What is Variable Pay – All You Need to Know

Are you looking to learn more about variable pay and how it works? If so, you've come to the right place! Variable pay, also known as performance-linked pay, is a form of compensation that an employer provides to an employee based on their contribution to the organization's growth and success. This type of pay can vary from employee to employee and may be tied to specific performance metrics or goals.

But what exactly is variable pay? What are its benefits, and how does it help companies to remain competitive? In this article, we'll answer all these questions - and more - to provide you with a complete understanding of what variable pay is, and why it's so important.

What is Variable Pay?

Variable pay is a type of Remuneration that is based on an employee's performance. When an employee meets or exceeds their monthly target, they are eligible to receive variable pay, which can take the form of incentives, bonuses, or commissions added to their basic salary. The basic wage remains fixed and is paid regardless of target achievement, and the combination of the basic salary and variable pay is referred to as the pay mix.

The amount and type of variable pay an employee receives depend on both their own performance and the company's overall performance. If a company experiences a loss, for example, employees may not receive the applicable bonus. Therefore, companies often set a target achievement scale and base payouts on the results. Additionally, factors such as team performance and project completion can also affect the pay scale.

Typically, a company will inform an employee of their achievement and the applicable variable pay, which may be provided in the form of stock,  gifts, cash, or paid vacations, among other things. It's important for employees to be aware that the variable pay they receive can vary greatly depending on their own performance, as well as that of the company and their team.

Who Gets Variable Compensation in an Organization?

The individuals who are eligible to receive variable compensation in an organization can vary depending on the specific company and its policies. In general, variable compensation is typically offered to employees who directly contribute to the success of the organization, such as salespeople, managers, and executives. These individuals may be rewarded based on their individual performance, team performance, or the overall performance of the company.

Some companies may also offer variable compensation to other types of employees, such as those who work in production or customer service, depending on their role and the impact they have on the organization's success. The specific criteria and eligibility requirements for variable compensation are typically outlined in an employee's contract or through the company's compensation policies.

What Are the Types of Variable Pay Plans?

1. Bonuses

Variable compensation in the form of bonuses is typically based on employee performance and the company's overall performance. Unlike incentives, the criteria for receiving a bonus are typically not disclosed to the employee in advance. Bonuses are often unexpected and may be given to individual employees, a team, or the entire workforce. The amount of the bonus is typically determined by management and can come in various forms, such as a signing bonus, spot bonus, annual bonus, or holiday bonus.

Employers may provide bonuses in the form of money or equity. Some companies may offer a higher percentage of the bonus with a lower base salary to help reduce operational costs. At the time of joining, employees may be able to negotiate the specifics of their bonuses, such as choosing between a smaller or larger variable component. Moreover, companies may incentivize their employees to refer potential candidates by offering referral bonuses to those who successfully refer someone that gets hired by the company.

2. Sales Commissions

Sales commissions are a common type of variable pay plan where employees receive a percentage of the sales revenue they generate. This type of plan is typically used in industries such as real estate, insurance, and retail where employees are directly responsible for generating sales. This plan motivates sales staff to sell more and to sell better, as their earnings are directly tied to their sales performance.

Sales commissions can be offered in different forms, such as a fixed percentage of sales revenue, a sliding scale that increases as sales increase, or as a flat rate per sale. The terms of the commission plan are usually outlined in a sales contract or agreement between the employer and employee.

3. Profit Sharing

Profit sharing is a type of variable pay plan that rewards employees based on the company's financial performance. This method of compensation is used by many organizations to encourage employees to feel like an integral part of the company's success. Profit sharing helps align employee interests with the company's financial goals, which can motivate employees to work harder and contribute more to the company's growth.

Profit sharing is usually applicable for companies that operate on a profit-based model, and it can be an intelligent way to address employees' concerns about being under-compensated despite the company's success. An example of this could be a company that generates 7,39,47,915 INR in a financial quarter, offering 0.05% of profits to employees who exceed their sales quota during that period. This way, eligible employees could earn an additional 36,970 INR in addition to their base salary, providing them with an added incentive to work towards achieving the company's financial goals. This type of incentive program is often employed in large-scale companies that generate significant sales.

4. Recognition and Awards Programmes

Recognition programs are a form of variable pay that reward exceptional employee performance through awards, incentives, or other forms of recognition. Companies may offer these programs to identify and develop talented employees by nominating them for training programs, sabbaticals, workshops, or fellowships. Based on individual performance, the company may choose to invest in an employee's professional skill development or higher education, thereby increasing their value to the organization.

Other ways that companies recognize outstanding employee performance include featuring employees on the company's website or in a newsletter. By publicly acknowledging employees' contributions and achievements, the company is not only recognizing the individual's effort but also encouraging others to strive for similar success. These recognition programs help build a positive work culture and increase employee engagement and motivation by making them feel valued and appreciated.

5. Incentive Programmes for Meeting Specific Targets

Incentive programs are another form of variable pay offered by companies, usually for sales or customer-facing roles in industries such as finance or insurance where targets are set. Unlike bonuses, these programs have predefined targets and conditions that are communicated to employees in advance. Payouts are made over and above an employee's salary only if they meet the targets set by management.

The structure of incentive programs can vary, with incentives being either a flat percentage or figure, or dependent on other metrics such as sales volume or attendance. Companies can customize their variable pay structure based on factors such as cost-to-benefit ratio, budget, and approach to employee recognition.

Incentive programs can be short-term or long-term. Short-term incentive programs include profit-sharing, sales incentives, and management incentives, while long-term incentives like equity, promotions, and partner tracks are typically reserved for middle and senior-level executives.

6. Gift-based Incentives

Some companies choose to recognize employee performance by giving gifts as a form of variable pay. These gifts may include things like gift cards, travel vouchers, or merchandise. They may also include company-branded items like clothing, bags, or accessories.

Gifts are a way for companies to express appreciation for employee performance in a tangible way, and they can be an effective incentive for employees to continue to perform at a high level. Additionally, gift-giving can help build a sense of camaraderie and teamwork among employees, as they may discuss and compare their rewards with one another.

While gift-giving can be a fun and effective way to incentivize employees, it's important for companies to ensure that they are giving gifts that are fair, appropriate, and aligned with the company's values. Companies should also consider the tax implications of gift-giving and ensure that they are complying with applicable laws and regulations.

7. Differential Pay for Certain Tasks or Conditions

Differential pay is a type of variable compensation that provides higher wages for certain work tasks or conditions that are more challenging or less desirable for employees. For example, companies may offer increased payment for working early morning or overnight shifts when fewer employees are willing to sign up voluntarily. Additionally, some companies offer differential pay for employees who take on extra assignments or responsibilities.

An example of differential pay is a company that offers an extra Rs. 500 per hour for overnight shifts, resulting in a staff member earning Rs.1500 per hour during that time slot instead of their typical 1000 per hour. This type of compensation can incentivize employees to take on more challenging or less popular tasks while also compensating them for the additional effort or inconvenience.

Differential pay can be an effective tool for companies to address labour shortages, retain employees, and motivate them to take on demanding or less desirable work assignments. However, companies need to ensure that their differential pay system is equitable, transparent, and aligned with their overall compensation strategy.

How to Calculate Variable Pay?

It is important for individuals to understand that the compensation package outlined in their employment agreement comprises both fixed pay and variable pay. This can be expressed mathematically as:

Employee package = Variable pay (100 - X% of total package) + Fixed pay (X% of total package)

In this formula, variable pay is determined by subtracting a certain percentage of the total package from 100, while fixed pay represents a specific percentage of the total package. Depending on the company policy, variable pay is typically distributed to employees on an annual or quarterly basis.

Example of Variable Pay

A company offers an additional incentive scheme beyond the fixed pay structure for its sales representatives, whereby they receive a flat 2.5% commission on every sale they close. However, to incentivize employees to aim for larger deals, the company may offer higher commission rates for exceeding certain sales thresholds. For instance, the commission rate may increase to 4.5% and 7.5% for sales exceeding Rs. 15 lakhs and Rs. 25 lakhs, respectively.

To illustrate, consider a sales representative who achieves sales worth Rs. 10 lakhs. In this case, they would receive a variable pay of Rs. 25,000. In contrast, a sales representative who achieves sales worth Rs. 20 lakhs would receive a variable pay of Rs. 60,000, while someone with sales worth Rs. 30 lakhs would receive a variable pay of Rs. 1,20,000.

What are the Benefits of Variable Pay to the Employees?

1. Talent Retention

Variable pay can be an effective tool for talent retention. When employees are offered the opportunity to earn additional compensation through variable pay, it can increase their level of job satisfaction and motivation to perform well. This can lead to higher employee retention rates as individuals are more likely to stay with a company that recognizes and rewards their efforts.

Additionally, the potential for increased earnings through variable pay can make employees feel valued and appreciated, which can contribute to a positive workplace culture and a sense of loyalty to the organization. Overall, the use of variable pay can be a beneficial strategy for retaining top talent within a company.

2. Performance Leveler

One of the benefits of variable pay for employees is that it can serve as a performance leveler. By tying compensation to individual and/or team performance, variable pay can create a more equitable distribution of rewards within a company. This means that high-performing employees who consistently meet or exceed expectations can be rewarded accordingly, while those who underperform may receive less or no variable pay.

This system can motivate employees to work harder and strive for better results, leading to improved productivity and overall performance levels. Furthermore, variable pay can help identify and reward individuals who may not have been recognized for their contributions through traditional compensation structures, providing a fair and transparent system for all employees.

3. Morale Booster

Variable pay can also serve as a morale booster for employees. When employees are offered the opportunity to earn additional compensation based on their performance, it can create a sense of excitement and motivation. The potential for increased earnings can give employees a sense of purpose and drive, leading to increased engagement and job satisfaction. This, in turn, can contribute to a positive workplace culture and a sense of connection among employees.

Furthermore, variable pay can demonstrate that a company values its employees and recognizes their contributions, which can foster a sense of loyalty and commitment to the organization. By boosting morale and creating a positive work environment, variable pay can ultimately lead to improved employee retention rates and better overall performance.

How a Variable Compensation Model Can Improve Company Performance

In the variable compensation model, a portion of an employee's pay is tied to their individual and/or company performance goals. This approach has several advantages for companies:

1. Decreases Base Salaries

By offering a lower base salary and a higher variable pay component, companies can control their fixed costs while also incentivizing employees to work harder and achieve better results.

2. Helps to Increase Staff Retention

Employees are more likely to stay with a company that offers a variable compensation model as it rewards them for their efforts and provides a clear path for career progression.

3. Encourages Employee Success

By tying pay to performance, employees are motivated to achieve their goals, which can lead to increased productivity, improved quality of work, and higher profits for the company.

4. Offers a Method for Assessing Progress towards Goals

A performance-based pay structure allows companies to track employee performance against specific goals and targets, making it easier to identify areas for improvement and provide targeted feedback.

5. Enhances Recruitment Efforts

Companies offering a variable compensation model can attract top talent who are motivated by the opportunity to earn more through their own performance.

6. Recognizes and Rewards Staff Contributions

Employees who feel appreciated are more likely to be engaged and motivated, leading to increased productivity and better results for the company.

7. Promotes Group Effort towards a Unified Vision

A variable compensation model can encourage employees to work together to achieve common goals, leading to better collaboration and teamwork.

8. Provides Clear Work Expectations:

By setting specific performance goals and targets, employees have a clear understanding of what is expected of them, leading to greater job satisfaction and better results for the company.

Pros and Cons of Variable Pay

Difference Between Variable Pay and Fixed Pay

FAQs

1. Is variable compensation part of CTC?

The term "CTC" stands for "Cost to Company," which refers to the total amount of compensation that a company provides to its employees. This includes both fixed and variable payments, such as bonuses and other monetary incentives for which an employee may be eligible. Essentially, CTC is the sum of all direct and indirect expenses that a company incurs in order to employ an individual.

2. Is variable pay paid completely?

Variable pay is paid based on achieving specific goals or targets. If an employee does not meet these goals or targets, they may not receive the full amount of variable pay or may not receive any variable pay at all. The payment structure and rules may vary by organization and should be outlined clearly in the employee's contract or policy documents.

3. Is variable pay compulsory?

If an employee fails to meet the established conditions or if the company experiences losses, the variable pay may not be paid by the organization. Similarly, if the wider team does not meet its targets, the variable component may not be disbursed. Therefore, the payment of variable pay is not compulsory.

4. Is it good to have variable pay?

Variable pay is a useful tool for organizations to balance out and equalize the salaries of their employees. However, if the criteria for determining variable pay are not clearly defined, it may lead to errors in the pay structure. By implementing performance-based variable pay, employees who work hard are rewarded for their efforts, which helps to boost their motivation.

5. Is variable pay and bonus the same?

Variable pay and bonus are similar in the sense that they are both forms of compensation given to employees based on performance. However, they are not the same thing.

Variable pay is a compensation system in which a portion of an employee's earnings is dependent on achieving certain goals or meeting specific targets. This may include performance-based pay, profit sharing, or any other incentive program that rewards employees for achieving specific objectives. The variable pay can be in the form of bonuses or commissions, and may or may not be paid out regularly.

On the other hand, bonuses are one-time payments that are awarded to employees as an incentive for meeting or exceeding performance expectations. Bonuses are usually paid out annually or at the end of a specific project or period. While bonuses can be considered a form of variable pay, not all variable pay is in the form of a bonus.

6. Is variable pay taxable?

Just like fixed pay, variable pay is subject to taxation in the hands of the employee.