Total Rewards Planning for 2004: Trends and Implications for Strategic Workforce Management

1. Total Rewards Planning for 2004: Trends and Implications for Strategic Workforce Management Charles Sterling, Ph.D. San Francisco

2. What’s on leadership’s mind? How can we… • Afford and sustain our current level of reward spending? • Bolster growth through the use of our compensation strategy? • Reallocate our reward dollars to achieve better control over spending? • Recognize and reward our highest performers, as well as continue to motivate our “B” level employees? • Ensure pay reflects and encourages productivity and results? 1

3. Current Economy Many economic indicators are beginning to look positive, indicating that the nation is pulling out of the economic doldrums: • Gross domestic product grew at 3.1% annual rate in this year’s second quarter • Consumer spending rose 3.8% from an earlier 3.3% estimate • Business spending increased by 8.2% • Corporate profits from current production rose by 10.8%, though after-tax profits fell 3.4% • Some predict economic growth to jump to 5% in the third quarter

4. Current Economy However, the labor market is still lagging the economic recovery: • Unemployment 6.2% in July • First-time claims for unemployment benefits below 400,000 • Number of people on benefit rolls rose to 3.66 million people • In general, annual economic growth would have to reach 3.5% – 4% to cut unemployment.

5. Impact of Economic Downturn • 12% of organizations report salary freezes for at least one segment of employee population • Executive, management, and technical/professional employee groups either had or were considering salary freezes, extended review periods, and lump sum payments as their top three cost saving measures 2003/2004 Mercer Compensation Planning Survey

6. The economic barometer from HR’s perspective Taking a wait-and- see approach Preparing for sales growth Still responding to the economic downturn Source: July 2003 SnapShot Survey “Measuring Return on Reward Investments,” Mercer Human Resource Consulting 6

7. Impact on Benefits – Health Care • Increase in health care costs paid by private-sector employers and their workers by almost 14% in 2003, the third year of double-digit increases • Implications: Higher out-of-pocket expenses (premiums, deductibles and co-payments) for workers • Why? Continued emphasis on expensive high-technology approach to medicine, including prescription drugs • Average annual cost of family coverage $9,068 • Percentage of companies offering coverage is slipping, from 69% in 2000 to 66% in 2003 • Impact particularly pronounced in small businesses • Shift in past five years away from HMOs (65% in 1999 to 54% in 2003) in favor of PPOs (81% in 1999 to 87% in 2003) and alternative medicine

8. Impact on Benefits • Overall decrease in number or organizations offering many benefits • Housing and relocation benefits either remained stable in 2003 over 2002 or experienced an increase • Executive benefit programs have been reduced • Sign on bonuses for both executives and non executives dropped 9% and 6% respectively over the prior year, large decreases from 2002 and the years immediately preceding • Elimination of benefits that are “nice to have but not affordable at this particular time”

9. Base pay increases: For whom and how much? Source: 2003/2004 US Compensation Planning Survey, Mercer Human Resource Consulting 2

10. Base pay increases: For whom and how much? Source: 2003/2004 US Compensation Planning Survey, Mercer Human Resource Consulting 3

11. Whose salaries have been frozen? *as applied at any employee category Source: 2003/2004 US Compensation Planning Survey, Mercer Human Resource Consulting 4

12. Inflation and labor market’s effect on pay CPI-U estimates provided by Economic Forecasting Center of Georgia State University * Estimated Source: 2003/2004 US Compensation Planning Survey, Mercer Human Resource Consulting 5

13. Metropolitan Benchmark Compensation SurveyComparison of 2002 and 2003 Data Source: 2002 and 2003 Mercer US Metropolitan Benchmark Compensation Surveys (Jul)

14. Top reward challenges facing HR % of companies rating issue as very important Attracting/retaining the “right” talent Differentiating high performers Cost control Ensuring pay-for-performance Developing a coherent and cohesive reward strategy Dealing with underwater stock options Source: July 2003 SnapShot Survey “Measuring Return on Reward Investments,” Mercer Human Resource Consulting 7

15. The “right” talent: Are you building or buying it? We will buy more (rely on new hires) Not sure We will build more (develop from within) It will be the same as in the past Source: July 2003 SnapShot Survey “Return on Reward Investments,” Mercer Human Resource Consulting 8

16. Rewarding the “right” talent Source: 2003/2004 US Compensation Planning Survey, Mercer Human Resource Consulting 9

17. Increasing role of short-term incentives Decreased No Change Increased Source: 2003/2004 US Compensation Planning Survey, Mercer Human Resource Consulting 10

18. Increasing role of short-term incentives Source: 2003/2004 US Compensation Planning Survey, Mercer Human Resource Consulting 11

19. The metrics behind short-term incentive plans Source: 2003/2004 US Compensation Planning Survey, Mercer Human Resource Consulting 12

20. How holistic is your reward strategy? 2003 2002 Pay only Pay, benefits, career, progression, and intrinsic work factors Pay, benefits, career, progression and their alignment with other intrinsic work factors Pay only Pay and benefits Pay and benefits Pay, benefits, and career progression Pay, benefits, and career progression Source: July 2003 SnapShot Survey “Measuring Return on Reward Investments,” Mercer Human Resource Consulting 13

21. Reward strategy: How are you making reward investment allocation decisions? External benchmarking Reliance on best practices among other organizations Employee surveys or other employee feedback Internal practices based on internal statistical modeling of workforce patterns Other Source: July 2003 SnapShot Survey “Measuring Return on Reward Investments,” Mercer Human Resource Consulting 14

22. Approach rewards based on today’s affordability and tomorrow’s ability to sustain cost strategy Balance pay rates and levels with productivity and results Continue to identify and reward top performers Make holistic decisions based upon your specific situation considering pay, benefits, and careers What we’ve learned Charles Sterling, Ph.D. San Francisco charles.sterling@mercer.com (415) 743-8960