In most companies, at some point in the next few weeks, the CFO will ask the Compensation Manager, “what’s the number?” What will the payroll budget need to be for next year?

Having been asked that number a few times in my career, I traditionally relied on the methods that, I think, most people in the position rely on. I would go to the big surveys, World at Work, Mercer, Hay, etc… and look at the various estimates based on geography, level (executive vs. hourly) and industry. That approach served me and my colleagues reasonably well but I think at best, it is inadequate.

Over the last couple of years I have attempted to refine my approach to that question. I am far from that refinement. Actually, I am still not even sure that the refinement is possible. Today’s posting however, will set out some of the things that I am thinking about. Maybe it will spur a thought for you, hopefully I will get some good constructive criticism of my thinking to help me improve.

Let’s set out some contextual information. Here is a great short article from the Wall Street Journal “Ahead of the Tape” column from Thursday July 3, 2008. It puts a great deal of data about the economy into a small space. (No need to read it; to get the rest of the post and especially not if you are not a Compensation Geek.) A few key words from Mark Gongloff’s column:

The Bureau of Labor Statistics releases June employment data Thursday morning. Economists figure nonfarm payrolls contracted by 55,000 jobs and that the unemployment rate fell to 5.4%, unwinding a bit of May’s half-percentage-point jump.

Weekly claims for unemployment benefits have risen to levels suggesting mounting job losses. The number of people on the dole for more than a week has risen to more than 3.1 million, the highest since February 2004. The Conference Board’s latest consumer survey showed that the percentage of individuals who worry that jobs are scarce is as high as it has been since December 2003.

This means workers don’t have much leverage to bargain for bigger raises. The Bureau of Labor Statistics measure of wage growth has decelerated. As of May, average weekly earnings of production workers were up 3.2% from a year ago, down from 4.6% in August 2006.

In recent decades, labor unions have lost power and companies have sent some jobs overseas and replaced others with machines. No hiring frenzy followed the 2001 recession, and there likely won’t be another one after the current downturn.

The downside of all this is that workers get squeezed: While their energy and food costs are rising sharply, their wages aren’t moving higher in step.

The benefit is that it is hard to get a wage-price spiral going in such an environment. That is one reason the Federal Reserve is hesitant to raise interest rates anytime soon.

So a few quick summary points:

1. Unemployment is up; payrolls are up (This seems like a contradiction but that’s the fact Jack. Some of this is that the number of people in each bucket is constantly changing. Also, some jobs PAY more and are PAYING more. The number of jobs is an independant variable from the amount of payroll in the economy.)
2. Housing has not yet hit bottom
3. Energy prices are through the roof - “Energy” in this context is a euphemism for “everything”. Everything requires energy to move it through the system. Especially food which is now under enormous pressure from energy cost, natural disaster (that was Iowa you saw under water my friend) and the fact that we now use corn not just for the Pop but for the Sugar too; we use corn as a universal sweenter; for gasoline; and for biodegradable plastic.
4. Weak Dollar - our exports are cheap and are increasing demand for what we make. What do we make? I think that we make high-end, highly engineered, sophisticated stuff. Stuff that factory workers with college educations, computer and math skills make using robotic technology. In short a medium to high education workforce using capital intensive infrastruture to make high margin equiptment (think contruction equiptment)

A video overview from the Journal and MarketWatch “Parsing Unemployment” is available as well. It is excellent and if you have 3 minutes, I suggest you watch it.

So - what does all of this mean for our weary Compensation Manager. Here are my questions. I am not going to necessarily apply them to my situation but will offer the generic analysis that hopefully shows the value of the questions.

•  What parts of my workforce are seeing wages go up and wages go down or stagnate? In other words, payrolls are going up but the the negotiating power of many workers is going down. What part of my workforce is in high demand positions and which workers are essentially in competition with off shore workers, machines and higher economic priorities (i.e., Starbucks announced this week that they are closing 600 stores. Those workers are not so much competiting with Dukin’ Donuts workers, or Saxby’s workers - they are competing with the people at the local gas station - luxury vs. staple.
• What is happening to the stuff we sell? Is it in demand? will it be in demand? Will people pay more for it? Think about coffee and gas again - prices go up people typically will use less. The decision about which to use less of faster has to do with the utility and value of each on the margin. I am guessing people will give up fancy coffee before gas at some point. Which catagory does your product or service fall into?
• With prices going up your workers are going to complain that they cannot maintain their standard of living with out more wages. Are you willing to leverage their inability (if it exists) to find another job to stare them down. (For the record, I am not talking about explotation of workers here or about opportunistically taking advantage of your bargaing position just to maximize profits. I am talking about some businesses in this country looking a enormous downturns and for some viability - car manufacturers and their suppliers; financial institutions, housing related products and services, travel and transportation. These companies need to make hard decisions about costs. I am asking you if you are willing to aid your executives in facing reality enough to ask yourself about staring at employees and saying “no.”
• Related - where will your workers look to go if they were to leave you and what are the prospects in that micro labor market. What is the next best substitution that a worker would have to working for you?
• Can you see your way to productivity gains? (This is not a post about talent mangement - there is a lot of talent management issues to deal with off of this same context.) Will the way of doing business or the business model change in the near future sufficient to warrant a play on wage increases tied to it?
• Can you stratify your workforce and differentiate your merit budget? Do you have high turn over at lower levels (if you do I bet it will slow - will that increase the burden on your merit budget? Is it an opportunity to lower starting wages - even temporarily in order to create dollars for your longer service workers whose wages you need and want to continue to increase? Again, this is not about talent management but can you have more focused increases for the most valuable workers within a strata?
• Do you understand the downstream implications of wage increases? Benefit costs tied to wages? Employer paid taxes? Cash flow demands in the coming months and year?

This post is too long already. So let’s jump to just one possible script that a Comp Manager might use.

“I looked at the surveys like we usually do and the market information here in the South, for hourly workers is about 3.5% projected for 2009. Normally I would have told you Ms. CFO that we should be at 3.5% too in order to stay competitive with the market. However, I have some thoughts that I want to run by you. As you know we have three major hourly work groups - the call center staff, the delivery and warehouse staff and the service technicians themselves. Instead of one merit number for all workers like we usually do, I think that we need to examine each group seperately. The call center is a rarity in these parts, many companies are still using off shore resources and even if they aren’t this are our lowest skilled positions and those with the highest availablity of other workers. I see that employment numbers on the state unemployment office web site show county unemployment is up .2% with new claims being higher than any time in the last 6 years and the newspaper call center is droping its second shift to boot. I think we use 2% for them. The delivery and warehouse group are in a similar situation but next year the implementation of the new robotic pick and pack equiptment and the new computers in the delivery trucks are coming on-line. We need a higher skill set in that workforce; some of our people are already not going to make the transition and will be reducing headcount by 10% due to productivity. I recommend that we bifrucated merits there next year. Give a modest increase now; offer a $500 retention bonus timed with the implementations; see who survives then give a modest 1.5% adjustment at that time. Of course, the 1.5% because it will be 3/4ths of the way into the year will only be effectively about .85%. And for the technicans, these guys look a lot like the folks that are being hired into the BMW/GE/CAT/HPMedical plant over in Springfield. I see that the plant is adding a second shift because the weak dollar is making their engines more attractive in the Middle East and China. At the end of the day, these folks have the customer contact, the IP, and the best prospects - I think that we go with 3.75% and also some education about giving them an above market increase.

I think that this is an important environment for HR/Compensation professionals to “get their market player on”. We are market players in that we need to understand the availability and market clearing price of labor. We need to be market players standing as part of management to get our expense structure adjusted for changing market conditions among our customers and investors. Imagine how differently you would be viewed if you shifted the conversation with the CFO from “here’s what our labor will cost”, or worse, “here’s what I think we give them” to, “here’s what I think we should pay and why”. You are also a direct market player in multiple labor markets - they are constantly changing and they are more complex than “3.5%” might indicate.

Has HumanMarkets lost the “Human” in lieu of the “Markets” in this long post? Maybe. But I don’t think so and I hope not. Your organization needs to be sustainable. You are not a charitable organization relative to being an employer. That is not to say that you can’t share the pain, or lower profits in order to preserve jobs or wages and the like. All I am saying is that understanding the market conditions and implications of your decisions makes you better.

 Make sense? Is this all just obvious? Is it really a refinement? Suggestions?