Short-sighted Frugality? Employers Who Rein in Compensation Too Much Could Pay a Price Later

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As economic malaise bleeds into another New Year, employers are making hard-nosed decisions about benefits and compensation. That means for many in the nation’s workforce, compensation remains flat, health care premiums are up, the 401(k) match has disappeared and bonuses are smaller or nonexistent. The result is not hard to guess. When workers feel that “the company is doing fine, but somehow I’m doing worse, at some point there has to be some dissatisfaction with that. It’s not sustainable,” suggests Wharton management professor Adam Cobb, who studies labor, worker benefits and income inequality. “I think there’s a general feeling of: This system is rigged and not in my favor.”

A recent survey of 2,500 workers by career website Glassdoor.com found that 17% of workers said employers had cut or eliminated bonuses and 15% had slashed perks such as commuter subsidies. About one quarter said their companies were in a hiring freeze, and about half reported that employers had cut pay or laid off staff in the last six months. January, once warmly anticipated for a year-end bonus, may be remembered in 2012 as the month that year-end gifts — along with other perks, pay and benefits — disappeared.

Going into 2012, employers have little incentive to loosen the purse strings. After three years of recession, company shareholders are clamoring for profits. Economic activity has increased, and economists speak tentatively of a turnaround, but the possibility of a financial crisis in Europe threatens recovery. In the U.S., the upcoming presidential election and the uncertain future of health care reform throw question marks into employers’ pay and benefits calculations. And with unemployment at 8.5% and competition for jobs fierce, most workers are staying put.

“Employees can be really disgruntled, [but] that doesn’t mean they’re going to leave,” Cobb points out. “Where are they going to go?”

Firms may pay a price for frugality when the economy turns around, says Cobb and other human resource experts. Companies are meeting short-term targets now, but it is not clear what the long-term impacts of cost cutting will be. Some note that slashing labor costs too severely — especially if a firm is healthy — could do long-term damage to a company’s reputation and morale.

“Worker productivity is going up, companies are sitting on mountains of cash and they are still cutting benefits,” Cobb says. He wonders what that might do to a company’s ability to attract talent long term, especially in an age of free-flowing online complaints. Could online posts by frustrated staff haunt companies down the road? The last recession came before the age of Twitter, Facebook, blogs and social media, Cobb notes. Workers today are able to vent frustrations online, and can find out more about companies by reading employee posts. If a frustrated worker “writes an angry blog about company X cutting health care benefits, that isn’t ever going away,” he says. “These are things firms might not be thinking about.”

Cobb points out that 2011 was a record year for stock buybacks, which cheer a company’s shareholders but do little for employees. “These firms are sitting on [piles] of cash and what are they doing with it? They’re buying back stock” to drive up share price, Cobb notes. “Why they aren’t starting to loosen up on the benefits is a really good question. I find it to be a more short-sighted approach … when the lever that firms choose to pull is immediately to cut labor costs.” Then again, he adds, “I don’t have shareholders breathing down my neck.”

To be sure, a few companies are experimenting with benefits as a way to keep employees engaged. A December article in USA Today reports that some companies are offering “quirky perks” like “at-your-desk meditation services, jewelry discounts and funeral planning” to “placate” frustrated employees. Cobb calls this “a little boy sticking his finger into the crack” in the dam. “It’s missing the bigger point. My guess is those things would work much better in a company where they had stable retirement and health care benefits. Otherwise, it’s an empty short-term morale-boosting strategy that falls flat — “kind of like the $20 gift card at Christmas,” Cobb says. “When I’m used to a $5,000 bonus, it doesn’t help me pay my mortgage.”

Keeping the Lights On

Steven D. Spencer, an adjunct lecturer at the University of Pennsylvania Law School and practice group leader for employee benefits at Morgan, Lewis & Bockius, a global law firm headquartered in Philadelphia, doesn’t see firms resorting to “quirky” perks to compensate for lost benefits. “I can’t really say I’ve seen a lot of money spent on outside-the-box benefits, and I work across a lot of different industries, from the arts to supermarkets to bakeries,” he notes. With many employees simply happy to have jobs, most employers aren’t using benefits to attract and retain talent, and they’re not trying to find new perks to add. Most firms are simply trying to meet existing obligations. “Since 2008,” says Spencer, “They’ve all been trying to figure out how to … turn on the lights and pay people.”

The cutbacks are starting to take their toll on employees. MetLife’s “9th Annual Study of Employee Benefits Trends”reportedemployee loyalty on the decline. The study found employers of all sizes had shown productivity gains, but more than a third of workers (36%) were itching to move. More recently, Careerbuilder’s 2012 U.S. Job Forecast found that 43% of human resource managers were concerned that top talent could leave in 2012. About one-third of human resource managers polled said that voluntary turnover at their organizations rose in 2011, with employees citing compensation and feeling overworked as the top two reasons for quitting.

A generation ago, when a company laid people off, employees who remained saw little change in their work, notes Wharton management professor Peter Cappelli, director of Wharton’s Center for Human Resources. “Now that’s not true. When there are layoffs, the people who survive find they have a lot more work to do.”

For large public companies, pressure from shareholders can drive cutbacks even if the company is doing well and productivity is up. Employers are looking at two things when making decisions about cutting workers, Cappelli says: “What’s happening to our quarterly financial performance? Are we going to make our numbers — and if not, we’re going to lay people off so we can — and the other is, what is everybody else doing?” If the competition is slashing pay and forcing furloughs, analysts may question why a firm hasn’t followed suit. Sometimes companies will announce layoffs and never follow through “as a way to get the industry analysts off their backs,” Cappelli notes.

Despite the bottom-line focus, companies are not yet calculating the cost that repeated downsizing, benefit trimming and pay freezes may have on employee performance, engagement and turnover, Cappelli says. “I have yet to see a company that has even attempted to work this out. That is, if we squeeze, what’s that doing to performance, engagement, quit rates…. They are not thinking about these employment issues in cost-benefit ways…. They say, ‘Well, the economy is still soft; people aren’t quitting.’ When employers have power,” notes Cappelli, “they push.”

Philip A. Miscimarra sees it more from the employer’s point of view. As a partner in labor and employment law with Morgan Lewis, Miscimarra frequently works with companies that are relocating, outsourcing, downsizing or undergoing some type of major restructuring — activities that have accelerated in recent years. “The pace of business has changed dramatically,” he says. “There’s not only more of this activity, but the growth of this activity has increased at a faster pace…. It used to be that companies would be doing one major change every five years. Now most companies are undergoing these types of changes all the time.”

Companies are not only facing a complex and competitive work environment, but also a diverging workforce that demands different types of compensation and benefits. Many companies have a workforce shaped like a W, Miscimarra notes — heavy in younger and older workers, with few in between. Structuring a mix of benefits that keeps everybody happy yet remains affordable for the company can be a challenge. “When I was a younger attorney, I probably would have accepted compensation in beer,” he jokes. “Now the mix I’m looking for is very different.”

When firms are constantly in the process of getting into new business lines, getting rid of old business lines or completely changing the nature of the business itself, it creates pressure on both workers and management. In the midst of such change, it can be very challenging to get compensation right. “I don’t see the companies that we work with going out and making hard-nosed decisions because they want higher productivity” at the expense of employee well-being, says Miscimarra, a senior fellow at Wharton and managing director of the Wharton Center for Human Resources’ research advisory group. “Everything a major company does is accomplished through people…. What I see is that people who drive these types of decisions within companies are trying to accomplish something…. We’re far from an environment where business can just make decisions unilaterally,” he adds. In this downturn, “more and more companies have an urgent need to do more with less.”

A Shift to Temporary Workers

In some cases, that means outsourcing work to contractors and avoiding employee benefits entirely. The Careerbuilder survey found that 35% of U.S. companies have smaller staffs than before the recession, and many are turning to staffing and recruiting companies to fill in the gap.

Staffing firms “are seeing a great market for their services,” and predict that “the experience of the savage cuts two or three years ago is going to contribute to more temporary work” in 2012, says Wharton management professor Matthew Bidwell whose research examines contractors, short-term workers and new patterns in work and employment. With a potential financial crisis in the eurozone still looming, “companies are going to be much more careful about having a lot of regular employees.”

It is too early to say whether the shift to temporary workers will be permanent, Bidwell notes. In past research, he found that companies that hired contract workers often did so for reasons of flexibility — such as not having to pay health care benefits or a full-time salary. But once the contractors had worked for a certain amount of time, they acquired knowledge that became critical for company operations. In the end, companies often converted the contract workers to permanent full-time staff. “Just because you don’t have to pay them severance doesn’t make it any easier to let them go,” Bidwell states.

Another wrinkle for employers: Health care reform could upend the traditional benefits of a temporary workforce. “One of the great appeals of temporary workers in some fields is that [firms] don’t have to pay health insurance, and that makes [employees] cheaper,” Bidwell says. Depending on how health care reform plays out, mandates for universal coverage could change that structure. “With the health care reforms, people are going to have to find ways to cover health care costs.”

Bidwell also wonders how three years of pay freezes might change company attitudes. “I’d be curious to know what the long-term impact of those pay freezes are. If the hiring market improves, will people quit? Or will some organizations decide that, ‘Hey, we don’t need to give automatic raises’ anymore.”

Doing more with less is also leading companies to link pay more strongly with performance, according to global human resource consulting firm Mercer. The firm’s 2011/2012 US Compensation Planning Survey, an annual survey of 1,200 employers representing more than 12 million workers, found companies increasingly segmenting their workforce to concentrate rewards on key and top employees. The survey found that the top 8% of the workforce rated as “highest-performing” received an average base pay increase of 4.4% in 2011, while those rated as “average performers,” or 54% of the workforce, got an average 2.8% increase.

In a recession, turnover of lower-level employees is likely to be less problematic for firms since it is easier to hire replacement employees at those levels, says Wharton accounting professor Wayne Guay, who studies executive compensation and incentives. “Therefore, compensation and/or benefits can be cut by more than for upper-level employees.”

Most perks and benefits stem from either the economies-of-scale efficiency with which the company can provide the service as compared to the employee acquiring it on their own — such as with health, dental and life insurance — or from tax advantages, such as a tax-deferred retirement account. “In a recession, all forms of compensation get cut, but certain forms of compensation are likely to be less essential to lower-level employees. For example, cash is more important to lower-level employees in a recession — in fact, during most times — than something like life insurance, so benefits/perks will be cut before cash pay,” he says.

While recent scrutiny of executive compensation has led many firms to scale back on elaborate perks for upper management, employees may still become disgruntled if there’s a perception that top management is well compensated while the rank-and-file suffer. “If senior management gets their increase and bonus, but the lower level employees aren’t getting anything, you can have morale issues,” Guay says. Employees may accept a salary freeze during a recession when times are tough, but “once unemployment rates go down, it’s just a matter of market forces…. If the demand for labor is growing or even stable, you would expect pay to have a rise.”

It is tough to say whether employee morale will become an increasing problem for companies as the financial crisis wears on, notes Wharton management professor Adam Grant, who studies job motivation and meaningful work. “On one hand, financial security is an important determinant of morale, so there’s reason to believe that companies will be facing difficulties. On the other hand, when times are tight, some employees become more grateful for the positive features of their jobs. This is only possible, though, if companies retain the practices that make employees’ jobs intrinsically motivating and meaningful.”

Extensive research shows that employees are more willing to accept negative outcomes when they feel that decision-making processes are fair and just, Grant points out. “When bosses can’t promise eternal employment, the best substitute is to offer neutrality, transparency and employee involvement in decision-making.”

Counterintuitively, the recession “might be a really good time to give people a small raise, or maybe a bonus,” Wharton’s Cobb suggests. “I think the evidence would show that having a good relationship with your workers is actually a strategic advantage for firms, but I don’t think that’s an attitude that is shared among many CEOs, because the easiest thing to do is cut labor costs. It’s tough, and it takes courage … to believe that the path to success is not making these cuts” and rewarding employees instead. Cobb does not expect firms will follow his advice, however. “Between Europe and the presidential election, there’s a fair amount of uncertainty” that makes companies reluctant to expand, he says. “I think companies will still sit on their big mountains of cash.”

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