Variable pay programs are an increasingly popular mode of compensation in today's business world. These programs, which are also sometimes referred to as "pay-for-performance" or "at-risk" pay plans, provide some or all of a workforce's compensation based on employee performance or on the performance of a team. Variable pay proponents contend that providing tangible rewards for superior performance encourages hard work and efficiency and serves as an effective deterrent to mediocre or otherwise uninspired work performance.
Variable pay programs are made up of a variety of different compensation methods. In the broadest sense, variable pay programs include annual incentives or bonus payments; individual incentive plans; lump-sum payments; technical achievement awards; cash profit-sharing plans; small group incentives; gainsharing; and payments for newly acquired skill and knowledge. Some analysts argue that variable pay programs should be defined far more restrictively, but most agree that all of the above share a common emphasis on recognizing achievement, which is the ultimate goal of variable pay plans.
VARIABLE PAY AND THE MODERN BUSINESS ENVIRONMENT
The growing prevalence of variable pay alternatives in business compensation strategies has been attributed in part to a couple of other business trends. Rapidly changing technologies have had an impact on the ways in which we do work in the 21st century. Along with these changes have come rapidly changing job descriptions and a need for people with flexible skill sets to man these positions. At the same time, business observers point out that increased emphasis on quick reactions to changing competitive conditions have triggered a growth in movement toward employee empowerment. And as employees become more empowered, employers have had to find new ways to compensate them for their contributions to the overall enterprise.
Other analysts frame the issue of variable pay in terms of return on investment (ROI). To minimize today's heightened business risk, businesses must reduce their investment in fixed costs and maximize the use of variable costs, which they incur only if they achieve certain results. Nowhere is this situation seen more clearly than in the balance between fixed and variable pay, since employee compensation in many industries is a company's single largest expense.
ADVANTAGES AND DRAWBACKS OF VARIABLE PAY
Most criticisms of variable pay can be traced to concerns about the nature, implementation, and execution of such programs rather than the theories upon which they are based. In practice, many companies fail to make variable pay programs meaningful to individual employees, which in turn robs the program of much of its power to facilitate increased productivity.
In a report published by the Institute of Management & Administration entitled Companies Are Not Getting Full Value from Variable Pay Programs, the findings showed, as the title implies, that companies report very mixed results from variable pay programs. The survey reported on in the Institute of Management & Administration article was carried out by the firm Hewitt Associates. The Hewitt data showed that about half of companies with single-digit revenue growth believed that the cost of their variable pay programs outweighed the benefit. Companies with double-digit revenue growth, however, almost all reported positive outcomes from their variable pay programs. "The fact that many companies don't benefit from variable pay plans is a significant issue, as they're spending more than $54 million a year on this type of pay. We've found that companies achieving high-revenue growth have successful programs because they provide the appropriate amount of administrative, communication, and monetary support. These organizations know that if this type of pay plan is implemented correctly, it will reinforce a performance culture."
One of the key differentials between companies with a positive and those with a negative experience with variable pay programs was the selection of appropriate performance measures. Those measures are the primary motivation for employees and they communicate to employees what the objectives of the company are. Companies that focused variable pay measures on the ability to reduce costs reported less satisfaction with the programs than those companies using increases in sales as the measure upon which variable pay was linked. According to Paul Shafer, a manager with Hewitt Associates, "If a company wants growth, it can't reward for cutting costs. Cost reduction and growth can be competing, rather than complementary, goals, so by blending the two, companies run the risk of confusing employees and, in all likelihood, accomplishing neither."
Despite these mixed results, business consultants agree that well-designed variable pay programs that truly reward individual performance can be helpful. The purpose of a good bonus program should be to make the company stronger, more competitive, able to react quickly to change and prosper through growth. A good bonus program draws people into that process. It drives the value of the company by educating people, not with formalized training sessions but through the work they do every day. It provides employees with the support and tools they need to make wise decisions. It provides them with business knowledge they can use to enhance the prospects of the company as a whole as well as their own professional lives.
ESTABLISHING A VARIABLE PAY SYSTEM
Proponents of variable pay programs contend that implementation of such a system is far more likely to be successful if the following conditions are met:
- Employees must have control over their performance. If employees are overly dependent on the actions and output of other employees or processes, they may have little control over their own performance. Variable pay programs that are not based on principles of employee empowerment are almost certainly doomed to fail.
- Differences in performance must mean something to the business. Employees must see that mediocre and high-quality performances are not rewarded equally, and that results count.
- Business goals must be clearly defined and adequately disseminated to employees, and they should be arrived at with their assistance.
- Performance must be measured regularly and reliably. A clear system of performance appraisal and feedback must be put in place, with regularly scheduled meetings as one component.
- Employers should use variable pay as a tool in reaching ambitious business goals. The targets should be set high so that extra effort is needed to reach them.
- Businesses should make sure that their variable pay plans reward employees for actions or skills that actually further the aims of the company.
Ang, James S., An-Sing Chen, and James Wu Lin. "Ascertaining the Effects of Employee Bonus Plans." Applied Economics. 10 July 2005.
"Companies are Not Getting Full Value from Variable Pay Programs." Report on Salary Survey. Institute of Management & Administration. July 2004.
Dietderich, Andrew. "Survey: Pay Based on Performance Gains Ground." Crain's Detroit Business. 3 April 2006.
U.S. Department of Labor. Bureau of Labor Statistics. Morton, John D. "Variable Pay in the BLS National Compensation Survey." 30 January 2003.
"Variable Pay Rising in Manufacturing." Financial Express. 22 March 2006.
Williams, Valerie L., and Stephen E. Grimaldi. "A Quick Breakdown of Strategic Pay." Workforce. December 1999.