How to set pay budgets

If you read nothing else, read this. . .

  • Pay setting should consider collective versus individual pay awards, base pay versus total earnings, benefits links, pay policy, equality and segmentation.
  • Segmentation, whereby different pay scales are created for different groups of employees, has been of increasing interest to employers seeking to make limited pay budgets go further.
  • Pay freezes are now few and far between, but pay rises remain low.
  • Non-financial ‘recognition budgets’ are a growing factor in pay setting.

Case study: Leeds builds on collaboration

Leeds Building Society’s pay-setting process is a result of a collaborative process involving senior management and negotiations with its staff association. Becky Hewitt, head of HR at the mutual society, says: “The financial and economic context is key to the discussions and the remuneration committee and board are involved in the approval process.”

Hewitt says all parties consider the total benefits package in the light of internal data and sentiment, as well as the financial and economic context.

Equiniti ICS provides Leeds’ payroll software, which Hewitt uses to produce and manipulate reports, with external advisers used, as required, for benchmarking purposes.

“We use internal and external benchmarking,” she says. “This can vary from reviewing individual roles to setting band pay ranges.”

The society usually applies pay changes from 1 August each year.

As the economic downturn continues, employers are looking at new approaches to staff remuneration, says Clare Bettelley

In recent years, the compensation scene has been dominated by excessive bonuses for the rich and minimal base pay increases or pay freezes for the relatively poor.

But employers’ approach to pay setting is shifting. Duncan Brown, principal, reward and engagement at Aon Hewitt, says: “An employer can do a freeze for a couple of years, but then it will really start to worry about whether it can hang onto its top people.”

According to Aon Hewitt’s Report on UK employee remuneration 2011/12, published in April, base pay freezes and cuts were not reported by any of the 319 participating employers in 2011 compared with 12% that reported a salary freeze in 2010. But although employers in all sectors have started reintroducing base pay rises, these have only been modest.

The report found that the average salary, across a range of industry sectors and including pay freezes, increased by just over 0.5%, from 2.5% to 3.1%, between 2010 and 2011. This compares with pre-recession average salary increase levels of 4.6% in 2007.

According to the Chartered Institute of Personnel and Development (CIPD), a range of fundamental factors should be considered when undertaking a pay setting process, irrespective of the economic climate. These include collective versus individual pay awards, base pay versus total earnings, benefit package links, pay policy, equality issues which consider, for example, gender and age, and how much need there is to segment pay.

Pay segmentation

Brown says segmentation, whereby different pay scales are created for different groups of employees, has been of increasing interest to employers seeking ways to make their pay budget go further. “Organisations are looking at job and career families, whereby they might still have, say, six grades, but there would be variations across each,” he says.

Chris Charman, director of reward, talent and communication at Towers Watson, is also advising employers on segmentation. “This could be about particular critical types of job and job families, pivotal roles or key talent,” he says. “It’s about stronger differentiation.”

Brown says segmentation is particularly helpful for employers that want to retain key performers and those that want to attract staff with specialist skill sets. “Almost every organisation says it has talent shortages in some areas,” he says. “There may be general austerity, but some pockets of the labour market are doing well.”

Brown mentions one organisation that awarded a pay increase to more than one-third of its staff despite having frozen both pay and headcount. “If an employer has good people, a general rule that it is not going to increase pay is tough,” he says.

Peter Reilly, director, HR research and consultancy at the Institute for Employment Studies (IES), says employers should also be mindful of global pay scales. “In some places, it is difficult to hold the line of a zero increase, particularly in parts of the world where markets have been buoyant, such as China.”

Towers Watson’s Charman acknowledges the danger of creating pay inequality by using segmentation, but says it is a trade-off any business-savvy employer should consider to retain talent. “It is the complete opposite to the ‘we’re-all-in-it-together’ approach, which is a good response in a crisis. It comes down to how an employer defines fairness and what makes good commercial sense.”

Discretionary bonuses

Aon Hewitt’s Brown says more employers are using discretionary bonuses in response to the inequality debate and to overcome the limitations of organisation-wide pay freezes. He cites the example of one employer that went as far as to award a profit-based bonus pool to its top performers, despite them failing to hit profit targets, to help retain them.

One of the biggest challenges for employers in granting discretionary pay rises is the underlying process of identifying deserving recipients. The IES’s Reilly says: “The question may be: ‘have you made the numbers?’ But an awful lot of people have been working extremely hard, but not made the numbers, so do you reward people who haven’t made the numbers but who have done their darnedest to be successful in doing so?”

This balancing act of rewarding high achievers and high performers is affecting the way reward professionals use external data to help set pay. Ruth Thomas, chief operating officer at pay system provider Curo Compensation, says there has been a shift in reliance on external data, including average sector pay rates, to a focus on internal data as reward professionals have become more accountable for their pay decisions. “There will be continual reviews,” she says. “The speed with which we see firms emerge from the recession will have an impact on when people worry more about the market.”

Rachel Stone, director, people management at accountancy firm Smith and Williamson, urges employers not to rely on external data when setting pay, but to get back to basics with their internal data. “Some organisations have got themselves large matrices that no one understands,” she says. “There needs to be a focus on what contributes to long-term value in a business. Remuneration committees must be prepared to sit down and decide what drives the business. They may need to go back to the business plan and identify how to pay for the delivery of these objectives.”

Stone says reviews should include job specifications and employers’ appraisal processes, plus a clear understanding of what makes each role successful. “No package is worthwhile if [employers] can’t justify to your management that the money spent on pay has resulted in long-term improvements,” she says.

Non-financial rewards are an easy win for reward professionals looking to demonstrate cost control. Stone has seen increasing take-up of ‘recognition budgets’ among employer clients: displays of gratitude by senior staff to acknowledge their team’s efforts, such as a Friday night out or theatre tickets.

But Charles Cotton, adviser, performance and reward at the CIPD, says reward professionals’ time would be better spent devising talent management strategies to avoid their organisation being at the mercy of competitors’ pay rates, which they may be unable to meet. “It can be self-defeating when [they] are always trying to keep up with what the market is doing, rather than focusing on what makes sense as an organisation,” he says.

“Employers need to be thinking about who their employees will be in two, three, 10 years’ time. If they are chasing the market, they have to have deep pockets to do so.”

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