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.