How to Structure Variable Compensation: A Step-by-Step Guide

Your employees might feel unmotivated and disengaged in their work when you only offer a fixed salary. Implementing a variable compensation plan that goes beyond the minimum can help boost their performance and align it with your company goals.

Thanks to Salary.com's Compensation Consulting Services, you can help your organization create and offer a more competitive performance-based compensation plan; all backed by over 70 years of compensation and total rewards experience.

What is variable compensation?

Variable compensation is a pay structure that goes beyond base salary. It includes cash and non-cash bonuses, profit sharing, and commissions that are all based on individual or company performance.

These plans are designed to balance the company's budget for compensation expenses with the payments that employees deserve. Companies use variable pay to motivate employees and sales teams to meet performance expectations that promote employee engagement.

With Salary.com's Variable Pay Program, you can design long- and short-term incentive programs that reward employees fairly and motivate them to achieve goals and deliver results.

Fixed compensation vs variable compensation

Fixed compensation is a stable and predetermined salary that employees receive regularly. It includes base salaries and set hourly wages that are given bi-weekly or annually with no direct link to performance outcomes.

On the other hand, variable compensation adjusts based on employee performance and company results. This includes cash bonuses or profit sharing that can only be given when employees complete a project or meet sales targets.

Why offer variable compensation?

Offering an effective variable compensation plan helps retain top talent as it makes employees feel valued and motivated to contribute more. It also attracts highly qualified candidates as 53.8% of senior managers view it as a key factor in job acceptance.

With Competitive Pay Assessment, you can help your organization assess the market competitiveness of your pay and benefits programs.

Benefits of offering variable compensation

Organizations that offer variable compensation can expect the following benefits:

• Attracts top talent through rare and unique offers that are more appealing in a tight labor market.

• Encourages employees to achieve specific performance targets and contribute to the company’s success.

• Offers employees, especially sales reps, the opportunity to earn sales compensation based on revenue and customer satisfaction scores.

• Improves employee retention by showing employees that you value and appreciate their job performance and efforts.

• Promotes a performance-driven company culture where high performance is recognized and rewarded as employees consistently strive for excellence.

Variable compensation examples

Here are some examples of performance-based compensation:

1. Non-cash bonuses

   Boosts employee morale and job satisfaction by offering gift cards, vouchers, training, or unique benefits to them.

2. Profit sharing

   Enables employees to have a share in company profits based on their contributions to the company's achievements or income.

3. Stock options

   Encourages long-term commitment by offering employee equity that allows employees to have a potential future gain.

4. Sales commission

   Allows sales reps to earn variable pay based on their sales performance that forms the basis of the entire sales compensation plan.

5. Quarterly or annual bonuses

   Allows employees to receive bonuses on a quarterly or annual basis for meeting the company's performance metrics during a specific period.

6. Cash bonuses

   Provides immediate financial rewards like extra paychecks or spot bonuses for employees' exceptional achievements that motivate them to excel.

Key considerations for structuring variable compensation

Here are some considerations in structuring variable compensation:

• Structure performance pay based on individual performance and revenue generated to reward employees fairly.

• Ensure that the bonus plan is easy to understand so employees know how their performance affects their pay.

• Align incentives with company objectives to drive overall company success.

• Incorporate a mix of short-term and long-term incentives to determine both immediate results and sustained performance over time.

• Review and adjust your variable pay plan regularly to ensure it remains effective in motivating and retaining talent.

To help address these concerns, organizations can take advantage of Salary Structure Building to model competitive salary structures and assign appropriate salary ranges.

How to structure variable compensation

Here are 7 simple steps on how to effectively structure performance incentives in your company:

1. Step 1: Define objectives clearly

   Set specific goals for your variable compensation plan, such as boosting sales or enhancing productivity. Match these objectives with your compensation strategy to ensure they drive the desired results and support your organization's success.

2. Step 2: Select appropriate variable pay types

   Evaluate various types of variable compensation such as cash bonuses profit-sharing or stock options based on your company's goals and employee roles. Choose the best to incentivize the behaviors you want to encourage and fit your organization's compensation strategy.

3. Step 3: Establish detailed performance metrics

   Identify specific, measurable, achievable, relevant, and time-bound (SMART) key performance indicators (KPIs). Establish benchmarks and targets for each indicator and develop a system for regular tracking and analysis of these metrics. Ensure that they are directly tied to the variable compensation elements to reward employees fairly and accurately.

   HR Metrics & Analytics can help review current metrics, establish benchmarks, and provide a model for measuring effectiveness over time.

4. Step 4: Create a structured compensation plan

   Design a comprehensive variable pay plan that outlines how and when rewards are distributed. Use information gathered and metrics created and include details like eligibility criteria and payout schedules. This is to ensure the plan effectively motivates employees, employee performance aligns with company goals and promotes a culture of accountability and fairness within the workplace.

5. Step 5: Communicate the plan effectively

   Ensure all employees understand the plan created by clearly communicating its details through discussion channels. You can use virtual or physical systems for regular tracking and printed materials. This promotes transparency, helps prevent confusion, and ensures everyone is aware of how their performance impacts their pay.

6. Step 6: Monitor employee feedback and performance

   Capture insights on employees' experiences and satisfaction with the compensation plan by gathering employee feedback through regular surveys or focus groups. This information can be used to improve the plan’s effectiveness by addressing what satisfies them.

7. Step 7: It should be Review and refine the program

   Regularly review the effectiveness of your performance incentive plan regularly by staying updated on current market trends, analyzing employee feedback, and referring to performance data. Identify gaps and discrepancies that need to be addressed and make adjustments if necessary. This is to enhance the program's impact on employee motivation and ensure competitive market standards.

Implementing well-structured variable compensation plans motivates employees to perform at their best. It goes beyond offering just a base salary and rewards employees for their specific contributions and achievements. With Salary.com's Compensation Consulting Services, you can create a performance-based pay program that aligns employee performance with company goals and contribute to the overall success of your organization.