Variable Pay: Incentives for Performance

Variable pay rewards employees for exceeding expectations and contributing to the company’s success, supplementing their fixed salary. It can include bonuses, commissions, or profit-sharing, aligning employee and company performance for mutual benefit.

By Douglas Wade, Attorney

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Table of Contents

1. How does variable pay work?

2. What does variable pay look like?

3. Different kinds of variable pay

4. How is variable pay implemented?

5. Pros and cons of variable pay

How does variable pay work?

Someone gets variable pay when they go above and beyond their normal duties to help the company succeed. The goal of variable pay is to get people to change how they act. Employees usually get variable pay on top of their fixed pay. This type of pay is based on both the employee’s success and the performance of the company.

What does variable pay look like?

Bonus for good work

When an employee, a group of workers working together, a division or business unit, or the whole workforce does a good job, they may get a performance bonus after the fact.

Sales commission

When someone sells a product or service, they get a sales commission, which is a set amount of cash that they get as a reward. The amount of the commission is usually a percentage of the gross sale or a flat amount for each unit sold. Some people call a pay plan that only pays on commission “full commission” or “straight commission.”

Profit-sharing arrangement

Some companies give their workers a cut of the money they make through a profit-sharing plan. Incentives for employees depend on how well the company does and how much money it makes each quarter or yearly. Employees get this in a number of different ways. It can be a portion of the profit in stocks or cash. A lot of companies also offer profit sharing as a way for employees to save for retirement. In turn, this makes workers feel like they “own” the business.

Bonus for referring someone

An employee gets a certain amount of money for bringing in job applicants or users for a program.

Different kinds of variable pay

Variable pay falls into three groups:

Individual

Variable pay depends on the worker and how much they produce. There is a clear link between how hard someone works and their variable pay, which is usually based on their total performance rating.

The following are a few examples of variable pay:

Piece rate structure: When you multiply the number of pieces you make by the piece rate for one unit, you get your salary.
An employer may give an employee a bonus in honor of good work.
Unique incentive schemes: Like cash prizes or awards for good work.
Commission: Money for making sales.

Team or group: This kind of variable pay either gives everyone in the group the same size reward or gives each person a different size reward based on how much they contribute. It makes working together stronger and can change and keep important team habits. It makes measuring team performance more important and lessens the focus on individual performance. This kind of team bonus usually gets people to work together.

This category has some unique variable pay, such as:

Gainsharing: A type of compensation in which employees divide an award based on how well they perform. Your workers will get a bigger share of the money you make as their work gets better. The “gains” gained must be measurable, like profits, savings, or lower costs, since gainsharing is self-funded. There are usually three payments a year, and the amount is based on things like production, quality, cycle times, waste/scrap, safety, and so on.

Goalsharing: A program that sets goals to support the company’s mission. In this case, it could be to make all customers happier. Goalsharing gives workers their pay when this goal is reached. It does not, however, pay for itself (like gainsharing does).

Organizational

Sharing profits with workers to boost morale, boost productivity, and improve the overall performance of the business. Some examples of variable pay in this area include:

Stock plans for employees
Stock options for executives
Delayed payment

How is variable pay implemented?

Some employers tell their workers about variable pay ahead of time as a reward, while others use it as a bonus after the fact. Different positions and levels get it paid as a portion of the base pay. There are jobs whose pay changes more often than others, like sales and managerial roles.

Typically, the pay mix is expressed as a percentage of total compensation, taking into account both total variable compensation and total compensation costs. To find an employee’s pay mix, which is their total flexible pay, do the following:

Variable pay percentage = Total variable pay / Total compensation cost x 100

Pros and cons of variable pay

Pros

Talent management: Since well-paid employees are less likely to quit, variable compensation helps employers keep high-achieving, goal-driven personnel on board. You can also give different rewards to employees based on how much they help.

Economic: It helps keep staff compensation in check. This is a part of pay that is self-funded and helps keep things in check. It also ties pay to how well the business does.

Motivation: Pay that changes based on success makes people more motivated and productive. It helps people pay attention to certain areas of success and results, and it reinforces and changes the way employees act.

Attracting talent: Employers who offer variable pay are more competitive.

Inclusion: This kind of pay helps each area and team stand out more, and it also makes it easier for people to be a part of a team. It also encourages people to work together and develop a sense of community.

Competition: It fits with the rules, habits, and customs of a competitive market and keeps companies from having to pay too much in set basic salaries.

Cons

Unfairness: If the right payment structure isn’t in place, it can lead to the perception of unfairness and make people in the company jealous.

Cost: If not done right, it can cost a company a lot of money.

Recency bias: Recency bias is a potential problem with variable pay. Since performance reviews are a big part of variable pay, managers may rate an employee based on how well they did on the job most recently instead of how well they did throughout the year. So, it rewards work and contributions instead of the end result.

Competition: Unhealthy competition can cause problems and make it hard to build teams that work well together.

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