In those challenging times, as recession hits and rising inflation pressures, salary rises cannot keep pace. Every employer is trying to find the right combination of matching fair compensation strategy for their employees with business goals.

In response to these difficulties, variable compensation programs are becoming more widespread. A variable pay option is a component of a compensation program designed to motivate employees. According to the survey, 76% of organizations use a form of pay other than fixed pay. 

The question is, does it fit your company’s needs? In this article, I’d like to explore this increasingly popular approach to employee compensation in more detail.

What is variable compensation?

Indeed defines variable compensation as a form of compensation that designs salary based on specific criteria. These factors are the quality of an employee’s job performance or/and business results.

In other words, variable compensation allows employers to reward employees based on their performance rather than the 40-hour-per-week work schedule.

Through the years, variable pay programs have been primarily used in the sales department. In recent years, variable incentive compensation has become more prevalent in other departments, too. Such incentives can help promote productivity and motivate employees if they are well-planned and adapted to the business’s needs, compared to fixed salaries.

Fixed vs. variable compensation

It is important to emphasize that this compensation type differs from traditional fixed-income compensation. Here are some examples to distinguish them:  

  • A fixed, base, or merit payment (exchangeable terms) – typically consists of a regular salary or hourly wage that remains the same throughout. 
  • Variable compensation, in contrast, is a payment determined by an employee’s work output.

What are examples of variable compensation?

For instance, a software licensing company employs sales reps. These team members receive a fixed salary and also gain a commission based on their sales results. The commission, say, can be 10% of every software license sale.

Paying commissions is not the only compensation option available. Here are some other examples of the most common forms of variable compensation:

Performance Bonuses

Essentially, it is the supplemental pay employees receive based on how they are performing at work. The purpose of bonuses is usually to express gratitude to employees. Another aim is to motivate them to work as before or better in the future.

To illustrate, project managers at the company receive a fixed salary and get a performance bonus every year. It can be based on overall project success and the specialist’s performance. If a project is delivered earlier than scheduled and under budget, they can get a bonus of up to 15% of their annual salary.

Profit-Sharing Plan

In this variable compensation plan, employees can receive a share of the company’s quarterly profit in addition to their merit salary.

Example: the company shares 10% of its profits with employees, according to their performance and duration of their employment. As a result, it fosters a sense of ownership and aligns employees’ efforts with the success of the company.

Stock Option

This option offers an opportunity for employees to buy or sell the company’s stock at a particular price and date.

For instance, a Chief People Officer receives stock options that allow the employee to purchase company shares at a set price. Typically, incentives of this kind encourage long-term commitment from employers and connect their interests with the company’s success.

Benefits & Challenges of Variable Compensation

A recent study from Harvard Business Review shows that performance-related pay positively affects employee satisfaction and organizational commitment. Additionally, it boosts overall management trust. Other variable salary benefits for all stakeholders are:

  1. Enhanced productivity and performance: Employees may benefit from performance-based salaries by being motivated to improve their results for a higher salary.
  2. Increased employee satisfaction and engagement: Variable salaries allow talented employees to earn more. In turn, according to the study, this helps improve employee engagement and retention. 
  3. Rewarding good performance: The variable compensation policy can help recognize employees and their high levels of performance. Likewise, reward them for their efforts. It increases employee morale, develops loyalty, and builds trust between management and their workers.
  4. Employee retention: It keeps high-performing, goal-oriented staff as well-paid employees are likely to stay longer, as shown by Glassdoor research.
  5. Financial flexibility: Flexible variable pay allows companies to pay employees after they have generated revenue for them. 

On the other hand, variable compensation can pose some challenges for employees and employers:

  1. Management is prone to availability bias: Managers tend to assess an employee’s efficiency based on their latest job performance instead of their overall year-long results. Thus, the assessment can be unclear and biased.
  2. Potential inefficiency: A poorly implemented program may cause high expenses for a company.
  3. Employees may feel unfairly treated: A lack of a proper payment structure can create a feeling of envy among colleagues. This can lead to a false impression of management decisions. 
  4. Disruption within teams: HBR research suggests that unhealthy competitive dynamics over bonus earnings can negatively affect teamwork.
Advantages and Challenges of Variable Compensation
Financial flexibilityPotential inefficiency
Rewarding good performanceRecency bias
Increased employee satisfaction and engagementEmployees may feel treated unfairly 
Enhanced productivity of employeesDisruption within teams
Attracting and retaining top talents

5 Steps for Implementing Variable Compensation Design Successfully in Your Company

As is now clear, variable compensation plans may bring advantages and challenges to business processes. In case you decide to put it into practice, here are five essential steps for a successful launch of your variable compensation design:

Step 1: Define Clear Objectives

The first step to start implementing is by defining and setting clear objectives. Think about what you want to achieve. Whether it’s motivating your teams or aligning their efforts with company goals. Or you would like to give rewards to top performers.

Step 2: Design Relevant Performance Metrics

After, create accurate and relevant performance metrics that directly tie employee efforts to the company’s success. These indicators should be measurable, achievable, and, most importantly, congruent with the organization’s strategic priorities. 

Also, set the seal that variable compensation structures are fair and equal for all employees. The level of variable compensation they earn should reflect the level of contribution they make.

Step 3: Clearly Communicate the Plan

Engage all employees in a transparent discussion about the company’s future compensation directions. Clearly describe how payments will be calculated. Remember to clarify an employee’s path to career growth and higher pay. 

Aside from this, make sure that management teams understand the performance-based measures they should use.

Step 4: Training and Implementation

The next step is providing training for both employees and managers before implementation. Check if managers are well-equipped to evaluate performance and know performance metrics. 

Step 5: Regular Performance Reviews

Finally, keep an eye out for the effectiveness of the plan and its impact on employee performance. After that, based on feedback and performance data, adjust the strategy to align with company goals. 

Pro tip: Employer-engaging platform provides easy-to-use tools for conducting surveys. It’s a great way to get direct and honest feedback from your team on the variable compensation strategy.

Legal and Compliance Considerations for Variable Compensation

In this section, I will explore the legal and compliance implications of variable compensation. Also, the importance of communicating transparently with employees throughout the process. Let’s examine the matter more closely.

Pay Equity

It is widely accepted that pay structures should not discriminate against gender, race, or any other protected characteristic. It would be better for your company to:

  • Establish fair and unbiased criteria for determining variable pay (performance, experience, and other relevant factors).
  • Regularly review pay equity policies to identify and fix problems.
  • Provide training to managers and HR specialists to help them make fair and unbiased decisions when awarding variable compensation.

Fair Labor Standards Act Compliance

The FLSA sets standards for minimum wage, overtime pay, and exemptions. Here are some Fair Labor Standards Act-related considerations:

  • Compensate employees who work overtime appropriately.
  • Calculate overtime by including variable compensation in an employee’s regular rate.
  • Communicate clearly to employees whether they are exempt or non-exempt in order to avoid wage and hour disputes.

Keep Documentation in Order

Legal and regulatory compliance also requires comprehensive record-keeping:

  • Maintain detailed records of compensation decisions, including the rationale behind variable pay awards.
  • Keep track of every pay equity review, FLSA classifications, and any adjustments you make to combat equity gaps.
  • All employment contracts and compensation agreements should be documented appropriately and accessible to everyone involved.

Tips on How to Communicate Your Variable Compensation Strategy and Maintain Transparency

Transparent communication about compensation plans and policies, as I mentioned earlier, is a crucial step when implementing a new strategy. To keep employee trust and compliance with the law:

  • It is important to clearly define the structure of variable compensation plans, including how they are calculated, eligibility criteria, and performance metrics.
  • Further, provide all teams with access to written policies across the company. You should clearly explain in those documents how you will determine variable pay and evaluate performance.
  • Then, describe how performance and variable compensation are linked, emphasizing how they reward exceptional performance.
  • Communicate if any changes to compensation plans will take place in advance. Do not skip Q&A sessions where employees can ask any questions that come up.

Implementing Variable Compensation Successfully: Case Studies

Here are some examples of big companies that successfully implemented forms of variable compensation to improve employee motivation and performance. They are worth a look.

Google Stock Units (GSU)

Google compensates its employees with GSUs, as a form of variable pay. These units represent shares in Google’s parent company, Alphabet Inc., and are often included in employee compensation packages. 

Employee stock options can provide them with the opportunity to share in the company’s success and performance.  Furthermore, it contributes to the long-term growth of the company through alignment with their interests. 

Sign-on bonus at Amazon

Want to learn more about an innovative variable pay strategy? Check out the sign-on bonus option Amazon offers. In general, it is a one-time cash or stock award offered to new employees for joining the company. These bonuses are typically provided to attract and retain top talent, especially for positions that require unique skills or expertise.

In most cases, they are usually paid out in a lump sum shortly after an employee’s start date. Worth noting is that employees do not receive them as part of their base salary or any other bonuses they may receive during their employment.

Future of Variable Compensation: Key Trends To Follow

Let’s take a closer look at promising trends in variable compensation pay practices.

  • Focus on Non-Monetary Rewards: The trend of non-monetary compensation still remains strong. From mood-tracking apps to company-sponsored offsites, health and wellness initiatives are becoming more common. Courses, certifications, and opportunities for continuous learning add value to compensation packages.
  • Broadened Equity Participation: In recent years, equity options have been extended even more to a wide range of employees. It will encourage employees to take an active role in the company’s success.
  • Freelancer and Gig Worker Compensation: With the gig economy growing, more companies will focus on providing rewards for freelance and contract workers. A project milestone or quality of delivered service is the basis for their payment, for example.
  • Compensation Based on Blockchain: Cryptocurrencies are growing in popularity worldwide and may change compensation and rewards programs.
  • Corporate Social Responsibility Incentives: Today, businesses are paying more attention to their environmental and social impacts. Compensation can be a part of this trend. For example, employees who actively contribute to green initiatives within a company receive rewards.

Key Takeaways

In summary, a well-designed and implemented compensation program can improve employees’ performance and boost their motivation. Moreover, it helps achieve the company’s goals as well.

Still, the process of implementing this pay strategy requires thoughtful planning and constant ongoing review of the process. In addition, make sure everyone is treated fairly.

When it comes to implementing your variable compensation strategy and getting data-based feedback from your employees, the right tools will come in handy. Discover, a tool that allows you to monitor your employees’ mental state, gather statistics on how they are performing, and give timely feedback to them.

Take a step towards optimizing your workforce engagement – schedule a free demo to get started.

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