Variable Pay Benefit Calculations

Thursday, August 24, 2010

The variable pay plan for our driver has been in place for a month, during which time we have made some minor modifications to the risk factors to account for a couple of unforeseen situations. It is now time to make our first payment calculations based on the data tracked for the four risk factors we believe will lead to a number of positive outcomes for our driver and our organization.

To restate the four risk factors selected:

    • 90% of all stops on time
    • No at fault accidents
    • No more than 3 unexcused absences
    • Customer satisfaction rating of “Satisfactory”, i.e., “3”.

Our plan documentation indicates that if our driver “meets” our expectations for all 4 risk factors he will earn an additional $1 per hour getting him back to the going market rate of $15 per hour. However, our plan says he could earn an additional $2 per hour taking him all the way to $17 per hour. During the design phase of building the variable pay plan, we modeled a number of calculation algorithms and after a significant amount of trail and error work, we settled on one that was acceptable to both our operations and financial partners.

• 90% of all stops on time
    If our driver makes 90% - 94.9% of his stops, he earns 25¢ per hour for the
    hours he worked this month.
    If our driver makes 95% - 99.9% of his stops, he earns 50¢ per hour for the 
    hours he worked this month.
    If our driver makes 100% of his stops, he earns 75¢ per hour for the
    hours he worked this month.

• No at fault accidents
   As long as our driver has no at fault accidents during the month he earns
   25¢ per hour for the hours he worked this month. This is a pass or fail
   risk factor.

• No more than 3 unexcused absences during the month
    If our driver has 3 unexcused absences, he earns no additional pay
    for the month.
    If our driver has 2 unexcused absences, he earns 25¢ per hour for the
    hours he worked this month.
    If our driver has 1 unexcused absences, he earns 50¢ per hour for the
    hours he worked this month.
    If our driver has 0 unexcused absences, he earns 75¢ per hour for the
    hours he worked this month.

• Customer satisfaction rating of “Satisfactory”, i.e., “3”
   If our driver has a custom er satisfaction rating of “3” or higher, he earns
  25¢ per hour for the hours he worked this month. We opted not to award
  a higher reward for this risk factor since we questioned the validity and
  reliability of the customer satisfaction survey and rating processes.

So how did our driver do during his first month under the variable pay plan for route drivers.

    • 90% of all stops on time: our driver completed 93.5% of his stops
      on time.
    • No at fault accidents: our drive had no accidents during the month.
    • No more than 3 unexcused absences: our drive no unexcused
      absences during the month.
    • Customer satisfaction rating of “3” or higher: our driver rated a
      2.5 during the month.

Appling our calculations we found that our driver earned the following:

    • 90% of all stops on time: 25¢
    • No at fault accidents: 25¢
    • No more than 3 unexcused absences: 75¢
    • Customer satisfaction rating of “3” or higher: Zero

For the month, our driver earned an additional $1.25 per hour for each of the 160 hours he worked or $161.25 total. For the record, our driver worked no overtime for the month. Had he worked any overtime, we would have had to factor in his variable pay into his overtime rate. The additional $1.25 per hour brought our driver up to the market rate and just slightly above the average rate for this type of driver in our area.

As part of our driver-mentoring program, the driver’s route supervisor will reinforce customer service by providing our driver with tips and suggestions on how to improve his customer service skills. As a new driver, it may take a few months before his has developed solid relationships with his customers. A portion of the route supervisor’s role is to ensure that new drivers have every opportunity to succeed. Our goal is not to see our driver fail, we want to be supportive of our drivers since this fits into our core values as an organization.

Variable Pay Post Implementation Considerations

Tuesday, August 24, 2010

Our driver variable pay plan has been operating for a few weeks now and we have had to make minor changes to two of the risk factors. We anticipated upfront and prepared our management for the possibility that adjustments might be necessary to work out any “bugs” in the plan's operations.

90% of all stops on time

We discovered that do to several recent weather related events; allowances had to be made for those days when storms passed through the metropolitan area. Traffic congestion on the major streets often forced our driver to look for alternative routes only to find that they too were heavily congested. Therefore, on those days when a severe storm is declared along the driver’s route, an extra 5 minutes plus or minus is allowed for the driver to make his stop. Unfortunately, it proved to be unreasonable to grant an allowance in units other than 5 minutes.

Customer satisfaction rating of “Satisfactory”

The vendor who conducts our customer satisfaction surveys takes a sample of the customers along each driver’s route. In order to be fair to the driver, the driver and his supervisor suggested that we blend the surveys together over a two-month basis. After reviewing the suggestion and making certain adjustments with the vendor, we were able to make this change.

To ensure that our variable pay plan was off to a good start and stayed on track, we have been monitoring it very closely. As we anticipated we had to make a few minor changes. Even during the first year of the plan, we can expect that other changes may be needed. We are taking the attitude that our plan is a design in process. Even if we had to abandon our design and start over, we will have learned a great deal about the design, development, and implementation processes.

Should we be forced to go back to the drawing board, we may want to “compensate” our driver for the missed opportunities on the variable pay plan. We might not make him whole, but we might look at some payment to offset the loss of potential from the plan. Since this effort was somewhat of an experiment, and since we are going to try a new design, we will want the full cooperation of the driver. Such offsets are only possible because we elected to hire below the going market rate, thus we have a small margin that can be used for a one-time lump sum offset.

Variable Pay Communications Considerations

Thursday, August 19, 2010

We have implemented our new variable pay plan, we found vendors who can reliably track the driver’s stop times and accidents. We are able to track any absences or missed time via our payroll system and we were even able to have the vendor who manages our customer satisfaction surveys to add a few questions about the assigned driver. What is left is to communicate the plan to the driver and help him understand how it will work for both the organization and the driver. It will be reasonable for the driver to be uncertain about the plan and have a number of questions. The driver may be highly skeptical of the plan and whether or not it will deliver the promised rewards. This may be the first time our driver has worked with any form of an incentive plan, so expect that your communications will need to be very detailed and complete.

90% of all stops on time

During our implementation, we concluded that “on time” was to mean plus or minus 5 minutes of the scheduled stop time. To test the validity of this standard we had our tracking vendor track our driver’s stops for a full business month and were able to confirm that our driver was able to make his scheduled stops within plus or minus 5 minutes 85% of the time. We shared this information with our driver and helped him understand that a mere improvement of 5% would allow him to meet the standard. It is in the organization’s favor that our driver succeed, after all we sent him to driver’s school for two weeks and the route supervisor road with him for two weeks. If he succeeds, the organization succeeds.

No at fault accidents

Although our driver has a number of years of driving experience, it is vital that he operate his truck in a safe and courteous manner. There is more riding on this than just the insurance premiums. Our organizational name is in 6-foot high letters on the sides and rear of the truck. If our driver behaves in an unprofessional manner, other drivers, customers, and the public will lower their perception of our organization, its services, and products. One reason why we elected to send our driver to school for two weeks was to ensure he had both the skill and the knowledge to operate the truck in a professional manner. Our competitors do not train their drivers and they are known for certain unsafe practices, speeding, and accidents. We hope that we have sent a strong message to our driver concerning safety and professionalism.

No more than 3 unexcused absences

The driver’s route supervisor has spent a considerable amount of time discussing the need to report to work daily and on time. The supervisor has explained how our driver is to request time off for such things as funerals, hospitalization, planned vacations, and planned medical treatments. In addition, the supervisor has explained how the driver is to handle unplanned emergencies and unforeseen events. If the driver fails to report to work, the route supervisor must drive the route. This creates a serious problem if more than one driver is out for an unplanned absence at the same time.

Customer satisfaction rating of “Satisfactory”

During the two week period in which the route supervisor road along with our driver, the supervisor was able to introduce the driver to each customer and give our driver an image of the customer’s business, the services, and products sold to the customer and some suggestions on how to build and maintain a relationship with each customer. The driver was fully briefed during the two weeks his supervisor road with him on how his customer interactions will be scored on the monthly customer survey conducted by the outside vendor. Since our driver interacts with our customers on a daily basis, the driver will develop a more detailed understanding of the customer’s needs, even more so than our sales staff. In fact, we have found that our sales staff often reaches out to the drivers for feedback and suggestions.

One reason why, we as an organization are able to recruit and retain employees is that we have a reputation in the community for being a highly ethical employer. The communications to our driver, as well as organizational communications in general, are based on and designed to reflect our ethical standards.

Variable Pay Implementation Considerations

Tuesday, August 17, 2010

We have designed our variable pay plan for our Truck Driver, now we need to implement it. While it is possible to design a plan for a single incumbent position, it more common to have a number of incumenbets at various stages in their careers with the employer. However, for illustrative purposes, it will be helpful to focus on our one driver.

Our plan design calls for a number of risk factors to be in play with our driver:

• 90% of all stops on time

• No at fault accidents

• No more than 3 unexcused absences

• Customer satisfaction rating of “Satisfactory”

Our plan also calls for us to pay out any earned variable pay monthly. 

Now let’s look at each of these factors in detail:

90% of all stops on time

If we are going to measure against this standard, we are going to have to track the driver’s delivery times over the course of the month and be able to relate it to the scheduled times. In addition, to be considered “on time” we must define what that means. Is it plus or minus 5 minutes, 10 minutes or some other allowance? If we make it too small, it becomes unreasonable and may introduce an unsafe driving situation as the driver speeds to their next stop. If we make it too large, we reduce any incentive to be on time. Finally, someone has to do the tracking; fortunately, there are GPS systems and vendors who will do this electronically for us.

No at fault accidents

If our driver is involved in an accident and they are issued a citation, we will consider them to be “at fault”. If however, they are later to be found not at fault, their performance records could be adjusted to reflect this change. We might also engage a vendor to track this information as well.  Furthermore, damage which occurs to the driver's truck must be relateable to the assigned driver's operation.  If the truck is damaged by someone other than the assigned driver, we will need to know that and not hold the assigned driver accountable.

No more than 3 unexcused absences, annually

What will be considered an “unexcused” absence? We may have a policy that says if the driver fails to call within one hour of the start of their shift that is considered an “unexcused” absence. Or that any absence for which the driver has no valid and substantiated reason, e.g., doctor’s note. Absences involving, funerals, hospitalization, planned vacations, and planned medical treatments would not be considered an “unexcused” absence. Our payroll system may be able to track this factor; otherwise, we will have to develop some method of tracking absences and missed time.

Customer satisfaction rating of “Satisfactory”

Our driver interacts with our customers on a daily basis; as such, the driver has the ability to influence the customer’s opinion of our products and services both positively and negatively. Not only do we as the employer want to know that our customers are satisfied, we want our driver to know that his actions and his customer interactions have the ability to affect him personally and financially. Assuming that we have a customer satisfaction survey and one that garners information on our driver, we want to track our customer’s perception of our driver’s performance. Since we are determining the driver’s variable pay on a monthly basis, we are going to have to measure customer satisfaction on a monthly basis. It might even be beneficial if a third party conducted the customer satisfaction survey. This could add creditability to the survey’s findings.

As you can see, implementation of even a relative simple plan requires some forethought and planning. This is one reason why we want to keep such plans as simple as possible. You can image a plan with a dozen on more risk factors involved and how an employer could manage to track, measure, and record keep a large number of factors.

Base Pay and Variable Pay Design Considerations

Thursday, August 12, 2010

A typical base pay design feature in many organizations is to fix pay at the 50th percentile, i.e., the median of the going market rate for a particular position, let us say a local, short haul Truck Driver operating a 1 to 2 ton delivery truck. There are numerous ways to determine mechanically what the median going market rate for a Truck Driver is, including online research tools, published surveys, industry and business groups and associations as well as governmental reports. For the sake of argument, we will fix that value at approximately $15 per hour in some metropolitan area in the Southeast United States for the current period in time.

The performance and effectiveness of our driver is dependent on a large number of interrelated factors such as:

• Types of cargo delivered

• Quantity of cargo delivered

• Point of delivery, curbside or the 25th floor

• Number of stops

• Restricted delivery times

• Traffic, weather, road construction

• Does the driver have a helper

• Mechanical condition of the truck

A number of these factors are beyond the control of the driver, e.g., traffic, weather, and road construction. Or are they? An alert driver might be able navigate around traffic and road construction by using alternative routes. A skilled driver might be able to safely minimize weather related delays. Therefore, a variable pay plan might contain features, which would recognize these limitations while incenting our driver to meet route schedules in a safe manner. Making delivery stops drops on time but having traffic accidents is counterproductive if insurance costs double, accident related legal actions eat away at profits or there are fatalities involved.

Our variable pay plan must reward our driver for safe, courteous on time deliveries, but in a way that pays for itself. Rather than pay our driver $15 per hour, we are going to offer the drive $14 per hour with a variable pay plan which gives the driver an upside opportunity to the equivalent of up to $3 per hour more paid monthly over the course of the year. However, our driver must make 90% of all stops on time, not incur any at fault accidents, have no more than 3 unexcused absences annually, and have a customer satisfaction rating of “Satisfactory” or higher from all customers. We do not want to make our plan too complicated, yet we do not want to create something that is not a pure give away. We want it to pay for itself by reducing insurance costs, retaining customers, and limiting vehicle maintenance costs and lost production time.

On the upside, our driver has the opportunity to earn back the missing $1 to get him to the median of the going market rate, and has the potential to earn an additional $2 per hour taking him up to a point 13% above the going market rate. If our driver achieves 100% of his target, his rate of $17 will approximate the 66th percentile of the market rate. Of course, our driver has to understand the features of the plan, perceive that he has control over enough of these features so he can achieve the performance levels, which will earn him the rewards, and the rewards must be relevant to the driver.

The one aspect of the plan that we do not want to occur is that the plan’s risk factors are set too low and the variable portion of the employee’s total compensation becomes a simple giveaway. The plan has to be designed in a way that it pays for itself while allowing the employee to earn the rewards and the employer to reach its goals associated with the plan. Finally, all of these factors are going to be different for each employer, depending on their individual situation.

Basic Variable Pay Plan Design

Tuesday, August 10, 2010

Variable pay can be, in its most basic form, an incentive plan, a bonus plan or any reward used to direct the employee's performance behavior to the next higher level. A sales representative’s commission earned from selling specific quantities of products or services at or above some fixed sales level is a form of variable pay. A bonus paid to a production line worker is also a kind of variable pay in recognition of a higher production level. Variable pay plans in one form or another have been around for decades and have gone under various names, i.e., bonuses, commissions, incentives, rewards, … etc. What generally differentiates a variable pay plan from a simple bonus or commission plan is its design, which attempts to improve performance in a careful and well planned and well thought out manner.

I once worked for a company that took scrape aluminum and reprocessed it into specification alloys for the automotive industry. During that reprocessing large amounts of expensive materials and in some cases, dangerous chemicals were used. If the furnace operator incorrectly added these materials or chemicals at the wrong time, in the wrong amounts or in the wrong combinations, several thousands of pounds of molten aluminum were often worthless. It might require a day or more to pour off the current worthless batch, recharge the furnace, bring the batch to the proper specification mixture, and pour the contents. A very expensive mistake to overcome, coupled with the real possibility of a missed shipment date, customer relations issues, wasted materials, and labor and fuel costs.

A variable pay plan would have looked at all of these factors and others, in an attempt to increase the likelihood that the furnace operator would understand his role in the process, as well as the financial and customer relations impact of potential mistakes. Consider that there are some factors the operator cannot control; however, a variable pay plan would use controllable factors in the design of the plan, such as when, how, and in what quantities alloy materials were added to the base aluminum.

At another employer, a large insurance company, our sales representatives certainly had incentive plans to sell more business, however those plans failed to factor in the quality of the group business sold. So a representative would sell coverage to groups without any consideration as to how profitable the group would be, the likelihood the group could be retained at renewal time, how difficult the administration would be. Thus, a representative might sell twice the amount of business as a peer but the company would actually take a loss on those groups due to the “quality” of the business sold. A well-designed variable pay plan might consider factors such as, group profitability, future renewals and retention, administrative factors, and even aspects around the future growth of the group and referral business.

Therefore, the design of a variable pay plan is unique to the industry, organizational unit, and even the culture for which it is being built. A plan design for aluminum reprocessing will not work in the insurance industry. A variable pay plan built for US workers may not appeal to workers in Asia or South America. Variable pay designs can be very complex or a simple design can be found that will drive to the root cause of a performance issue very effectively.

Salary Increases Going to Top Performers

Thursday, August 05, 2010

On July 21, 2010 WorldatWork, the global human resources association focused on compensation, benefits, work-life, and total rewards, released its "37th Annual Salary Budget Survey Analyzes Employer Pay Strategies" report. The annual survey is the largest of its type and pulls from over 2,400 respondents covering some 15.5 million US employees.

As expected and as has been the trend for several years, the average salary increase has generally ranged between the mid 2% to the upper 3%. However, employee performance does seem to matter, as the Survey reports that higher performers are receiving over 50% more than lower and middle performers. While a 50% differential sounds great for top performers, when taken in terms of absolute values, 3.5% vs. 2.5% is still a very thin margin.

The survey also reported that one third of respondents indicated that they have an independent budget for promotional increases. These promotional increases have the ability to yield from 7% to 8% for the employee’s compensation. In addition, employers have increasingly been utilizing variable pay practices to supplant some of their traditional compensation methods of the past. While variable pay in the form of bonuses and commissions have been used for decades in roles such as sales, they are finding their way into non-managerial and staff support roles.

SHRM, the Society for Human Resource Management reported on March 1, 2010, that variable pay, e.g., “Companies Worldwide Rewarding Performance with Variable Pay” as a means of rewarding employee performance. SHRM quoted from the Hewitt Associates worldwide survey of over 6,000 large organizations in 46 countries who were queried about their pay practices. The survey indicated that roughly 80% of employers globally are using variable pay programs to recognize employee performance. What makes variable pay different from bonuses, commissions or other pay practices is that conditions around variable pay payouts change every year. While on the surface, this does not sound any different that any sales commission scheme, a degree of risk is introduced into variable pay plans.

Generally, employee variable compensation is composed a fixed pay and variable pay portion in some relative ratio, i.e., 90/10, 80/20, 75/25. The actual ratio is determined by a number of factors including, the position, industry, earnings opportunities, and employee’s control over the earnings environment, … etc. The variable portion is placed “at risk” relative to the performance of both the employee and the organization. The organization could be the employee’s entire employer, department, location, facility, team or some other “unit”. When the variable plan is designed, the employee’s fixed portion is not set to equal the market rate for the employee’s position. Rather it is backed down to say 90%, 80%, or even 75% of the market rate, the variable portion is designed to allow the employee to fill the “gap” to 100% and on the upside, even reach 110% or 125% of the position's market rate.

Numerous articles and books are available on variable pay iincluding those from WorldatWork.
Google Books also has an outstanding selection of books on variable pay, including variable pay plan in the international community.

More Favorable State Wage Laws Prevails

Monday, August 02, 2010

Generally, Federal law, even Federal regulations will supersede state and local laws and regulations. However, there are situations where state and/or local law or even regulations will triumph over the Federal government’s counter-part, i.e., Federal vs. state minimum wage and overtime laws. The US Court of Appeals for the Seventh Circuit in Spoerle v. Kraft Foods Global, Inc., 09-2691 affirmed that if the state law provides for a wage higher than the Federal Minimum Wage, the state wage prevails. Thus, the Appeals Court concluded that the district court did “… not err in concluding that plaintiffs are entitled to be paid for all time required by Wisconsin law …”

In the original case, a Kraft worker argued that required safety equipment, i.e., “steel-toed boots and hard hats, plus a smock that keeps other garments clean” does not meet the definition of “clothing” under Federal labor law and the time spent “donning and doffing“safety equipment should be considered compensatory time and paid at the higher rate of pay, i.e., the Wisconsin state minimum wage. The worked argued this even though his union had bargained in good faith to exclude this time from time worked. 29 U.S.C. §203(o), provides that unions and employers may bargain for “donning and doffing“ time and agree that such time is exempted from paid time, rather it is compensated for by a higher rate of pay during the rest of the shift. Usually, “donning and doffing” time at the beginning and the end of each shift entails 5-15 minutes and is integral to the safe and hygienic operations of a food processing plant.

In addressing the worker’s first point, that “donning and doffing’” time should be considered compensatory time the Appeals Court dismissed the argument every quickly with little fanfare by commenting:

“They have two principal arguments: first that protective gear is not “clothing” under §203(o), and second that Wisconsin’s own wage-and-hour legislation lacks any equivalent to §203(o). The first of these arguments is a loser, for reasons given in Sepulveda v. Allen Family Foods, Inc., 591 F.3d 209 (4th Cir. 2009). We agree with Sepulveda and need not repeat its analysis.”

In agreeing with the Kraft workers' second position, the Appeals Court concluded that:

“Nothing that labor and management put in a collective bargaining agreement exempts them from state laws of general application ... States can set substantive rules that determine the effective net wage, even when a CBA plays a role (as it does when a law requires overtime pay at some multiple of the base pay set in a collective bargaining agreement).”

Therefore, in this case state law provided for a higher rate of pay than the Federal Minimum Wage provider for and since nothing in Federal labor law pre-empted state law, state law prevailed.

When employed by an organization that operates in numerous states, it is essential that you understand the fine line details of Federal, state, and local wage and hour as well as labor law.

As always, you should seek out qualified professional and credentialed advice when dealing with wage and hour as well as labor law issues affecting your organization.