Variable pay and modern business environment
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Variable pay programs are an increasingly popular mode of compensation in today’s business world. These programs, which are also sometimes referred to as “pay for performance” or “at risk” pay plans, provide some or all of a work force’s compensation based on employee performance or on the performance of a team. Variable pay proposals contend that providing tangible rewards for superior performance (a true merit system) encourages hard work and efficiency and serves as an effective deterrent to mediocre or otherwise uninspired work performance.

Variable pay programs can take a range of forms, including annual incentives or bonus payments; individual incentive plans; lump sum payments; technical achievement awards; cash profit sharing plans; small group incentives; gain sharing; and payments for skill and knowledge. Some analysts disagree about whether some of the above offerings are true variable pay programs, but most agree that all of the above share a common emphasis on recognizing achievement, which is the ultimate goal of variable pay plans. All agree that standardized merit programs, in which individual performance is a negligible factor in determining compensation changes, do not qualify.

Businesses that adopt variable pay have to recognize the importance of tailoring the program to account for different circumstances. Factors that have to be considered include:

  • Achievement of business and personal growth goals
  • Compensation packages that are available to employees if they decided to look elsewhere for work
  • Current level of pay based on salary range relative to skills and experience
  • Eligibility of variable pay as an ingredient  in total cash compensation

In a pay for performance environment, true differentiation is expected based on these types of factors. Managing a performance based salary program requires a strong commitment to goal setting and measurement.

The prevalence of variable pay alternatives in business compensation strategies has been attributed in part to a couple of other business trends. Employers are facing a new reality about the way jobs should be valued and compensated in the age of rapid technological change. Gone are the days when employee’s skills lasted a lifetime and companies could predict the future value of jobs, and thus a fixed pay increase, based on past performance.

Today, as customers’ needs shift rapidly due to advances in technology, the skills you need to make a profit may change almost before the ink is dry  on your job descriptions. At the same time, business observers point out that increased emphasis on quick reactions to changing competitive conditions have triggered a growth in movement towards employee empowerment. And as employees become more empowered, employers have had to find new ways to compensate them for their contributions to the overall enterprise.

Advantages and drawbacks of variable pay

Most criticisms of variable pay can be traced to concerns about the nature, implementation, and execution of such programs rather than the theories upon which they are based. Many companies fail to make variable pay programs meaningful to individual employees, which in turn robs the program of much of its power to facilitate increased productivity.  According to an analyst, “Most variable pay programs provide no incentive to anyone and never deliver the promised results.” Why not? Because in 9 cases out of 10, they are not true bonus programs at all; they are simply profit sharing programs, and there is a world of difference between the two.

Profit sharing is the practice of taking a percentage of a company’s profits, put it into a pool, and disburse it to the company’s employees, usually sometimes after the close of the year. However, such distribution plans are unlikely to encourage employees towards greater productivity because they do not get an adequate sense of how their personal contributions helped generate the business’s profits. Many of the failures to date in variable pay plans have occurred because companies simply reshuffled the same amount of compensation in a new plan, offering some through fixed pay and some through incentives.

But business consultants agree that variable pay programs that truly reward individual performance can be helpful. The purpose of a good bonus program should be to make the company stronger, more competitive, and able to survive and prosper in the months and years ahead. A good bonus program drives people into that process. It drives the value of the company by educating people, not with formal training programs but through the work they do every day on the job. It gives them the tools they need to make and understand decisions. It provides them with business knowledge they can use to enhance their own standard of living and job security as they are making a measurable difference to the company as a whole.

Establishing a variable pay system

Proponents of variable pay programs contend that implementation of such a system is far more likely to be successful if the following conditions are met:

  • Employees must have control over their performance. If employees are overly dependent on the actions and output of other employees or processes, they may have little control over their own performance. Various pay programs that are not based on principles of employee empowerment are almost certainly doomed to fail.
  • Differences in performance must mean something to the business. Employees must see that mediocre and high performances are not rewarded equally, and that results count.
  • Business goals must be clearly defined and adequately disseminated to employees, and they should be arrived at with their assistance.
  • Performance must be measured regularly and reliably. A clear system of performance appraisal and feedback must be put in place, with regularly scheduled meetings as one component.
  • Employers should use variable pay as a tool in reaching ambitious business goals.
  • Businesses should make sure that their variable pay plans reward employees for actions or skills that actually further the aims of the company. 

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Bernard Taiwo

I am Management strategist, Editor and Publisher.

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