Variable pay increasingly used by employees to differentiate
With a still-uncertain economy, along with falling oil prices and a low Canadian dollar, “caution” is still the word of the day for many employers when it comes to salary predictions for 2016.
What is notable, however, is the increasing emphasis on variable pay, as employers go beyond limited base salary increases to try and have a greater impact on valuable employees.
Ninety-eight per cent of the 422 employers polled by Towers Watson are planning to give raises next year, with a projected increase of 2.9 per cent across all employee categories.
Since 2009, increases have hovered around three per cent, according to Sandra McLellan, North America practice leader for rewards at Towers Watson in Toronto.
“(It’s been) very consistent year over year.”
The sub-story in all of this is these budgets — 2.9 per cent in Canada, three per cent in the United States — seem to be the new norm, says McLellan.
“It seems like companies are getting and keeping the employees they need at this level of increases.”
And inflation has not been moving that aggressively, she says.
“The other thing that drives salary increases budgets is how much inflationary pressures there are.”
Almost two-thirds (62 per cent) of Canadian organizations report the overall economic climate as the primary factor influencing compensation planning decisions, according to Mercer’s 2015/2016 Canada Compensation Planning Survey.
“I would characterize it as absolutely cautious and probably more uncertain than it was a year ago, particularly due to the price of oil, state of the economy, that sort of stuff,” says Gordon Frost, Mercer’s talent business leader for Canada in Montreal. “Some (employers) are actually holding off on making their final decision until we get closer to 2016.”
As a result, salary budgets have remained flat and the average raise in base pay is expected to be 2.8 per cent, found Mercer’s survey of almost 600 Canadian organizations.
“The results are actually relatively stable for the rest of Canada and it’s really the West where the numbers have come down year over year, which is influencing the overall Canadian average,” says Frost. “But if you look at the results for Ontario,
Quebec, Atlantic Canada… it’s really more of a stable year-over-year situation… When you go city by city or province by province, most of them are actually relatively stable.”
Employers are expecting salaries to rise by an average of 2.5 per cent in 2016, according to Morneau Shepell’s annual survey for Canada. This is down from the 2.8 per cent increase expected for 2015 and includes expected salary freezes.
It’s fairly reasonable considering employers were still pretty cautious when the survey was done in the early summer, says Randal Phillips, executive vice-president and chief client officer at Morneau Shepell in Toronto.
“There was talk of recession in the air, everybody had seen the crash in oil prices, there were big changes in expectations,
particularly in Alberta, and in the rest of the country, the falling Canadian dollar hadn’t yet had any material impact on business outlook.”
Some sectors, such as mining and oil and gas, are expecting average salary increases of about 2.4 per cent for next year, found Morneau Shepell, compared to a forecast of 3.4 per cent last year.
“People aren’t feeling desperate at all, they’re just being careful,” says Phillips, adding organizations are taking a wait-and-see approach. “They’ll continue to monitor things — but the overriding sentiment seemed to be caution.”
Aon Hewitt’s survey of more than 475 employers found employees can expect an average total salary increase of three per cent in 2016, up from this year’s estimated average salary increase of 2.8 per cent.
Performance-based, variable pay
The expected variable pay averages across performance tiers for 2016, according to Aon Hewitt, are 4.5 per cent for those who “far exceed” expectations, 3.6 per cent for those who “often exceed” and 2.5 per cent for those who “meet” expectations.
Many companies are shifting more of their spending to variable pay, says Suzanne Thomson, senior consultant, global data solutions, at Aon Hewitt in Toronto.
“With increases being at two and three per cent — and they’ve been like that for the last couple of years anyway — it makes it difficult to apply an increase across for high performers if you’re trying to average it out at two or three per cent, so by adopting a variable pay approach, employers are able to focus on the key roles and high performers; and by paying them more based on their performance, they’re able to spend their dollars better, more wisely.”
About 82 per cent of organizations have variable pay programs and the majority of those are based on corporate performance measures, says Thomson.
And in looking at the most common type of awards based on performance, they tend to be individual performance awards, at 62 per cent; team awards and gain-sharing at 25 per cent; profit sharing at about 20 per cent; and special recognition, which is closer to 40 per cent, she says.
When it comes to long-term incentives, about 55 per cent of organizations offer these, says Thomson, and of those, about 75 per cent provided grants to executive employees in 2015.
Employees who received the highest performance ratings were granted an average salary increase of 4.5 per cent this year, about 80 per cent larger than the 2.5 per cent increase given to workers receiving an average rating, found Towers Watson. Workers with below-average performance ratings received salary increases of less than one per cent.
Companies are making dramatic changes to their approach to performance management, including eliminating formal reviews or taking a ratingless approach, says McLellan. But that’s not to say performance doesn’t matter.
“It doesn’t mean that your annual bonus goes away, it just means that you’re not having to translate a rating into… ‘How do I relate that rating with what I received as a bonus?’ There’s just more clear
communication that says, ‘Here’s what we set out to do, here’s what your bonus target is and here’s how the year turned out for the company and what you accomplished in the year and here’s the reward.’ So it just sort of eliminates that middle label, and so that simplifies communication.”
Based on responses from employers with an annual performance program in place, 81 per cent of professional and management employees received a bonus this year — up from 76 per cent last year, found Towers Watson.
Many organizations are rethinking whether it makes sense to link base salary increases primarily to last year’s performance or if this should be the role of short-term incentive and bonus programs, she says.
“The annual incentives by design are meant to fluctuate up and down with the results of the business and the performance of individual so, done right, they’re very clear that they fluctuate, that they’re tied to performance, and so that ties people closer to what the organization has planned in terms of their results for the year and what the outcomes are.”
Annual bonuses or short-term incentives are an effective way of aligning performance with rewards without increasing fixed costs, says Frost. And in 2015, 84 per cent of organizations had short-term incentive programs in place for at least one segment of the employee population, according to Mercer’s survey.
These are usually targeted at the managerial level and above and allow employers “to still recognize the top performers while balancing it off with company performance,” says Frost.
The highest-performing employees (seven per cent of the workforce) received average base pay increases of 4.6 per cent in 2015 compared to 2.6 per cent for average performers (57 per cent of the workforce) and 0.2 per cent for the weakest performers (three per cent of the workforce), found Mercer’s survey.
And while companies such as GE have announced they are doing away with ranking systems, performance rating systems are still very prevalent, he says.
“Certainly, organizations are rethinking how they evaluate performance in today’s environment but, at the end of the day, if they still want to be able to differentiate their rewards, to divert more dollars to their best employees, they’re going to need a way to determine who those people are.”
The overall challenge, really, is trying to balance a really limited budget with employee retention, says Frost.
“Organizations are trying to figure out how to make the most of a small budget, and then thinking about ‘How can I focus my dollars on where my highest priorities are? So that might be on my high-potential employees or best-performing employees. It might be types of jobs where I have the hardest time finding new employees…’ So it’s causing organizations to be a lot more thoughtful and strategic in the way they spend their dollars based on their organization’s needs and challenges.”