compensationxl.com

When it comes to making the business case for using a truly automated compensation planning tool, the first question that always comes up is what will be the return on this investment? After spending a couple of decades trying to come up with hard and fast numbers to support the business case, the answer is it really depends on your current approach.

Before we discuss the purely financial ROI, it is important to state some facts relating to compensation management that may or may not be obvious. These are as follows:
 

It goes without saying that payroll is the single highest expense item for nearly every company. The going average is approximately 50% (plus or minus depending on the industry) of the overall expenses incurred. When organizations have to cut expenses significantly, the top of the list to get cut is payroll. It is common that payroll related expenses are at least as much as all other expenses combined and therefore is an obvious target when these types of cost cutting activities take place.

 

The planning compensation rewards for employees is typically run the Human Resource department, and for medium to large companies there is a department dedicated to not only the planning process but all things related to compensation. This includes participating in compensation surveys, collection of data from these surveys, and determination of how well the organization is paying in relation to the rest of the market…and hopefully against the competition.

 

Even though the compensation planning process resides on the HR side of the house, it is almost exclusively a financial budgeting process. The HR mission is to not only run this process but to build in enough business rules and guidelines to ensure that managers are using good judgment and are spending their budgets in the most appropriate ways.

 

In the last few years, all of the experts agree on one thing…the professional workforce is shrinking and the need for organizations to hold onto their top talent is paramount to succeed not only today, but well into the future. Several recent studies have shown that on average 18% (and as much as 25%) of employee separations can be attributed to an organization’s compensation policies and administration. Given the importance of retaining your top talent in the shrinking workforce it is imperative to ensure the right money is getting to the right people, or they will become someone else’s top talent.

 

At this point, you may feel the business case has been made. Without a solid compensation planning approach and system to support, a company is not managing their number one expense, budgeting without proper financial checks and balances, and increasing the likelihood of losing significant resources in a shrinking workforce…that’s a scary thought.

 

The ROI components we will be showing are broken into four categories: Turnover Cost, Manager Cost, HR Cost, and Opportunity Cost. Each cost category will show examples of the savings for employee populations of 1,000, 2,500, 5,000, 10,000, and 20,000 in order to show the magnitude of the cost savings as the number of employees increases. There are also several assumptions that are used in each of the cost savings calculations along with the rationale for the values that were used.
 

The first and perhaps most costly of these is the turnover cost which primarily affects those organizations without a formal plan or system for guiding them through the budgeting process. Based on current studies the average cost of turnover ranges from 50% to 150% of an employees annual salary, with the wide variation based on the level of the employee and the industry type of the organization. For our examples we will use $50,000 which represents 100% of the annual base pay of many types of organizations. Also, we will use a relatively conservative 20% for the turnover calculations given that the Bureau of Labor Statistics for 2006 shows this number to be 23.4% as shown in below.

 

Shown below is the resulting cost savings comparison associated with turnover. It is important to note that the turnover reduction factor used in this ROI calculation is an extremely conservative 2% reduction of the existing turnover in the size of organizations shown. For those organizations having serious compensation related separations, this number could be as high as 10%.
 

 

For the manager cost calculations, we are defining the time savings associated with using a system with formal guidelines and business rules for not only compensation planning but for performance management system as well. This calculation utilizes several assumptions for determining the cost, including:

·        Average base salary of the manager population is $70,000

·        Managers currently spend 3 hours on planning compensation rewards for their entire direct report population as well as reviewing subordinate manager recommendations

·        Managers currently spend 3 hours per employee per year managing performance

·        On average, each manager has 10 direct reports

·        Finally, having true compensation planning and performance management systems will reduce the time spent in these functions by 50%

The resulting productivity savings for managers is as follows:
 

 

The HR cost calculations will apply to every organization that either has no system or has been tasked with manually creating spreadsheets to send out to their manager population. As with the samples above, we will make a few assumptions:

 

·        Each HR person working on the planning process has an average salary of $50,000

·        On average the person supporting their current process will spend 2 hours with each manager spreadsheet, including producing the spreadsheet, distributing it, supporting manager questions, reviewing the finalized spreadsheet, merging back into the master data set, and verifying that the merge was completed successfully

·        In addition, it is assumed that there will be fixed number of 200 hours that will be spent during the entire current process to provide support, resolve general issues, and provide senior management with reporting and analytics

·        The estimated hours associated with using true compensation planning and performance management system will very little time per manager spreadsheet (one-tenth of an hour) since there is not production, distribution, or merging of spreadsheets in the new process, however there may be support questions or issues

·        In addition, there are a fixed number of 160 hours associated with supporting the new product as well as providing rolled up analytics, and working with the vendor as part of the system rollout.

 

The cost comparison for the HR efficiency savings is shown below. Again the savings estimates are very conservative, especially in the first assumption area for organizations that create spreadsheets manually for every manager. Using an assumption of 2 hours per manager worksheet is quite given that it is common with this approach that worksheets must constantly be updated and re-planned due to changing populations, recommendations not meeting budget guidelines, and general data issues that cannot be handled through a central data repository.

 

 

It is also important to note that even with the conservative assumptions used in this analysis that either having your HR department spending countless hours creating spreadsheets takes between 3 to 4 times the amount of effort to manage a process that not only impacts the bottom line but also affects employee satisfaction. On top of that, the people handling this process almost have no choice but to ignore to some extent their day to day duties during the planning process, which is elongated as result.
 

The final category for cost savings in our calculation examples deals with the opportunity cost associated with manager recommendations for employee rewards. Again we will make assumptions for the provided examples:

·        The overall average base pay of the employee population at $50,000

·        The budget percent of compensation rewards is 4% of payroll

·        Using a true compensation planning system will increase the accuracy of budget spend by 5%, or basically reducing the under/overspends that occur without checks and balances by 5%

·        The value of money saved by using the system is at the current prime rate of 5%

 

Shown below is the cost comparison associated with increasing the accuracy of manager recommendations by using a tool that utilizes a robust business rules engine and can hold hard and fast against financial budgets, and at the same time ensure that the right people are getting the right amount of compensation.
 

  

This article has laid out the significant cost impact with not having robust and user friendly compensation planning and performance management systems. The idea of managing the largest single expense item with a makeshift approach is like throwing out your accounting system in lieu of a pad of paper and a calculator. There can be no strategy without information and you cannot implement a strategy without controls and business rules.
 

There are many challenges within every organization today, and given the aging and ever decreasing workforce, organizations must be constantly monitoring and adjusting their approaches to keep the best talent. It doesn’t take much to make your top talent someone else’s top talent.