tools

What do managers need to get the job done? Obviously they must be willing and able to address a system that wants the most valuable people to stay and add value. They also need tools—training and development, of course, and any other help that can be provided, such as practice sessions and development in this process before they become managers. Good people who do not want to make distinctions between and among others should have the chance for an attractive career without being required to do so. Taking the best non-manager and making them into a mediocre manager destroys talent because in too many instances it is not possible to move back to a non-management job if management does not “work out.” Perhaps a trial run at management would take the pressure off becoming a manager. Or perhaps a career path that makes it possible to have similar pay and rewards by growing in skill, competency, and performance outside the management career path.

Translating Strategy to Practice

The tactical answer is that whatever is valued in terms of a reward (pay being one) should be given consistent with an objective evaluation of which employees add most value in any job category—management, technical, professional, clerical, etc. Assume it is base pay adjustments, which become an “annuity” to the employee and a fixed cost to the organization. Allocating base pay adjustments is in some ways more problematic than granting variable pay awards because the base pay change is typically permanent and communicates the existence of a lasting relationship between the employee and an organization. Will the message from base pay in your organization be value-added or entitlement? That is the real question.

In each job category or organizational level, rank your employees from top to bottom in terms of scarcity/skill/performance, in whatever order you value most in the organization. Then rank them in order of base pay. What does this show you about paying in order of the value people add to your business proposition? What does this uncover relative to making it worthwhile for scarce/skilled/high performers to stay? If the relationship is “topsy-turvy,” your organization may indeed have a pay result that retains the bottom 50% of the workforce better than the top 50% because poorer performers are less likely to leave regardless of what they are paid.

The Fix Is In

When the distribution does not meet the goal, logic says you begin to redistribute. You are not likely to reduce the base pay of people who are overpaid for where they rank, but you are probably going to want to use future pay increase dollars to incrementally correct the imbalance between pay and value. Here are some possible steps to consider for correcting the challenging issue:

Step 1: Communications: The “Pay for Skills/Performance” message becomes more than just a slogan without substance. The message is that the organization’s managers will meet with each employee to discuss the individual’s performance and where the individual is paid relative to their value in terms of performance/skills/competencies and why. Those who are paid more than their value should know why and what they can do to regain traction and increase their value to truly earn the pay they receive. Those who are undervalued are typically aware of this so the organization needs to acknowledge their contributions and value and communicate both why and what is being done to change the situation over time.

The change process puts credibility into what the organization is saying with concrete actions. The misalignment will not be fixed all at once but will get fixed. During the change process, managers are deeply involved in coaching, training, and setting goals for all employees and engaging them in how to achieve these goals. Pay is a strong communicator of directions and values and substantiates the value of being someone who makes a positive business difference.

Step 2: Performance/Skill Tool Design: Much is said about performance and talent management and how to make it work effectively. In a fix-it plan like this, the tools include communicating how people are doing and what they need to do going forward. But it also shows that a “course correction” is in progress and how it will impact the pay of the individuals involved. An effective management tool is a worksheet showing the pay of individuals and where a ranking by scarce talent/skill/performance would place them. What does the average employee in the category get, and what does the high performer get and what does it mean? Are the high performers ahead in pay compared to their value? Are they lagging in pay compared to their value? And most importantly, how is this being corrected by a combined effort of employee and the manager and organization? Many of these tools can be computer or web-based, but the objective is to chart a journey from where the employee is paid to where they should be paid, with involvement from the employee in terms of business results and skill/competency development.

Step 3: Budget Reallocation: More directed pay adjustment budgeting is required to remedy a misalignment situation. Simply have managers allocate any budget dollars to the people who are not paid consistent with their skill/scarcity/performance. Grant functional pay increase budgets based on the balance of the workforce relative to pay and value, putting your money “where your most critical talent is.” Whereas most organizations budget fairly evenly, this approach would require some focused budgeting that gets dollars to where they are needed.

Step 4: More Communications: Change works only if it is constantly communicated and explained. Prepare managers to provide feedback and coaching continually during the change process. Show the top-performing 20% of the workforce that the issue is being addressed and what they can do to keep the process proceeding (i.e., continued performance). Explain why large dislocations may not be resolved in one or even two performance periods, and ask for patience where this is required. Communication is essential because once valued, the organization will work to accelerate their pay (provided they continue to sustain their performance level) and they will be kept in the loop.

All employees—not only the top performers—must understand that the change underway is essential to sustain organizational performance and career opportunities for the broader workforce.

For those whose pay will be slowed or not increased, communications is especially critical. Those people must understand the reasons and what is needed to have the opportunity to have their pay increase in the future—“Here is what you need to do to perform and add value similar to high performers.” It is only fair to communicate to those who will not receive pay progression without a change in their skill and performance so that they can make choices relative to their own careers.

Step 5: Assessment of Progress: How is the process working, and what course corrections may be needed? Keeping on top of this change is an important task because as it proceeds, everyone learns. What made sense at the start may need modification when the reality of seeing it in operation provides new insights.

Continuous improvement is essential to such an important process. Fine tuning ensures effective customization.


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