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Variable Pay Is the Solution


When organizations rely on fixed compensation plans, they have no flexibility in a dynamic economy. In down times, compensation expense gets out of their control and so the only recourse is to reduce headcount—and that’s not a solution.

 
Most things in life are variable: the economy, politics, financial results, sports franchises and even employee and organizational performance. So why do we seem to insist on fixed pay systems? Why, as a business organization, do we hamstring ourselves with a fixed liability and, in fact, one that typically amounts to the largest single cost of doing business? Just look at Uncle Sam and how well he’s doing with virtually fixed entitlement programs that amount to the largest segment of government spending in a receding economy. And closer to home, almost every business and public organization with largely fixed pay systems has had to reduce or delay pay increases or, in many cases, reduce pay levels and reduce employment levels in response to difficult economic conditions.

When organizations rely on fixed compensation plans, they have no flexibility in a dynamic economy. In down times, compensation expense gets out of their control and so the only recourse is to reduce headcount—and that’s not a solution.  
 

What is variable pay?

Variable or incentive pay plans aren’t new and have been used extensively in both sales and executive pay programs, and to a limited extent in the general workforce. The concepts are simple enough: Pay flows with the fortunes of the organization. You set mutually understandable goals for some period, you objectively measure the degree of success and you pay according to a preset pay schedule that’s mutually understood. And you pay as close to the success as practical. And just to differentiate, bonus plans don’t link preset goals to a preset payout and thus have no incentive value.

The bad: Variable pay systems require more work to establish and maintain. They’re not particularly egalitarian and are certainly not favored by bureaucrats, union sympathizers or below-average performers. Further, they upset certainty, introduce an element of risk into the pay equation for employees and tend to foster discrimination based on performance among participants.

The good: Variable pay systems are more relevant and more reflective of the real world. They tend to focus and stimulate performance against stated organizational targets. Pay and related costs fluctuate with organization and employee performance, and thus enable organizations to more closely balance performance and the cost of doing business. In short, you pay for success.

Variable pay programs designed to reward, motivate and retain talent have grown in use over time. According to a 2008/2009 U.S. Compensation Planning Survey by Mercer, Inc., as many as 50 percent of organizations have some sort of variable pay plan for their general workforce. So what would we have to do if we wanted to establish some sort of variable pay system for the general workforce?
 

In general, we’d have to:

•     Understand the extent of the compensation we’re paying now, our market position and what, in general, we’re getting in return.
•     Know what our near term business plans and goals are and how we’re going to measure them.
•     Explore what type or mix of individual, group or overall organization-wide plans would be most appropriate for the size, composition, location and so forth of the workforce.
•     Outline how the efforts of individuals, groups and/or the overall organization link to the organization’s goals.
•     Establish a budget in line with the goals outlined here, and a method for funding to include both additional successes (for example, profitability) as well as perhaps redeploying funds from the existing compensation program.
•     Track, measure and communicate more openly and more regularly, both employee and organization performance (including financial plans and results) with our workforce.
 
To optimize the success of the plan, we’d have to communicate and engage the workforce in the broadest way possible in the formulation of the goals that are under their control. No small set of tasks, but here is the payoff:
 
•     For the organization, more control over pay expense, with the size of the expense better matched to the organization’s success.
•     For the workforce, a clearer line of sight between what they accomplish and what they’re paid.
•     A better understanding by both management and the workforce of what's important to the success of the organization.
 
Variable pay plans move the organization’s focus away from well intended pay plans that may be merit- or pay-for-performance oriented, but which do not typically incent performance nor result in marked differences in performance and pay among employees. Variable pay does incent performance and does provide for differences in pay based on such performance. Moreover, it’s a more flexible compensation system that enables increased focus, participation and engagement on the part of the general workforce in the business goals and success of the organization.
 
 
Don Helt’s professional background includes industry experience as director and VP of human resources for both public and private corporations in a variety of industries, and as the principal in a human resource consulting practice serving mid and large market clients. Current client projects include workforce, executive and sales compensation; technology solutions for human resources departments; and strategic organizational planning and development. He’s served as founder and chairperson for the Bay Area Compensation Association and as board member for the Northern California Human Resources Association. Contact information is available at donheltassociates.com and salescompassociates.com.

 

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