Mercer: Managing human capital in unprecedented timesHuma… · 2 Managing human capital in unprecedented times Adjusting human capital investments in an economic downturn We believe

Managing human capital in unprecedented timesRemaining competitive and planning now for an economic recovery

2009

Table of contentsIntroduction 1

Adjusting human capital investments in an economic downturn 2

Managing salary and reward budgets: Achieving more with less 4

Leadership and talent management: Right people, right roles, right time 6

Managing executive remuneration in unprecedented times 9

Conclusion 12

1Managing human capital in unprecedented times

While Australia has not escaped the global economic turmoil, it has not been as deeply impacted as many other developed nations. However, economic pressures are forcing many Australian businesses, and their HR leaders, to make some tough workforce decisions and increasingly do more with less.

In the current economic climate, one of the biggest challenges facing organisations, aside from the need to survive, is managing the competing pressures of:

Containing employment costs in a cost-focused ��

environment

Maintaining levels of employee engagement ��

and productivity to ensure continued quality and delivery of services and products in a more difficult market

Retaining the right talent to ensure a ‘head-start’ ��

when the market recovers

There is a real risk in this environment that some employers will make knee-jerk decisions to contain costs and in doing so will jeopardise their ability to maintain a productive and viable workforce in the medium-to-longer term.

It is important in these unprecedented times that employers join the dots between employee retention and engagement, talent management, and salary and reward-related decisions in 2009 and beyond. Businesses that view workforce cuts and staff retention through a cost cutting lens only will miss opportunities and at worst, struggle to survive the worst of this global economic crisis.

Maintaining the right balance between short and medium term objectives and priorities is particularly challenging in such volatile economic times. Future business success will depend on getting this balance right.

Introduction

2 Managing human capital in unprecedented times

Adjusting human capital investments in an economic downturn

We believe the most prudent course of action in these times, at least initially, is for organisations to adopt a cost containment rather than a ‘cost slashing’ approach, and avoiding actions that could later undermine a competitive position and ability to respond when conditions begin to improve.

Mercer’s most recent Market Issues Survey* (MIS) confirmed employers are not taking a broad-brush approach to cost-containment measures such as blanket workforce reductions, hiring, or wage freezes. Contrary to common perceptions, they are being much more targeted in where they reduce spend.

Almost half (48%) of the companies we surveyed reported they will either substantially or slightly reduce their operating budgets, this is a 15 percent increase compared with six months ago. However, standard responses concerning current economic

conditions include moving to cut discretionary spending, slowing or deferring investments, aggressively managing cash flows and containing labour costs.

Consistent with Mercer findings around the globe, our Australian research confirmed the majority of Australian companies (71%) are selecting a limited and targeted range of actions whilst also indicating that more dramatic actions are being considered should the downturn become deeper or more prolonged. Companies are applying a limited number of ‘low-impact’ cost reduction and efficiency measures aimed at causing minimal disruption.

“The (MIS) data has reconfirmed what we were planning to do, and given us different angles in which to go back to the business”

Mercer Forum: Remuneration trends and human capital insights March 09 Melbourne attendee

Some of the cost reduction and efficiency measures being adopted include:

Cost reduction measures: Efficiency measures:

Reduced fixed pay budgets Optimising the organisation structure

Hiring freezes Re-allocating and re-deploying staff

Workforce reductions Optimising reward spend (e.g. program redesign, re-allocation of spend)

Reduced incentive quantums budgets and payment deferrals (both short and long term)

Redevelopment or design of new processes, particularly due to increased governance spend

Postponement of major incentives

* Mercer’s MIS is conducted biannually and provides an insight into the remuneration and human capital trends across various jobs, states and industries in Australia. The latest survey, of 352 companies, was conducted in January 2009.

“Optimising reward spend is a huge issue (currently) for our business”

Mercer Forum: Remuneration trends and human capital insights March 09 Sydney attendee

Our MIS results also confirm that employers are reducing spend on fixed pay, short term increases and learning and development. These are the same areas which attracted increased spend just twelve months ago. Conversely, there are three main areas where companies expect to increase their HR expenditure:

Talent management and succession planning 1. (45% of companies)

Leadership assessment and development 2. (43% of companies)

Implementation or enhancement of HR 3. information systems to improve decision-making or increase the efficiency of transactional processing (35% of companies).

Chart 1 outlines the areas for planned human capital investments in the future.

Chart 1: Planned human capital investments

0 24 48 72 96 120

45%

43%

49%

48%

57%

65%

60% 6%

6%

9%

8%35%

34%

34%

TalentManagement& Succession

Planning

LeadershipAssessment

& Development

HRISImplementation

or Enhancement

PerformanceManagement

Process

Work &LifestyleBenefits

Investing more than before

Investing lessthan before

Remaining Steady

1%


The anticipated investment in areas such as talent management and leadership succession clearly indicates many Australian organisations recognise how critical it is to proactively manage and allocating key talent to navigate through these difficult times. These companies also understand that workforce decisions must be underpinned by the necessary data and information, not just cost-cutting objectives.


Managing salary and reward budgets: Achieving more with less

The majority of Australian organisations recognise a complete freeze on salary movements could have negative consequences on productivity, employee engagement and retention of key employees.

Many organisations have continued to put fixed salary increase budgets in place for the year ahead. However, salaries are growing at a much slower rate. National salary increase budgets have declined from five to four percent over the past six months and are predicted to fall further during 2009 with 18 percent of companies planning to reduce their fixed salary increase and short-term incentive budgets over the next 12 months.

As of January 2009, only 2 percent of companies expected to apply a blanket salary freeze across their entire workforce this year. A further, relatively small proportion (11%), expect salaries to remain at 2008 levels for one or more segments of their workforce — i.e. specific roles or key business units, but not all staff.

With fewer resources available for rewards, differentiation of key talent through reward and career opportunities will be more critical than ever. Cost containment can be achieved by better targeting rewards, as opposed to simply putting a hold on expenditure. Companies will have to consider segmenting the broader employee population as a means of maximising the reward budget they have available. This could mean re-considering how salary and incentive budgets are spread across various workforce segments such as critical roles, key talent, high performers, key business units, or across career levels as opposed to blanket percentage increases.

Targeting rewards to the right people enables an organisation to develop required workforce capability, elevate performance and productivity, and ultimately positively impact the bottom line.

Getting creative with employee rewards and benefits is more important than ever. Employers need to consider the demographics of their workforce and respond with an appropriate benefits menu to help retain the right people, and this will inevitably mean being creative whilst operating in a cost-containment environment.

To remain ahead of the game, particularly with an ageing workforce, employers need to:

Better understand what their employees value ��

and want

Acknowledge diverse employee segments and ��

the different values of each segment

Think outside the square in terms of employee ��

benefits — for instance, by considering whether financial advice should play a more prominent part

Improve how benefits are communicated ��

to employees

Consider introducing a level of flexibility ��

to benefits packaging

Our MIS data revealed that organisations are looking towards opportunities that boost workforce productivity and increase employee engagement, including:

Access to financial education to ensure employees ��

better understand their superannuation investment choices and long-term savings objectives

Wellness programs to improve health-related ��

behaviours and productivity


Australia’s 2-Speed economy disappears

It is clear that Australia’s two-speed economy has dissipated and predicted salary movements between the states are set to converge.

Mercer’s early market forecasts suggest that salary differentials across Australian states and territories will continue to narrow as demand for certain skills in high demand sectors has weakened, particularly in Western Australia and Queensland, which have been impacted by falling commodity prices.

Salary movements for 2009 are forecast to:

Rise by 4.3 percent in Queensland, the only state expected to exceed the national average of 4 percent��

Grow in-line with the national average in Western Australia and New South Wales ��

Be below the national average in the ACT (3.9%), South Australia (3.8%) and Victoria (3.6%) ��

Mercer’s research also illustrates that the boom times have ended for the mining and construction sectors , among the hardest hit in the crisis.

The differences in salary movements between industries are likely to change in 2009, creating a new profile for what’s hot and what’s not. Those least impacted by the downturn, so far, such as selected pharmaceuticals and energy, are maintaining healthy fixed remuneration increase budgets, while those hardest hit, such as mining and construction appear to be reducing their budgets fairly drastically.


The global financial crisis will provide only a short reprieve for employers from the associated challenges of an ongoing talent shortage and ageing workforce.

While the squeeze on the labour market has loosened as a result of the economic downturn, talent in many areas remains scarce despite rising unemployment. The ‘war for talent’ is far from over.

Many employers have learned critical lessons from previous downturns, including not to cut too deep or too far to ensure they can bounce back when we do come out of this period of uncertainty. Keeping the right people in the right job at the right time, at all levels of an organisation, could be the determining factor in whether a business survives the economic downturn. At the very least, it will affect how quickly a business can recover.

Employers understand even the most well-crafted business strategy has little value unless it can be implemented successfully by a qualified workforce and leadership. Leadership teams that lack focus, or work at cross purposes, and workforces that remain disengaged or distracted will challenge their organisations’ success in these testing times. On the flip side, organisations that fully align their leadership and workforce behaviour with their business strategies will be in a position to leapfrog their competition.

What will Australia’s labour force look like in the next three years?

- By 2012 the number of workers in Australia’s labour force aged 55 or older will increase by more than 15 percent while the number of workers aged 25–54 will only increase by just over 6 percent

- More than 1 in 5 workers will be aged 55 or older in Australia by 2012

- The biggest increase in labour force between now and 2012 will be amongst females aged 60–64 — this group will increase by 19 percent

Source: Mercer’s Workplace 2012: Beyond the Global Financial Crisis, December 2008

Leadership and talent management: Right people, right roles, right time

All eyes are on leadershipThe visibility and decisions of leaders in volatile times have a heightened ability to either instil or subdue confidence in employees - people throughout the organisation will take their cues from leaders in terms of how to react and what to focus on.

Businesses cannot afford to have a leadership team that sends mixed signals to the organisation by failing to consistently communicate the priorities, model the right behaviours, or stop the old, non-productive behaviours within the workforce.

Leaders are one of the most effective levers an organisation has when implementing change or engaging its workforce. Our workforce engagement research consistently shows that leadership and a clear vision, not just pay, are among the top motivators for employees to stay or to perform. Getting the mix right will be the real challenge for today’s leaders.

Arguably, current leadership pools are full of people and skills that have been conditioned in times of economic growth and are now being forced to make decisions based on a very different reality. There is a real risk that a lack of the right leaders in tougher times will have repercussions right through to the bottom line and destabilise an organisation’s capacity to recover in the future.

Today’s leaders are operating in an environment where there is much less room, and indeed less tolerance, for error. Organisations are going to increasingly require and rely on leaders who can get the balance right between ensuring employees have the right skills and capabilities to ‘get the job done’, whilst being tough enough to intervene on employees making the least contribution to the organisation. At the same time they must have the intuition and soft skills to ensure their employees are engaged and aligned in order to grow the business through this period of uncertainty and economic constraint.


Checklist for leading through unprecedented times To survive and possibly thrive in this environment, leaders and managers must be able to:

Understand the likely impact of the current environment on their business and know what part ✔✔

of their business will thrive and which may not

Be agile enough to anticipate and respond to change in the current environment✔✔

Adopt targeted, less invasive and more creative approaches to cost management, such as reduced ✔✔

hours, shorter working week, and targeted reward spend.

Focus cuts on low value/high cost reward components, to minimise disruption and maximise impact✔✔

Ensure the right people are working on the right things in the right roles✔✔

Anticipate and avoid creating new risks by continuously measuring and monitoring disparities ✔✔

in rewards and other aspects of employment

Focus on the areas of greatest value to the business such as reducing costs and ✔✔

accelerating growth.

Talent management critical to business successIn tougher economic times it is more difficult to create new opportunities or deliver on promises made to high potential employees than it is in boom times, which makes talent management even more complex. Companies need to remain committed to developing the skills and the people critical to future success, both now and when the market recovers.

However, workforce cuts are often inevitable in tougher economic times. According to our MIS data 37 percent of companies reported increased levels of involuntary turnover over the last six months. The approach has been targeted with many companies trimming their workforces or implementing hiring freezes with strategic, laser-like precision among specific workforce segments, business units or geographies.

This targeted approach is expected to continue, although fewer companies at this stage are expecting to make cuts to the workforce. As is shown in Chart 2, 16 percent of organisations indicated plans to make cuts in at least one segment of their workforce, while only 1 percent indicating across the board cuts.

Chart 2: Measures are being precisely targeted

0

10

20

30

40

50

44%

24%

12%

36%

10%

16%

Expected Workforce Reductions

In at least one Worforce Segment Across the Board

Expected Hiring Freezes

1%

The MIS data also shows that while companies have indicated it is getting easier to source and recruit talent across all positions, many are finding that senior executives (60% of companies), management roles (46%) and industry specialists (56%) are still in limited supply, as shown in Chart 3.

Chart 3: Shortage in key skills still prevalent despite a recent easing in the labour market

0

16

32

48

64

80

12%

60%

Still Limited Supply Planning to Hire

46%

56%

32%28%

38%

55%

42%

50%

35%

29%

22%

Senior Executives

Management

Professionals — Industry Specialists

Professionals — Support Functions

Operations Support

Sales

While we can expect these supply issues to improve in the short term, it seems that many companies are ensuring they’re in a strong position to attract and retain the capabilities they require.

To cope with the increasing drain on talent out of the workforce organisations must understand the demographics of their workforce, employees’ intentions and expectations around work, as well as identifying what skills the organisation will need and whether these skills are in short supply.

Effective leadership and people management practices have never been as critical to achieving business goals as they are right now and clarifying purpose and objectives before taking action is absolutely fundamental.



Managing executive remuneration in unprecedented times

In these unprecedented times, a combination of falling shareholder returns, market volatility, recessionary economic conditions, and some very public examples of perceived excessive CEO pay packages and controversial CEO termination payments, have put executive remuneration very much in the spotlight.

Increased public and regulatory attention has created a greater impetus for organisations, and in particular Boards, to improve executive reward programs.

However, this needs to be palced in context. While there has been some high profile and controversial cases of executive pay deemed excessive, the media headlines refer to some notable outliers and Mercer’s research suggests the majority of companies are effectively aligning performance and reward. We have assessed the performance of Australia’s top listed companies and found the lowest performing third of the companies paid incentives well below target levels, and 30 percent of these did not pay incentives at all.

The issue remains however, that many shareholders and other stakeholders perceive a mismatch between pay and performance at the CEO and executive level.

While performance against financial measures such as revenue growth and EBITDA have been largely consistent over the past three years total shareholder return (TSR) dropped significantly over the same period. These sort of results highlight a potential disconnect between share price and the underlying financial performance of an organisation. It is this disconnect, when the share price is declining yet the financial performance of the company may be on track, that can blur shareholders’ perceptions of executive remuneration. A potential solution is to diversify performance

metrics. Many companies use only one metric to cover a range of dimensions such as growth, profitability, returns and shareholder experience.

With more volatile times ahead it will be increasingly difficult to set targets, evaluate performance results, and make incentive payment decisions which are acceptable to shareholders, particularly as share prices may continue to fall. These factors will increase the challenge of designing effective and responsible reward and retention programs for senior executives and the broader employee population.

For the new financial year a review of targets and incentive plans will be required. There are few organisations that could exceed or match their 2007/early 2008 performance, and goals should be adjusted accordingly. Goals need to be realistic so that employees believe they have the opportunity to earn the incentive and the incentive program retains credibility. But rather than just lower the bar, companies should consider:

Broadening the target range��

Adjusting the levels of payment so that ��

incentive payments correspond to varying levels of performance

Use of relative rather than absolute measures — ��

eg. performance above the median of a peer group or index rather than 10 percent revenue growth

Recent events also act as a timely reminder for companies to assess the appropriateness and effectiveness not just of their executive remuneration programs, but also of their leadership talent management and development programs as they seek to ensure a pipeline of leadership talent for the future. Organisations may find it appropriate to apply discretion at levels below senior executive to assist talent retention. In these instances decision makers should review their company performance relative to that of their industry peers discretion may be more defensible if the company has outperformed peers in this tough economic climate.


The long and short of itMarket volatility has highlighted the need for a discussion on whether the overall executive remuneration program appropriately covers different performance time-horizons. Companies need to balance incentives for short-term, mid-term and long-term performance to reward sustained performance, not just outstanding short-term results.

Recent economic and stock market turmoil will force some companies to review and address the immediate issues of short term incentive payments and fixed salary increases for the year ahead. Many executive incentive plans for 2008 were not funded because unpredictable external market factors prevented organisations from achieving their incentive goals. While this may cause concern within the company, we believe targets set for 2008 should not be changed retrospectively nor should discretion be applied to pay bonuses to senior executives if performance targets were not achieved.

Long-term incentive (LTI) vehicles also require review – in particular equity based pay. The steep decline in share values creates a serious problem for companies who are targeting a LTI award value, as the number of shares required to deliver the same value as in 2008 will increase dramatically. There are a number of approaches that companies could consider to manage the dilution, such as granting the same number of shares as last year, reducing the value by a fixed percentage, and using an average share price to smooth the impact.

Companies could also revisit the mix of vehicles, decrease options in favour of shares or revert to a cash based LTI.

We believe that as companies plan for 2009 and beyond a balanced approach will be prudent. A reward program that provides a mix of measures, performance metrics, pay vehicles and rewards over a range of time horizons will help mitigate the biases in any single compensation plan or measurement approach and discourage excessive risk taking. This will ensure companies establish and maintain responsible executive remuneration programs that are aligned with business objectives and attract and retain executive talent, but most importantly, stand up to external scrutiny over time.

It pays to have a talent pipeline

There is a very good financial argument for continuing to invest in talent development and retention and increasing the focus on succession planning. Mercer did a study of Australia’s top listed companies and found that external CEO hires are paid much more than the previous CEO incumbent, in some cases up to 23 percent more. External hires are also more likely to receive short and long-term incentive sign-on grants. This highlights the significant financial implication for those companies not actively identifying executive and leadership talent in their organisation and not establishing succession plans for critical roles.

Executive remuneration checklist

Develop leadership talent from within✔✔

Align remuneration programs with business strategy✔✔

Differentiate performance✔✔

Balance incentives for short-term, mid-term and long-term performance✔✔

Examine role of different long term incentive vehicles✔✔

Review the level of risk in programs✔✔

Ownership guidelines and deferral mechanisms✔✔

Engage shareholders✔✔



Conclusion

Delivering on human capital investments and dealing with the pressures that risk derailing them is possibly the biggest challenge HR leaders and CEOs will face during 2009.

By making smart decisions now and using this time as a reality check, employers can future-proof their organisations, protect jobs and productivity, to prepare for when the market conditions become more favourable. We know, despite the headlines, widespread job cuts are not the norm and the majority of Australian employers are being cautious to optimise salary and reward spend and cause minimal disruptions.

In response to the current climate, it is critical for organisations to re-clarify their business imperatives and talent requirements as these may have changed. This means getting the facts right before making decisions and taking a holistic and integrated HR and reward approach when thinking about how to manage the complete ‘employee experience’ during this time.

Employers must ensure they openly communicate and connect the dots for employees by linking actions taken with the current business context and assessing the impact on their workforce of the decisions taken. This balanced approach is vital for organisations to survive the current climate but also thrive when the upswing occurs.

Copyright 2009

Mercer (Australia) Pty Ltd

ABN 32 005 315 917

All rights reserved. 9393

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For further information about this paper, please contact:

David AbusahPrincipal P: +61 2 8864 6638 E: [email protected]

Adelaide108 North Tce Adelaide SA 5000 Tel +61 8 8110 3400 Fax +61 8 8127 9581

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SydneyDarling Park Tower 3 201 Sussex Street Sydney NSW 2000 Tel +61 2 8864 6800 Fax +61 2 8915 1526

www.mercer.com.au

Mercer: Managing human capital in unprecedented timesHuma… · 2 Managing human capital in unprecedented times Adjusting human capital investments in an economic downturn We believe

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