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Compensation and Benefit Trends in Central and Eastern Europe
In the ten years since they launched democratic and free market reforms, the countries of Central and Eastern Europe (CEE) have experienced tremendous change in all aspects of their economic life. During this period enormous regional disparities have surfaced in these countries that are frequently regarded - albeit wrongly - as a single homogenous region. 1998, for example, was the year when the five Central and Eastern European front-runners (i.e. the Czech Republic, Estonia, Hungary, Poland and Slovenia) started the accession process to join the European Union, and when the Russian economy almost collapsed. Russia's crisis, which dragged with it a number of its neighbours with economic difficulties (especially Ukraine and Belarus) also demonstrated how far Central Europe has developed since the collapse of the Soviet Union. The main concern was the impact the crisis was going to have on the European Union as this has become their main market.
The economic conditions and how they have transformed in this region undoubtedly have an impact not only on the corporations that do business there but also ultimately on the employees. How corporations then react to the economic changes and how this reaction is translated into Human Resources policies and programs is of particular interest to us and our clients. In this article, we will focus on how these changes are being reflected in the trends that can be observed in the area of compensation and benefits. These observations are based on benefits and compensation surveys and other research that Watson Wyatt has carried out during 1999 among companies operating in CEE.
Regional snapshot
Despite many years of consistent, substantial pay increases across all the countries in the CEE region, the pay gap between CEE and the members of the European Union is still large. This difference is put into even greater relief by the fact that the CEE countries border on the so-called 'high-pay zone' (EU countries such as Germany and Austria). Middle management or specialists for instance are still at 25-30% of the salaries of their counterparts in 'Western' Europe. One notable exception, however, is Russia where their salaries are higher. This is partly because Russia has one of the region's tightest job markets and is partly due to the curse of job-hopping of Russian employees. This phenomenon has become less pronounced in recent times following the wave of downsizing at the end of 1998.
CEE vs.EU: General Manager (A)
Nominal in US$ as of 1 January 1999
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Salaries of manual workers across the region are only a fraction of those in the EU, with direct comparison becoming all the more difficult when productivity differences are taken into consideration. The gap has been narrowing at the top of the structure: general managers' and senior managers' remuneration are reaching the levels of EU markets such as Portugal where pay levels are lower, but are at approximately 50% of the neighbouring high-paying EU countries (see diagram A). When the pay levels are adjusted for purchasing power this gap reduces.
Compensation trends
Generally speaking, salary increases in nominal terms are coming down thanks to decreasing inflation in most of the countries (diagram B). Russia once again is at the extreme of the spectrum. Our Russian compensation survey revealed that 66% of the companies surveyed did not increase salaries at the start of 1999 , 14% of companies chose to give a lower increase, two per cent a higher increase and 18% decided to reduce the salaries. The practice of hard currency linkage for locally delivered pay is disappearing in most countries, except for Russia and Romania and some other countries of the former Commonwealth of Independent States (diagram C). Interestingly, as a reaction to the 1998 economic crisis, around 30% of companies active in Russia took the initiative to denominate pay in local currency, at least for non-managerial personnel. Companies working in local currency are generally giving extra salary increases to compensate for the reduction in purchasing power. However, as inflation is lower than currency depreciation, this represents a decrease in relation to salaries measured in hard currency terms. The decrease in local currency value could lead to big changes in the salary landscape. For example, a company that was known as a high-payer that is now not linking salaries to a hard currency may move to the lower end of the pay range.
Ultimately, this will mean companies will have to take a long, hard look at their reward strategies and may well have to restructure them. With the growing maturity of both economies and labour markets in most countries of the region, companies have started refining their reward systems in the last couple of years. They are moving to broad-banded base pay structures and are beginning to seriously implement the 'pay for performance' principle. Salary reviews are being closely budgeted, HR professionals are using established pay ranges, and merit increases are being allocated individually on the basis of performance. The days when 'cash was king' now appear to be over. Employees in the main CEE markets are finally becoming aware of the total package, i.e. cash compensation, benefits and other non-monetary incentives offered by the employer.
Slowing salary increases (B)
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Both short-term and long-term incentives are being used on a growing scale: more specifically, annual bonus programs have high levels of eligibility (80% of general managers, 70% of middle management and more than 50% of professional staff are usually eligible). In general, the variable pay that is actually paid out (as a percentage of annual base salary) is similar to Western Europe.
There is also increasing focus on retention, at least for key employees. When multinationals entered the region a decade ago, the biggest challenge was to find capable staff in a market of scarcity. Today there is a growing pool of talented local staff, particularly in the more advanced markets where the crucial issue has become keeping this staff on board. In countries where market economies are deep-rooted (for instance Poland, Hungary, the Czech Republic, Slovenia and the Baltic States), a 'fair' salary has to be topped up by a package of other rewards, incentives and working conditions. Key motivators are cars, death and disability cover, medical benefits (particularly in Poland), company pensions and housing loans. An increasing emphasis is also being put on enhanced job satisfaction and non-financial incentives such as training. Substantial relocation benefits are more widespread in CEE than in the rest of Europe as local employees are reluctant to move from the capital cities to provinces, even when such a transfer would be rewarded by a dramatic career advance.
Stock option plans
Long-term incentives such as stock option programs are being observed in a growing number of companies in the region, especially in the fast growing hi-tech and telecommunications sector. Driving this change is the competition for experienced executive talent and the fact that stock options can help create an ownership mentality. This latter point is a particularly important issue for companies in emerging markets where, up until the 1990s, employees worked for state-run enterprises. Furthermore, stock options offer an excellent way to build more leverage into the pay package.
Hard Currency Linkage 1997/1998
% of companies
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From a recent study Watson Wyatt carried out for 25 high-tech and telecommunications multinationals operating in CEE, we found that companies are fairly democratic in providing long-term incentive programs. In fact, of the companies surveyed, 63% grant stock options to all employees. Whereas, restricted stock and other long-term incentive plans reserved exclusively for executives at higher levels of the organisation are rarely found in this region. The length of the minimum period in which the employee may exercise stock options is critical in terms of tying a person's interests to the success of the company. Most companies (60%) consequently use a phased vesting schedule, typically over four years.
To illustrate the impact of stock programs, diagram D shows the value of the stock covered by options at the time of grant. The 'investment value' is the amount of money that would have to be invested in order to get the same opportunity for gain on subsequent movements in the stock price.
We can see from diagram D that the range of values becomes larger as jobs increase in importance. In the Watson Wyatt system of Global Grades, 10 is a professional employee, whereas 18 is typically a general manager of the local subsidiary. The median investment value at grade 10 is approximately US$17,000, while at grade 18 it is US$143,000.
Diagram E demonstrates how these investment values relate to pay based on Watson Wyatt surveys in Poland. For employees at grade 10 who receive options, 71% of pay (at the median) is being granted on an annual basis. This percentage rises to 211% at grade 18. However, this does not mean that the employee receives this much benefit, as that will depend on the future growth of the share price. Based on accepted measurements for valuing stock, some very substantial sums are being added to the overall reward package of those employees lucky enough to receive options.
Changing benefits picture
Practice as regards provision of benefits is also changing rapidly in the CEE region. This too is being driven by the need to retain skilled, experienced workers and to attract the appropriate level of staff. An additional pressure on some countries is that of moving benefit provision more in line with western Europe in preparation for EU membership. The most widely provided benefits in the region are death and disability cover, as illustrated in diagram F. Over 60% of companies in Hungary, Poland, Romania and Slovakia offer death benefits.A disability benefit is offered by over 50% of companies in the Czech Republic, Hungary, Poland, Romania, Russia, Slovakia and Slovenia. These percentages have increased over the years as multinationals impose their global philosophies locally and employees start to expect these benefits as part of their total remuneration package. The most typical payout in case of death or total disability is two times annual base salary.
Benefit Plans (F)
% of companies
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In most countries, it is still rare for company sponsored, supplementary medical benefits to be provided by a majority of employers. The exceptions are Poland, Russia and Kazakhstan. In these countries, over 76%, 53% and 50% of companies, respectively, provide this benefit compared to only five per cent of Croatian companies. The prevalence of medical plans is better understood when viewed in conjunction with the general condition of the state health sectors in each country. Despite numerous reforms during the last decade, the situation has improved very little and demand for private health care has risen significantly as a result.
In Poland, this has been further fuelled by a new amendment to the Labor Code, which has been in force for the last three years. The code dictates that every company must perform pre-employment medical examinations and, thereafter, regular checks at specified intervals. Companies have therefore officially set up health plans to provide these compulsory examinations and the plans are thus considered as a tax-free benefit. The plans typically only cover outpatient care (specialist visits, medical tests and minor surgery); dental and optical services are not usually covered but are often offered at a discount to employees. Top management often get a major medical plan which includes family cover.
An area that is still slow moving but is generating a lot of interest is that of retirement benefits. Generally, fewer than 20% of companies offer retirement benefits with Hungary, Russia, Slovenia and Bulgaria at about 18% compared to one per cent in Lithuania and the Czech Republic. Needless to say, whilst companies in Central and Eastern Europe have not yet fully embraced the need to offer supplementary retirement benefits, this is changing. The increasing focus on retention coupled with reduced state provision makes retirement benefits an increasingly significant issue.
This issue will be further stimulated by the sweeping social security reforms in the region. Hungary introduced a three-pillar pension system at the beginning of 1998, and Poland has been following suit since 1 April 1999. Croatia, Slovenia, and Romania are planning to introduce three-tier pension systems in 2000, whilst Lithuania and Latvia are preparing legal frameworks for voluntary pension funds. The statutory pension funds in the Czech Republic, which until now have been scarcely used, will probably receive more interest in the future thanks to a recently approved amendment and, once again, a discussion focusing on more radical reform of the pension system.
Where next?
This brief tour of Central and Eastern Europe can only touch on the issues that will be relevant to a multinational with operations in the region. How pay and benefit programs develop will be a function of economic progress as each country endeavours to reach the norms of Western Europe. The days of regarding these countries as low cost manufacturing locations are gone. Each country has a skilled workforce that is becoming ever more sophisticated as contact with Western Europe and other regions of the world grow. Flexibility and innovation will be imperative if a company is going to be successful in retaining and motivating its employees.
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