This article outlines the human capital strategy, defines the concept of ‘total rewards', lists the benefits of a strategic total reward package and provides a seven-step process in developing a successful reward strategy which addresses the human capital implications of their organisation's business context and strategy.
Who could argue with a human resources policy that encourages teamwork? Or one that emphasises pay for performance? On the surface, these two concepts make perfect sense in today's fast-paced, demanding business environment. But as a leading business services provider discovered, unless your reward program elements are strategically integrated and effectively delivered, the outcome can be quite different to the original intention.
While senior executives of this global firm told employees, “If your performance helps to build the bottom line, you will be rewarded”, its line managers struggled to balance this philosophy with a team orientation designed to foster cooperation and innovation. As a result, the line managers did not emphasise individual performance when allocating incentive dollars; instead, they focussed more on group performance, resulting in minimal differentiation between outstanding and poor performers. In essence, the company was subsidising its lower-performing employees, with analysis showing that the bottom 25 per cent of employees were receiving about 25 per cent of the “pay-for-performance” pool.
The unintended consequences of this reward disconnect were significant. The company's revenues fell well short of targets; its new businesses were under-resourced because its reward resources were being diverted elsewhere; few low performers left the company, and the company share price plummeted.
This company's experience highlights the need for integrated, strategic total rewards programs. When properly designed and executed, a total reward strategy – which typically represents the largest single expense for many organisations - can be a powerful driver of business success. But when designed and implemented badly, one of two outcomes is likely. At best, the organisation doesn't yield the greatest possible return from its investment in a total rewards package, and at worst, the reward program elements directly and openly clash with each other, potentially undermining the success of the overall business strategy.
Attitudes toward reward programs have changed in recent times. For many years, reward programs were viewed primarily as a “necessary evil” to attract and retain competent employees. Today, organisations acknowledge the important role reward programs play in contributing to business success. Put simply, an effective total rewards strategy enables organisations to deliver the right amount of rewards, to the right people, at the right time, for the right reason.
Organisations now have a broader understanding of the concept of ‘rewards' – largely as a result of better understanding of their human capital strategy, or the ‘people' side of business design – the selection, development, deployment, motivation, management and retention of people to carry out the business strategy.
Human capital strategy has many components: how work is processed, how information and knowledge are shared, how decisions are made and how people are managed. It also includes the types of employees (characteristics, skills, education, attitudes, etc.) and how those people are rewarded. Each organisation's human capital strategy is unique because it is based on their own business strategy and business context. A reward strategy must be deliberately created to support this human capital strategy. Organisations are realising they can't merely replicate the reward practices of other organisations (ie: taking a ‘best practice' approach) but need to figure out what works specifically for them – ie: a ‘best fit' approach.
The definition of rewards has also changed. Previously broadly defined as the base salary employees collected every fortnight or month, the concept of rewards has expanded to encompass the overall value proposition that the employer offers to the employee. It's a total package which includes:
Remuneration (including base pay, short-term incentives and long-term incentives). Many human resource and business leaders once believed that pay represented the total solution for attracting talent, motivating high performance, reducing turnover and a host of other human resource challenges. However, remuneration is just part of the picture. Other reward program elements can be just as important, if not more important, to employees.
Benefits (including superannuation, cars, work/life and other benefits). Benefits account for an increasing part of the reward package, and employees recognise this. They look closely at the company's superannuation plan and other benefits, and select elements in their remuneration packages aligned to their needs. And not only do needs and preferences vary from employee to employee, they also change over time.
Careers (including talent “build or buy” strategy, training and development, and career opportunities). HR professionals, while trying to determine the right combination of pay and benefits, sometimes overlook an equally important reward component: careers. To employees, careers represent the future value of staying with an organisation. Many will even forgo higher salaries and better benefits for the opportunity to learn and grow and advance their careers. (See table 1.)
Table 1: Click to enlarge
In Australia , increasing use of remuneration packaging over the last 5-10 years has introduced some variability into the definition of remuneration used by organisations. Remuneration packaging approaches typically include base salary and benefits such as superannuation, cars and annual leave loading. The prevalence of remuneration packaging in Australian organisations can be seen in chart 1. Changing the definition of rewards to include incentive opportunities and careers components has proved more challenging.
Chart 1: Remuneration Packaging in Australian Organisations
Key: Shaded area indicates proportion of Australian Companies offering Salary packaging, by employee category.
Source: Australian Benefits Review, Mercer Human Resource Consulting, July 2004.
Employers' broader definition of rewards fits more closely with employees' actual experience. When considering employment with one company versus another, or when considering a new opportunity with their current employer, employees tend to consider all rewards over time. In other words, they are inclined to ask, “What can the organisation provide to me during my tenure in terms of pay, benefits and career opportunities?” rather than just “How much is my salary?” or “What's included in the remuneration package?”
Bringing all of these different reward program elements together in a strategic, holistic manner is a much greater challenge than simply setting a competitive pay level. An effective, strategic total reward package:
- Creates affordable and sustainable costs, by helping organisations evaluate and better manage the overall costs of the total reward package and therefore make smarter choices about where to invest reward budgets. This is particularly critical in today's competitive business environment.
- Connects with the business strategy to create a high performance culture. An organisation becomes what it rewards. A reward program can either drive or diminish organisational performance, depending on how well it connects with and supports the business strategy. Too many companies fail to grasp the connection between poor performance and a misaligned reward strategy. They don't typically stop to ask “What are we currently rewarding?” versus “What do we need to reward?” Business strategies tend to change every three to five years, but how often is a company's total reward strategy reviewed to ensure ongoing alignment with the business strategy?
- Generates maximum return on the reward program investment. Organisations typically spend more than a third of their revenues on people-related investments such as remuneration, benefits, training and other human capital programs. Often, these huge investment decisions are made with little knowledge about the potential return in terms of greater productivity, greater profitability and other key business measures. Today, these returns can be measured just like any other significant capital investment.
- Supports the “employment brand. ” A total rewards package is a key tool for influencing employee behaviours and attitudes. For rewards to drive a change in workforce behaviour, an organisation must deliver on its brand message by implementing its reward strategy effectively – considering communication and administration requirements to both guide the “transformation” process and monitor progress.
A holistic approach to developing a total reward strategy can have a significant impact on human capital decisions, leading to enhanced business results. Below is a seven-step process for developing a successful reward strategy, taking into consideration the human capital implications of the organisation's business context and strategy.
- Define the context and issues. The first step is to build understanding of the key factors both outside the organisation (economic, geographic, regulatory, political, labour and supplier) and inside the organisation (business goals, performance metrics, and needed workforce capabilities, behaviours and attitudes) that affect internal business and human capital decisions.
- Set the total reward strategy. With the business context in mind, an organisation can develop guiding principles for its total reward programs, which will provide the overarching framework for future reward program decisions, as well as form the basis for a strategic change agenda around reward priorities. Guiding principles should include degree of emphasis, competitive positioning, cost effectiveness, flexibility/uniformity, risk-sharing and performance link.
- Set reward change agenda. Guiding principles represent the ‘desired state' of rewards at the organisation, which leads to the next question: Where are we today versus where we need to go? This crucial third step assesses the current state of reward programs at the organisation to establish the degree to which change is required – to meet future business goals and performance objectives. This holistic assessment leads to a ‘change agenda', with key priorities for change based on the impact, cost, risk and feasibility of specific reward program alternatives.
- Implementation overview. Once the change agenda has been set, the organisation can create an implementation plan including the timeframe for the development of individual plan design details, major communication activities and associated administration considerations. This implementation plan also should include budget estimates to complete these core tasks.
- Design individual plans. Designing individual plans is not a new exercise for most organisations. However, the context for aligning these detailed plan designs with the overall reward program strategy is new for many organisations. With this added perspective, organisations have an opportunity to creatively and proactively view how individual plan designs can link with and support other aspects of the reward package and broader workforce objectives.
- Implement. Effective implementation requires integration of communication and administration activities – that is, the how, what, why and who to deliver on the reward strategy. This step also engages employees around both the change objectives and administration support system itself.
- Measure and manage. Going back to the core belief that an organisation becomes what it rewards, monitoring the progress of specific program design changes and related business outcomes are critical to ensure that the organisation indeed does what it sets out to do. As part of the ongoing monitoring process, the organisation can utilise a core scoreboard approach to measure key workforce and reward metrics on a regular basis.
The final outcome of this process will be a cohesive and comprehensive reward strategy that is both value-oriented and cost-effective and aligned with the organisation's business strategy.
As companies look more closely at how to create an effective total reward strategy, they need to keep five critical success factors in mind. To be effective, a strategy must be:
- Holistic. A total reward strategy must address the entire employment ‘value proposition' of remuneration, benefits and careers.
- Integrated. Disconnected solutions are not the answer; the components must fit together and complement each other.
- Aligned. The plan must be designed to support the organisations unique business strategy.
- Measurable. Intuition, anecdotes and best practices are no longer enough. A total reward strategy should also be based on hard facts and quantitative analysis.
- Delivered. Effective communication and administration of the strategy, as well as ongoing monitoring, is critical to realising the value of a total reward package. It is easy to put words on paper; it is much harder to change ‘what an organisation is becoming'.
- Australian Benefits Review , Mercer Human Resource Consulting, July 2004.
- Creating an Effective Total Reward Strategy: Holistic Approach Better Supports Business Success by Steven E. Gross and Helen M. Friedman, published by Benefits Quarterly Volume Twenty, Number Three, 2004.
- Striking the Right Balance: Total Rewards that Work TM by Bob Moreen and Steven Gross, published by Mercer Human Resource Consulting.