Philip Pritchard has just decided to take a 25% pay cut. It is not because he will be working fewer hours or moving to a different job; he will simply have his salary reduced for 12 months from January 2009.

He is not alone. Pritchard is UK chief executive of CLSA, a brokerage firm that has asked its 500 senior staff across the world to consider taking pay cuts of between 15% and 25% to avoid redundancies during the economic downturn.

“The obvious option, which most banks take, is simply to lay off people to achieve cost reductions,” he said. “The problem with that is that it causes a lot of internal disruption, both to staff morale and to our structures. This in turn leads to a reduction in the services provided to clients.”

Reducing the wage bill without redundancies means that the firm has the same staffing levels – and thus can offer its clients the same levels of service – at a lower cost.

The firm was clear that pay cuts needed to be chosen, not imposed. “It has to be voluntary. If people were forced to do it, it would backfire,” said Pritchard. As it is, 90% of his senior managers in London have taken cuts. He said there was a sense of everyone working together to keep the business on track.

Managers were also offered significant incentives to take up the option – repayment of forgone wages plus a bonus of between 8% and 25% of their annual salary, depending on the size of the cut they took – but these will be paid only if the business meets specific targets.

Stuart Smith, managing director of Bourton Group, a management consultancy, went through a similar experience in the last recession. “I was a manager at a company where we had to choose between redundancies and pay cuts,” he said. “All the senior managers took a 10% pay cut. It was good in many respects. It brought about a good team atmosphere . . . When things picked up after six months we repaid the deficit.”

But organisations that choose to make savings by cutting pay need to be very careful. If the move is handled badly, it can create a great deal of disruption and upset among staff – the very people needed to get the business through the hard times – and lead to bad publicity that could affect relationships with consumers and suppliers. In some circumstances it could also be illegal.

Any decision needs to be part of a carefully thought-through strategy rather than a knee-jerk reaction, said Smith. He also advises that pay cuts should be considered only when every bit of waste has been trimmed out of the organisation and the only remaining option is lay-offs. “And it has to be top down. It should not be imposed on other people while the top guys still take home the same pay,” said Smith.

Andy Neely, professor of operations strategy and performance at Cranfield University’s school of management, said that good communication, a joint employer-employee solution and procedural fairness are all essential. “When talking to staff, have an open dialogue about what you face and what the solutions might be,” he said.

Organisations that ask employees to take pay cuts need to be sure that they send out consistent messages with their actions as well as their official statements. Asking all staff to take a pay cut then having the boss arrive at work in a new company car or carrying a shiny new laptop will damage the sense of shared adversity that is needed to see such schemes through. “You have to pay attention to all the signals that make people feel they are in the same boat together,” said Neely. “Trust of that nature takes a long time to build up and is easy to destroy.”

The other thing to watch out for, particularly if you are an employee considering accepting a pay cut, is the knock-on implications, said Peter Reilly, director of HR research and consultancy at the Institute of Employment Studies. If the cut is to base pay and the rescue attempt is not successful, staff who are then made redundant or retire on a final-salary pension will find themselves looking at much smaller payouts than they might otherwise have received. Where possible, cuts should be made to variable pay, such as bonuses, he said.

But just how widespread are pay cuts? Things are certainly looking gloomy. A survey by the Federation of Small Businesses found that a fifth of small and medium-sized businesses had reduced staff numbers while a third were considering it; another third were thinking about cutting employees’ hours and 14% had already done so. Stephen Alambritis, the federation’s head of public affairs, expects matters to get worse if Christmas trading is poor. “If Christmas turns out to be bad, you will start to see [pay cuts],” he said.

And if things are tough for employees, spare a thought for the freelance contractors working at the desks next to them. Many are being told to accept pay cuts or lose their contracts, according to the Professional Contractors Group. Robert Kerr, an IT expert, was working at a bank when he was given notice that his contract would not be renewed unless he took a 10% cut. “Staff were protected by their unions, but contractors were exposed,” he said.

Kerr accepted the cut, but several months later he was given notice that his contract was to be terminated. This happened to him during the last recession, when it took about a year for pay to pick up again.

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