Keep the Faithful

Is it better to cut positions or just salaries? . . . and carry the eight . . . wait, stop calculating and think of employee morale.
Magazine Contributor
5 min read

This story appears in the April 2002 issue of Entrepreneur. Subscribe »

Last summer, sales were slowing at ChatSpace Inc., a 25-employee technology company in Carlsbad, California. The company's corporate customers were holding back on purchases, waiting to see where the economy was headed. Although ChatSpace had a history of strong growth, by mid-July it was clear that the company wasn't going to hit its third-quarter projections. Two of its sales positions were eliminated, and by mid-August the company faced the prospect of making deeper staff cuts. But rather than go through further layoffs, ChatSpace went with a new strategy: Everyone took a temporary 10 percent pay cut until the company could get back on track.

"The 10 percent pay cut is roughly equivalent to two and a half people that we would have had to eliminate out of the group," says Eric Olinger, 37, president and CEO of the 3-year-old company. "There was no one we didn't need and didn't want to keep."

This attitude is a far cry from the downturn of 1990-91, when employers didn't waste time trimming employee rosters to cut costs. With all the money they've put into recruiting and retaining talent, however, laying off people hurts employers more today than it used to. So some are keeping their people by postponing or lowering raises, bonuses, base salaries and profit-sharing plans until their situations improve.

Cutting Up

The trend is already surfacing in the corporate world. A survey released in November by The Conference Board found that more than 40 percent of large companies planned to hold back on raises throughout 2002, and some had decided to reduce or eliminate bonuses and matching contributions to employee 401(k) accounts.

Even in this new employer's market, however, entrepreneurs fear taking this type of decision to their employees. When Olinger and his management team met with ChatSpace's staff to outline the reasons behind the temporary pay reduction and to explain the company's recovery plan, he expected employees to start looking for other jobs. But the reaction was better than he expected. No one left. "I was anticipating the worst, but people accepted it," he says. "I heard a few people talking about how [the pay reduction] was saving deeper layoffs."

Paying less can present challenges if you've got a structured performance plan in place, however. You'll need to look at any paperwork and manuals that would create "even a quasi-contract" toward benefits and pay, says Allan Weitzman, an employment and labor partner with Proskauer Rose in Boca Raton, Florida. Be wary of handbooks that don't reserve your right to alter pay and benefit structures. Also review any correspondence with employees that may have implied certain pay and benefits. "Even an offer letter can come back to haunt you," Weitzman says. Speak with your accountant and attorney before making any pay cuts.

The Big Payoff

A temporary pay reduction may have a quicker impact on the bottom line. "If you pay three or four months of severance, it's going to take you four or five months to actually realize the savings because you're continuing your business with a leaner work force and your payroll hasn't changed," says Bill Coleman, vice president of compensation for career Web site ChatSpace didn't see any cost savings from its two layoffs for at least three months, Olinger says. But the pay cut, combined with a reorganization of the company's marketing and travel expenditures, created immediate cost savings that helped the company remain profitable in the third quarter. "If we had not done the pay cuts, we would have run a loss," he says. With the pay cuts, company sales were a healthy $2.8 million last year.

So how do you explain a pay reduction to employees looking for the message behind the action? First, don't let it look like a punishment, and be fair across the board. Nothing's worse in an entry-level employee's eyes than knowing he took a pay cut while management is still receiving regular raises and bonuses. Management should take the same cut, if not more. Second, be honest about the market forces that are hurting your bottom line and how you'll work as a team to get salaries and benefits back to normal. Don't make promises that you can't keep, though. Saying that a pay reduction will only last 30 days when it drags on for months will damage morale. It's best to give yourself some flexibility. "Communicate with employees that we'll come back together [after a specified period] and tell you where things stand and what we expect to see at that point," Coleman says.

ChatSpace's 10 percent pay reduction lasted 45 days. While Olinger says the company is still "a little behind" where it would like to be with payroll and bonuses-it deepened the reductions on senior management salaries during the fourth quarter of last year-just getting employees back up to their original salary levels has been a "strong vote of confidence," Olinger says.

"The company didn't lose anything because of the salary reduction, and yet it expended less cash," Olinger continues. "That's always a good scenario."

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