Meeting the HR Challenge

Strategic overhauls of outdated compensation and reward systems are helping companies control labor costs while at the same time meeting new business imperatives.

The goal of enhancing work force performance while reducing spending has moved to the top of the corporate agenda.

Labor costs are under close scrutiny by finance executives facing slower growth and thinner margins. Many businesses have already trimmed salary budgets, cut benefits, and pushed through two or three rounds of layoffs. They must now pursue strategies that address ongoing cost concerns while boosting -- or at least without sacrificing -- performance. The key is to reshape human resources with an emphasis on improved performance management, stronger pay differentiation and innovative approaches to compensation.

With budgets drifting downward, there's little leverage to be found in merit increases. Early data projections from Watson Wyatt Worldwide, a human capital consulting firm headquartered in Washington, D.C., show that 2004 merit-increase budgets will fall to around 3 percent on average, down from actual increases of 3.5 percent for 2003, marking the third consecutive year of decline.

"It's very difficult to differentiate pay based on performance in the 3 percent budget increase range," points out Laura Sejen, national practice director, strategic rewards, in Watson Wyatt's New York City offices. "By the time you get to 3 percent, you could consider 2.5 percent and put the money saved into either short-term incentives or a cash recognition plan and get a much better return. Half a percent point frees up a tremendous amount of resources that can be redeployed into more effective reward programs."

Companies can improve work force performance while living within slim budgets by more effectively balancing fixed base salaries and variable incentive plans. "Merit increase programs still have an entitlement feel, and the economic reality is that companies cannot afford to spend that money when there is such a low return on that investment," Sejen says. "Variable pay is a much stronger communication vehicle for helping employees understand new business imperatives."