Compensation 106: Variable Pay

The final feature in our Astronology six part series is here! In this issue of Astronology, we will discuss variable pay. WorldatWork’s 2012 Compensation Programs and Practices Survey found that 84% of organizations use some form of bonuses or incentive compensation to reward employees. With the popularity of variable pay, there also come questions, such as: what are the pros and cons of some different variable pay design options?  Does one variable pay design fit all?  Should the variable pay design change over time?  We will explore these questions and more in our final Compensation Practice Basics article.

Variable pay is a form of compensation that typically is earned by accomplishing specific goals, and is not equally paid throughout the year. It is also referred to as “performance pay.”  Variable pay is used to “recognize and reward employee contribution toward company productivity, profitability, team work, safety, quality or some other metric deemed important.”  When it comes to variable pay, one size does not fit all.  Variable pay can take one of several forms, including the following:

• Incentive
• Profit sharing
• Bonus
• Holiday bonus
• Deferred compensation
• Cash
• Goods or services

Many organizations look to variable pay during uncertain economic environments. It is easier for employees to accept and understand a reward that is tailored to one’s personal performance and the organization’s overall performance, than to understand low or no salary increases. As such, many organizations in both the for profit and non-profit worlds have issued employees bonuses instead of annual salary increases in order to retain their top-performing workers.

The practice of variable pay has also fostered an increase in productivity. Employee engagement increases as workers become highly engaged in achieving goals to receive rewards. Employees take a larger role in the responsibility for their work outcome, which also drives commitment to the organization.

Some drawbacks related to variable pay can include execution. If a variable pay plan focuses on quantity, the end results can be a lack of quality. Tangible measurements become more valuable than innovative techniques or genuine customer satisfaction. While an increase in performance is always welcomed, if not careful a variable pay plan could result in outright cutthroat competition…thus ruining an organization’s cohesiveness.

As there are different forms of variable pay, every organization that wants to include it in their compensation mix must consider their individual circumstances. It is suggested that a task team should be appointed to consider variable pay as an option. When planning and designing the program this team should consider the following:

• Identify if more than one plan is needed based on employee groups,
• Identify plan participants,
• Determine how to encourage the entire organization to success through positive communication,
• Determine how the plan will be funded, and
• Determine the plan’s key aspects, weightings, and measurement methodologies.

Once a plan has been selected, thoroughly develop the modeling criteria, methodologies, and formulas. Create a document that outlines the plan, policies, and procedures. In non-profit organizations, ensure that the maximum potential payouts have been included in the organization’s budget to address the legal and tax considerations.  Conduct focus group sessions to determine if the plan is easily understood by employees, while paying close attention to the motivation the focus group members demonstrate. If needed, revise the plan based on the focus group results.  Ensure that focus group members understand that the payouts from the plan are at risk – not a guaranteed payment that employees can rely on to pay the mortgage or other critical bills. 

This task team and focus group approach should be revisited every few years.  Variable pay plans generally have a window of greatest effectiveness.  Once employees have achieved the targeted goals, it may be time to revisit the plan or eliminate it altogether. 

As with every new initiative in an organization, it’s important to have full cooperation with all of its members. In order for this to happen, clear communication must be made on the full details of the variable pay. All must be able to understand how this new system will work, how it will benefit them, and what is expected of them once the new pay variable plan goes into effect.

Are you considering introducing variable pay to your organization or updating an existing plan? Need some help getting started? Astron Solutions is here to help! We offer compensation consulting and can assist in introducing a variable pay plan through our cloud-based Talent Management system, FLARE™.  Please contact us today with any specific questions you’d like us to explore with you!