The economic downturn is now forcing companies to take a more detailed look at their spending and one tactic they are turning to is zero-based budgeting.
The budgeting method is growing in popularity but has the potential to be carried over when it comes to total compensation planning. This tactic not only helps identify short-term areas but also prepares for possible long-term changes in business travel and other spending areas.
Zero-based budgeting is an expense-management strategy requiring company executives to question and justify each line item in their budgets from the bottom up. This approach is in direct contrast to more traditional budgeting techniques that involve adjusting the previous year’s spending and cutting top-line budget amounts by a flat percentage based on economic forecasts.
Now is an ideal time to adopt this clean-sheet approach to budgeting because it requires justification and helps to budget and plan for longer-term business changes.
From a compensation and benefits perspective, the traditional approach often looks at merit budgets to adjust current compensation levels. The same occurs for benefits planning—what was spent last year and what can change based upon our current goals. The disruptions of COVID-19 are forcing companies to fundamentally rethink their budgets and this should be carried over to all business aspects.
The following is how this approach can be applied to total compensation.
Base Compensation, Salary Structures, and Incentives
Employers must reconsider pay levels but more importantly what type of organization that will be required in order to successful in the future. Beyond crisis management, the clean sheet approach provides a unique opportunity to alter compensation structures and create proper balances between costs and the continued ability to attract, retain, and motivate employees, especially in the required skill areas. Gone are the days where all positions would be paid at the same level compared to the marketplace. Skill-based compensation programs will have to be considered and should be variable in nature so they can be readjusted in the future.
Salary compensation structures will then need to be realigned. Traditional slotting should be evaluated and movements to alternate pay grades with different compa-ratios will need to be considered. Then, proper movements from the current structure to the new arrangement can be planned and communicated. Both internal and external pay equity will also have to be considered in order to defend pay practices.
Annual incentives and sales compensation plans must be evaluated to match the future organization. It is not just simply cutting forecasts but carefully examining all performance measures and performance benchmarks. Define the new thresholds for performance and determine how much should be paid out at various levels and why.
Health, Welfare, Time-Off and Retirement Benefits
Employers may quickly discover what workers truly value from their employment has changed. Employers will have to consider new models that provide more security, flexibility, and cost-certainty. Offering total compensation package options where employees can choose a package that better reflects their needs with the necessary trade-offs vs. the current one-size fits all style. As noted above, these options must meet the operational needs for each company.
Uncertainty about health care costs had already posed a challenge. Now, with the impact of the pandemic and concerns about pent-up demand driving costs, using the 2020 actual experience may pose a challenge when forecasting for 2021. For self-insured companies, 2021 risk profiles will change. Simply obtaining new rates without considering the new and evolved organization and its views on risk will put companies on the wrong track. Zero-based budgeting is a better approach.
Plan design options must aggressively focus in areas that may require more intervention in benefits management and force employees into potentially uncomfortable positions. The reason for this relates to attempting to reduce actual costs by limiting claims in the system vs. simply shifting costs. Revamped health reimbursement accounts (HRAs) should be carefully considered as a real alternative, as the desire may ultimately lead to moving benefits more towards a defined contribution approach vs. a defined benefit approach.
More benefits may become voluntary with the use of employer seed funding as a way to assist in the transition. This also establishes how an employer allocates limited resources to key areas. By placing a focused budget tied to core beliefs—offering essential and affordable medical/Rx benefits for example, and eliminating other employer sponsored benefits (e.g., dental, vision, life, disability).
During the pandemic, many companies elected to freeze 401(k) matching contributions. Rather than simply restarting the same plan, consider alternate plan designs vs. the same approach (e.g., 50% match on the first six percent deferred). For example, using formulas that allocate a greater contribution tied to service may be a better option. If a company is using a health savings account, why not provide a matching contribution to that plan as maybe more meaningful then a 401(k) match.
If a frozen defined benefit plan still exists, move to aggressively manage it as a discontinued operation. Passivity has proven to cause issues. If a concern related to implementing a de-risking strategy were an earnings charge, 2020 would be a good year to take the hit as a component of restructuring and move forward.
When we start to have a better handle on the future strategy of the organization, careful planning must be conducted to determine the financial impact on the company. On a parallel track, consider the overall impact on a fair cross-section of employees to avoid surprises and/or unintended consequences. With both approaches, careful communications must take place—for stakeholders and employees.
Elliot Dinkin is president and CEO at Cowden Associates, Inc., specializing in helping corporate clients find the best solutions, both for the enterprise and its employees, with regard to compensation, healthcare benefits, retirement and pension issues, and Taft-Hartley fund consulting.
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