Benchmarking overall costs with key business ratios
In determining the effectiveness of reward programs, many organizations benchmark compensation levels for jobs. But this is only one element of an effective reward program. Benchmarking reward programs against key business ratios can help an organization remain competitive and profitable.
Plus, by providing information operations-focused leaders can relate to, HR ensures its place at the table for key decisions.
To gain a broad picture of the overall effectiveness of your reward programs compared with the competition, benchmark the overall costs of reward against key business ratios, such as revenue, profitability and business strategy.
One measure of reward effectiveness is how much profit is gained from each employee compared with the competition. This is done by calculating the “real” productivity per employee less the average cost of each employee. If the profit per head is relatively high for your industry, that reward is working effectively.
In looking at four global beer manufacturers, when it came to economic profit per employee, Hay Group found the highest was $60,000, the average was $30,700 and the lowest was $10,900. This shows organizations can generate five to six times more return on reward than competitors, even if they compete in the same markets with similar products and jobs.
High economic profit per employee could be a good sign as employees are being very productive. But this could also signal levels of productivity are unsustainable and more staff are needed. Employees can only “overproduce” for so long without burning out, reducing their efforts or leaving, resulting in high turnover. Retention rate metrics, the cost of turnover and staff morale should be monitored in tandem with profit per employee.
On the other hand, low economic profit per employee suggests there may be too many employees and current work levels could be maintained with fewer staff or a change to structure.
Banking on profit
Before the recession, spending on personnel expenses rose sharply at many of the world’s leading banks. Since 2009, banks have made an effort to reduce personnel expenses in relation to profitability; in other words, increasing employee productivity while controlling reward spending.
A useful metric for measuring the relationship between reward spending and profitability is the ratio between personnel expenses and the organization’s net income — the net profit or bottom line. A falling ratio means the bottom line is increasing more rapidly than personnel expenses. This means each additional dollar spent on employees is increasing net profit by more than one dollar.
In contrast, an increasing ratio means personnel expenses are increasing more rapidly than the bottom line. This is a likely short-term outcome if you’re increasing the dollars spent on workers to increase retention.
Many banks have successfully reduced employee expenses relative to productivity. Ratios at large Canadian and American banks have followed similar trends over the past five years and while these banks spend more on rewards relative to net income than global counterparts, the gap between the ratios has diminished since 2009.
Knowing how much is spent on rewards in relation to overall operating expenses helps to reveal how much to adjust pay before it starts to affect profitability. This ratio varies by sector as sectors that rely more heavily on employees to create value (relative to other inputs, such as workspace or office supplies) spend more on personnel relative to other operating expenses. Sectors that rely more heavily on other inputs (such as oil and gas refineries) spend relatively less on employees.
When pay is as high a percentage of total operating expenses as in support services, controlling levels is critical. Small increases could destroy company profitability while small savings might boost it greatly. In sectors with lower ratios, there’s more latitude to increase reward spending before profitability is affected.
There is no ideal ratio — it’s about taking the median ratio for your sector as a rough guideline for the ratio your organization should aim to achieve.
The best way to check how well reward programs are working is a mix of tangible metrics, such as the number of employees, and intangible measures, such as employee motivation. Here are 10 checks to get the best reward “fit”:
Do the rewards reflect your business strategy? The business strategy should inform the compensation and reward philosophy as well as how much turnover an employer is willing to accept. If employees aren’t behaving in a way that’s expected, there may be misalignment between the rewards and business strategy.
How do the total costs of your package compare with the competition? If competitors are getting more out of employees than you are, you could be spending too much — or not wisely enough. Are you paying for rewards employees don’t use or care about? Take a look at the reward package being offered and compare it to the needs and wants of employees.
Do you have more employees than your competitors? You may have too many full-time employees (FTEs) or larger operations than your competitors — or both. Fewer employees (relative to organization size) than the competition could result in burnout or high turnover. It’s important to consider FTE count in conjunction with related metrics.
Are employees in the right grades for their work? Different grades are associated with different reward levels. Having people in the right grades helps to ensure the effort-reward ratio makes sense for both employees and the organization. It also helps to ensure internal equity.
Are employees motivated by their rewards? Employee surveys measuring engagement and enablement are a good way to check the pulse of employee motivation. Regular check-ins with managers and monitoring of turnover rates and exit interview data also help.
Do you have the right reward mix of fixed and variable pay? Market benchmarking — using an appropriate comparator group — can show what kind of mix competitors are offering. Be sure to balance the data with what current and potential future employees want and need.
Do the rewards suit the demographic profile of employees? Employees with different ages, family situations and personal characteristics can have vastly different wants and needs.
Are you paying for performance? Structuring employee compensation to put a focus on performance can help increase productivity and communicate an organization’s values to employees. Make sure the compensation structure aligns with the managerial strategy and types of behaviour you want from employees.
Have you risk-tested your policies? Rewards are associated with a level of risk. For instance, all employees could hit their stretch targets and be eligible for maximum performance payouts — or the organization could have a terrible year and employees may be unsatisfied with the resulting effort-reward ratio. It’s important to stress-test reward programs to see if they deliver results and are within budget, given the array of scenarios a business might face.
Do you regularly review the effectiveness of rewards? Check to see which rewards are most and least used and which rewards people love and hate. As employees change and grow, so should the reward programs.
David Hoad is a senior consultant in Hay Group’s reward practice and Nathalie Olds is an analyst in Hay Group’s reward practice in Toronto. Hoad can be reached at firstname.lastname@example.org and Olds can be reached at