What Is Variable Pay?
Every employer wants to see employees succeed and grow with their organisation. So, to reward employees for great performance, you may offer them variable pay. But, what is variable compensation exactly?
Variable pay comprises extra wages paid to employees based on their performance results; when they hit certain performance marks or make more sales. It is usually offered in addition to an employee’s fixed salary and comes in various forms.
The word “variable” reflects the fact that employees rarely, if ever, earn the same amounts per payroll cycle. Conversely, fixed salaries are constant and don’t vary between pay cycles. A combination of both fixed and variable pay is referred to as an employee’s pay mix.
The Evolution of Variable Pay Over Time
In the 20th century, when the modern corporation began to take shape, employers paid employees’ salaries in the form of wages, overtime pay, and festival bonuses.
Some pioneering companies, such as General Motors under its leader, Henry Ford, believed that employees should be paid salaries that would ensure they had enough money to spend on consumer goods.
With the gradual evolution of corporations, owners and capitalists decided that employees should also be paid bonuses depending on their performance in addition to the basic salaries.
Whereas the initial focus was on bonuses during festive periods and which were the same for all employees, the later decades witnessed the early forms of linking bonuses to employee performance and, thus, the concept of variable pay.
The major difference between variable pay and straight pay is that the latter is paid according to the employee’s rank and designation. In contrast, the former is paid according to their performance over the period for which it is being paid.
Back when the manufacturing sector was the predominant part of the economy, salaries were usually uniform for each designation, and only the bonus varied a little.
This was because the majority of the work done then was manual and mechanical in nature. This meant that even the best-performing employees could only manage a marginal increase in productivity compared to others on the lower end of the performance scale.
However, once the service sector rose in prominence and the knowledge workers started gaining traction, employees became more innovative, and some mastered their jobs better than others.
Over time, marketing became prominent, and it became necessary that a percentage of the sales generated be given to employees as incentives. Thus began the concept of employee variable pay in addition to the basic pay and other benefits.
4 Major Types of Variable Pay
There are four most common forms of variable pay plans that are in use today; they include commissions, bonuses, profit sharing, and management by objectives (MBOs).
1. Commissions
Several employers reward their sales agents with a percentage of the value of each sale they make. This structure is known as commission.
For example, a sales agent might earn a 2% commission on all their sales. If the sales agent makes a $6,000 sale this pay cycle. 2% of $6,000, or $120, will then be added to their next paycheck.
2. Bonuses
Where commissions vary by the value of a sale, bonuses can be independent of sales.
Sure, the highest-performing salespeople will most likely earn larger bonuses than the lowest-performing agents, but the amounts given aren’t necessarily tied to sales values.
Instead, bonuses are single-instalment payments on which individual sales have only an indirect impact.
3. Profit-Sharing
An option for tying employees to the organisation’s economic success is by giving them a share of its profits. This type of incentive is only useful in profit-based organisations.
Profit-sharing may be the oldest form of an organisation-wide variable pay plan. They were installed to deal with employees’ grievances over low salaries and combat the feelings that organisations made huge profits but paid workers very little of the gains.
Later the idea of aligning worker and management goals appeared.
4. Management by Objectives (MBOs)
An MBO (Management by Objectives) bonus is a performance-based reward an employee earns when completing the goals stated in their MBO program.
These bonuses and objectives result from discussions held between management and employees, which stem directly from higher-level organisational targets.
When you set MBOs for your employees, several goals are assigned to them, which they must achieve by a certain deadline. Financial incentives are offered to encourage your team to achieve these goals on time.
Why Do Employers Offer Variable Pay?
Variable pay plans are designed to align an employee’s daily activity with company objectives. Employers offer them to encourage employees to produce better business results.
It subsequently helps employers attract top talent who desire to see their ability to create value reflected in their paycheck.
Variable pay structures incentivise your employees to put in extra work to make more sales, but this is not the only reason they are valuable. You also give yourself a competitive advantage against other companies recruiting similar talent when you offer variable pay.
In addition, your team members are less likely to leave when their pay mix exceeds what they could find with other companies.
Employee variable pay can also help shape how your team makes sales. If you want to steer your team in a certain direction, their variable pay can be tied to how well they achieve these goals.
A team whose performance is tied to your goals is more likely to hit your ideal figures, making variable pay good for both employers and employees.
Steps to Setting Up a Variable Pay Plan
Thinking about setting up a variable pay plan for your employees? Before you can implement a plan, you need to follow the steps below:
- Establish the target and goals you’d like to hit and determine your incentives based on your goals
- Brush up on all labour law requirements to ensure that your business is compliant with in-country variable compensation and overtime rules
- Create a variable pay policy and include every detail about your plan for the different levels of employees
- Which employees are eligible for variable pay
- The maximum variable pay the employee can earn and if there’s a cap
- What employees have to do to earn variable pay
- When and how employees will receive the variable pay they’ve earned
- If other factors, like company sales, will influence the variable pay
- Have all employees sign a copy of the policy and keep it in your records
When tracking progress to see if the incentive pay is working well for your company, you can monitor employees’ performance over time.
Consider meeting with each employee to review results, get feedback, and then use employee feedback to improve your variable compensation plan.
