Variable Pay in Lean Salary Budget Times

Monday, September 27, 2010

With frozen salary budgets, staff reductions, plants closures, and high rates of unemployment, any kind of significant employee salary increases are far and few in between. One area where organizations appear to be willing to continue to provide financial reward is variable pay. While variable pay has been around for decades, its use has become increasingly widespread. Variable pay may also be recognized by other names, including “incentive pay” and “pay for performance”.

Variable pay is a reward that is focused on a specific achievement, goal attainment or accomplishment such as changes in organizational productivity, profitability, teamwork, safety, quality, or some other measureable factor. Organization could be an individual employee, a group or groups of employees, a department, plant, mill, office location or the entire company. Variable pay (financial and non-financial) may be awarded in a number of methods and includes many familiar arrangements such as; formal profit sharing plans, bonuses, commissions, deferred compensation arrangements, cash, and even in-kind merchandise as in paid vacation trip.

Where variable pay differs from a simple bonus is that payment of the reward is often based on multiple factors. It  is just not acceptable to sell 10,000 units of X to a client. The sale needs to be the right client, the sale needs to be highly profitable, and it needs to be a client that will provide repeat business. Selling 10,000 units below cost, to a client that will never provider repeat business or selling to a client that defaults on the credit arrangements is not going to meet the organization’s needs. I once worked for a large insurance company whose sales representatives might sell a group contract below actuarial cost, or to a group that would not renew, or fail to cross sell multiple product lines, resulting is a lost opportunity. Finally, variable pay should never be guaranteed, rather variable pay is always at risk.

The risk associated with variable pay should be substantial. It has to be more than just the loss of a few dollars. It would not be unusually for variable pay to make up 25% to 50% of an employee’s total earnings potential. The design of a variable pay plan in complicated and detailed but an example might be: base pay is set at 75% to 70% of the average market wage rate for a position and the variable pay potential is set at 25% to 50%. This potential allows the employee to opportunity to earn back to a point where they are at the average market wage rate for their position, plus up to an additional 25% above that rate.

Since variable pay could be directed at any organizational achievement and not just sales. Consider a variable pay plan directed at the reduction or production errors or waste, addressing plant or mill safety issues and injuries, reduyction in fuel usage in fleet vechiles, on time, under-budget software project implementation. I once reviewed a variable pay plan for a small steel mill near Tampa Florida where even the administrative staff pitched in during the annual maintenance furlough.

Variable pay plans have seen a significant growth in the last 20 years, and why is that? Organizations are finding that “merit” pay plan do not work, especially in a down cycle. Since variable pay is generally tied directly to organizational performance, variable pay plans have the ability to for themselves.