Most companies treat benefits as a cost of doing business. They should see them instead as a competitive weapon.
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As the bill for US health care mounts, companies struggle to reconcile their need to offset the rising cost of employee benefits with the desire to attract and retain the best talent. Some engage in an arms race of sorts, blindly matching or beating the benefits offered by competitors and spending billions of dollars in the process. Yet these benefits often fail to reflect either the preferences of employees or corporate objectives.
A few companies, however, are changing the game. Emerging best practices are reducing the cost of benefits by 10 to 20 percent a year, keeping employee satisfaction steady—or better—and linking these expenditures more tightly to corporate objectives, particularly investments in talent to gain competitive advantage. Such investments are increasingly important to the profitable growth of the world's most successful companies: from 1995 to 2005, profits per employee jumped to $83,000, from $35,000, and the number of employees more than doubled.1 Benefits represent a major part of that outlay: US companies spend more than $2 trillion on them each year, but though the cost of health care in particular is on the rise, companies aren't scrutinizing benefits as closely as they do other investments.
Benefits are much more than just a cost of doing business, even though many executives don't understand that. In many companies, the chief financial officer hands down a cost goal for benefits each year, and then the HR department works to meet it. In the end, business unit leaders get stuck with increasingly expensive benefits without understanding what they get in return.
We advocate a much more active approach: employers should tailor their investment in benefits to the preferences of their employees, as some leading companies do already. The same sophisticated market research tools companies now use to launch products and services ought to be used to define employee "customer" segments. Benefits packages should then be tailored and marketed to them accordingly. This approach, balanced with return-on-investment (ROI) objectives and rolled out over several years, will help companies meet their increasingly vital need to offer knowledge workers higher rewards while minimizing the cost of employing a large frontline workforce.
Treating Employees As Customers
When buzz about a potential change in benefits makes its way through employee networks, they often respond with anxiety and consternation. Companies should approach them with the same caution that consumers get, using market research to understand the workforce, segment it, and gauge its responses to potential changes. When a company tinkers with benefits, it should "brand" the adjustments with themes that research shows are important to employees. Then it should aim those themes at relevant employee segments and actively address the concerns of people who will dislike the changes, while also emphasizing the positive ones that other segments will applaud.
These efforts should take the form of a marketing campaign, similar to what the company would use to launch a new product, that emphasizes aspects of change employees will value. E-mail, the Web, mailers, and company newsletters ought to explain, in simple language, the nature of the changes, their rationale, and the improvements they will bring. Such communications should also directly address things that certain segments of the workforce may dislike, balancing these changes with the positive ones dictated by the preferences of the majority. A benefits "hotline" (on the telephone, the Web, or both) lets employees ask questions and voice concerns. This important tool helps the company to get real-time reactions and to identify and lubricate squeaky wheels.
Such an approach is particularly important in union environments. One heavily unionized manufacturer, for example, is marketing its benefits with the theme "empowering you to better manage your health" through new nurse hotlines and increased preventive-care coverage. Its marketing campaign appeals to that large segment of employees who value broad health care services above all other benefits. When negotiating with unionized locations, the company's leadership, understanding that the largest segment of union members values higher take-home pay more than rich benefits packages, emphasizes the point that soaring benefits costs make it harder to raise wages.
These principles can be applied in nonunion environments as well. A major transportation company, for example, launched an effort to save more than $100 million a year, in part by cutting its annual spending on benefits by 10 to 15 percent. One element of its plans—a dramatic cut in retirement benefits—stood to upset employees greatly. Research into their attitudes showed that although this move was extremely unpopular, the more they knew about the overall package, the more satisfied with it they were. Furthermore, the research revealed that most of them didn't realize the richness and breadth of the benefits offered. The company used these insights to plan a broad campaign to educate the nonunion workforce on the virtues of the package. It also added several low-cost benefits, which allowed it to cut others, to save money overall, and to minimize employee dissatisfaction.
A benefits package should be marketed not only internally but also externally. Well-handled benefits changes can help a company that has a large presence in a community to strengthen (or establish) a position as an employer of choice. Handled poorly, such changes can enrage local activists and legislators.
Benefits through the ROI Lens
Companies should see benefits as an investment in their employees, with the aim of motivating the workforce to realize and even exceed their objectives. Those that redefine benefits in this way, instead of treating them as a cost of doing business, stand to gain a significant competitive advantage in attracting, motivating, and retaining the best talent.
An effective benefits strategy engages the chief executive officer, the top team, and, in some cases, the board in an effort to identify the ROI objectives of benefits spending. These objectives vary by company but typically include elements such as the productivity and well-being of employees, talent management, community perceptions, union relations, and costs.
Demonstrating a strict cause-and-effect relationship between the investment in benefits and the return is difficult at best and often impossible: many variables are involved, and the payoff lags behind the expenditure. But developing some kind of quantifiable estimate of the ROI of benefits is much better than no estimate whatsoever—the current standard in most companies, according to a recent survey of employers.2
Such metrics and goals can, for example, help companies to assess the general effectiveness of their investments in benefits over several years. Employee satisfaction is measurable through annual surveys. Likewise, management can define targets for productivity (for instance, health-related absence days per employee) and for retention (say, the turnover of important employee groups).
Like metrics for benefits, benchmarking may have to be rethought. One major industrial company's approach to benchmarking, for example, was raising its costs, lowering the growth of wages for its unionized employees, and making them less satisfied to boot—even though it actually offered above-market benefits. Recognizing the problem, the company's executives established a clearer objective for its investments in benefits: supporting and rewarding efficiency. They also engaged the union's leaders in a dialogue centering on the fact that the company's total compensation was a relatively stable share of its profits and that over time, the mix between salaries and wages, on the one hand, and benefits, on the other, was shifting toward the latter. The union's leadership had previously understood neither this game's zero-sum nature nor the linkage to corporate profitability. Through these discussions, the union got a better sense of the company's constraints and objectives, of the preferences of its members, and of the failure of past negotiations to obtain the best result for the union, its members, and the company alike. Now the discourse revolves around these factors, with advantages for all parties—lower costs, better labor relations, and higher productivity.
Productivity also turned out to be the problem when another company, this one with both consumer and industrial offerings, reviewed its benefits. Executives noticed that the ongoing salary it gave employees with short-term disabilities seemed to make some of the beneficiaries less motivated to return to work and therefore reduced productivity. Research also showed that when the company cut back its prescription drug benefit, it made its workforce not only less satisfied but also less productive: the remaining weak prescription benefit discouraged employees with chronic conditions from diligently complying with their drug regimens and thus led to complications and absences down the road. By eliminating less valued benefits, such as the disability payments, and focusing on worthwhile ones, such as prescription benefits, the company stood to improve its employees' satisfaction significantly while also cutting its costs.
A Multiyear View
Armed with this kind of useful information, companies can formulate clear objectives for their benefits, predict which their employees will probably want, and develop a multiyear plan to implement a strategy. Most companies, by contrast, follow a piecemeal yearly "keep up with the Joneses" approach that has the effect of shifting compensation from the more flexible salary and wages to the less flexible benefits, and as a result it is harder for employers to reward individual employees for their performance differentially. In view of the increasing importance of attracting and retaining top talent, this issue should get much more attention than it has.
The precise multiyear strategy will depend on a company's priorities, as well as its financial situation, relationship with employees, and reputation among prospective hires. Given the annual open-enrollment cycle for health care benefits, such a plan typically covers three years and rolls out changes incrementally in each of them. Full, annual run-rate savings are usually realized by the end of the second year.
A staged, multiyear approach can be desirable for other reasons as well. One major packaged-goods company, for example, was about to introduce a benefits plan that placed more responsibility—both financial and decision making—on its employees. The company realized that the changes were likely to upset them, because research showed that they were risk averse and poorly educated about health care. It therefore decided to phase in the changes, so that employees would have time to learn more. The first stage of the process involved relatively small changes, such as the introduction of plans with a higher deductible and of financial incentives to increase their attractiveness. As employees become more comfortable making their own health care decisions, the company believes, it will be able to roll out more substantial changes, such as health savings accounts and health reimbursement accounts.
By James Kalamas, Paul D. Mango, and Drew Ungerman / McKinsey Quarterly
