modernizing the annual compensation review process · modernizing the annual compensation review...

Modernizing the Annual Compensation Review Process

By Mercer’s Stephanie Wilson | 1 August 2017

The annual compensation review process can be tedious, time‐consuming, and expensive – so it’s

important to get it right. Stressed human resources departments gather competitive data, managers

conduct performance discussions with their direct reports, multiple rounds of calibration meetings are

held, tough decisions are made, and managers communicate the final results. All this effort, and rarely is

anyone elated with the outcome.

As salary budgets are squeezed and employees demand more frequent feedback, some have suggested

eliminating the annual compensation review process altogether. However, there are ways to improve it

that avoid a full repeal. Modernizing the process includes:

Ensuring intended pay drivers and each reward element are linked

Strengthening the business case for salary‐increase budget requests

Increasing the quality and quantity of communications about pay and performance

This article examines the objectives, execution, and effectiveness of the annual compensation review

process in the light of results from Mercer’s 2017 Rewards Decision‐Making and Communications Survey

and outlines action items. This is the first in a series of articles examining how organizations are handling

this compensation dilemma. Others in the series will focus on how the salary increase budget is

determined, how those budgets are allocated to employees, and how the final decisions are

communicated.

OBJECTIVES: WHAT ARE ORGANIZATIONS TRYING TO ACHIEVE?

Building Over Buying Talent

The first consideration in a compensation strategy is the age‐old question of build versus buy as an

overall talent strategy. Slightly more than half of the

Mercer survey participants indicate they have a build‐

from‐within philosophy. Organizations with lower

turnover (<10%) are more likely to have a build‐from‐

within philosophy (63% compared to 53% overall),

potentially indicating the engagement created when employee development is a focus.

SM

Industry Insight: Build-from-within strategy less

prevalent in financial and professional services

This does not mean these organizations don’t hire externally. 61% do so across all levels of the

organization. Organizations with higher turnover (>25%) are more likely to hire externally across all

levels (71%). There is slightly more agreement among organizations with varying turnover rates

regarding critical roles, with both groups hiring more often from within for those positions.

Paying for Performance

Whether building or buying talent, organizations continue to utilize a pay‐for‐performance approach to

rewarding that talent. When they adopt a pay‐for‐performance strategy, most organizations do so

primarily to attract and retain the right employees,

and secondarily to motivate them. It is not the

equitable allocation of scarce resources that prompts

companies to adopt differentiated compensation; it is

the need to reinforce the right priorities within their

workforce and drive them to higher levels of production.

RankedHighestPriorityOutcomesofPay‐for‐PerformancePrograms

N = 328 organizations Source: Mercer’s 2017 Rewards Decision‐Making and Communications Survey

The performance being paid for is defined as individual

performance. Two‐thirds of organizations agree that

financial incentives are a primary mechanism by which

individual performance is rewarded. Only 21% believe

that team or group performance, rather than individual

performance, is rewarded through financial incentives.

What’s Not Being Rewarded

There are other objectives that organizations are not pursuing, including:

Priority Outcome Ranking

Highest Second Third

Attract and retain the right employees 49% 22% 12%

Motivate employees to focus on the right things and perform at higher levels

35% 32% 18%

Encourage/reinforce specific behaviors 4% 13% 26%

Promote employee engagement 4% 13% 19%

Allocate scarce rewards in an equitable manner 3% 5% 9%

Encourage synergies across teams and business units 2% 8% 9%

Motivate employees to work harder 2% 7% 8%

Other 0% 1% 0%

Industry Insight: The energy industry has a greater

focus on motivating employees than attracting and retaining them

Industry Insight: Financial services organizations

believe more strongly that financial incentives reward individual

performance, while life sciences organizations are less sure

Providing below‐market pay early in service and increasing market positioning as years of service grow. While this encourages long‐term commitment to the organization, high performers are liable to leave for higher‐paying jobs rather than wait.

Paying above market to attract premium talent and exiting those who don’t deliver on their promise. This strategy can be useful for the most critical, specialized roles, but is usually not an overall objective of the program. However, organizations with more than 20,000 FTEs were more likely to do so than smaller organizations.

Rewarding performance through a series of competitive promotions with associated significant pay increases. This approach can be complicated by a lack of openings to which employees can be promoted, as well as by limited budgets for promotional increases.

EXECUTION: WHAT’S ACTUALLY HAPPENING?

Base Salary Differentiation

Three‐quarters (75%) of organizations differentiate base

salary increases for some (15%) or all (60%) employee groups.

The remaining quarter don’t differentiate base salary

increases at all.

BaseSalaryDifferentiation byEmployeeGroup Percent

Executive 4%

Management 14%

Professional ‐ Sales 8%

Professional – Non‐Sales 13%

Para‐professionals 8%

All employee groups 60%

We do not differentiate 25%


Individual performance is the highest weighted factor used to determine base salary increases,

regardless of the employee group (approximately 50%). This is followed by company performance (10%‐

18%, depending on the employee group). Team performance is rarely considered.

Of the nonperformance factors considered in base salary increase differentiation, internal equity is the

most popular (7%‐9% depending on the employee group). Organizations with turnover greater than 15%

are less likely to differentiate by potential and development

than organizations with lower turnover. Increases are

driven by union contracts for some paraprofessionals (6%).

Unions are more of a factor in EMEA (9%) and less of a

factor in APAC (4%).

Industry Insight: Life sciences organizations are more likely to differentiate base salaries (83% differentiate for all

groups; 14% for none)

Industry Insight: Union contracts are more likely to drive

base salary increases for para-professionals in manufacturing; less so for professional services and high tech

Short-term Incentive Payout Differentiation

Slightly more organizations differentiate via

short‐term incentive (STI) payouts (83%) than

base salary increases. Larger organizations are

more likely to differentiate STI payouts than

smaller organizations.

Short‐term IncentivePayout Differentiation byEmployeeGroup Percentage

Executive 32%

Management 35%

Professional ‐ Sales 19%

Professional – Non‐Sales 23%

Para‐Professionals 10%

All employee groups 41%

We do not differentiate 17%


Organizations place more weight on company performance when evaluating incentive payouts for

executives and managers, but tend to assess individual performance for lower‐level employees.

However, organizations with higher turnover (>15%) have

noticeably stronger linkages between company

performance and STI payouts, with less linkage to team or

individual performance at all levels. This practice can be

discouraging to the employee and lessen the effectiveness

of rewarding for performance, as employees want to be

measured on performance that is within their scope of

control.

Nonperformance factors, including development or growth and competencies also are considered when

differentiating STI payouts, but by relatively few

organizations.

Industry Insight: High tech and energy organizations are more likely to differentiate STI

payouts, while financial services and life sciences organizations are less

Industry Insight: Professional services organizations

place more weight on individual and team measures than on

company measures

Industry Insight: Tenure or experience are more

commonly considered in STI payouts in professional services;

competencies in high tech

Other Elements

The large majority of organizations consider individual performance when awarding spot or project

bonuses, recognition awards, development opportunities, and advancements and promotions. Team

performance is also considered for spot or project bonuses and recognition awards. It’s extremely rare

for these rewards not to be linked to performance of some kind.

OtherRewardsLinked toPerformance

N=

Linked to

Individual performance

Team performance

Corporate performance

Not linked to performance

Spot or project bonuses 229 81% 58% 18% 5%

Recognition 298 91% 43% 13% 5%

Development opportunities 310 90% 11% 9% 7%

Advancement/Promotions 335 98% 11% 9% 1%

Source: Mercer’s 2017 Rewards Decision‐Making and Communications Survey

EFFECTIVENESS: HOW’S IT GOING?

Effectiveness of Rewards Decisions

The biggest frustrations faced by organizations in implementing their reward strategies are rewarding

and engaging employees with unique skill sets and communicating rewards to employees. Most

organizations report being able to successfully

deal with most of the implementation issues

outlined below. More of the remaining

organizations find the issues to be challenges to

success rather than an actual success for their

organization.

Industry Insight: Financial and professional services

organizations struggle more with setting expectations and

performance targets, evaluating performance, and communicating

rewards. The manufacturing sector successfully links performance to

base salary increases, and life sciences succeeds in ensuring

equity

EffectivenessofRewardsDecision Approach

N=

Percentage

A current challenge

or frustration

point

Our HR team

successfully addressed this issue

A signature point of success

Not an objective

Setting expectations & performance targets 346 26% 49% 19% 5%

Evaluating performance 349 28% 50% 19% 2%

Linking performance assessments to base salary increases

353 22% 50% 23% 6%

Linking performance assessments to annual incentive awards

353 18% 46% 23% 13%

Rewarding and engaging high‐potential employees

352 27% 44% 22% 7%

Rewarding and engaging long‐tenured employees

348 19% 34% 12% 35%

Rewarding and engaging employees with unique, hard‐to‐find skill sets

351 33% 38% 17% 12%

Communicating rewards to employees 350 29% 52% 16% 3%

Ensuring equity or fairness of rewards 347 24% 54% 19% 3%


These results vary by the level of organizational turnover. As turnover increases, organizations are less

likely to experience success in setting expectations and performance targets, linking performance

assessments to base salary increases, and rewarding and engaging employees with unique skill sets. For

the highest‐turnover organizations, the biggest challenges are communicating rewards to employees

and evaluating performance. On the flip side, the lowest‐turnover organizations report their biggest

challenges are rewarding and engaging employees with unique skill sets and rewarding and engaging

high‐potential employees.

Challenges Specific to Paying for Performance

Manager‐level inconsistencies in policy application and communication and the perception of reward‐

decision fairness are the most prevalent obstacles to the

success of pay‐for‐performance programs. As turnover

increases, organizations report more difficulty reliably

measuring an employee’s contribution.

Human Resources professionals feel most confident in

performance measures. High volatility of performance

measures used to determine pay‐for‐performance,

tension between individual and team performance

requirements, and monitoring employee or team efforts

against performance metrics are the least worrisome of

the issues studied.

ChallengestoEffectivePay‐for‐PerformancePrograms

N=

Percentage

Not at all

To Some Extent

To a Greater Extent

Not applicable

Difficulty reliably measuring an employee's or team's contribution

350 22% 56% 15% 7%

Difficulty monitoring employee or team work effort 352 28% 55% 9% 8%

Achieving business objectives requires long‐term over short‐term focus

349 21% 44% 24% 11%

Frequently shifting priorities/goals 351 19% 44% 28% 9%

Tension between individual performance and required teamwork

349 29% 49% 11% 11%

Perceptions of fairness in rewards decisions 349 12% 58% 26% 4%

Complexity of business/job 351 19% 52% 21% 9%

Manager level inconsistencies in policy application/communication

350 11% 53% 31% 5%

High volatility of performance measures used 349 34% 44% 9% 14%


Employee Survey Results

Nearly a third (61%) of organizations that recently conducted employee satisfaction surveys reported

employees were either as satisfied or more satisfied with their compensation than they were two years

before. This means that despite the angst about pay for performance, pay communication, pay equity,

and transparency, many employees feel just as good about their compensation as they did previously.

Industry Insight: The consumer goods sector

faces little challenge with measuring an employee’s

contribution. Financial services and high tech struggle with the

perception of fairness in rewards decisions. Professional services report more challenges to paying for performance in general than

other organizations

ChangeinEmployeeSatisfaction withCompensation,perEmployeeSurvey Percentage

Have not conducted a survey in the last two years 33%

Much better than previous survey 7%

Better than previous survey 21%

Same as previous survey 33%

Worse than previous survey 6%


THE FUTURE: WHAT CHANGES ARE PLANNED?

Nearly half of respondents are making or

considering plans to adjust pay for performance

differentiation – largely to increase differentiation.

Increasing emphasis on pay equity/fairness and

paying for potential are also in the works for at

least a third of organizations. Organizations with

higher turnover are more likely to increase focus on

pay equity than lower turnover organizations, as are public companies compared to those privately

owned.

Reward StrategyChanges

N=

Percentage

Increase or Decrease

Percentage*

Changing in 2017

Considering in next 18 months

No change Increase Decrease

Increasing/decreasing pay for performance differentiation

357 20% 27% 53% 93% 7%

Increasing/decreasing emphasis on tenure

356 6% 7% 87% 50% 50%

Increasing/decreasing emphasis on paying for potential

356 11% 25% 65% 99% 1%

Increasing/decreasing focus on pay equity or fairness

357 17% 26% 57% 96% 4%

Other 51 6% 18% 76% NA NA

*For those Changing in 2017 or Considering in next 18 months Source: Mercer’s 2017 Rewards Decision‐Making and Communications Survey

Industry Insight: Professional services plan to

increase paying for performance and potential. The high tech sector

will focus more on pay equity. Energy organizations plan less

emphasis on pay equity

ACTIONS TO TAKE While the current environment can prompt a desire to give up on performance ratings and/or paying for

performance entirely, there are ample opportunities to improve the process instead. A few areas to

consider:

Ensure links exist between pay and the intended pay drivers for each reward element. Start by identifying the intended pay driver(s) for each element, typically getting input and buy‐in from senior leadership. Then determine how to measure the pay driver(s). For instance, if the driver is potential, select from amongst the variety of existing high‐potential assessment tools.

Strengthen the business case for salary increase budgeting requests. Build a solid business case that explains the amount of the request, the rationale, and the expected return on that investment. This process should address the following:

o Projected sizes of relevant peer group budgets

o Financial, economic, organizational, and employment metrics that typically affect market salary increase budget sizes, as well as projections for how those are expected to move over the next year

o Competitiveness of current salaries against relevant labor markets, including identification of shortfalls for anyone in jobs critical to the success of the strategic plan

o Internal equity issues

o Voluntary turnover metrics for the organization (versus labor market peers, if available)

o Cost estimates of that voluntary turnover (e.g., hiring, training, transition downtime)

o Relevant employee engagement survey results

Increase the quality and quantity of communications about pay and performance. Training managers who are having the conversations is key, as they must feel confident and prepared to explain the organization’s approach to reward decisions as well as answer any tough questions. Managers are the voice of HR in these matters, and if they are not well armed, HR may get the blame for any actions that have made employees unhappy. Also, implement more frequent performance discussions that link to broader career development and engagement topics – don’t make it all about the compensation.

Appendix

Methodology

Mercer’s 2017 Rewards Decision‐Making and Communications Survey was conducted during Q2 of 2017. Over 350 organizations participated in the survey, covering 50 countries around the world. Topics included rewards strategies, setting salary increase budgets, allocating rewards to employees, communicating rewards to employees, and planned changes to the process. MSI members can view more details at https://select.mercer.com.

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