What is variable compensation?
Variable compensation is pay given to an employee based on the results they produce. It is usually offered on top of a fixed salary and comes in various forms.
- Commission: This is a portion of revenue given to the sales employee as part of an official compensation plan.
- Profit-Sharing Plan: This plan gives employees a portion of the company’s quarterly or annual profit in addition to their base salary.
- Bonus: This is an extra lump sum given to employees based on the company’s performance. It’s often an unspecified amount on an annual basis and will vary depending on the year’s results.
- Stock Option: This option gives employees the right to purchase shares in the company under certain circumstances. They are sometimes offered as an alternative to cash compensation.
Why do employers offer variable compensation?
A variable compensation plan is designed to support the align salespeople’s daily activity with company objectives. Employers offer commissions to encourage sales reps to produce better business results.
It also helps employers attract top salespeople who want their ability to create value reflected in their paycheck. The best sales reps pride themselves on their ability to control their income based on performance. Flexible compensation allows them to do that.
Advantages of Variable Compensation
Variable compensation provides several benefits.
1. Increased Productivity
Performance-based pay gives employees an incentive to improve their individual performance. If the IC plan is not driving better business results (revenue, user growth, etc.), then it is a waste of resources.
2. Employee Engagement and Retention
Variable compensation helps talented employees earn more, which helps to improve retention and engagement. But a badly managed sales compensation plan could have the opposite effect.
3. Correlation with Performance
Variable compensation — such as commission — correlates performance with income. Employees can see and quantify the value they add to their employer and vice versa.
4. Financial Flexibility
Flexible pay allows employers to pay employees after they have generated revenue. That means that employers don’t need cash to pay new reps upfront. It also helps to align expenditure with income.
Disadvantages of Variable Compensation
Variable compensation has several key downsides.
1. Poor Execution
Successful incentive compensation programs are very complex to administer and are often manually managed, even in large enterprises.
Multiple stakeholders also make setting the measures of performance and goals difficult. Cost-reduction measures are often very ineffective. Companies that use incentives to drive sales revenue tend to happy with their IC plans.
“If a company wants growth, it can’t reward for cutting costs,” said Paul Shafer, Manager at Hewitt Associates. “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.”
Companies that offer commission-only salaries will struggle to attract or retain talent. Even though fixed salaries don’t help to increase sales performance, they provide employees a safety net. A combination of fixed and variable income is the best way to motivate employees effectively.
Should I offer my employees variable compensation?
Despite its popularity, variable pay is not easy to manage. Hewitt Associates found that 50% of companies with single-digit growth believe the cost of their compensation program outweighs its benefits.
Flexible compensation programs can help you motivate employees and achieve superior business performance. But, they must be administered properly to be profitable.
Employees’ goals should be achievable, clearly defined, and drive wider business objectives. For an incentive to be successful, employees must have control over their performance and feel their targets are achievable.