October 2002

Bridging the
Chasm
To a New Pay System

Howard
Risher

Public employers are confronted with an
important and difficult human resource problem. On the one hand, demographic
trends, combined with the emergence of a knowledge economy, have triggered tight
labor markets for selected occupations. The problem of recruiting and retaining
qualified IT specialists is only the tip of this iceberg. The imbalance of
supply and demand prompts the escalation of pay at rates faster than the levels
for those occupations in which knowledge is not a critical consideration. To be
competitive in tight labor markets, employers have little choice but to adopt
policies that allow them to be responsive and competitive in those
markets.

On the other hand, government pay programs are anything but
flexible and responsive, and the problem is compounded by the deeply entrenched
belief that employees should all be treated equally—a policy that makes change
almost impossible. Government leaders have effectively stopped defending their
pay practices; there seems to be a widely shared realization that the
traditional model for public pay programs is no longer meeting the needs of
government.

A few public employers—perhaps the most prominent is
Charlotte, North Carolina—have successfully moved away from the traditional
public sector program model. However, there still is a sense of hesitancy to
take this step. Differences between the old and the new cause apprehension, and
this can be a chasm that is difficult to bridge. This article looks at some of
the considerations that affect these decisions.

The
Reasons for Change
Government pay programs have their origins in a
different era. The federal pay system was adopted in 1949 and, except for the
introduction of locality pay in 1990, has been static. To be sure, many public
employers have “tweaked” their programs, but the basic pay model and its
components can be traced back at least that far. It is almost impossible to find
other management practices that have been essentially the same for half a
century.

The new compensation model
relies on: a framework using a simple set of salary bands, alignment with market
pay rates, a strengthened commitment to a pay-for-performance philosophy, and a
responsibility delegated to line managers for day-to-day salary actions. The
salary system now is seen as a management system that reinforces the goal of
successful performance. The “new model” is not new, however; experience with
these ideas goes back 20 years.

Are traditional government pay programs
working? This is a difficult question. From one perspective, as long as
vacancies do not result in operating problems, there may not be pressure to
change. The common expectation is that any changes will increase the payroll,
and this often counterbalances the interest in program changes. In Charlotte,
however, the reason for change was integral to a broader strategy to change that
city’s government and to use financial rewards as a tool to shift employee focus
to improved performance.

Escalating corporate interest in new pay systems
has been triggered by the realization that traditional salary management
practices are simply too bureaucratic, too slow and unresponsive, and too costly
to administer. Traditional pay practices also have produced a culture of
entitlement contrary to the importance of individual initiative and commitment
to success. With the emphasis on reengineering and on cost-cutting steps that
arose in the early 1990s, companies concluded that they could no longer afford
the “price” of a traditional pay program.

Public employers may not be
able to live with the traditional model much longer either. The reasons that
have prompted corporate actions are, to be sure, relevant for government.
However, two more pressing reasons are the emergence of the knowledge economy
and the aging of the workforce. The former is important to employers that need
to compete for people in technical fields like IT. The latter will affect all
private and public employers with an older workforce.

The baby boomers,
who were born between 1946 and 1964, are fast approaching retirement. Over the
next decade, organizations will see a rapid exodus of people now serving in key
management and senior professional roles. And an important aspect of the problem
is that the next generation of workers is smaller and growing slowly. This fact
is attributable to lower birth rates from the late 1970s through the early
1990s. The severity of the problem has been reduced by immigration, but the
demographic trends have already contributed to tighter labor
markets.

Demographic trends, combined with the growing demand for
knowledge workers, indicate that the supply of qualified workers in some
occupations will be inadequate. Tight labor markets and their attendant problems
will continue for at least the rest of the current decade. Projections by the
U.S. Bureau of Labor Statistics show that the number of new jobs created in a
long list of occupations will grow much more rapidly than the overall
workforce.

In addition to the IT fields, health and personal care
occupations will grow much faster than the norm of roughly 2 percent annually.
Public school systems, for another example, will need to fill more than 1
million new jobs, and this does not take into account the retirements over the
period.

Tight labor markets trigger an escalation of salaries. The IT
market is an example in which some specialists have commanded increases in
excess of 20 percent a year. This is simple economics: for mission-critical
jobs, corporations will pay whatever they have to pay. Public employers will
have trouble competing under any circumstances, but a traditional pay system
will exacerbate the problem.

At the same time, a number of occupations
important to state and local government will grow more slowly than the norm.
With few exceptions, manual and clerical support-job families are projected to
grow slowly. This will affect prevailing pay levels: there will be no economic
reason to grant pay increases. And, in fact, pay surveys over the years have
shown an increasingly wide gap between professional pay levels and those for
manual/clerical jobs.

Another aspect of the problem is the growing
commitment of private employers to recognizing and rewarding their better
performers. Several prominent companies have recently been spotlighted for new
policies requiring a forced distribution on performance ratings: a specified
percentage of employees have to be rated as outstanding, and a smaller
percentage as inadequate.

A similar philosophy is reflected in the
practices of many companies. The purposes are to reinforce the importance of
good performance and to reward and, ideally, retain the better people. In
practice, this means that the pay for the “best and the brightest” will
increase, with compounding, at even faster rates.

It is not going to be easy for public
employers to compete in this environment. The graying of the workforce will mean
clogged career ladders that may prompt younger, better-qualified workers to look
for more attractive opportunities elsewhere. It is unlikely that the new
generation of workers will be comfortable with the traditional, seniority-based
pay model.

The First Step Is a Long
One
Experience confirms that it is difficult for public employers
to break away from the traditional salary model. There is often support for the
different alternatives in initial discussions; it also is easy to develop a
consensus that the problems of the current system are serious. But the unknowns
and the anticipated reactions of employees make any decision to move to the new
model one that is fraught with apprehension.

Pay always is a sensitive
subject in any organization. It affects employees’ perceptions of themselves,
along with their lifestyles. Pay can trigger anger quickly. And, of course,
anticipated changes in a pay system make employees anxious. Moving to the new
pay model is easier in a corporation that can argue that the change is needed to
be competitive. This argument justifies a lot of management actions, but it will
be less credible in government.

In the public sector, the problem is
compounded by the fact that no one “owns” the pay system. That is to say, no one
has the responsibility for keeping it up to date, for modifying it, or for
taking the lead in initiatives to improve it. For most management systems or
policy issues, someone is the resident expert or is responsible for their
maintenance. Corporations always have a director or manager of compensation.
Government has specialists who manage the classification process, but this is
not the same as compensation management.

The personnel/human resource
function administers the pay system, but even the best government HR managers
have rarely had direct experience in planning and implementing new systems,
which has not been part of their job description. At the same time, however, pay
administration is not seen as a management concern, that is, as long as job
vacancies and turnover do not affect operations. All of these circumstances
contribute to an environment in which the pay system is prominent in every
departmental budget but no one is truly accountable for it.

The Importance of Leadership
Compensation is an
important management tool. It can inhibit employee behavior if employees act
only to preserve their status or income. Or it can be used to motivate an
employee’s efforts. It can in fact be used strategically to accomplish
organizational goals, as is routine in the private sector.

When Louis Gerstner became CEO of IBM in 1993,
he realized that the company would have trouble surviving unless it changed its
culture. The proud IBM was seen as too rigid and slow-moving to compete
effectively in the highly competitive and dynamic IT market. Gerstner was
brought in to revive the company, and one of the keys to his strategy was the
introduction of a new pay system that ended the culture of entitlement and
delegated much of the day-to-day responsibility for rewarding key contributors
to managers. One of the reasons for IBM’s turnaround and recent success is the
change in the culture, in which the new reward system has been key.

In
Charlotte, it was the city manager who saw a need to change the way the city was
managed and began a significant reorganization of the structure and operation of
city agencies. One of the prominent changes was in the way people are managed
and compensated. The city adopted a market-based pay system, administered within
salary bands; annual salary increases take into account market trends and
individual performance. Managers make these decisions. There also is a gain or
goal-sharing incentive system that has enabled all city employees to earn an
extra $400 to $600 annually. The city has not raised taxes since
1986.

Effective managers can make change happen; they control the
“levers.” When they conclude that change is necessary, there is likely to be
little resistance. Control of the reward system is one of the most powerful
levers available. But major organizational changes do not happen unless someone
in a leadership position decides that change is necessary and takes control of
the change strategy.

Leadership is not the same as effective management;
it is the ability to identify organizational needs, to introduce new ideas that
satisfy those needs, to define the strategic direction, and to gain a shared
commitment to the success of the change initiative. Even the best manager,
however, may not be willing to lead an initiative to change a pay
system.

Introducing a new pay system is a source of concern for many
managers in public as well as private organizations. The term “bloodletting” has
been used to refer to the reactions of people and work groups who feel they have
not been treated fairly. This is perhaps an overstatement, but the wrong
implementation strategy can undermine a leader’s credibility. People often are
reluctant to support an initiative that is not popular. But this fact is at the
heart of the reason why leadership is fundamentally important.

One
strategy that often is used when an employer decides to evaluate the need to
change the pay system is to assign the task to a committee. It is difficult to
criticize a committee’s decisions. If the committee members decide that change
is needed, their involvement helps to convince others.

Clearly, in the public sector the various
stakeholders and constituencies have to be involved, which makes the composition
of the committee a focal concern. It also makes it important to consider the
need for leadership within the committee so that members are able to reach a
sound conclusion. Without that leadership, a committee is likely to be stymied
by the same chasm.

The final
decision to change the pay system always is going to be difficult. Expected
benefits may not be fully realized if the new system is poorly designed or the
implementation strategy is faulty. And managers have heard rumors of other
employers that changed a pay system and experienced problems. In this context,
managers find it all too easy to study the problem and rationalize the deferral
or rejection of changes in the pay system.

So Why Tackle
the Problem?
The reason that a growing number of organizations
have moved to the new pay model is simple: it facilitates improved
organizational performance. The new model has a proven track record in the
corporate world Surveys show that less than 1 percent of companies have
considered moving back to a traditional program. The new model also
substantially reduces the administrative costs that support the pay system.
Charlotte has a single person who manages the system for the entire city
government. With the new model, pay no longer commands as much attention,
resources, or organizational energy. Charlotte’s experience confirms this
point.

Moreover, as stated, the concern about increased payroll costs is
not valid. One of the decided advantages of the new salary banding is that
individual salaries can generally be “slid” without adjustments from the old
grade-and-range structure to the new salary bands. (This does not, of course,
include necessary market adjustments.) Companies control salary costs with a
budget, and the need to manage a budget is not new to managers.

The
business reasons to make the decision to switch to the new model are obvious.
But there still is a reluctance because the new model is so different. It
involves a new employee relations philosophy, new values, and the requirement
that managers develop new skills. It also calls for an intensive educational
campaign because discomfort with change always is an issue. These organizational
change issues can, however, be planned and managed. The chasm can be
bridged.

As an outsider involved with many organizations that have
bridged the chasm, I believe it is clear that change needs to happen. When
managers and employees adjust to the new environment, they like it, or at least
they learn to live with it. If anything, the new model presents new
opportunities to people. The labor supply is going to be tight in some
occupations for years. For organizations with a maturing workforce, retirements
will exacerbate the problems. Employers that do not adapt their pay systems to
this market reality are going to have progressively serious problems in
competing for talent. The federal government already has found that it is unable
to compete for qualified college graduates in technical fields. And salary
increases compound over time, so the situation is only going to get worse unless
changes are made.

Suggested Steps for Bridging the
Chasm

1. Seek out opinions on problems with existing pay
programs from major stakeholders, and develop summary documentation. If
something is “broken,” everyone is aware of it.

2. Conduct/sponsor an educational workshop on the
primary new program concepts. People have generally read or heard
anecdotal comments that have influenced their opinions. Everyone who will
be involved in planning needs to get on the same page.

3. Discuss and seek to reach consensus on the goals
for changing the program. This step also should include an initial attempt
to articulate a new pay philosophy. People need to know how the new
program will benefit the organization.

4. Develop a preliminary model for the new pay
program. People need to see and understand what the new program will look
like. This model does not have to include all details; the purpose is
simply to move the discussion away from the abstract.

5. Discuss how a new pay program will be affected by
other management practices. It may be that other changes will be needed to
support the new pay philosophy (e.g., performance management, supervisor
training). It also will be important to estimate the cost, if any.

6. Develop a tentative schedule for planning and
implementing the new program. People need to know what they can expect,
and when. The duration of the schedule may well extend over more than a
year, but it will be useful to establish a date when the old system will
be replaced.

7. Give the stakeholders a chance to “fine-tune” the
preliminary plan. People need to know that their opinions were valued and
affected the planning process. They also need to know that the plan will
be evaluated and fine-tuned again, if necessary, after the first year or
so.

8. Identify a champion. The organization needs someone
to champion the program changes. This individual needs to believe in the
changes and to have credibility as a
leader.

Howard Risher is a senior fellow at the
Center for Human Resources at the Wharton School, University of Pennsylvania,
Philadelphia ([email-masked])

Copyright © 2002, the
International City/County Management Association (ICMA)