Human Capital Perspective

Update Perspective
October 19, 2007

Compensation trends of the future: Designing a sustainable global total rewards strategy
Workforce and compensation research reveals some fundamental shifts underway in the global labor markets that are already affecting companies and have implications well beyond 2008 compensation planning. In this article, we will describe these macro shifts and then discuss what you can do to develop a longer-term total rewards strategy that will enable you to attract, engage and retain the workforce you need at a sustainable cost level. By anticipating these challenges, your company will be better positioned to compete in the war for talent and win in the global business environment over the next three to five years.

Global trends affecting the future of total rewards planning
Three major global trends are driving significant changes in standard employment models and have profound implications for total rewards planning. The first is the emerging shortage of skills, knowledge and experience available to employers given large-scale, global shifts in the demographics of the workforce. The second is the growing interest among an increasingly diverse global workforce in alternatives to traditional career paths and work arrangements. And third is the continuous rise of employment costs as a percentage of revenues. These three trends are largely responsible for the challenges HR leaders are facing and will continue to face in the coming years; they also point to some of the total rewards solutions that best-practice employers have already begun implementing today. Let’s take a closer look at all three. The workforce itself is changing. Employers across the globe who participated in Mercer’s Global Total Rewards SnapShot Survey in 2006 reported that their number one challenge is recruiting and retaining key talent. There are several demographic reasons why this is becoming an ever more serious problem for employers.

For more information about compensation trends of the future, visit our Compensation Planning 2008 Resource Center at www.mercer.com/ compensation2008

First, workers around the world are getting older. The baby boom cohort is aging, while birthrates around the world have declined (see Exhibit 1). This means not only that there is a scarcity of young talent in the pipeline but also that many seasoned workers – those with valuable institutional knowledge that can’t easily be replaced by new hires – will be moving out of the workforce en masse in the coming years.
Exhibit 1. Aging of workforce contributes to shrinking labor pool

Population over age 60
40 35
Percent of total population

■ 2000 ■ 2025 ■ 2050

30 25 20 15 10 5 0 Europe North America Australia Asia Latin America

Today’s global workforce is diverse, and not all employees value the same things.

Source: United Nations Population Division

Second, it is becoming more difficult for employers to recruit employees with the technical skills they need. For the last two decades of the 20th century, for example, US Department of Labor statistics show a continuing decline in the number of students enrolled in career and technical education. Third, today’s workforce tends to be more geographically mobile, making retention of workers more difficult for most companies. For example, manufacturing work from around the world is moving to lower-cost centers in Eastern Europe and China, while qualified professionals and skilled trade workers are moving to more mature economies to take higher-paying jobs. Employees are demanding alternatives to traditional work arrangements. Today’s global workforce is diverse, and not all employees value the same things. This diversity is putting pressure on employers to move beyond one-size-fits-all total rewards programs if they want to compete successfully for talent.

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Mercer’s global What’s Working™ studies have found similarities, but also significant differences, in what most influences employee commitment and motivation. For example, while workers in Asia value base pay above all other factors, those in North America value five other factors – including work-life balance, being treated with respect and benefits – more highly than base pay (see Exhibit 2).
Exhibit 2. Employees value different aspects of the employment relationship How important are the following factors in influecing your commitment and motivation at work? North America Being treated with respect The type of work that you do Work-life balance Benefits Working in an environment where you can provide good service to others Base pay The quality of the people you work with Long-term career potential Having flexible working arrangements Learning or training opportunities Promotion opportunities Variable bonus/incentive bonus
Source: Mercer’s What’s Working Global Employee Survey

Asia 2 3 5 7 10 1 11 4 12 9 6 8

Western Europe 2 1 3 9 5 4 6 8 7 11 10 12

1 2 3 4 5 6 7 8 9 10 11 12

Different generations also have different priorities. For example, while employees over 60 years old (the “Traditionalists”) tend to value security and company loyalty most highly, those between 18-29 (the “Millennials”) tend to value their contributions and learning opportunities and thus are more willing to change jobs repeatedly, while those between 30-42 (“Generation Xers”) tend to value work-life balance most highly. Cost escalations are threatening the sustainability of traditional rewards programs. According to another finding in Mercer’s Global Total Rewards SnapShot Survey, HR leaders globally cite keeping total rewards costs affordable and sustainable as one of their biggest challenges. When rewards are defined primarily as pay and benefits, they are right to worry. To illustrate the challenge of keeping total rewards costs sustainable, let’s suppose an organization’s cost of pay and benefits equals 60 percent of revenues in 2007. If we assume an annual 2 percent growth in employee headcount, 5 percent growth in revenues, 3.5 percent growth in pay and 12 percent

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growth in benefit costs – fairly realistic estimates for companies operating in mature economies – then the total cost of pay and benefits to this organization five years out will equal 67 percent of revenue! (See Exhibit 3, an example for illustration purposes.)
Exhibit 3. Assessing the sustainability of current costs

Escalating total rewards cost as a percent of revenue
70% 60%
Percent of revenue

60% 10%

61% 11%

62% 12%

64% 13%

65% 14%

67% 15% Total benefits

50% 40% 30% 50% 20% 10% 0% 2007 2008 2009 2010 2011 2012 50% 50% 51% 51% 52% Total pay

The companies that succeed in the future will be the ones that are able to attract, engage and retain the people they need in a way that is sustainable from a cost perspective.

Example for illustration purposes

How should global companies respond?
The companies that succeed in the future will be the ones that are able to attract, engage and retain the people they need in a way that is sustainable from a cost perspective. In our view, doing this requires moving beyond traditional compensation planning toward the development of a total rewards strategy that acknowledges a broader interpretation of rewards with differing appeal to employees:

Compensation, which includes base pay, short-term and long-term incentives, and recognition awards Benefits, which includes health and other group benefits, retirement plans, work-life programs, and perquisites Careers, which includes performance management, career pathing, training and development, talent review and succession planning

Two-thirds of companies surveyed by Mercer as part of our SnapShot survey are now taking this holistic view, including not only compensation and benefits in their total rewards mix, but also career opportunities and alternative work arrangements.

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Our research and work with global companies indicate that developing a total rewards strategy for competitive advantage will require HR leaders to take the following five steps: 1. Segment and reward employee groups according to relative value creation. 2. Understand and plan for employee total rewards preferences. 3. Offer attractive non-cash compensation to appropriate employee segments. 4. Maximize the return on limited total rewards investments by differentiating pay based on performance. 5. Review and refresh your total rewards strategy. 1. Segment and reward employee groups according to relative value creation. When companies align their total rewards strategy with their business strategy, they help to ensure that expenditures are yielding the maximum returns in terms of productivity. Achieving alignment requires understanding how your business creates value, mapping distinct employee groups to the value creation process and then allocating total rewards accordingly.

When companies align their total rewards strategy with their business strategy, they help to ensure that expenditures are yielding the maximum returns in terms of productivity.

Understand how your company creates value. This is predicated, of course, on understanding your business model and revenue generating strategy, which involves answering questions about the business lifecycle, business design, brand impact and geographic requirements of your company, such as: – How do we make money today – and will that change three years from now? – What skills and behaviors are required at different stages of growth and decline? – What business design supports our ability to make money? – What are the skills and competencies required in those areas? – What’s the value of our brand in attracting and retaining employees? – Where do we want to be geographically? Do we need global consistency or local focus in order to succeed?

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Segment your workforce. After you have clearly identified your business needs and the workforce characteristics that propel your business forward, the next step is to identify the corresponding workforce groups of employees that create value for your organization. These segments may include: – Performance drivers, who directly create value for the organization, such as marketing in consumer products companies or research scientists in pharmaceutical organizations – Performance enablers, who support value creation by facilitating the efficiency of performance drivers, including human resources or finance staff at many organizations – Legacy drivers, who created value for the organization historically, but no longer drive competitive advantage; for example, production and circulation functions in a media organization may become legacy drivers as content is increasingly delivered online Keep in mind that how employee groups are segmented will be unique to each company. Specific job families, geographies or skill sets do not consistently map to specific workforce segments across companies. Rather, segmentation in your company will depend entirely on the role of different employee groups in creating value and adding to your bottom line. Take IT professionals, for example. For a retail chain that partners with an outside vendor for IT services, they may serve as performance enablers, while for an IT consulting firm, they may serve as performance drivers.

[S]egmentation in your company will depend entirely on the role of different employee groups in creating value and adding to your bottom line.

Offer different total rewards to different employee segments. Lastly, having identified distinct employee segments in terms of the value they create for your business, you can then determine how to allocate your finite total rewards dollars accordingly, offering premium, standard or discounted rewards to various segments as appropriate. For performance drivers – your value-creators – you must succeed in attracting, engaging and retaining them through an optimal total rewards mix depending on what is important to them. A more standard total rewards package may be appropriate for your performance enablers, while the appropriate total rewards for legacy drivers will depend on the value of retaining their institutional knowledge.

2. Understand and plan for employee total rewards preferences. While the increasing diversity and evolving wants and needs of the global workforce make total rewards planning today a more complex task, it also opens up valuable opportunities for overcoming recruitment, retention and cost challenges. But to take advantage of those opportunities, employers must learn more about what actually motivates their employees.

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Survey your employees. A first step toward planning for employee preferences is to survey them about the work arrangements and total rewards elements that are most important to them. You may be surprised to learn of the relatively inexpensive – or even cost-neutral – things you can do to improve attraction, engagement and retention. Analyze other employee data. Beyond analyzing survey data, you can also take advantage of new statistical modeling techniques that allow companies to analyze other existing employee data to better understand employee behavior. Remember that what employees really care about – as measured by things like making a decision to leave the company – is sometimes different than what they say they care about. Broadened inputs provide HR leaders with more robust information on which to build an effective total rewards program. Compare internal and external data. Finally, you can compare internal survey data with reliable normative data, such as Mercer’s What’s Working data on country- and regionspecific employee perceptions and attitudes about work, to help guide decisions about how best to structure total rewards in a given market.

Beyond analyzing survey data, you can also take advantage of new statistical modeling techniques that allow companies to analyze other existing employee data to better understand employee behavior.

3. Offer attractive non-cash compensation to appropriate employee segments. More and more companies are seeking to limit fixed costs by holding base pay increases to modest levels while investing in other non-cash and variable pay options. With a solid understanding of both your own business needs and employee preferences, you may be able to identify high-value, non-cash compensation alternatives, such as flexible schedules, alternative work arrangements, and career development and training opportunities, that will allow you to better attract, engage and retain employees while meeting your business objectives and managing costs.

Offer flexible work options to key employees. It is becoming common for employers to offer key employees flexible work options such as telecommuting, job-sharing, flex-time, compressed work weeks, sabbaticals, and greater autonomy in scheduling and delivering work. This trend speaks to what employees want and need and how employers are accommodating them. While a 1999 Mercer study, US Policies and Practices Survey, found that 32 percent of companies surveyed had telecommuting arrangements, twice as many had made them available to professional staff by 2006. And while over half of companies surveyed in 1999 offered flex-time arrangements, 95 percent offered them to professional staff by 2006 (see Exhibit 4).

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Exhibit 4. Increasing flexible work arrangements

Flexible schedule becoming common
100

■ 1999 ■ 2006 95%

80
Percent of employers

64% 60

58%

40

32%

28%

31%

20

0 Telecommuting Job-share Flex-time

Source: Mercer’s Policies and Practices Survey, 1999 and 2006

Global HR leaders who participated in the SnapShot survey say that they are planning to increase their investments in these areas [career development and training] over the next 12 months.

Consider alternative work arrangements. Beyond flexible schedules, the use of temporary/contingent and contract labor is helping companies balance their own business needs with employee demands – while getting the greatest returns for their total rewards expenditures. From the employer’s point of view, the traditional model of permanent, full-time employees is not flexible or cost-efficient in addressing periods of under-capacity or over-capacity. And for employees, building a career through a variety of non-linear work experiences that are a mixture of temporary, full- and short-term employment, and contractor assignments can provide even greater learning opportunities and better value than more standard career paths. Given these advantages for both the employee and employer, growth in the temporary/contingent labor market is expected to significantly outpace total employment growth over the next decade. Invest in career development and training. Another non-cash compensation option that can help you meet business objectives, employee demands and cost constraints is to offer employees more in the way of career development and training opportunities. Global HR leaders who participated in the SnapShot survey say that they are planning to increase their investments in these areas over the next 12 months.

While these investments can help employers more quickly develop employees’ technical and leadership skills, they are also highly valued by many employees and so can aid with attraction and retention. Mercer’s What’s Working surveys of European employees, for example, show that two-thirds of workers are satisfied with their jobs when there is a good opportunity for continuous learning; however, where such opportunities are lacking, only 17 percent of employees say they are satisfied.

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4. Maximize the return on limited total rewards investments by differentiating pay based on performance. Recent research indicates that companies are increasingly differentiating pay based on performance in order to wring the greatest return from limited total rewards dollars. Mercer’s SnapShot survey study found that in North America, for example, the highest performers earned one-anda-half times or more what is provided to mid-level performers (on a percent-of-salary basis for both base salary increases and actual bonus payouts). Low performers, on the other hand, earn half of what is provided to the mid-level. (See Exhibits 5 and 6.) Moreover, North American employers strive for even more differentiation through their plan designs, in which the maximum award opportunity for annual incentive plans is often two times target or more.
Exhibit 5: Base pay increases as a function of performance Percent of workforce Highest-rated Next highest-rated Middle-rated Low-rated Lowest-rated
Source: Mercer’s 2007/2008 US Compensation Planning Survey

Average pay increase 5.7% 4.5% 3.5% 2.0% 1.7%

12% 28% 52% 6% 3%

Based on the pace of change in the global business environment as well as the fluidity of most business strategies, we recommend that you review and refresh your total rewards strategy at least once every three years.

Exhibit 6: Bonus payouts by performance Executive Management Professional (Sales and Non-sales) 27% 20% 10% 20% 14% 7% Office/ Clerical/ Technician 15% 11% 6% Trades/ Production/ Service 13% 11% 4%

Highest-rated Middle-rated Lowest-rated

64% 44% 30%

Source: Mercer’s 2007/2008 US Compensation Planning Survey

5. Review and refresh your total rewards strategy. Keeping your total rewards strategy in sync with an ever evolving business strategy can be demanding. It requires frequent review and revision if it is to continue to deliver business results. Mercer’s SnapShot survey found that, of the firms that said that their total rewards strategy is fully aligned with their business strategy, over three-quarters had made changes to their total rewards strategy in the last three years. In contrast, three-fifths of firms reporting a weaker alignment had not revised their strategy in the past three years. Following are suggested best practices:

Review strategy at least every three years. Based on the pace of change in the global business environment as well as the fluidity of most business strategies, we recommend that you review and refresh your total rewards strategy at least once every three years. This review should go far beyond one-year-out compensation planning and include all of the steps discussed in this article.

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The Update is published by:
Mercer 1166 Avenue of the Americas New York, New York 10036 You are welcome to reprint short quotations or extracts from this material with credit given to Mercer. Visit us at mercer.com.

Communicate to employees using a variety of communication channels. Organizations cannot reap the full benefits of a well-designed total rewards strategy if employees are not aware of all of the elements offered. You must effectively communicate to employees the value of the total rewards package in order to maximize its value in attraction, engagement and retention. According to Mercer’s SnapShot survey, HR leaders in North and South America report that they are using at least three vehicles to communicate with employees, particularly if they have changed their total rewards strategies within the past three years. The most popular methods include individual meetings, hard-copy personalized statements, and presentations to employees made by leadership.

The challenge for HR
Developing a sophisticated total rewards strategy that is tailored to various workforce segments is a challenge. For organizations accustomed to a traditional one-size-fits-all approach, change could be slow and strained. But for organizations that take the steps necessary to better understand their workforce – both the needs and preferences of the people they employ and the contributions to value creation that various segments make – the pay-off is a total rewards program that not only drives performance but also helps to maintain sustainable employment costs.

For more information about compensation trends of the future, visit our Compensation Planning 2008 Resource Center at www.mercer.com/ compensation2008

Perspective Update author: Steven Gross Global leader, Broad-based Performance and Rewards Consulting +1 215 982 4257 steve.gross@mercer.com

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© 2007 Mercer (US) Inc.