2014 Compensation & Benefits Conference - · PDF fileAon Hewitt U.S. Salary Increase Survey...

2014 Compensation &

Benefits Conference Connecticut Business & Industry Association

Incentive Pay: Making it a Lasting

and True Motivator

Prepared by Consulting Performance, Reward & Talent

Aon Hewitt, the global talent, retirement and health solutions business of Aon plc

(NYSE: AON).

Consulting | Broad-Based Compensation

Proprietary & Confidential | 2014 Compensation Planning Briefing

Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON). 2

Bottom Line on Top

Variable pay has become the primary mechanism to pay for performance

today

There are sub-optimal practices that are inhibiting the effectiveness of variable

pay plans

Now is the time to Get it Right!




Road Map for Today’s Discussion

Prevalence and trends

Is incentive pay inherently effective?

Ensuring effective incentive pay




Sources of Information

Variable Compensation Measurement™

(VCM ™) Report 2013

Created in 1996

740 U.S. Companies and over 1,000

globally

Broad-based plans

– More than 380 cash variable pay

plans

– Plan information covering over 2

million employees

Plan characteristic driven database

– Prevalence

– Effectiveness

Aon Hewitt U.S. Salary Increase Survey

2014/2015

Created in 1976

Fortune 1000 companies

1,064 companies in 2014

Merit/overall salary increases

Salary structure movement

Variable compensation

Pay practices

Data effective as of June/July 2014




Variable

Pay

Fluctuating component of compensation that is delivered contingent upon results

Performance award, usually covering 12 months

Must be re-earned

Does not increase base salary

May or may not be considered in benefits calculation

Defining Variable Pay

Base Pay

Variable

Pay

Total Cash

Compensation

A Focus on Base Salary Is So Twentieth Century!

Wall Street Journal

Talent Management

Wharton School of

Business

The Washington Post




Prevalence of Broad-Based Variable Pay

Broad-based variable pay is a key component of companies’ total

compensation programs

Use of broad-based variable pay is widespread and continuing to expand

47%

51%

61%

68%

60% 59% 61%

67%

72% 70%

78% 81% 80%

77% 78% 78% 80%

90% 90% 88% 88%

92% 90% 90% 91%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Percent Organizations With at Least One Broad-Based Variable Pay Program

Source: Aon Hewitt U.S. Salary Increase Survey 1990–2014




Variable Pay is a Global Phenomenon

0 10 20 30 40 50 60 70 80 90 100

United States

Canada

Venezuela

Puerto Rico

Mexico

Chile

Brazil

Argentina

United Kingdom

Switzerland

Sweden

Spain

Netherlands

Italy

Hungary

Germany

Belgium

Austria

Thailand

Taiwan

Singapore

Philippines

Malaysia

Korea

Japan

India

Hong Kong

China

Australia




Eligibility for Variable Pay Across Employee Groups

Percentage of Employees Eligible for Variable Pay Plans

92%

66%

45%

6%

Exempt >$60,000 Exempt <$60,000 Nonexempt Union

Source: VCM Report 2013




Aon Hewitt U.S. 2014/2015 Salary Increase Survey—

Variable Pay Budgets by Employee Group

11.3%

6.0%

5.3% 4.6%

11.6%

6.3%

5.2% 5.0%

12.0%

6.2% 6.0%

4.9%

12.0%

6.0% 5.4%

4.8%

12.7%

6.7%

6.1% 5.6%

12.7%

6.8%

5.9%

5.0%

Salaried Exempt Salaried Nonexempt Nonunion Hourly Union

2010 Actual

2011 Actual

2012 Actual

2013 Actual

2014 Actual

2015 Projected

Variable Pay

Pe

rce

nta

ge

of P

ayro

ll

Source: Aon Hewitt Survey—U.S. Salary Increases 2014/2015




Industry Variable Pay Outlook for 2015 Salaried-Exempt Employees

20

0

15

12

5

Pe

rce

nta

ge

of P

ayro

ll

Energy Industrial

Machinery/

Equipment Chemicals

18.0 15.3

14.3

Aerospace

8.6 Business/

Computer Services

10.0

Industry

Not for

Profits

9.4

Health Care/

Medical Services

7.9

Construction/

Engineering

15.0


Perennial

Winners and

Losers




Shift in Pay Mix

8.2%

10.0%

5.5%

4.3%

1.8%

3.0%

4.2%

9.7%

12.0% 12.7%

1977 1981 1990 2000 2009 2015 Projected

Salary increase

Variable pay spend

Source: Aon Hewitt Survey—U.S. Salary Increases 1977-2014

Pe

rce

nta

ge

of P

ayro

ll

Change in the Total Compensation Budgets and Spending for Salaried-

Exempt Employees (1977–2015)

Why?

Fixed vs. variable costs

Need to focus and drive

behaviors

Need to create alignment

Perceived control

Shareholder/

analysts value it




Putting Our 2015 Plan Into Perspective: Salary Increases

5.5

5

4.6 4.3 4.3 4.3

3.6 3.4

3.7

1.8

2.4 2.7

2.9 2.9 2.9 3.0

1990 1991 1992 1993 2000 2001 2002 2003 2008 2009 2010 2011 2012 2013 2014 2015 Projected

Most Recent Recession Had the Most Dramatic Impact

1991 Recession 2002 Recession 2009 Recession

Pe

rce

nta

ge

of P

ayro

ll





Putting Our 2015 Plan Into Perspective: Variable Pay

4.2 3.8

5.7 5.9

9.7

10.8 10.5

8.8

10.8

12.0 11.3 11.6

12.0 12.0 12.7 12.7

1990 1991 1992 1993 2000 2001 2002 2003 2008 2009 2010 2011 2012 2013 2014 2015 Projected

Upward Trend in Spending

1991 Recession 2002 Recession 2009 Recession

Pe

rce

nta

ge

of P

ayro

ll





Funding

The majority of plans are funded as an add-on expense, without specifically

tying it to a formula based on financial/business results

Source: 2013 Aon Hewitt Variable Compensation Measurement (VCM) Report




Conclusions

Cost containment on fixed expenses (salaries) will continue for several years

Alternatively, funding for variable expenses (variable pay) is at record

high levels

Spending will continue to rise

– Organizations are placing their pay for performance bets on variable

pay programs

Organizations must be more bold in channeling their limited

dollars to their top performers— even at the risk of

alienating their average performers

Is Incentive Pay Inherently Effective?




Incentive Effect

Effect on what current workforce does

Meta-analysis findings on pay for performance (Gerhart & Rynes,

Compensation, Sage, 2003)

– 30% improvement in productivity due to introduction of incentive plans

(Locke et al., 1980)

– 49% improvement in productivity due to introduction of incentive plans

(Judiesch, 1994)

– r = .32 (d = .68) between incentive use and performance

quantity/productivity (Jenkins, Mitra, Gupta, & Shaw, 1998, k = 41 studies)




Sorting Effect

Effect on who current and future workforce is

High performers are attracted to organizations that pay for performance and

recognize their contributions

High performers will leave organizations that do not reward performance

Low performers will self select out of organizations that emphasize high

performance in rewards

Low performers are more likely to stay with an employer when pay for

performance relationships are weaker

Source: Compensation 11th Edition, Milkovich, Newman & Gerhart




Pay differentiation is strongly associated with successful Pay-for-Performance

Effects of Successful Pay-for-Performance Programs on:

…High Performers …Mid-Range Performers …Low Performers

Up Down No Change Up Down No Change Up Down No Change

Engagement 78% 0% 22% 63% 2% 34% 21% 26% 54%

Innovation 80% 3% 18% 45% 5% 51% 11% 21% 68%

Productivity 88% 0% 13% 65% 0% 35% 31% 18% 51%

Quality of work 80% 0% 20% 60% 3% 38% 28% 21% 51%

Teamwork 65% 3% 33% 67% 3% 31% 23% 21% 56%

Turnover 20% 50% 30% 20% 34% 46% 54% 15% 32%

Source: Hewitt—WorldatWork, Joint Research on Pay-for-Performance, 2004

Underperformers start looking

elsewhere

Making the best better!

…and more of them stay

These employees get stronger too…

Keeping more of the right

people

Pay-for-Performance Can Have a Dramatic Impact on the Overall Workforce




Incentive and Sorting Effect Combined

Pay for performance (an incentive plan) was introduced at an automobile parts

manufacturing plant that did not have pay for performance previously; the

following effects on productivity were observed

44% increase in productivity

22% (or half) of the increase in productivity was due to those employed before

and after the change being more productive under the incentive plan

The remaining increase in productivity was due to attrition of poor performers

and the addition of new employees with higher performance

Source: E. Lazear




Point/Counterpoint

Incentive plans are based on faulty underlying psychological assumptions and

are doomed to fail (Kohn, Deming, et al)

Rewards succeed at securing one thing only: temporary compliance

Extrinsic motivators do not alter the attitudes that underlie our behaviors

People who expect to receive an award do not perform as well as those who

do not

Rewards have a punitive effect because they are manipulative

Incentive programs reduce cooperation

When employees compete for a limited number of incentives, they view each

other as obstacles

Employees may be tempted to conceal problems rather than ask for help

Incentives are perceived as bribes, and by association these must be tasks I

wouldn’t want to do

Incentive plans may promote unethical behavior




Point/Counterpoint

Intrinsic motivation only goes so far (Lawler, et al)

Temporary compliance can be extremely important to an organization

Underlying attitudes may be less relevant than achieving objectives

Not all tasks are intrinsically fun and interesting

Business needs change; incentives are an effective megaphone for

communicating these changes and combatting inertia

Incentive programs can be structured to enhance cooperation

Competition can be a healthy thing

Incentive plans allow organizations to pay people fairly for their performance




From Our Database

29%

58%

12%

1% 0%

Helped Somewhat helped

Had no effect Somewhat hindered

Hindered

Impact on Business Results

Source: Variable Compensation Measurement™ (VCM™) Report 2013

Ensuring Effective Incentive Pay




Factors Contributing to the Success

of the Plan


Percent of plans1 n=

Support of executives/management 56% 78

Employee ability to impact results 38% 53

Employee understanding of plan objectives 37% 52

Effective communication of plan 24% 34

Realistic goals/Targets 24% 34

High employee commitment/Participation 19% 27

Appropriate Award Size 16% 22

Continued employee participation in plan design or ongoing goal setting 10% 14

High-level champion 8% 11

Eligibility limited to key contributors 1% 1

Other 5% 7

n=139

1Percentages will total more than 100% since more than one response was provided by some participants




Factors Hindering the Effectiveness

of the Plan

Percent of Plan1 n=

Poor communication of plan expectations/Objectives 37% 42

Payouts viewed as entitlements by employees 35% 40

Plan design too complex 23% 26

Employees had little ability to impact results 22% 25

Unobtainable targets or goals 17% 19

Lack of employee participation in plan design or ongoing goal setting 15% 17

Award size 12% 14

Lack of executive/management support 5% 6

Lack of employee commitment 4% 5

Inappropriate measures 3% 3

Lack of high-level champion 2% 2

Plan improved results of one measure while reducing another 0% 0

Other 3% 3

The effectiveness of the plan was not hindered 19% 22

n=115 1Percentages will total more than 100% since more than one response was provided by some participants





Types of Variable Pay Plans

Types of Incentive Plans

Incentive Plan Type

% of companies surveyed

2013 All Industries

Business incentives—Combines financial and/or operating measures for the

company, business unit, department, plan and/or individual performance

58%

Cash profit sharing plans—Designed to award employees a percentage of the

company’s profits. Typically make equal payment (as a flat-dollar amount or percent of

salary) to all or most employees based on organizational profitability.

14%

Individual performance plans—Payouts are based solely on individual performance

criteria and the amount typically varies from one employee to another.

44%

Gainsharing/Productivity plans—Designed to share a percent of cost savings of a

group, unit or organization. Gains are typically shared uniformly among all participants.

5%

Team awards—Designed to reward employees for the result/improvement in team

results. Provide incentives to individuals on a project work team.

17%

Special recognition plans—Plans that are designed to recognize special individual or

group achievements with small cash awards or merchandise.

52%

Source: Aon Hewitt U.S. Salary Increase Survey 2013–2014




Strategic Impact By Plan Type

Plan type

Incentive

effect

Sorting

effect Bonus Incentive Behaviors Results Individual Group

Business

incentives

Cash profit

sharing

Individual

performance

Gainsharing

Team awards

= Primary impact




Create focus

on required

results

Share in

successes

and failures

Facilitate

ideas and

improvements

Motivate

desirable

behaviors

Improve

performance

Role of Variable Pay




Design With Strategic Intent

Bonus

Behaviors

Individual

Incentive

Results

Group




Bonus Incentive

“Bonus” Versus “Incentive”

Rewards performance after

it occurs

Subjective

Eligibility uncertain

Award uncertain

Payouts discretionary

Share successes/failures

with employees

Goals established up-front

Objective

Eligibility known

Award must be earned

Payouts based on

goal achievement

Intended to change behavior




Objective

Less reliance on

managerial discretion

More directly aligned with ability

to pay

Behaviors Results

“Behaviors” Versus “Results”

Subjective

Allows for managerial discretion

Can factor in variables

out of employee’s control

Assesses how the

results were achieved




Individual Group

“Individual” Versus “Group”

Employees want to be judged

on their own contributions

May result in higher

individual productivity

Strong line of sight

All employees measured

and rewarded collectively

and share similar rewards

Less likely to create competition

among employees




Critical Plan Design Components

Measures

Eligibility

Funding

Alignment

Line of Sight

Plan Mechanics

Targets & Stretch

Participation

Requirements

Communication

Plan

Administration

Measuring P

lan E

ffectiveness

Identifies factors (financial, nonfinancial and individual) to determine performance

Must be controllable and relevant to business

Considers eligibility for both exempt and nonexempt employees

Be as inclusive as possible

Means of funding and spend on variable pay as percent of key financial parameters

Should be accrued, reflective of actual business results and sufficient

Determines the degree of inclusiveness across all-employee groups

Checks for common goals and clear linkages

Analyzes ability of the individual to impact the performance measures

As much direct influence on outcomes as possible

Evaluates levers on which the plan operates

Reflective of pay philosophy and culture, balanced between realistic and challenging

Assesses payout targets and degree of stretch built into target level of performance

Competitive with appropriate pay at risk given line of sight and role

Explores clauses associated with a variable pay plan

Causes under which participation and payouts can be denied

Considers frequency, methods and details of plan features that are communicated

Understandable and communicated goals, timing and updates

Time required to evaluate performance, payouts and frequency of review

Should include assessment of continuous improvement

Source: Variable Pay Index™ (VPI™) 2013




Aon Hewitt’s Variable Pay Index™ (VPI™)





Changes in Plan Effectiveness

Actual Score as Percent of Maximum

52%

36%

49% 48% 41%

38%

57%

71%

78%

49% 53%

59%

44%

63%

40%

30%

56%

71%

59%

92%

Measures Eligibility Funding Alignment Line of sight

Plan mechanics

Targets Participation requirements

Commun- -ication

Plan administration

2010

2013





Comparative Variable Pay Plan Characteristics

Highest Performing

Greater incentive opportunity

Greater emphasis on communication

– Communication vehicles

– Performance targets and updates

on projected results

More accurate goal setting

Realistic goals and targets

Formal recognition of individual

performance when determining

incentive awards

Lowest Performing

More moderate incentive opportunity

Less leveraged incentive

opportunities

Fewer communication methods—

less likely to communicate

Less frequent communication of

performance targets

Broad measures—low line of sight

Entitlement-based payouts for poor

results (payout ratios)




Line of Sight by Plan Type

Strong

Individual performance

Business incentive

Team awards

Profit sharing

Weak




Limited Line of Sight: Entitlement or Futility?

Corporate Results

X X X X X

Business Unit Results

Department Results

Individual Results

X

Nonexempts Entry Exempts

Managers Directors Executives




Relevant Weightings for Line of Sight

Executives

Sr. Leaders

Directors

Managers

Individual Contributors

Clerical/Technical

Organizational

Performance

Weighting

Individual

Performance

Weighting




Dilutive Impact of Too Many Measures in the Plan

Plan Weights

Employee With $50,000 Salary (5% Bonus Target)

Corporate 50%

■ Net Income 25% $625

■ Revenue 25% $625

Business Unit 20%

■ Cash Flow 10% $250

■ Revenue 5% $125

■ Quality 2.5% $62.50

■ On-Time Delivery 2.5% $62.50

Department 20%

■ Safety 10% $125

■ Attendance 10% $125

Individual 10%

■ Attendance 2% $50

■ Project Completion 3% $75

■ Idea Creation 5% $125

100% $2,500




Miscalibration of Funding Requirements

$1.0M $1.5M $3.0M $6.5M

Maximum

Target

Threshold

Funding

Funding Gap

Funding Required by Plan

Actual Available Funding




Bonus Pay Back Design

Grade

Midpoint

Employee

Salary

Salary to Midpoint Comparison

$5,000

Less

Salary

Over

Midpoint

Calculated

Bonus

Payment

Bonus Payout Calculation

$10,000

$5,000 $5,000

Actual

Bonus

Paid

– =




Why Incentive Pay Has Limited Impact As a Pay Differentiator

For incentive pay to reach its potential as a pay differentiation tool…

An organization has to have a broad-based incentive pay plan

– 10% do not

Employees have to be eligible to participate in the plan

– 34% of exempt employees earning less than $60,000 are not

– 55% of nonexempt employees are not

There has to be an individual performance component

– Only 42% of plans incorporate an individual performance component

There has to be sufficient weighting on the individual component

– The average weighting is 22% of total opportunity

• E.g., of a 10% total target opportunity, the individual performance component is

2.2%

The plan has to allow for sufficient leverage (i.e., upside/downside)

– Typically, it is 50% to 150%

• Continuing the previous example, outstanding individual performance might be

worth 3.3%




Individual Performance Determination

The most common form of determining employee performance is through a

performance rating

Source: 2013 Aon Hewitt Variable Compensation Measurement (VCM) Report




How We Can Do Better

Line-of-sight measures

No more than 3 to 5 metrics

Adequate funding modeled for expected performance outcomes

Performance delimited

More weight on individual component

Assess how the plan is working and make changes to the design frequently




For Further Information

Preston Handler

Norwalk, Connecticut

[email protected]

To learn more about any of our surveys, please visit

www.aon.com/salaryresults

mailto:[email protected]

http://www.aon.com/salaryresults

Questions




About Aon Hewitt

Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent,

retirement and health solutions. We advise, design and execute a wide range of solutions that enable

clients to cultivate talent to drive organizational and personal performance and growth, navigate

retirement risk while providing new levels of financial security, and redefine health solutions for greater

choice, affordability and wellness. Aon Hewitt is the global leader in human resource solutions, with over

30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information

on Aon Hewitt, please visit www.aonhewitt.com.

© 2014 Aon plc

This document is intended for general information purposes only and should not be construed as advice

or opinions on any specific facts or circumstances. The comments in this summary are based upon Aon

Hewitt's preliminary analysis of publicly available information. The content of this document is made

available on an “as is” basis, without warranty of any kind. Aon Hewitt disclaims any legal liability to any

person or organization for loss or damage caused by or resulting from any reliance placed on that

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