The Art of Cutting Pay, Not People
In a recession, the standard management playbook prescribes layoffs,
reduced discretionary spending, and a host of other cost-cutting techniques.
But salary cuts? Those are taboo. Who's going to work as hard —
or stay loyal — for less compensation? "Reducing someone's
pay is like reaching out to the third rail," says Ken Abosch, a
principal at Hewitt Associates, a human resources consulting firm. "Companies
have done everything in their power to avoid touching that."
Not anymore. FedEx, Hewlett-Packard, and
AMD have already taken a hatchet to pay. More than 52 percent of HR executives
say their companies have reduced or frozen salaries, nearly twice the figure from
January. To be sure, pay cuts are never easy to institute (or accept). But here's
why slashing salary doesn't have to be a motivation killer.
The Morale Question
Yale economist Truman Bewley established the prevailing
theory for why wages tend to stay “sticky,” or steady,
during downturns. After studying the early 1990s recession, he found that
employers feared pay cuts would embitter workers, making them less loyal to the
company, and therefore, less inclined to work hard. The potential savings
simply were not worth the liability. Layoffs, on the other hand, at least moved
the resentment out of the office.
Nearly 20 years later, with U.S. companies mired in a much
deeper recession, economists and management experts see the morale question in
a very different light — mostly because employees see it differently
now, too. In short, workers know they have few options when the
href="http://www.bls.gov/news.release/empsit.nr0.htm">unemployment rate hits nearly 10 percent. “When
you have a nationally recognized recession, it’s easier to explain to
workers that you’re cutting wages, that you’re not doing it
to exploit them,” says Arnold Kling, a Cato Institute adjunct scholar
and former Federal Reserve economist.
In light of the massive number of layoffs, pay cuts look
like the more humane cost-cutting tactic because they save jobs. UCLA
management professor David Lewin says a small reduction in pay, when handled
carefully, can even foster a collegial spirit during hard times. “It
sends a signal that no one is expendable, but everyone is valued. We all suffer
the pain together,” he says.
Even more important, says Lewin, cutting pay instead of
people can preserve a company’s competitive position when a recession
subsides. Consider
href="http://resources.bnet.com/topic/southwest+airlines+co..html">Southwest Airlines (
href="http://finance.bnet.com/bnet?Ticker=luv&Page=Quote">LUV). In response to the
2001 recession, the company’s six biggest competitors laid off about
70,000 employees. Southwest avoided layoffs entirely. Instead, from October
through December 2001, executives received no salary. The company further reduced
labor costs in 2002 by freezing managerial pay and cutting bonuses and
profit-sharing payments, reserving the largest cuts for the CEO. When the
economy improved, says Lewin, the airline didn’t have to spend funds
to recruit new employees, allowing it to emerge from the downturn on a strong
footing with the right staff in place.
Making the Cuts
So how exactly do you ask employees to work for less pay?
First, understand that the recession only gives you so much cover. Company
culture matters when it comes to keeping morale high and hanging onto good
employees. Firms with highly loyal workers to begin with, such as Southwest
Airlines, tend to have an easier time slashing salaries without losing top
talent, explains UCLA’s Lewin. Even so, there are several ways
companies can soften the blow.
Prove that everyone is sharing the burden —
especially management. Do this by
href="http://www.bnet.com/2403-13241_23-251266.html">reserving the biggest pay cuts for executives.
At HP (
href="http://finance.bnet.com/bnet?Ticker=hpq&Page=Quote">HPQ), CEO Mark Hurd slashed
his base pay by 20 percent after his firm posted a first-quarter loss in
February. Other executives took 10 and 15 percent cuts. But most rank-and-file
employees saw their salaries shrink by 5 percent or less.
Keep employees informed. “Even if
[managers] are communicating bad news, it’s a lot better than not
communicating at all,” says Tom Rath, who leads the workplace
consulting practice at Gallup. Given a lack of information, employees will
often dream up worst-case scenarios. Re-engage emotionally with staff, he says,
and give them an honest explanation of why the cuts are necessary and how they’re
going to happen.
Don’t discount praise and recognition as a
way to keep talented staff from looking for a new job when the economy begins
to recover, says Abosch. Explain to top performers how they help drive results.
Offer opportunities for personal development, such as a key role in an
important project, or access to higher levels of leadership, such as lunch with
the CEO.
Bringing Wages Back
How you restore salaries to their prerecession levels
matters almost as much as how you announced the cuts. “You’re
basically relying on an implicit contract with [employees],” says
Peter Cappelli, a management professor at the Wharton School at the University
of Pennsylvania. If you promised to bring back wages on a certain timetable
after profits bounce back, the best thing you can do for company morale is make
good on that promise.
HP is hoping that the prospect of bonuses will keep employee
motivation high until the company can restore salaries. In a
href="http://news.cnet.com/8301-1001_3-10167884-92.html">memo to staff in February,
Hurd explained that the company planned to keep its employee
pay-for-performance plan intact: “If the company performs well, if
our individual businesses perform well and if you perform well, then you could
potentially make up the difference with your bonus.” In the meantime,
after a second quarter of decline, Hurd hasn’t made any promises and
the company won’t comment on where that leaves employee bonuses.
More on BNET: