Business & BPO

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 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 Southwest Airlines (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 reserving the biggest pay cuts for executives. At HP (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 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.

Credits: bnet.com