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Compensation & Benefits in South Africa

Compensation & Benefits in South Africa

Is an inflation allowance justifiable?

When there is a sudden increase in inflation, one of the acceptable, well established and dependable Rewards tools available, is the introduction of an inflation allowance (“IA”). The salient advantage of an IA is that it does not increase fixed employment costs in perpetuity; rather, it recognises that the current high inflation rate is temporary and transient.

The mechanics of an IA are simple:

One elects a base inflation rate. For example, 6.0%.

If inflation this month is 6.8%, the employee will have a 0.8% IA added to their basic salary or cash component where a TCTC approach is used.

The IA is paid in that month.

When the inflation rate falls to 6.0% or lower, no IA is paid.

The question now arises whether an IA is justifiable in South Africa. In order to interrogate this question, we need to examine both actual and forecast inflation; the table below details known inflation in black and Axiomatics’ forecast in red:

Represents actual inflation

Represents Axiomatic forecast

Cognisance must be taken of the fact that when most companies determined the 2022 salary increases at the beginning of the year, inflation was 5.7%. However, the consensus at the time, including the forecast by the Monetary Policy Committee (“MPC”), was that inflation would drift down during the year and average between 4.5% and 5.0% for 2022. Adding the “new normal” real increase of 1.0%, many companies granted salary increases of between 5.5% to 6.0% for 2022.

The table above clearly illustrates that inflation did not fall and continued its upward trajectory to reach 7.4% in June 2022. Our forecast average inflation rate for 2022 is 6.6% which is closely aligned with the MPC’s forecast of 6.5%.

Assuming we are correct, essentially this will mean that employees will receive a negative salary increase in 2022 of (1.1%) if a 5.5% salary increase was granted or (0.6%) where the employee received a 6.0% salary increase.

There is little doubt that employees in South Africa are under severe pressure to make ends meet. A Household Affordability Index, compiled by the Pietermaritzburg Economic Justice and Dignity Group in July, highlighted the rising cost of food in the country.

transport costs are increasing due to fuel hikes, as are electricity prices – up more than 9% in some areas – which has eroded the food budget.” He stated further that “…the rising cost of living is not only a burden on those living on the breadline, with middle-class South Africans also struggling. And it is likely that if the current interest rates trajectory continues into the next year, that many households currently in the middle class will more than likely drop into the lower-income bracket.”

The Program Co-Ordinator

The Great Resignation

The Great Resignation is no longer an esoteric term coined by Texas University’s, Anthony Kotz. It is real and it is here. The pandemic has meant that many employees have been working remotely and this has afforded them the rare opportunity to revaluate their lives, priorities, values, circumstances, career choice, and most importantly, their employer.

While the number of resignations in the US and some other developed markets is alarming, South Africa has not escaped the Great Resignation – several of our clients have expressed concern that staff turnover is at record levels and they are struggling to attract and recruit top talent. US Labour economist Lawrence Katz calls the Great Resignation “a once-in-a-generation ‘take this job and shove it’ moment” – which gives employees a once-in-a-generation upper hand.

Given employees’ tenuous financial position, the Great Resignation, and the fact that employees, in general, have received a negative salary increase this year, we are of the opinion that employers should consider introducing an IA.

We would further suggest that a base inflation rate of 6.0% be used. The IA would thus only be paid if inflation is greater than 6.0% and the amount of the IA would be the difference between the latest inflation rate and 6.0%.

If our forecasts in the above table are correct, then:

The IA will be paid from the current month until May 2023. For a period of 11-months.

The average monthly IA paid, will amount to 0.9% monthly over the 11-month period.

This allows Finance to formulate some indicative budgeting and or costing.

The introduction of an IA will bolster, augment and improve the Employee Value Proposition (“EVP”). Employees will realise (and appreciate) that the employer understands the increasing cost of living pressure and is prepared to assist. This decisive action – ensuring employees do not receive a negative salary increase- will hopefully furnish the company with a tangible Return on Investment because it will reduce staff turnover, improve the EVP and mitigate the high cost of recruiting new employees. Further, it may facilitate higher productivity.

In addition, from the employer’s perspective, the mechanism ensures that high fixed employment costs are not entrenched in perpetuity; rather only some temporary relief is afforded to employees.

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I’m coming to poach your Top-Talent

I’m coming to poach your Top-Talent

In April 2021, 2.7% of employees in the United States left their jobs. This represented a significant increase from 1.6% the previous year and is the highest level for almost two decades. Equally alarming, a Prudential Financial Inc survey of 2,000 employees conducted in March 2021, indicated that 25% of US employees plan to actively look for a role, in the short term with a different employer.

Why? What is causing employees to actively look for a new job?

Covid-19 is the obvious answer. The pandemic has resulted in employees re-imagining their lifestyle, re-examining their current job and benefits, re-focusing on their career path and re-considering where they want to live and work. Millennials are more likely to be considering these questions.

Remote working has furnished almost all employees with the opportunity to work from home. Initially, a work life balance was thought to be the advantage of remote working, but employees have since discovered that they are probably working longer hours. However, what this has demonstrated, is that remote working facilitates flexibility. A mother can now go to a child’s piano recital; although it probably would mean that those hours must be caught up in the evening.

All, or most, employers are grappling with the “back to the office” question and while the current consensus is to introduce a hybrid solution, this may not suit all employees. Some may want to work from the office full time, others may want to work 100% remotely- a dictatorial approach by the employer will lead to an exodus of top talent.

Importantly, the ability to work remotely has widened the talent selection pool for employers. A company in Dubai is thus no longer restricted to hiring from the Dubai talent pool but can now cast a global net. The corollary to this is that the competition for your talent is no longer restricted to Dubai companies but rather competitors from anywhere- Kazakhstan to the British Virgin Islands to Malta. Beware: they are coming to poach your top talent.

Jonas Riddestrale and Kjell Nordsrom in their book Karaoke Capitalism, identified a frightening trend -

“The talent market does not operate like markets for raw material. Competent individuals are unique and different. Economists would even describe the talent market as imperfect.

Power is now in the process of being transferred from the owners of financial capital to those in control of intellectual capital. In the gold-collar niche of the labour market, firms may end up as price-takers-being forced to accept whatever fees or salaries talented men and women suggest.”

Unfortunately, there is no panacea, magic bullet or one-fits-all scheme which can be implemented to retain your top talent. However, one thing is certain; we have moved from the “Normal”, past the “New Normal” and are entering the “Next Normal” phase where we must change our preconceived long-held ideas and adopt an agile HR approach. Also, you must accept that talent is a crucial catalyst to unlock your competitive advantage and ensure financial success post the pandemic.

When considering retention mechanisms, the entire Employee Value Proposition is important but what is even more vital, is to anticipate the trend and immediately start implementing retention tools/ schemes for your top talent NOW – certainly before your competitors do.

Once again, there is no generic magic bullet scheme applicable to all companies but whatever you chose, it must:

identify your top talent. Not the talent from your old business model but rather those employees who will be crucial in building your business in the post-Covid business environment.

Whether the retention policy includes short- or medium-term monetary schemes, or a flexible remote working policy, it must be crafted to align with the strategy and financial constraints of the company; and

be designed in an adroit manner to act as a motivator which boosts productivity and concomitantly profits, while at the same time, effectively retaining your valuable top talent. And of course, prevents me and your global competitors poaching your top talent.

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UAE Short-Term Incentives (STI)

UAE Short-Term Incentives (STI)

Psychologists Argument

Alfie Kohn in his seminal article in the Harvard Business Review entitled “Why Incentive Plans Cannot Work” stated:

It has been “shown over and over again [that] the more you reward people for doing something, the more they tend to lose interest in whatever they had to do to get the reward”.

“Incentives…do not create an enduring commitment to any value or action. Rather, incentives merely – and temporarily – change what we do”.

“As for productivity, at least two dozen studies over the last three decades have conclusively shown that people who expect to receive a reward for completing a task or for not doing that task successfully, simply do not perform as well as those who expect no reward at all”.

Frederick Hertzberg famously stated that just because too little money can irritate and demotivate, it does not mean that much more money will result in satisfaction and increased motivation.

Economists Argument

Economists however disagree and postulate that the salient function of incentives should be to increase the productivity of the activity.

Jenkins when formulating his article “Financial Analysis” studied 28 previously published studies and found that 57% had in fact had a positive effect on performance but only when the performance measures were quantitative in nature, such as producing more of something and/or faster. The take-away from this is that STI performance targets must be quantitative – achieve an EBITDA of X or revenue of Y.

We have been saying this for years – any goal, objective or performance condition should have a calculable return on investment (“ROI”) and be “self-liquidating”; where the cost of the incentive represents a percentage of value added for the company.

Prendergast in an article entitled “The Provision of Incentives in Firms” found that there was empirical evidence that the use of incentives improves performance.

Edward Lazear in his article “Performance Pay and Productivity” examined the impact of a change from fixed salaries to piece-rate compensation in an auto-glass factory. Productivity soared and output per worker was increased by 44%.

Axiomatic’s View

Considering the conflicting opinions elucidated above, we feel that we need to declare our position.

An appropriately designed STI scheme will support and reinforce a high-performance culture and encourage ethical behavior consistent with the company’s values. However, the risk-reward must be balanced where the scheme is structured in such a manner that it incentivises the employee to promote sustainable long-term growth, without encouraging excessive risk taking or a short-term parochial focus.

The scheme should be designed with a view of encouraging recognition and strengthening the psychological engagement with employees, while at the same time, providing top talent with an extrinsic monetary reward for their hard work and dedication.

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Long-Term Incentives (LTI)

Long-Term Incentives (LTI)

Over the last few months, several exasperated clients have expressed difficulty determining new grants for their Long-Term Incentive Schemes

Without being inane and stating the obvious, LTI is a vital component of your Employee Value Proposition (“EVP”) and influences the company’s ability to attract and retain talented individuals, introduce a high-performance culture, and ensure the attainment of the company’s strategy- ultimately resulting in increased profitability.

Let’s examine a few truths about current LTI schemes extracted from behavioral psychology:

The most important observation from behavior psychology is that executives are prone to hyperbolic discounting. Assume I was to receive $100 in 3 years. The present value (the value today) should simply be the future value discounted by the risk-free rate applicable in that country – as a global average this would probably be around 5% per annum. $100 would then be worth $86.38 today – a discount of 14%. Executives however discount the $100 by almost 50%.

Executives are risk adverse and prefer a smaller guaranteed amount to a possible bonus of higher value.

Inclusivity Recognition Need – in various surveys, only 50% of executives state that an LTI is an effective incentive but 66% stated that they valued the opportunity to participate in such a scheme.

LTI’s have always been proposed as the ideal vehicle to address Agency Theory which states that by bridging the divide between the executive and company, this will ensure that both are working towards a common goal and the implication is that both will strive to increase the long-term value of the company.

However, various studies have shown that there is LITTLE correlation between LTI schemes which are designed on the Agency Theory methodology and/or incorporate the agency philosophy, and the share price. If shareholders do not receive the benefit of a higher share price, why have an LTI, in its current format, at all? Professor Alexander Pepper in his article, “The Case against Long-Term Incentive Plans” which was published in the Harvard Business Review, October 2016 issue states

” My research suggests, somewhat perversely, that companies would be better off paying larger salaries and using annual cash bonuses to incentivize desired actions and behaviors. Additionally, they should require leaders to invest those bonuses in company stock (or should pay the bonuses in the form of restricted stock) until a certain share of leaders’ net worth, or some multiple of their annual salary, is invested”

We would contend that the following incentive scheme design could be an option:

1. Short Term Incentive (“STI”) scheme

50% of the pay-out would be subject to a short deferral period.
The remaining 50% would be paid into the Long-Term Incentive (“LTI”) scheme.
The employer would double the employee’s payment to the LTI.

2. Long Term Incentive (“LTI”) scheme

No other LTI scheme would be introduced other than the vehicle to house the deferred pay-outs from the STI.
The employee would receive growth in the share price (or other measurement criteria) on both the employer and employee amounts in the LTI from the outset.
Vesting and exercise of the LTI are only permissible 1 to 3 years after the executive’s last day of employment.
Additional conditions could be introduced to allow the executive to partially exercise if a minimum holding requirement is exceeded.
The design ensures that all decisions taken by the executive are based on long-term value creation.
Negates the temptation to implement short-term initiatives which may boost the share price in the short term, but which may not be a driver of long-term value creation.
Aligns the design of incentives with the principles of Agency Theory.
Reduces the occurrence of hyperbolic discounting given that the value is not some intangible possible future amount but rather the quantum is known.
One of the issues which may be raised by executives (and especially CEOs) is that the actions of the new CEO may lead to a decline in the share price.

This methodology will ensure that adroit succession planning is done. The outgoing CEO will know that the actions of the new CEO may affect the value of his LTI and thus the new incumbent will be subject to a stringent and robust selection process; and
Further, so often a new CEO is appointed and writes down the value of assets. The suggested methodology will ensure that a “clean balance sheet” is left.
Clawback provisions seldom work. The computation of a clawback is fraught with difficulty and will often involve significant legal costs. This methodology has an in-built clawback and allows the market to determine the clawback and further, aligns the clawback amount with the interests of shareholders.

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South Africa Projected Salary Increases 2022

South Africa Projected Salary Increases 2022

Has the dreaded E-mail arrived yet?

You know the email that strikes fear into all HR colleagues…

And this year, it will be even more difficult to formulate an equitable salary increase which solves the dichotomous problem of

The best way of providing Mike with an accurate and equitable salary increase for 2022 is to formulate the forecast percentage in a scientific manner; one which is both logical and defensible. We will take you through the necessary steps.

Salary increases are implicitly linked to inflation; where inflation is one of the most important determinants when deciding on the amount of the salary increase. Our employees want to retain the same purchasing power with their earnings year on year.

The departure point is to forecast future inflation rate

The table alongside details South Africa's historic inflation rate (in black) and Axiomatics' forecast of future inflation (in red)

Our inflation forecast is slightly higher than the South Africa Reserve Bank’s (“SARB”) forecast of 4.2% although the SARB did state at the September 2021 meeting that, “The risks to the short-term inflation outlook are assessed to the upside”. We are a little concerned that even our higher forecast may be too low given rising global producer prices, the supply chain constraints, food price inflation, higher oil prices, electricity and administered price increases, higher domestic import tariffs, and union demands for higher wages.

This is to establish the possible quantum of the “real increase”. A real increase is defined as the increase after inflation has been considered. As an example, if the salary increase is 6.0% and inflation is 4.0%, then a 2.0% real increase has been granted. The table below illustrates the average real increases granted by South African companies over the last 15 years.

The historic methodology adopted in South Africa, when determining an equitable salary increase in the past, was to add a 2.0% real increase to the forecasted inflation figure. However, there has been a discernible trend over the last few years of lower real salary increases being granted. This assertion is corroborated by the 5-year moving average in the graph above, which has been steadily declining in recent years from 2.0% to 1.2%.

A 1% real salary increase is the "new normal"

4.4%

2022 Inflation

1.0%

2022 Real Increase

5.4%

2022 Salary Increase

The above is a scientific and quantitative derivation of the percentage. Before firing off the email to Mike, qualitative factors must now be considered…

StatsSA announced that the weights of the CPI components will be updated in the January 2022 CPI which will be released in February 2022. The current weights were last adjusted in January 2017 and the revision to inflation may therefore be significant.

This year, and perhaps more than in the past, the granting of salary increases will be dependent on financial affordability.

1. Some companies have experienced boom trading conditions during the Covid pandemic; for example, online and tech-based companies where significant real salary increases are being considered to retain staff in an increasingly competitive labour market segment;
2. Other companies remain in a perilous financial position where any salary increase is just not feasible;
3. Diverse salary increases will be granted, and one must concomitantly be careful of salary surveys. Companies in a. may grant a 7.0% increase while companies in 2. may grant 1.0% – this does not mean that the market, in general, is granting an average 4.0% salary increase.

Even though unemployment is 34.4%, many companies report that they are struggling to attract and retain talent. Further, several of our clients have stated that their staff turnover in 2021 is at record levels. This is not a local phenomenon – in April 2021 in the United States, resignations were at the highest level since 2000. This has been attributed to workers reaching a breaking point after months of high workloads and pressure.

In addition, employees are rethinking their work and life goals and their future career paths.

The scientific salary increase formula derived a rounded 5.5% salary increase for 2022 however, given the qualitative factor review and especially when considering the ability to attract and retain talent, who will be crucial for the future growth of companies, our 2022 salary increase forecast is:

6.0%

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