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Think Outside the Box: Better Labor Cost Management

Think Outside the Box: Better Labor Cost Management

Home » Uncategorized » Benchmarking

“What is our average compa-ratio, Jim?” asked the CEO as I sat down to report on our annual focal exercise.

Having been through enough of these meetings over the years, of course I had the answer; as a matter of fact, I had it calculated not only for the whole company but for each division, each country, and each corporate function. But I didn’t want to just spout off the answer, I wanted to educate him about how to think differently about his labor cost. Unfortunately, he had worked with enough compensation professionals over his storied career and had been taught by each and every one that if he could just get the compa-ratio to 1.0, another year could be put in the books.

“We ended at 0.99,” I said, “but what I really wanted to review with you was…”

“That’s great Jim, and tell your team that Jerry thinks they did a grrreat job! Could you ask Kathy to come in here on your way out?”

I shook my head again as I headed for the door. Not only because he still referred to himself in the third person, but again I was not getting the sort of traction that would really make a difference in the company’s performance. I mumbled to myself, “Yes Jerry, it’s just wonderful to know that all your averages are aligned. In addition, do you know you have 20% more Senior Professionals than your competitors? Do you know that when it all adds up our labor cost is 4.5% more than your competitors, and on a $200M payroll, that’s $8M, or about $0.05 per share?”

As the aisle row occupants of cubeville stared at me talking to myself again, I decided I needed a better approach than expecting the CEO to just nod his head and hang on my every word. What I needed was a few more people with some time and some skin in the game in order to make the difference bottoms-up rather than top-down. I needed people with shortages of resources to get their jobs done. I needed Human Resources.

Even then it was a hard sell. I had a solution looking for a problem. I finally found an ally in the HR Director of the Technical Services organization, a group that was in the process of trying to manage her global labor cost through a planned migration to lower cost-of-labor markets and away from some of our higher-cost US urban locations.

It didn’t take long for her to get it – it seemed she was “high-potential” after all! Her organization’s costs and associated factors looked something like this, with these assumptions:

  1. Our average wages were the same as the market at each job family level
  2. Our benefits were equal to the market, 35% of base pay
  3. Our incentive targets were competitive and identical to the market

The difference in how we’d looked at this in the past was taking off the “Jerry Glasses” and looking at the data in a whole different way – our total labor costs, not just our average labor cost… our “Portfolio” of employees. You see, you have choices in how you manage the decisions around factors and variables that make up your labor costs, even while maintaining the typical “50th percentile” strategies that so many companies employ.

So even though we’re matching the market in all the traditional senses we’ve become accustomed to, we’re still exceeding the overall market cost-of-labor by 4.5%, or with this example the sum of $13,000,000!! Would that make a difference anywhere in your business – hiring more skilled technicians, salespeople, funding a new product line, avoiding layoffs… you fill in an example.

How does this happen? Here are a few things to check for after you’ve done an analysis like this:

  1. What is your promotion policy and practice? At Our Co, we enabled a process that says that people can come to expect promotions when they are high performers. Nothing really wrong with that on the surface, but it got away from us, and we didn’t take into account how many people we already had doing work at senior levels. We probably should have thought about more rapid promotions for employees hired at lower levels and slower rates for higher leveled employees.
  2. We’ve had a few difficult years on the merit budget, so pay increases have been hard to come by. But when a new employee is hired, they can be hired at pretty much whatever level the manager wants. Our managers started over-hiring levels because they didn’t expect they’d be able to give pay increases. We’ve got a lot of competitively paid but under-skilled people as a result.
  3. We’ve ruled out the geographic labor cost issues – we know that the cost of labor is higher in places like the Bay Area, so that’s not a factor here.
  4. Obviously we also discovered a few more dollars hiding from us, since incentives and benefits are a factor of base. Never forget that, as a business it’s all about fully-loaded labor costs.
  5. One thing we did do right was we “gated” movement into the P5 or expert level of the job family. That means it requires additional approval to promote or hire someone there. It is more administration, but at that level the responsibilities are so much greater and implications of misplacement are of greater consequence so it’s worth it.

What can HR do with data like this? Thinking first of a popular topic, how about an element of workforce planning, as in an overlay around labor cost? How about coming to the table with a proposal to reduce labor costs over time by realigning skill requirements and leveling? Obviously, there are many other aspects of workforce planning to consider, but armed with cost-of-labor data, a smart HR Leader can create hiring plans around needed skills and determine whether training and development may enable business needs rather than taking an expensive hiring or replacement route.

Data can be intimidating, or at least that’s what people tell me when I ask why they never got into compensation. But almost anyone can see the clear benefits that present themselves when looking at data differently than the way we’ve been training everyone else to do so for so many years.

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Jim Harvey is a Managing Partner with Alliance Compensation LLC (www.alliancecompensation.com) , a team of seasoned experts and trusted solution for clients across the Western US in public and private companies. He has over 40 years of experience in corporate leadership roles and consulting, and lives with his wife and three dogs in Sherwood, OR.

To read other blogs, go here: https://alliancecompensation.com/blog/

To see our Linked-In company page, go here: https://www.linkedin.com/company/alliance-compensation-llc/about/

Data can be intimidating, or at least that’s what people tell me when I ask why they never got into compensation. But almost anyone can see the clear benefits that present themselves when looking at data differently than the way we've been training everyone else to do so for so many years.

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Follow The Leader

Follow The Leader

When I first thought about this idea — that a lot of what we do in the compensation world is to follow the leader — it was the children’s game that came to mind.  Remember – if I’m the leader and I skip in a circle, you do to; if I put my right-hand pinkie finger in my ear, you do too.  Sort of a cousin of Simon Says.

Then my mind went to what really happens when we play follow the leader in compensation.  Maybe some or all of this has been on your watch:

  • We let market data dictate what “we believe” jobs are worth and how employees are paid
  • We design incentives based on how our competitors do it, or how the VP did it at her last company
  • We enable management’s somewhat mistaken belief that benchmarking is the only valid approach to program design

When we play Follow the Leader, we handicap our creativity to align our reward programs and systems to our unique business philosophy, strategy, objectives and values.

Throw Out Benchmarking? In Compensation? Heathen!

It’s not my intention to totally scrap the idea that we can learn from others.  Some of the best learnings I’ve had in my career have been from people that have faced challenges and found unique solutions that worked.  For years I kept paper copies of presentations I had attended at conferences, industry meetings, consultant presentations, etc.  And I did go back over them to pull out ideas, but I didn’t take that material and just paste my current company logo in the upper left corner.  It did help though to add elements to programs that would fit the needs of the problem I was trying to solve.  For example, should a bonus program have a payout threshold?  Should a vesting component be used?  These are ways to put real value into company bonus, sales incentive and executive compensation plan designs.

Reasonable Thought

There are other aspects of benchmarking that I am solidly behind (especially when it reinforces my own beliefs!).  Of course, many pay programs are benchmarked to a local market – Seattle, Los Angeles, Phoenix, you name the location and that’s probably right when it comes to certain jobs and levels of pay, for example non-exempt work.  And for example, I see pay practice surveys that show the quantitative metrics participants use in their broad-based bonus plans and the prevalence of that.  (I’d bet right now that not many readers of this know what EVA is, but I worked in a company once where it was the primary metric in the employee bonus plan).  I could easily show how it simply wasn’t appropriate for the level of employee that needed to understand it, but it took an executive departure before we could wrestle that one down.

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(By the way, bonus points if you know the answer to this related quiz question.  What are the two most common quantitative metrics that companies use for their bonus programs?)

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Lemmings?

You might be living under a rock if you’ve never heard (herd?) of Herd Immunity.  (Talk about follow the leader, and yes that’s a jab). One of the more common applications of the compensation ‘herd mentality’ is on market pricing of jobs.  If you are an old-timer like me, you probably know that at one time, job evaluation systems like point factor, classification or factor comparison systems were more prevalent than market pricing.  And if you haven’t taken C2 (the job evaluation class) from WorldatWork, you may never have heard of those.  But much more so than market pricing, they enabled companies to determine how to pay their employees when they selected what was important to them rather than letting the market do it for them.

I still tell my clients that “the market is… interesting… but don’t let it tell you what to do.”  What I mean by that is this: Follow the Leader isn’t always your best choice.  And as a trusted advisor in your company, take heed that if you are going to play that game then you know what you’ve signed up for.

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Quiz Answer: Revenue and Profitability

Internal and External Linkages

To read other blogs, go here: https://alliancecompensation.com/blog/. Here are some of our services related to this topic: Market Review, Short and Long-Term Incentives, Sales Compensation.

To see our Linked-In company page, go here: https://www.linkedin.com/company/alliance-compensation-llc/about/.

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Jim Harvey is a Managing Partner with Alliance Compensation LLC, a team of seasoned experts and trusted solution for clients across the Western US in public and private companies. He has over 40 years of experience in corporate leadership roles and consulting, and lives with his wife and four dogs in Sherwood, OR.

When I first thought about this idea — that a lot of what we do in the compensation world is to follow the leader — it was the children’s game that came to mind.  Remember – if I’m the leader and I skip in a circle, you do to; if I put my right-hand pinkie […]

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