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Compensation decisions influence organization’s performance by influencing costs or revenues. Compensation budgeting involves balancing tradeoffs between merit-based raises, across-the-board increases, short- vs. long-term incentives, and cash vs. benefits. While compensation costs are tangible and measurable, analyzing returns (like productivity or performance improvements) is equally important, though often overlooked.

Labor cost management during economic downturns often involves headcount reductions, such as layoffs or exit incentives, which can lower both wage and benefit costs. Targeted workforce reductions face legal hurdles, especially under the Age Discrimination in Employment Act (ADEA) and related laws that protect older workers. Poorly targeted exit incentives may lead to top performers leaving, producing an undesirable “sorting effect.”

Reductions in force (RIFs) carry risks such as low morale, process disruption, upfront costs, and diminished future capacity to ramp up operations. Regulations in some countries, particularly in Europe, make layoffs and wage cuts more difficult, complicating labor cost management. Employers increasingly use a dual workforce model: core employees for long-term stability and contingent workers (e.g., contractors or temps) for flexibility. Another labor cost strategy is balancing overtime vs. hiring, particularly among nonexempt workers, where overtime can be more costly than new hires.