Can Variable Pay and Non-Financial Rewards Replace Annual Increases?

Friday, July 26, 2013

 

2013 is shaping up to be yet another year in which merit budgets and compensation increases are modest at best.  The surveys from WorkatWork, the Hay Group, Milliman and a score of others point to about a 3% target for most increases.  At the same time, the economy is slowly improving, organizational hiring is up moderately, and employees are beginning to think about alternative employment opportunities.  With an emphasis on holding fixed labor costs down, employers are trying to balance employment costs with the need to retain their best talent and hire a limited number of talented employees.  To accomplish this, organizations are relying more on both variable pay and non-financial rewards to keep their workers motivated.  But can theses efforts replace the standard model of annual increases?

 

Variable pay can take many forms, from short and long term bonuses and incentive plans to spot awards for exceptional performance to sales commissions, and even employee stock and ownership plans.  Variable pay plans may be based on individual employee or group performance, e.g., a department, a plant or an entire company.  For Variable pay to be effective, it must never permanently add to an employee’s base pay, benefits are generally not based on a definition of compensation which includes variable pay, and employees clearly understand that variable pay must be re-earned.  This definition means that a portion of an employee’s compensation is “at risk” of not being earned or being less than it was during some former period.  This risk factor contributes to the employee’s motivation to strive to re-earn a similar amount and even more than they did previously.

 

As with variable pay, employers are engaging in the use of non-financial rewards as a means to motivate employees while keeping compensation costs down.  And just as with variable pay, non-financial rewards can take on a multitude of forms such as training, trips, recognition awards, gift cards, promotions, special assignments, letters of commendation, merchandise and even bragging rights.  Organizations often overlook the most common form of non-financial reward, simply acknowledging the employee’s contribution and efforts with a “Thank You”!

 

It is known and understood that any reward system which occurs on a regular and predicable cycle will sustain behavior, but only at a fixed level.  However, rewards which take place on a variable basis tend to increase behavior to its maximum level.  Therefore, a compensation system with a portion of its pay based on a variable reward design will tend to increase performance.  At one end of this method is a function whose compensation is 100% commission and at the other extreme is a job paid 100% by fixed wages.  For most variable pay designs, the desire is to have a reward system designed between these two extremes.

 

Variable pay and non-financial rewards will see even greater use in the future, even in jobs which traditional have been compensated on a 100% fixed based salary.  However, it is unlikely that annual pay adjustments will completely disappear from the compensation manager’s tool box.  There will always be a need in some situations with selected jobs to annually review and adjust base pay due to organizational demands, labor market pressures or the contributions of individual employees.