We’ve gone through two tough years in compensation, and 2011 isn’t shaping up to be much better. And that means another year of tough questions from employees.

Teresa Murphy and David Wudyka have some ideas about how to make those conversations go as well as can be expected.

Murphy is the principal consultant for HR Partner Advantage, an independent Human Resources advisory firm based in Raleigh, N.C. Wudyka, SPHR, MBA, BSIE, is the founder and managing principal of Westminster Associates, a Massachusetts-based human resource and compensation firm that specializes in pay, performance, and productivity issues.

They made their comments during a recent webinar sponsored by BLR®, publishers of this newsletter.

Three Critical Steps
To prepare for 2011, says Wudyka, HR departments should consider these three critical steps:

1. Know the compensation trends for the new year—across the country, within your region, and within your industry (as much as possible). In comp, you have to be scanning the market and analyzing surveys. You have to have the data to make good decisions. Ideally, you have a survey that gives information that is local and in your industry.
2. Decide up front how you’ll divide the available compensation dollars. Before you’re scheduled to allot and award any increases, make the broad decisions about compensation budgets.
   Some companies just divide up the budget, but others allocate funds differently across departments depending on the value of the function to the organization.
3. Prepare your managers and supervisors. Most of all, says Wudyka, prepare your supervisors and managers for dealing with tough pay conversations with their teams. You especially want to manage any unrealistic expectations your rank-and-file employees may already have.

Factors to Consider In Calculating Raises
Most U.S. employers consider one or more of the following factors in calculating and awarding pay raises to their workforces, says Wudyka:

• Performance/merit increases.
• Cost-of-living increases. Beware of this terminology, he says. If you are just giving an across-the-board raise, don’t call it a COL raise; if you do, people will expect it every year.
• Collective bargaining agreements. Of course, you have to observe the requirements of your CBAs. Also, take great care in negotiating 3 years out—it’s hard to tell what’s going to happen, Wudyka says.
• Local pay rates. Know where you are hiring your employees, he says. Some positions you’ll hire local, some regional, some, generally higher level, you’ll recruit on a national basis.

Beyond the “macro” factors above, also take into account the “micro” considerations of your individual employees. When they ask you “How much will my raise be this year?” you will have to think about these criteria, Wudyka says:

• The employer’s overall financial situation. No matter how much you want to give big raises, if the company doesn’t have the money, it doesn’t matter. Employees have to be sensitive to these realities, Wudyka says.
• The department’s or division’s “budget” for raises. As mentioned, you may want to consider allocating at varying levels, he says.
• The employee’s length of service.
• The employee’s qualifications. (i.e., the scarcity of certain talents in the labor market and the likelihood that the employee will be paid more for them elsewhere)
• How much other employers in the local area are paying for similar jobs. Again, it is necessary to monitor pay surveys annually, Wudyka says.
• What the employee requires in the way of incentives. Or what the company believes it can do.
• General economic conditions. The inflation rate, changes in the cost of living, etc.

Changing the Schedules For PAs and Raises
Some U.S. employers have reported that they are “solving” the problem by changing their schedules for issuing performance appraisals and raises.

By delaying reviews and raises past their normal annual time frames, they believe, economic conditions may improve to the point that they can issue higher-than-expected raises to their employees.

For example, instead of offering its usual midsummer appraisals and pay raises tied to the July-June fiscal year calendar, an organization might consider delaying those events until November or December and telling workers the reason for the delay.

Proceed with caution if you’re considering changing the traditional time frame for your reviews and raises, Wudyka says. Many workers may not appreciate the delay, arguing that they deserve whatever raises you can offer at the usual review times.

Also, you risk the appearance of being inconsistent in your compensation policies, and you could face negative fallout if you arrive at the new raise time only to discover the economy hasn’t improved substantially.

How to Prepare Employees For Disappointing News
Because the economic situation is well reported, many employees will be expecting disappointing news.

Here’s the number one piece of advice to prepare your workers for any unhappy surprises with their current pay and any possible raises, says Murphy: Communicate early and in full, explaining your pay policies thoroughly.

It’s surprising how many employees believe that their pay levels—and whether they receive raises, and how much—are completely arbitrary decisions by HR and by management.

Many employees use pay raises as their scorecard of how they are doing. If they get no information about the basis for compensation decisions, employees will feel disappointed and deflated, Murphy says.

That’s why it makes sense to explain your compensation practices—how you arrive at pay levels and pay raise decisions. Then employees will have a better understanding of delays or reductions.

What should you explain to your employees about your pay policies?

• Explain the company’s compensation philosophy and how it is driven by the business mission and strategies, the organizational design and structure, and the critical skills and people needed, Murphy says.
• Cover the role of job descriptions in delineating duties and responsibilities, determining exempt and nonexempt status, and facilitating pay comparisons.
• Describe the company’s pay ranges, including how they are determined, such as by market surveys, benchmarking, maintaining internal equity, and other factors.
• Help employees understand the competition by including salary and benefit comparisons.
• Present the organization’s total compensation (or rewards) package.
• Explain the minimum, mid-point, and maximum in pay ranges, and talk about the role of skills in placing employees in the range.

Wind up by discussing how salary increase decisions are made: on the basis of annual budget, prevailing economic conditions, and individual performance, Murphy says.

Employees who have a good understanding tend to have better retention, she adds.

Even after identifying the organization’s pay philosophies, structure, and practices, many top-management teams will resist communicating them. They won’t want employees to know what the pay grades and ranges are, lest they question the wisdom of the structure.

More important, shining a strong light on structure and practices is very likely to reveal at least one, if not several, instances of true inequity—cases where the guidelines have been bent or ignored to allow someone to be paid substantially more than his or her pay grade would allow.

The answer? Address such situations and rectify them, Murphy says. Continuing to coddle the individuals who’ve benefited from the inequities is less important than a comprehensive communications program regarding the company’s pay practices that will pay off quickly in greater overall satisfaction and better retention and productivity. (Meanwhile, those who were being paid “too much” don’t have to get pay cuts, just endure a suspension of raises until their pay rates are sufficiently in line with those in the same grade, Murphy says.)

Even if you decide not to share more details with your workers about pay policies, it’s absolutely critical that you train your frontline managers and supervisors in these policies.

Training Managers
Training managers and supervisors is your armor against lawsuits, says Murphy. They’ll take most of the hits, at least initially.

If supervisors aren’t prepared for the tough question, they can give a wrong answer that makes things worse. Employees assume that managers know what they are talking about. They’ll listen and they will pass on what they heard.

If your supervisors understand how pay levels are set and raises are determined, they can head off many uninformed complaints from their workers before those complaints fester and get out of control.

Often supervisors aren’t involved in the budgeting process, yet they have to respond to the tough questions.

Consider holding one 90-minute training session before compensation plans or allocations are public knowledge, Murphy advises.

Watch out for your managers, says Murphy. For example, they may try to arbitrarily move people to be exempt because there’s no money for overtime.

Most Common Complaints
Murphy shared her suggestions for handling the most common compensation complaints.

Complaint: “I’m one of your best workers!”

Honor the employee’s contributions, says Murphy, but don’t overdo it. Use concrete examples in your conversation to show that you do, indeed, realize how valuable this worker has been. At the same time, if the worker hasn’t honestly been that great an asset, don’t “overpraise” what he or she has done. Overly positive statements might come back to haunt you later if the worker files any sort of claim, Murphy explains.

Help the employee to understand that the situation isn’t a reflection of individual performance, but a reflection of the overall economy and state of the organization.

Be as upfront as you can if you’ve “maxed out” your ability to reward this employee. If you’ve done all that you can do to offer this worker a pay raise, make sure he or she understands (in dollar terms) how you fought for the money to offer a raise in the first place. (Example: If he or she got a raise that’s larger than two-thirds of the workforce, it’s important that this worker recognize how well he or she made out.)

You do want employees to feel that their contributions are appreciated. But you also want to be genuine, says Murphy—employees know when you are not.

You should have performance appraisals in place that will provide a basis for your discussion.

Accept that some pieces of recognition may not be possible. So, seek inexpensive ways you can recognize your people. For example, a newsletter is an excellent way to call out great performance with little outlay.

Explore nonmonetary rewards that might appeal to this employee and recognize his or her efforts. You want to have some of these in place—leave early, work on a special project, modest gift card—so you can use them when needed without breaking the bank.

Complaint: “I can’t live on what you’re paying me!”

You can’t fall into the trap where you are responsible for individual employees’ finances, says Murphy. Don’t assume any responsibility for the employee’s personal budget.

You can commiserate with him or her, emphasize that you did all that you could do to provide a raise, etc., but, at the end of the day, if you’ve done all that you can do as the employer, it’s the employee’s job to make his pay stretch or not, Murphy says.

Don’t say, “We’ll get back to bonuses next quarter” unless you really mean it—you’ll lose your integrity very quickly if you can’t live up to that promise.

Use the “times are tough all over” approach this year. Unlike other tough compensation years, the last 2 years have been a different period because all employees have seen the day-in, day-out media coverage about the economy—it’s obvious that employers and employees across the country are hurting.

Remind this worker that your organization is stretching dollars as much as possible to keep everyone on the job.

If this employee is truly someone you’d rather not lose, swing into retention mode right away, particularly in search of nonmonetary rewards or benefits you might offer to keep him or her.

Complaint: “I’m making less now than my direct reports!”

Often managers get trapped by this comment and respond without having the facts.

Confirm the accuracy of this claim before you do anything, says Murphy. If you have a supervisor who’s honestly making less than his or her direct reports—and there’s no business reason for the discrepancy—you could have a serious problem on your hands, especially if the supervisor is in a protected employment class.

If pay mistakes were indeed made, fix them as soon as possible. If you can’t justify the disparity, this may be a case where, indeed, you’ll have to come up with more money or better nonmonetary benefits to bridge the gap.

Point out any extenuating circumstances that led to the disparity. For example, if the supervisor’s direct reports earned more recently due to larger-than-usual commission payments, that’s a valid reason for the pay differences.

Don’t apologize. Here’s the reason, let’s move on.

By the way, says Murphy, you should be looking regularly at compensation so that these situations don’t stay unidentified for long.

If you feel uncomfortable by questions such as this, or put on the spot, don’t feel the need to give an answer right away. Just say, I hear you, let me investigate and find out. And then you must follow up and get back to them in a reasonable time, Murphy says.

Complaint: “I’ll have to start looking for other jobs!”

When you hear this one, decide up front if you’d like to retain this employee. Murphy says. If so, you can focus on meeting his or her pay demands, finding benefits changes or other nonsalary compensation to bridge the gap, or offering non-monetary improvements such as flextime.

Try to pin down exactly what this valued worker is seeking to stay on the job—you may be surprised many times to find that it’s not always about a huge pay bump, says Murphy.

On the other hand, if the employee in question is an average performer—or, worse, a “problem child” you wouldn’t miss—then threatening a departure may indeed be a positive development for you as the employer.

If so, try to defuse the immediacy of the threat until you can make plans as needed to cover the person’s absence—and try to control how much griping this employee may do among colleagues once your conversation has ended.

“You need to do what’s best for you,” is a good response.

Be on lookout for “viral” employees, says Murphy. They are the ones who try to bring everyone down around them. You want to stop this. Having a policy and enforcing it helps in these situations.

Complaint: “I want something else in place of my lost raise!”

Take a moment to reflect on the situation. Are demands reasonable? Is the employee a top performer? What does the employee suggest? Maybe he or she just wants to work from home one day a week.

Before you wheel and deal, decide if you’re committed to keeping this employee.

Explore nonmonetary benefits and rewards that will help make up the difference in a lower-than-expected raise.

However, keep in mind any precedents you may be setting. If this employee wins a nonmonetary benefit from you, for example, and then proceeds to brag about it in the break room, you could be facing a flood of similar requests from other workers.

Tips for Retention
Despite the tough economy, your very best employees will always have plenty of opportunity to jump ship for another job. Keep these ideas in mind to improve your chances of retaining those workers while the recession is raging:

• Stay professional just as you would with a client.
• Don’t hide the truth about what’s happening. Be honest about your organization’s current financial condition, and give your most valued workers as much detail as you can about why you can’t offer raises this year. If you hide things, they’re more likely than other employees to find out sooner—and they’ll blame you for it.
• Focus employees on future rewards. If you can offer these employees goal-driven bonuses, especially if they’re tied into revenue increases or cost savings, you’ll have a better chance of keeping them motivated—and, you’ll postpone the expense of the extra pay and tie it into your own bottom line.
• Spend extra time with your top performers. Train your supervisors, for example, to monitor the top performers’ morale and keep everyone posted on your organization’s financial progress.

Legal Issues
Because raises have been given like clockwork for years, people think they are owed them, says Wudyka, but generally speaking, U.S. employers are not lawfully required to provide pay raises to their employees.

Exceptions include federal, state, and local minimum wage requirements and any contractual obligations you may have in this arena (e.g., collective bargaining agreements, individual employment contracts that require raises).

Here’s a good rule of thumb to remember when making pay raise decisions that you feel might prove controversial or troubling for employees: Always have a very strong, defensible business reason for any and all pay decisions.

Here’s a short list of the most common legal issues that may arise in difficult pay raise situations:

• Changing work schedules, changing titles. These changes may be necessary or appropriate, but be careful that you don’t do something that voids an exemption. For example, a manager may take back certain decision-making responsibilities to help an overworked supervisor. In doing this, the duties that gave the job the exemption may have been taken away, Wudyka explains.
• Discrimination claims. Raises given (or withheld) in ways that discriminate against workers in protected classes or that have a disparate impact on them will give rise to claims. Identify alternatives (e.g., title changes, schedule changes) given in lieu of raises that have the same discriminatory or disparate impact.
• Collective bargaining agreements. Raises structured so that they violate CBA provisions, such as cost-of-living adjustments or automatic scheduled pay increases, will bring suits.
• Employment agreements. Highly compensated employees may have employment agreements that require an annual increase.

One Final Thought for Training
Make sure that your supervisors and managers understand that when troubling questions and issues come up in conversations with employees, always alert HR, says Murphy.