Variable Pay

Variable Pay and Gainsharing Plans

Variable pay is an umbrella term. Under the umbrella you can find any number of bonuses, incentives, commissions, and other cash compensation that is contingent on something happening.

Depending on who you talk to, this could be either potential pay (“I can earn this money if I just work hard enough for it”) or pay at risk (“This is money I’m not guaranteed, so I don’t trust that I’ll receive it’).

People differ in whether and how much they are amenable to variable pay, depending on their job level, job function, life stage, financial goals, and personal risk versus reward calculus.

Variable pay plans put some portion of the employee’s pay at risk, subject to the organization meeting its productivity/financial goals.

That is, variable pay plans usually means incentive plans that tie a group’s pay to company profitability (although some experts use variable pay to include incentive plans for individual employees); profit-sharing plans are one example.

In either case, when both the organization succeeds and the employee succeeds, the employer hands out a performance-based check, and the amount depends on how well the organization performs during the year and how well the employee performs during an evaluation period. For many organizations, employee performance is measured at the end of 12 months.

In one such plan at the DuPont companyOpens in new window, for example, employees could voluntarily place up to 6% of their base pay at risk. If they then met the department’s earnings projections, they would get that 6% back plus an additional percentage, depending on how much the department exceeded its earnings projections. Other organizations have gain-sharing plans.

gain-sharing plans are incentive plans that engage many or all employees in a common effort to achieve an organization’s productivity goals.

Implementing a gain-sharing plan requires several steps:

The organization establishes specific performance measures, such as the cost per unit produced, and a funding formula, such as “47% of savings go to employees.”

Superior leadership decides how to divide and distribute any cost savings between the employees and the organization, and among employees themselves. If employees are then able to achieve the desired cost savings, they share in the resulting gains.

Leaders should understand that variable pay plans can motivate employees, which is one of the pros of this type of incentive. Although some employees aren’t motivated by compensation and benefitsOpens in new window, a year-end bonus can prod many workers to a higher level of performance.

In this case, a variable pay plan is akin to dangling a carrot in front of workers who otherwise would perform just satisfactory work rather than strive for excellent ratings come performance appraisal time.

High performance ratings are a boost for employees, but the challenge for leaders and their organizations is to sustain employees’ job performance levels beyond the season when companies disburse performance pay.

The prevalence and use of variable pay has increased over time and there is every indication that it will continue to be a prominent player in the modern compensation landscape. And this is because more and more organizations believe variable pay is a better way to motivate employees and reward top performers.