What Is Variable Pay and Why Do Employers Offer It?

By Indeed Editorial Team

Updated 21 September 2022 | Published 8 September 2021

Updated 21 September 2022

Published 8 September 2021

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Variable pay is an incentive scheme provided by many employers. It offers several advantages for both the employee and the employer and is a popular format for compensation in several industries. Whether you are an employee or an HR manager, it is beneficial for you to know how this payment scheme works. In this article, we examine what variable pay is, how it can be calculated and review some examples of this payment type.

What Is Variable Pay?

Variable pay is the part of compensation an employer pays to an employee based on their performance or the results of their work. The amount of pay is variable and depends on the employee's and the organisation's performance. The organisation pays the variable compensation in addition to the base pay. Variable payment is subject to pre-determined conditions and is usually linked to productivity. It differs based on the job, the employee's experience and the company's policies.

For example, a company may have an incentive scheme stating that all salespeople get a flat 5% of every sale they make. To encourage employees to make larger sales, the company may declare that this figure is 7% for all sales exceeding Rs. 10 lakhs. The same company may offer 10% of the sales profit to its top sales executives who consistently secure business transactions above Rs. 15 lakhs. Using sales data and performance records of employees, the company can speculate that a certain percentage of employees may be eligible for each of these variable compensation schemes.

Related: What Is a Salary Slip? Importance, Components and Format

Why Do Employers Offer Variable Compensation?

There are many reasons for employers to offer variable compensation. Some prominent ones are:

Talent retention

Companies that invest in employee retention and recognition may offer more in terms of variable compensation. Since companies cannot increase an employee's basic pay very often, talented employees are always looking for better opportunities. Variable compensation plans give monetary incentives to the top talents and encourage them to stay with the organisation longer. If a resourceful employee shows they are looking to leave the company, management can increase their variable salary component and motivate them to stay longer. Variable compensation may prevent employees from moving jobs quickly in industries that have high turnover rates.

Related: What Is Talent Management? Importance, Strategy and Process

Talent appreciation

Every employee has a job description and a specific set of duties. There could be situations where an employee completes additional responsibilities or exceeds their employer's expectations. Bonuses and incentives may help to encourage team members to work beyond their fixed scope and duties.

Performance leveller

Incentives in the form of variable compensation can help reward better performers. It can also motivate others to increase their effort and productivity. Variable compensation encourages competitiveness among employees and reduces the chances for stagnation.

Morale booster

A good variable payment scheme can be a morale booster, as it can relate to the specific financial needs of employees. Securing an incentive once can boost their confidence and help them do their job with more enthusiasm. When employees know their company recognises and rewards their performance, they may be motivated to excel in their duties.

What Are Some Examples Of Variable Compensation?

These are some common examples of variable compensation policies:

Incentive programmes

A company pays incentives only when an employee attains specific targets within a specific period. The company decides and conveys the conditions of incentive programmes in advance. Then, the employer makes the payouts over and above the salary only if the employees meet certain targets set by management. The incentives can be a flat percentage or figure or dependent on other metrics, like sales volume or attendance. There are no formally designed incentive plans that a company has to follow. Such incentives are very common for sales and customer-facing roles and among employees in target-driven industries like finance and insurance.

A company can customise its variable salary structure based on its cost to benefit ratio, budget and approach toward employee recognition. Incentive programmes can be self-funded in the case of revenue-generating departments like sales. For other domains, companies may allot budgets for variable compensation. Some companies also offer merchandise, employee discounts, holidays packages or travel allowances as part of their incentive schemes. There are short-term and long-term incentive programmes. Profit-sharing, sales incentives and management incentives are short-term plans. Equity, promotions and partner tracks are long-term incentives typically reserved for middle and senior-level executives.

Bonuses

Employee performance and company performance are the basis of another type of variable compensation, known as a bonus. One of the main differences between bonuses and incentives is that the employee does not know the bonus criteria in advance. A bonus is typically unexpected or a surprise, whereas an employee may know beforehand what incentive schemes are available for them. An organisation may give a bonus to one employee, a team or all of its employees. The management usually decides the size of the bonus.

Some examples of the different types of bonuses include annual bonus, signing bonus, spot bonus, holiday bonus and profit-sharing bonus. Employers typically give bonuses in the form of money or as equity. To reduce operational costs, companies may choose to offer a higher bonus percentage with a smaller figure for base salary. You may be able to negotiate the specific details of bonuses at the time of joining. Companies may allow you to choose between a smaller or larger variable component. The management may also offer referral bonuses to employees who refer another candidate, who the company consequently hires.

Related: What Is a Bonus? Definition and Types

Recognition programmes

Recognition programmes involve awards of either cash or other recognitions to employees for exceptional performance. Some companies identify talent and nominate employees for training programmes, sabbaticals, workshops or fellowships. Based on an individual's performance, the company may choose to invest in their professional skill development or higher education. Some companies recognise talent by including employees on their websites or newsletter. These programmes enable companies to make their employees feel valued and appreciated for their work.

How Is Variable Compensation Calculated?

Companies may have specific policies to calculate variable compensation. These policies may also evolve and change over time, depending on the company's profitability and growth. When calculating annual budgets, companies may set aside a budget specifically for handling variable compensation requirements. Since variable compensation depends on several factors, including productivity and employee performance, it is challenging for companies to get an exact figure at the start of a financial period.

Companies may rely on estimations to allocate a budget for variable compensation. They can determine the actual cost after they make the payouts for a particular financial period. Companies that provide incentive schemes in the form of holidays, employee discounts or gift vouchers may also work using estimated figures.

Is Variable Compensation Part Of CTC?

CTC, or Cost to Company, includes all fixed and variable payments a company gives its employees. This may include performance bonuses, annual bonuses and monetary incentives that you are eligible for. It also includes the cost of training and onboarding an employee and their business and travel allowances.

Is Variable Compensation Mandatory?

Though variable compensation is part of your CTC, the company may not pay the variable compensation if you do not meet certain conditions as stipulated. If you have not met your incentive targets or your team has not met its performance targets, the company is not liable to pay you the variable component mentioned in your job offer. If the company is at a loss, it may also nullify incentive programmes and bonuses for a specific time period.

What Are Some Disadvantages Of Variable Compensation?

Companies and employees do not know the exact amounts involved in variable payments. This creates a fair amount of ambiguity and makes accounting and budgeting tasks more complicated. As an employee, if variable compensation is a significant component of your salary, you may find it challenging to do accurate financial planning. In many such job roles, employees may depend on factors outside their control. For example, a salesperson who relies on consistent performance for adequate payment may be at a disadvantage if they fall sick for an extended period.

Variable compensation plans can also lead to competition between coworkers, which can affect a healthy work environment. To prevent this, many employers advise employees against discussing details of their variable compensation. Financial incentives also have the potential to lead employees to overwork. Some companies may even enforce an upper limit on the variable amount employees can take home to reduce this risk and improve the working environment.


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