Variable Compensation Explained: A Complete Guide

Employers use variable pay to encourage their employees and recognize their hard work. Variable pay is extra money given on top of a salary and can be in different forms, not just cash. Knowing about variable pay helps you understand how you may get paid at work. Explore what variable pay is, its different types, who can receive it, and how it is different from traditional pay.

What Is Variable Compensation?

Variable compensation, or variable pay, is extra money you can earn based on achieving specific goals tied to performance. These goals may relate to your individual work, a project you're part of, or overall company performance.

With variable pay, you have targets to meet during a certain period. When you meet these targets, you receive additional money on top of your regular salary. Sometimes, the amount you get can vary depending on how close you come to reaching the goals.

Variable pay has traditionally been used for sales teams, where meeting sales targets leads to bonuses. But it is now being used more widely across different parts of companies to motivate employees. In the U.S., most businesses (about 77%) already have variable pay programs, and more companies (around 9%) are planning to start using them.

Types of Variable Compensation Plans

Variable compensation is additional money given on top of a base salary to encourage and reward salespeople based on how well they perform. Here are five common types of variable compensation programs used in sales:

Bonus

A bonus is the amount of money that salespeople receive when they meet or exceed certain sales goals. For instance, a company may give a $10,000 bonus for every $1 million in sales made during a three-month period. When a salesperson reaches $3 million in sales, they will get a $30,000 bonus.

Incentive

Incentives pay salespeople a percentage of the total sales they make. This commission can be based on sale value, profit margin, or a combination.

Recognition

This kind of extra pay gives salespeople rewards when they meet certain goals, milestones, or perform exceptionally well during a certain time.

Management by Objectives (MBOs)

MBOs involve setting strategic goals that are specific, measurable, achievable, relevant, and time-bound (SMART).

Profit-sharing

Salespeople share in the company's profits based on performance metrics.

Who Receives Variable Pay?

Variable pay is often given to various groups depending on their roles and duties. Here are some typical groups that might receive variable pay:

Risk Takers

People who do risky jobs such as operating cranes, working in logging, or doing steel construction, may get extra pay. This is different because it is meant to reward them for the danger they face at work and to encourage them to take on tough jobs. Typically, these brave workers earn extra money based on the risks they take or how well they perform their duties.

Sales Representatives

People who work in sales, like those selling jewelry, cars, or fancy things, often earn money based on commissions. This means they get paid more when they sell more. Commission pay helps salespeople learn better ways to sell things and helps the company make more money. It also makes them feel like they are part of the company's success, which can make them want to stay at the job longer and work harder.

Leadership Roles

Leaders like managers or team leaders often get extra pay because they have more responsibilities. Being a leader requires good skills in leading and making decisions, so offering them more can make them work better. Leaders may earn bonuses based on how well they do their job, or they might get a share of the company's profits as part of their extra pay.

Benefits & Challenges of Variable Compensation

Variable pay has its advantages, but it poses challenges for both employees and employers as well.
Benefits

• Better work and results: When employees know they can earn more by doing well, they work harder to get better results.
• Happier workers: Top-performing employees can earn more money; they usually feel happier in their job and become more committed to the company.
• Reward for doing well: Variable pay programs recognize and reward employees who do an outstanding job. This boosts morale, loyalty, and trust between workers and bosses.
• Keeping good workers: Employees who are paid well based on how they perform are more likely to stay longer with the company, which keeps valuable workers around for longer.
• Flexible finances: Companies benefit because they can adjust how much they pay based on how well the business is doing, which helps control costs.

Challenges

• Managers' biases: Managers may judge workers based only on recent successes instead of looking at their overall performance for the year, which can lead to unfair evaluations.
• Wasting money: A variable pay system that is not set up well can cost the company a lot without improving performance.
• Feeling treated unfairly: Some employees who get paid differently for similar work can make others feel jealous and unsure about the fairness of how decisions are made.
• Team problems: Employees who compete too much for bonuses can hurt teamwork and make it harder for everyone to work together well.

Implementing Variable Compensation Successfully in Your Company

Variable compensation plans can be helpful, but they must be set up carefully. Follow these five important steps for optimum results before introducing variable compensation in your organization:
Step 1: Set clear goals
Start by deciding what you want to achieve with your variable compensation plan. Do you want to motivate teams, match efforts with company goals, or reward top performers? Setting clear goals will help shape how you design and put the plan in place.
Step 2: Choose the right performance measures
Pick specific and relevant ways to measure performance that directly connect what employees do with how well the company does. These measures must be something you can track and achieve and align with what your company is trying to achieve. Make sure the plan is fair, with each person's pay reflecting their level of contribution.
Step 3: Talk clearly about it
Make sure everyone understands the plan. Explain how pay will be figured out and show how it can lead to career growth and higher pay. Make sure managers know what is expected and how they fit into the plan.
Step 4: Train everyone
Before you start, make sure employees and managers have training on how the plan works. Managers need to be able to judge performance correctly and understand the measures used in the plan.

Step 5: Keep checking in
Regularly check how well the plan is working and how it is affecting employee performance. Ask employees for feedback and look at performance data to see whether changes are needed to stay on track with company goals.

Variable pay plans have many benefits for both employees and businesses, but they can be complex to manage effectively. To ensure success, it is important to find the right system to handle your compensation needs.

Salary.com provides an ideal solution for simplifying pay management for your employees. It is the top incentive compensation management software, designed to be user-friendly while managing the intricacies of variable pay plans.