The impact of benefits on business performance
As the war for talent rages, employee benefits have a key role to play in helping to retain and engage our most valuable assets - our workers, says Debi O'Donovan
In today's knowledge-based, service economy, a substantial proportion of an organisation's value is held in its employees. Customer service levels, sales ability and intellectual assets tend to be worth more to the bottom line than the physical, non-human assets of many companies.
Increasingly, therefore, business leaders are recognising the correlation between employee attitudes and total shareholder return. David Ulrich, professor of business at the University of Michigan and HR guru says organisations which have seen an average 10% increase in positive employee attitudes, experience an average 4% increase in customer sales, leading to an average 2% increase in investor returns. "It's a clichÈ, but in a knowledge economy, employees are an organisation's greatest asset," says Ulrich.
As Jon Ingham, director at human capital consultancy Strategic Dynamics, points out: "Many organisations are starting to understand that ongoing competitive advantage will depend increasingly on the quality and engagement of their people compared with competitors. So investing in human capital is partly about ensuring that the people in the organisation are fully equipped to deliver short-term business success, but secondly, it's also about having the capability to take the organisation forward and ensure that there is a basis for sustainable competition too."
In the UK, vanguard organisations such as the Royal Bank of Scotland, Nationwide and Standard Chartered have been able to apply scientific approaches to quantify the value of human capital investment on improved business performance. They have the advantage of holding data that they collect for the Financial Services Authority, as well as having many branches or call centres all doing pretty much the same thing, so they can scientifically test one operation against another, apply the data they hold and look for statistically valid correlations.
Ingham warns that in most organisations the costs of gathering that level of data is punitive. He recommends a more qualitative, and discursive analysis on understanding the value of human capital in the organisation: "Look at the investments that have gone into human capital, like the spend on employee benefits. [Gather information] across the boardroom or the executive team involving finance and HR and managers of the business about what the organisation is experiencing in terms of engagement; external perception; [being an] employer of choice; staff engagement survey results; and then finally place focus on the business results."
Naturally, a financial director's primary attention tends to be on the harder metrics of cost control and growth, than the seemly intangible, hard-to-measure HR concerns of employee recruitment, retention and engagement. But focusing solely on what can be measured can undermine the potential to improve business performance.
Jim Crawley, a principal at Towers Perrin explains: "The people angle on cost control is making sure you have got the best people, in particular making sure they don't leave again, because the cost of staff turnover is disproportionately high. If you can do clever things, clever things with benefits in this context, to make sure that you can bring people in, and in particular that you can persuade them not to leave again then that keeps your costs down and finance directors [are] happy."
He adds that "top line growth is less associated with attraction and retention, it is more associated with the other label we call 'engagement'".
Employee benefits have a small role to play in engagement, they tend to be more effective on recruitment and retention. Benefits are what management theorist Frederick Hertzberg would call a 'hygiene factor'. Crawley says: "The idea is that if you don't give people enough hygiene factors they will be demotivated, but not necessarily motivated. You don't necessarily get anything back by being overly competitive or giving people additional provision on benefits, or indeed pay. But if you fail to meet their needs personally or if you fail to be competitive in the marketplace then you are screwed."
The place of benefits is reflected in Towers Perrin's Global workforce survey 2007 released this month, where they are one of the top-ten drivers for attracting staff to an organisation. However, they are not in the top-ten for either retention or engagement, as was the case in the 2005 survey.
"What we saw for 2005 was something of a temporary blip because of all the insecurity that [surrounded] pensions. [Now] people have become reconciled to the fact that the landscape has changed and what we see in the other drivers is that all the traditional things - such as the relationship you have with your line manager, issues surrounding leadership and personal career development and may be workplace environment - have reasserted themselves. [This is] particularly [the case] in engagement and to a certain extent in retention," explains Crawley.
So not offering benefits can damage business performance and affect the ability to compete for recruits, and perhaps chock off access to key talent; but offering them does not directly drive business growth. As with all business and human capital strategies, what and how you offer benefits depends on your particular workforce's business drivers.
Accounting firm, Deloitte uses a concept it calls 'reward transformation' to identify critical employee groups and how their contribution to the business can be improved through reward strategies. Tony Clare, rewards and benefits partner at Deloitte, says: "You segmentalise your workforce into different units [and ask]'Are these people critical?'. Are they critical because they have unique skill sets, [or perhaps] difficult to replace in the market, or they have lots of experience, or are they critical because they are our chief executive, and getting that person replaced is not going to be easy?" You then perform analysis on how each group can best contribute to the business. "You go through a listening process and you change the remuneration structure to change behaviour. You are then into saying, for those different parts of the workforce, what reward package should we be offering? Also asking how is that going to impact on the bottom line?," says Clare.
One option is to look at cost control metrics such as recruitment. "Asking what am I going to do to keep these people happy so they don't leave [and thus make gains] in recruitment fees and training costs. If we have a stable workforce as opposed to a 20% attrition rate [where we are constantly] bringing everybody up to the same speed to do their job, the training need is much lower. If you are continually having to train new staff, it is an expensive process."
In some cases the solution may be to offer more learning and development opportunities, in others, a better work environment, or better pay, or better benefits. Grouped together, these four key areas are commonly known as the 'employment deal', and the emphasis placed on each varies between organisations.
Towers Perrin's Crawley, says: "In different scenarios, different parts of the package will play different roles. We would say that pay and benefits play a bigger role in attraction and retention; and learning and development and work environment play a bigger role in engagement. The notion of the deal is always in flux, but somehow it ought to always be in balance."
Businesses and their finance directors would want to see a clear return on any investment they put into pay, benefits, training or other initiatives. They would want to be sure that every £100 invested gave a return of at least £100 in reduced costs or increased business performance. The returns vary dramatically between organisations, but one company that Towers Perrin worked with received £47 back for every £100 invested in pay, and £700 for every £100 invested in leadership.
However, for many finance directors the very notion of investing in benefits and other HR practices to drive business performance, is often sidelined, as employers try to solve the multi-million pound problem that is the defined benefit pension scheme. However, there are a number of strategies, including using benefits, that can be utilised so that the pension too, has less of a negative impact on the profit and loss account.
As Suzi Lowther, a senior consultant at actuarial firm Punter Southall, says: "I feel sorry for FDs, they manage the financial strength of the company, but they inherited the pension, so they have to deal with it and make the hard decisions."
And that hard decision revolves around getting rid of the pensions risk. Steven Dicker, UK head of M&A at consulting firm Watson Wyatt, says: "On the point of shutting off future accruals, what FDs are asking is 'how do I hedge out the risk or get rid of it altogether?"
The routes they take depend on a number of factors, including: their objective in offering a pension; how many current staff are members of the scheme; and what the size of the deficit is. Towers Perrin's Crawley says: "Some organisations who regard the pension as being the mainstay of their employment deal, have steadfastly kept with DB schemes. Of course they are often the ones who are in decent funding shape. In other organisations, where perhaps the workforce is younger or more transient, the pension is less important."
The move to defined contribution plans
About five to ten years ago many schemes were closed to new entrants. Therefore, as Dicker explains: "There are increasingly organisations now that are seriously considering cutting off DB schemes to existing members; or at least changing it to make it career average; and taking some of that risk out for the existing members as well. And the reason for it is pretty obvious, like the WH Smith case where they discovered they only had 10% or so of their employees left in DB. Whereas ten years ago it would have been organisationally painful to upset your employees - all of which were in the DB, and now that only a rump of them are applicable, it is actually easier to run the opposite argument that it is fairer to put everyone in the DC when 80% of the workforce are already in it."
This especially true when you realise you are forking out costs to run a pension scheme for ex-staff who are now working for your competitors. Heath Lambert, director, employee benefits at pensions advisers Johnson Fleming, says: "Why spend money on people who left years ago? It doesn't make sense to the FD. We worked on a DB scheme with 52 members and a £500,000 annual administration fee. Most organisations don't mind paying for pensions, but do not want to pay for ex-staff who are now working for someone else."
Getting rid of the pension scheme is the current number one issue for FDs. "What FDs are doing is looking to close out or settle the liability one way or another. So we have things like the Saul pension scheme and the Thompson Newspaper Group [DB] where they have not [opted for] buy outs, but have got rid of their pension schemes altogether as a one-off settlement," says Dicker.
Alternatively there are partial buyouts, of which there are two variants. In the first, you keep your active members but buy out all the pensioners with, for example, an insurance company. And under the second, you offer deferred pensioners a transfer value so they can take their pension somewhere else.
In this case the employer offers a transfer value which is greater than normal, but less than the accounting cost. "So it is a win-win, the person gets a bigger transfer value and the company gets rid of a liability for less than the accounting cost so both are happy. That's the idea, but it is not quite as easy to execute as that might make it sound!" says Dicker.
Although there has been plenty written about bulk buy outs in the past year or two, take up has been low. Chris Erwin, investment principal of Aon Consulting, believes that this is because in most cases it is cheaper to continue to pay out pensions than to bulk buy an annuity. "When FDs find out how much extra it will cost, most won't do it. Most organisations are looking over time to de-risk. But lots of organisations say 'it is costing us a lot of money to de-risk', so they are looking more broadly at the business and decide to leave the risk in the pension."
For many pre-1997 schemes with guaranteed 5% increases, there is the option to offer cash sums to pensioners in exchange for reducing the increase to price-index inflation. "It is crucifying some schemes if the increases are 5%," says Lowther. Employees are advised to see a financial adviser when making this decision. "Lots of staff still do it even if adviser advises against it. The employer gets criticised but it is the employees' choice," she says.
And there is what you might call the Hobson's Choice option of changing contribution and payout levels. So if an employee is currently paying a 5% contribution for a one-60th DB scheme, they may be given the choice of continuing to pay 5% but they will only get 80ths; or increasing their contribution to 7.5% to keep their 60ths. "They are presented as a choice, but either choice is worse than what you currently have. It's all to reduce cost," says Dicker. "There are more elaborate ones, like the BAE Systems one: if life expectancy increases that effect is shared between the company and the employees, but it is reducing their pension in effect."
To soften the blow to employees some employers are looking to broader benefits strategies. "FDs are driving the need to take risk and cost out. And HR directors are saying 'if you go that far then you'll cause a problem in the business so can we mitigate it in some way?' Flexible benefits is a very good tool for doing that sort of thing," says Dicker.
In addition to using flex to give something back to staff, it can save money by cutting employer NI costs through the use of salary sacrifice. "FDs are only now really beginning to realise the power salary sacrifice holds to deal with deficits. HR have put [salary sacrifice] in the 'too difficult' box for too long, but it is the basis of building a business case for flexible benefits," says Lowther.
This is a key area where finance and HR can work effectively together. FDs are comfortable dealing with tax and legal experts that are needed to set up a salary sacrifice scheme, while HR are more experienced in communicating with the workforce.
"Sometimes FDs have to do things that employees might not like, but they can soften it by using other benefits. Doing the two together is sensible, it's a case of give and take," says Lowther.
- Investment in human capital leads to increased business growth (through employee engagement) and better cost control (through increased staff retention and reduced recruitment costs).
- Lack of employee benefits leads to demotivated staff, which can retard performance and hamper recruitment; but perks do not directly drive growth.
- Which benefits you offer depends on your workforce's business drivers.
- It is possible to calculate a return on investments put into pay, benefits, training or other HR initiatives.
- For many finance directors, their primary benefits concern is to de-risk their defined benefit pension.
- Solutions to limiting DB include: closing schemes to existing members; changing final salary schemes to career average schemes; conducting partial buy outs (for example of pensioners); bulk buying annuities; offering cash sums to change guaranteed 5% pension increases to price-index inflation; increasing contribution levels; and reducing payout levels.
- To soften the blow of pension changes, some firms look to broader strategies such as flexible benefits and salary sacrifice.