How to develop a strategy for controlling expatriate compensation costs — and stay in sync with the local culture and business climate.

Keeping a Lid on Costs

Here are some of the most widely used steps for containing expatriate costs, according to a survey of 103 companies conducted by Runzheimer International in Rochester, Wis.

Hiring more locals

52%

More tax planning

38%

Developing a corporate plan

25%

Reducing incentives

23%

Nothing

21%

Shorter assignments

17%

Less expensive cars

17%

Fewer cars

12%

Locating expatriates in the suburbs rather than the city

12%

Smaller housing

7%

Fewer domestic servants

7%

Increased use of public transportation

6%

Charging higher housing norms

1%

There is good news and bad news on the global compensation front: The good news is that pay for performance is gaining a stronger foothold worldwide. The bad news is that costs for expatriate assignments continue to skyrocket, and companies continue to stumble when trying to find the right way to pay local nationals. However, with a little strategic thinking, these issues can be dealt with effectively and even turned into a competitive advantage. The key is to get a handle on expatriate compensation costs while also finding ways to pay and motivate local country nationals that mesh with the local culture and business climate.

Answering the Expatriate Question

Once upon a time, companies routinely sent employees on expatriate assignments with a compensation package full of allowances, subsidies and other goodies. This package had a critical purpose — to entice reluctant employees into taking overseas assignments by protecting them from any financial or personal hardship. But that is all changing. "Expatriates cost more than you think they do," said William J. Hibbitt, partner in charge of KPMG’s international executive services practice in New York. "Expatriate packages typically cost three times the employee’s salary, but it is not unusual for them to reach five times salary."

These rising costs have companies scrambling to find ways to cut expenses and maximize the benefits of the expatriate dollars they do spend. "Companies are taking extreme measures to contain the costs of expatriate compensation and are making significant changes to their programs to make this happen," said Hibbitt. But they are doing so carefully. "On the one hand, they don’t want to shortchange the employee, but on the other hand, they don’t want the employee to get a windfall." Here are some ways to accomplish this.

Set a policy. Companies need a policy to deal with expatriate compensation. "Smaller companies often have no defined policy, so the last expatriate package becomes the floor for the next package," said Hibbitt. This is not only inconsistent, it also serves to continually ratchet up expatriate packages. Overall, this policy should outline what elements of the package will be offered and under what circumstances, using fixed tables for the cost of each element in each location. Furthermore, by incorporating the cost of a given assignment on the profit and loss statement, managers will be forced to document that payments have not deviated from policy, said Hibbitt.

Think before you assign. Perhaps more important than straight cost-cutting initiatives, companies are also thinking more carefully about who they send on expatriate assignments and why. For example, companies are increasingly making cost projections to determine if a given expatriate assignment is worth that cost. More specifically, companies are taking a hard look at what positions require expatriates and what positions can be filled by local nationals. Companies are also getting more creative by filling assignments with expatriates from a less expensive country who, consequently, will require a less expensive package to be "made whole." Another more frequently explored option is filling the position with someone hired from outside the company who won’t require an expatriate package at all.

Structure the assignment for the best results. Companies also are looking at the structure of the expatriate assignment itself. "Companies aren’t necessarily sending fewer expatriates, they are sending them more strategically," according to David Rehbock, senior consultant within global HR solutions at PricewaterhouseCoopers in Westport, Conn. For example, a company that needs someone to accomplish a specific two-year project in an overseas operation can structure that assignment in a number of ways, with or without expatriates. By breaking up the assignment to avoid sending one person for the full two years, the company can also avoid offering a long-term expatriate package with full relocation benefits. By sending two people for one year each, the company may be able to offer a short-term expatriate package that, because of the relatively short duration of the assignment, does not include relocating the family, thereby significantly reducing the overall cost of that package. Depending on the country, the short-term nature of the assignment may also create more favorable tax treatment of expatriate compensation. "The key is to manage the people and the purpose of the assignment to be more effective," said Rehbock.

Match the package to the assignment. When it comes to compensation, not all expatriates are created equal. "It is no longer a given that expatriates will get the full package," according to Michael Keppler, a principal with Towers Perrin in New York. "There are new distinctions around who gets what." The reason for the assignment is a key factor in these distinctions. The package for an assignment designed to help an employee gain international experience will differ greatly from the package designed for a global employee who moves from assignment to assignment around the world or the employee who accepts an expatriate assignment strictly to fill a company need with little or no career development potential for the employee. "Each of these individuals has different issues that need to be addressed by the compensation package," he said.

Structure the package to minimize the tax burden. Most expatriate packages offer some form of tax equalization, usually with the employee paying taxes equal to what they would have paid if they had stayed in their home country with the company paying the rest. Unfortunately, by taking overly conservative positions relative to tax filings and by not doing enough tax planning when structuring the package, many companies miss out on the opportunity to minimize this expense. For example, a company may be able to minimize taxes by paying lump sums of compensation to the employee in his or her home country prior to or after returning from the assignment, thus avoiding foreign taxation. Companies can also take advantage of various tax treaties to avoid social taxes, particularly if the assignment duration is short. The key is to press for the maximum available relief in a given location and to structure the package to get the best results.

Pick and choose. Some companies are taking something of a "defined contribution" approach to expatriate packages by providing a lump sum of money that expatriates must manage themselves instead of the company covering each specific expense. This makes expatriates more accountable for their expenditures and prevents them from going over budget. Some companies build in a cost-management incentive by sharing any leftover savings.

Measure the impact. In addition to analyzing the costs and benefits of an expatriate assignment before it takes place, companies need to better analyze the return on investment of the assignment once it has been completed. "Companies need to make sure they are seeing a positive return on each assignment and whether the objectives for the assignment are being met," said Mark Allen, principal, William M. Mercer in Stamford, Conn.

Protect your investment. An employee who has grown and developed new skills from an overseas assignment increases his or her value to the company. Unfortunately, a disturbingly large number of repatriated employees quickly choose to leave the company, taking with them the company’s investment in global operations. "You need to keep tabs on expatriates after they return home," warned Hibbitt. "These people need greater challenge and are often used to having a lot more authority." The trouble is, many companies do not consider that when finding a new role for repatriated employees. Consequently, many expatriates leave the company within two years after repatriation.

Motivating Local Nationals

Although the compensation practices commonly found in U.S. companies are slowly making their way around the globe, each country has its own culture, customs and legal requirements that must be considered when developing compensation programs for local nationals. "Overall, companies do a poor job of managing local national pay because they do not rely enough on local experts," said Tolo Rimsky, a principal with the Center for Workforce Effectiveness in Northbrook, Ill. "But if they look for local expertise, they are likely to find it." Make no mistake, designing these programs is very complicated and country-specific. Here are four guidelines to get the process started:

  1. Don’t impose U.S. compensation standards overseas. When it comes to designing compensation programs for local nationals, "U.S. companies commit the cardinal sin of trying to impose American compensation standards on their workforces in other countries," according to Rimsky. "It almost never works out." In many cases, local nationals resist these attempts because many countries’ workforces have traditionally been less performance oriented than the workforces in North America and Europe. To avoid difficulties, it is a good idea to "let local management deal with local compensation practices by providing them with the parameters within which to work," said Allen.

  2. Accommodate cultural differences. One of the biggest mistakes companies make when developing compensation programs for local nationals is to overlook the cultural nuances involved. For example, companies often make the mistake of thinking and communicating about pay in terms of annual salary when workers in most countries focus on monthly compensation. "Saying someone will make $50,000 a year doesn’t mean much to a local national," said Rimsky. "Companies should first convert salaries to the local currency and then break that down into monthly compensation." Companies should also accommodate local common practices as much as possible. For example, executives in countries like Chile and Argentina routinely get company cars, a perk that their U.S. bosses may not enjoy. "Companies can’t expect to change the traditions of the market," said Rimsky. "If you want to be competitive, you have to do what the market does."

  3. Introduce incentives slowly. It is true that there is a global trend toward incentives and other variable compensation tools, including stock options. "There was a time when no one wanted stock options because they didn’t know what they were," said Allen. "Now, everyone wants them." In many areas of the world, now is a good time to increase the use of variable-pay programs. For example, Asian nationals are probably more likely to accept changes to compensation now because they "just want to keep their jobs," said Keppler. To make these variable-pay efforts succeed, companies must be prepared to spend time communicating about the programs and designing plans that are specific to a country or operation. This also means developing performance goals that are linked closely to the local country to increase employee buy-in and line of sight between payouts and company performance. In some cases, a company may have to introduce performance management programs where none existed before. To help guide this process, many companies use the headquarters compensation program as a framework which can then be adapted to local needs.

  4. Make room at the top. In many companies, local nationals encounter their own version of the glass ceiling. The reason? Many companies prefer to fill the top jobs, particularly in operations and finance, with home country nationals. Therefore, a local national moving up the corporate ladder will have little hope of moving beyond a certain point. "Companies with such a policy must recognize its impact on talented local nationals," said Hibbitt. "It is important to find some middle ground" that addresses the long-term career needs of local nationals and the long-term operational needs of the parent company, he said.

By heeding these suggestions, global companies can develop an international compensation approach that meets the needs of an increasingly diverse employee population. At the same time, it can also help the company manage costs and resources more effectively.