Paying for differences

The gap between pay levels and cost of living is ever apparent for companies
moving people around the world. Friction can arise when expats and local staff
work together on very different packages. Rob Outram reports

It was late 2000 and student representatives – "tomorrow’s
leaders" from around the world – had gathered for a conference in
Edinburgh, Scotland. The keynote speaker, the chief executive of one of the
biggest IT and management consultancy firms in Europe, was telling them they
were valuable people. The war for talent was the biggest challenge facing
global corporations, he said.

But one of the students – from Lima, Peru – disagreed. "In my
country," she said, "medical and engineering graduates are waiting in
restaurants and driving taxis. There are just not enough jobs for qualified
people."

It was a salutary lesson that conditions in developed, wealthy economies do
not represent a universal way of life. Pay levels and the cost of living vary
widely. These stark differences become an issue for companies operating
globally when they move people around the world. Pay differentials can make it
harder to persuade employees to go abroad on assignment, or they may make it
hard to bring them home. They can also create friction when people working
together, notionally at the same level of responsibility, are on very different
packages.

Jeanne Poole, vice-president, global compensation and benefits at
multinational telecoms company Acterna, says, "It can depend on the
employee. Is this a global employee or a short-term assignee?

"If it’s the latter, it makes sense to keep them in their home country
pay structure – although some companies would switch people onto local
pay."

As Carolyn Gould, an international compensation specialist at professional
services firm Pricewaterhouse-Coopers explains, "More and more companies
are sending people around the world to meet general staffing needs, not
specific strategic needs. In that case the most common approach is local levels
of pay, with allowances."

Expats expect to be well rewarded and compensated for any extra costs and
hardships associated with the move. When the move is to a country where pay is
much lower, that can create friction with local staff.

Lance Richards, former director, global HR of Teleglobe Communications
Corporation, based in Virginia US, was formerly in Beijing, China, where the
cost of living and salary rates were much lower than in the US. Richards says,
"In China my monthly expat salary was more than the local HR manager
working for me earned in a year. But she knew I had come in with 17 years’
experience, to set up the office and transfer skills to the local staff."

The main problems came, says Richards, when the company brought in two
Chinese nationals returning to the US. As he explains, "There was a lot of
noise about that and the fact that they were on expat packages. The local staff
felt that just because these two were lucky enough to leave China and complete
their education in the US, they were not worth 10 times the local rate.

"But one had a second MSc to add to the one he had gained in China and
a PHD at Cornell University, in the exact technology we were working on. The
other was an attorney, a Chinese national who had practised in New York City,
who knew Chinese and US intellectual property law.

"Over the two years the locals did grow to understand why Western
training was worth a premium, but they were never comfortable with the size of
that premium."

Alice Wong, an HR consultant based in Beijing, agrees. She says, "In
general expats are very well respected [in China] but friction will arise if
local staff think that the expat is not as competent as they are, and if HR
cares too much about the expats and ignores compensation and benefits for local
staff."

The gulf between wealthy expats and locals is also a particular issue when
benefits are more apparent, says PwC’s Gould. "For example," she
says, "Colleagues may not know your salary but they will be aware that you
live in a better neighbourhood. Sometimes it may even be a better neighbourhood
than the head of your local company."

Another problem is that a too-generous expat package can provide a major
disincentive to ever return home. Lance Richards cites the example of a British
company that paid two expats a hefty £70k-plus salary (approximately US$98k)
plus housing allowance to work in Atlanta, Georgia, in the US where housing
costs were actually lower than in the UK. Says Richards, "The American
view was ‘You Brits are crazy – if you pay them that much they will never want
to leave!’"

One solution is to settle differences through clearly identified allowances
for cost of living, hardship, education and so on, rather than through basic
salary. That way, expatriate packages are easier to justify to the expats
themselves and to their colleagues. It also helps if those allowances are not
arbitrary, but based on objective information from one of the specialist
companies providing such information. These include ORC, AIRINC, William M
Mercer and ECA International and Runzheimer.

Denise Oemig, director of international services at Runzheimer, advises, "We
would not recommend paying more than the market rate in basic salary.
Relocation, for example, should be a separate payment. It should not be part of
salary or linked to salary."

Firms like Runzheimer provide up-to-date reports on cost of living differentials
and the cost of relocation. Life can often be more expensive for an expatriate
than for locals. Language, culture or safety considerations might dictate that
expatriates live in certain high-cost areas and educate their children at
fee-paying international schools.

As Willam M Mercer’s Worldwide Cost of Living Survey 2001 shows (see above),
the most expensive cities for expats are not necessarily those with the highest
standard of living. For example, Moscow is the second most expensive city (after
Tokyo) while Sydney, Australia is only 103rd worldwide in cost terms.

At least the cost appears to be narrowing, according to Mercers. The gap
between the world’s most and least expensive cities has shrunk by around 20%,
says senior researcher Rehan Mustafa. He explains, "What we are seeing is
a gradual reduction in global cost of living extremes. This reflects price
reductions from wider availability of international products, particularly in
third world countries."

Cost of living is not the only factor affecting pay differentials. The job
market itself plays a part. For example, an international survey published in
Management Today magazine in July 2001 found that chief executives of companies
in the UK were paid on average a third more than their French peers – £509,000
as opposed to £382,000 (US$713,000 to US$535,000 approximately) – but just over
half their counterparts in the US rake in nearly £1m annually. Pay
differentials like that mean, when home country pay is used as a basis, there
will be considerable anomalies between teams of expats from different home
countries working together in a third country.

Jill Mervin, an American HR consultant based in London explains, "The
complication comes when people are working side-by-side from several different
countries. The traditional ‘balance sheet’ approach is based on the idea they
will all go home at the end of the assignment. But as a rule, the American
always ends up with more money. It’s OK if you only look at the individual. If
they work together, it’s a problem."

"Sensitive employers might say ‘everybody’s allowance will be the same
and it will be paid in local currency, and the difference in salary can be paid
at home’. But employees might well say ‘That’s a sham, you’re playing
games’," adds Mervin.

An even bigger problem can come when moving someone to a much wealthier
country. Malou Roth, HR consultant and former vice-president HR, training and
development at Molex, a global high-tech manufacturing company, argues that the
standard "balance sheet" approach may not be right in such cases.

Roth gives an example, "We transferred some entry level engineers into
the US, from China and Taiwan. Their home country salaries would have converted
to a very low US salary, even adding the cost of living allowances."

"In practice, you don’t worry if you have a Swede and a German working
side by side and one is making 10 per cent more, but when you bring the
lower-wage countries into the equation it can be an issue."

Technically, Roth says, if you adopt the balance sheet approach "you
are handling it". But if the cost of living allowance is calculated as a
percentage on a very low base salary, you will still end up without adequate
money to live comfortably.

As Mervin says, "If you have employees from a variety of countries
working side by side, each should be able to buy a round of drinks without
going broke."

But while the simplest short-term solution is to transfer the employee onto
the US payroll, says Roth, that can create problems in the long term. The
person may be reluctant to return home if the net host country salary, taking
taxes into account, is much higher than the net salary they would be earning in
their home country. The differential between the high taxes of most Western
European countries and low tax levels in, say, Hong Kong or the Middle East, is
very marked. Also, a period on a foreign payroll could affect the employee’s
pension, social security, and some social benefits in the home country.

Some forward-thinking companies are looking at alternatives, according to
David Arkless, CEO of Empower, an international performance improvement
consultancy based in London. One is to reduce the need for expat assignments.
Arkless says, "The exchange of expertise internationally is happening more
and more, not so much physically as over networks, mentoring over a company
intranet."

Another is to create a cadre of globally mobile employees, typically young
MBA graduates, remunerated on a global package and mentored by an experienced
manager back in head office. Arkless says, "The big petrochemical
companies are among those doing this."

There is no evidence that the movement of expats in itself is narrowing pay
differentials. So for any international transfer, according to Runzheimer’s
Oemig, "The intent of the move is all-important."

To arrive at a fair and workable solution, line management and the HR
function must both understand the nature of any international transfer. And
that means talking to each other.

As Oemig puts it, "Sometimes companies can get confused about the
reasons for the assignment. They only know that they need someone in that
country next week. And the HR department is often the last to know about the
move. The guy may already be on the plane by the time they find out!"

Robert Outram is editor of CA Magazine, the journal of the Institute of
Chartered Accountants of Scotland and Scotland’s largest circulation finance
and business magazine.

Expatriate pay – three main approaches

– Home country salary adjusted by
cost of living, relocation, hardship and other allowances (the "balance
sheet" approach).

– Local pay rates, with or without
allowances.

– Global "expat" pay scales
unrelated to any one home country.

The world’s most and least
expensive cities for expatriate assignments

Top 5

1st        Tokyo, Japan
2nd      Moscow, Russia
3rd       Hong Kong
4th       Beijing, China
5th       Osaka, Japan

Bottom 5

140th   Johannesburg,   South Africa
141st    Madras, India
142nd  Quito, Ecuador
143rd   Bangalore, India
144th   Blantyre, Malawi

Source: Worldwide Cost of Living
Survey 2001, William M Mercer

Calculating "hardship"

Physical threat:

– Actual or potential violence in area

– Hostility of local population

– Prevalence of disease

– Limited medical facilities and services

Discomfort:

– Difficult physical environment

– Geographic isolation

– Cultural or psychological isolation

Inconvenience:

– Educational system

– Quality or availability of housing

– Community/ recreational facilities

– Availability and quality of goods and services

Source: AIRINC

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