Effective Rewards Strategies for Public Sector Organizations

Public v Private sector

Effective rewards strategies contribute to an organization’s ability to attract, retain and motivate the talent required for its success. Rewards are a significant element in the value proposition offered by employers and contribute to shaping the employer brand. The current struggle to attract and retain the acquired talent has made rewards philosophy and strategy even more important.

Strategies must fit the context within which they must function if they are to be successful, which can mean emulating other organizations can be fraught with peril. What succeeded “there” may not succeed “here.” An organizational context is shaped by its mission, objectives, internal and external realities, and its culture. Contexts may differ between two organizations even when they are similar on the surface. Cities and counties in the same region are likely to have contexts which differ to varying degrees. Two entities located close to each other might face different economic realities, offer different services, and have a citizen population that has different characteristics and different management styles.

While consulting with public sector organizations, I often find that management believes there is a dramatic contrast between the public and the private sectors, and that rewards strategies successful in one cannot succeed in the other. Admittedly stock options are not available in public sector organizations, but most types of rewards are. Implementing merit pay or cash incentive plans in a city, county or public utility may encounter resistance from some who believe they are not appropriate. However, there are no legal prohibitions and there have been successful plans used in the sector.

What Are the Important Differences Between the Sectors?

Public sector organizations answer to different constituencies than do private sector organizations. In addition, elected officials determine how a public sector organization should pay its employees and how much to pay them, accomplishing this through budgeting and policy making processes. Also, public sector organizations often make decisions based on political considerations rather than on the impact to the organization or the ability to fund obligations in the future. 

Organizations that operate in the public sector measure organizational effectiveness differently than private sector organizations. Many private sector organizations believe that profitability, growth and total shareholder return are the only legitimate measures of their success. Shareholders often balk at letting non-financial measures, such as citizenship in the community, dilute the focus of management. Conversely, concerns about profit and shareholder return do not exist in the public sector organization and growth may or may not be considered a legitimate objective. 

In the public sector, there also may be uncertainties about the financial resources that will be made available through the political process. This difference can have a profound impact on an organization’s ability to pay employees at fully competitive levels. Although it can be argued that the private sector also is full of financial uncertainties, there is at least some ability to fund current shortfalls through assuming debt or using discretion to reduce profits to ensure compensation levels remain adequate for attracting and retaining critical employees. 

Finally, the governance of the sectors is very different. Private sector organizations answer to boards or to owners if the organization is privately held. Private sector boards are generally concerned about workforce costs only as they impact profitability … that is, they are often willing to compensate employees generously if the financial performance of the organization seems to warrant premium rewards. In contrast, public sector boards, legislatures or city councils must be sensitive to the opinions of taxpayers and voters. If these constituencies believe compensation costs are excessive or unwarranted, they will put pressure on those responsible for oversight, either through the media or the voting booth.  

The employee benefits provided in the public sector are not limited by the same fiscal discipline that exists in the private sector. Pension liabilities and other benefits costs are not subject to the same accounting mandates, since unfunded pension liabilities can be made to seem smaller by making unrealistically high investment return assumptions (e.g., pension funds assuming an 8% investment return when 3% is realistic). This enables legislatures and councils to leave serious underfunding of plans with certain liabilities for future parties to deal with. This reality has allowed public sector benefits to be significantly more generous than those existing in the private sector and to accumulate trillions of dollars of unfunded pension obligations.

Which Sector Is a Better Place to Work?

As a result of these differences there is a widespread belief that different types of people gravitate to public and private sectors. Those seeking stable employment and generous benefits might be inclined to prefer the public sector compensation packages to those in the private sector. But the underlying preference for the public sector also may be due to a desire to do something meaningful that impacts the lives of others rather than making anonymous investors wealthy. 

Too often, stereotypes about public vs. private sector employees lead people to make assumptions about the factors that influence employment choices. Alas, there appears to be little solid evidence to determine which considerations are given the most weight. Decades of experience have suggested people who place a higher value on employment security might favor a public sector employer. For example, if someone highly values a defined benefit pension plan to a defined contribution retirement plan, it is more likely to be found in the public sector.

It is important to be aware of public opinion since everyone funds the cost of public sector workforces through taxation, and during periods such as the 2007 to 2010 economic downturn, there was increased criticism of the “safe harbor” public sector employees are thought to have. The pandemic has caused these same criticisms to again become more prevalent.

The Economist has contended that public sector employees are paid 17% more than private sector employees if the actual time worked is considered. In addition, it is estimated that the benefits in the public sector are 30% more generous than in the private sector. Taxpayers who believe the public sector employees they pay for are enjoying 47% more in total rewards than private sector employees are certain to view this as unacceptable. The 47% does not have to be true, only believed to be so, for people to react. This places public sector employers under pressure to defend their practices.

Are Different Rewards Strategies Necessary?

When comparing the rewards strategies and programs prevalent in the two sectors, several differences are found. It is common for private sector organizations to attempt to set their direct compensation levels above prevailing market rates. The objective is to attract and retain a higher quality of employee. Although research to show that this is effective is not compelling, it stands to reason most candidates would prefer more pay to less. A public sector organization will likely face opposition to that philosophy by the taxpayers and the board/commission members who must justify it to the citizenry.

It also is difficult to gain acceptance of the need for merit pay programs. Although far fewer governmental entities at all levels continue to use automatic time-based pay progression systems, many federal government agencies persist in doing so. Perhaps even more challenging is getting support for cash incentive programs, since it is difficult to objectively evaluate the performance standards used to determine awards. This creates difficulties in getting agreement on what constitutes results that are good enough to warrant additional compensation.

Employee benefits programs differ dramatically between the sectors. Public sector organizations generally provide much more paid time away from work than the typical private sector organizations. Defined benefit pension plans persist in the public sector, while they have become almost obsolete in the private sector.

Most people believe job security in the public sector is far greater than in the private sector. Even though it is possible to terminate public sector employees, the process presents barriers that make it far more difficult. Given the labor market turbulence that occurred during the financial crisis and that now exists, mainly because of the pandemic, being able to hold on to one’s income stream has been a huge benefit. 

The Bottom Line

Contextual differences between the two sectors are significant and certainly influence workforce management strategies and programs. Practices such as paying for performance used to be rare in the public sector, but that has changed considerably (40% of federal employees have exited the GS system into systems that are designed to reward performance). A failing of guaranteed pay increase programs and egalitarian administration is that they do not appeal to the better performers, who know they can do better where merit pay and incentive programs are used. Another failure is that it signals that performance is not important to the organization. 

Some rewards programs that are common in the private sector are increasingly being adopted by public sector organizations. Yet, due to the cross-sector contextual differences, it is incumbent on management to ensure that adopting different strategies will fit the context of the adopting organization. The organizational differences within the sectors are an important consideration, since what works is what fits each setting.

The value proposition offered by employers undoubtedly influence people’s decisions about where to work. During a time of skill shortage and inflation, pay has increased in importance. The right organizational rewards strategy increases the chances of having the right workforce.

Reprinted with permission from the author.

Subscribe to the HR Bulletin