Variable Pay Structure: Pros & Cons

Leaders have a lot of options when it comes to finding ways to encourage employees to perform at their best. Offering variable pay is one of many of these options. However, there are pros and cons to the variable pay structure that a leader must consider before implementing it.

The number of employees who earn variable pay has risen significantly within the past 4 years. From 2020 onwards, it is now estimated that variable pay accounts for 15% of employee salaries across all levels and industries and that 77% of American businesses use variable pay.

While this can be great for team performance, it may also raise concerns about cash flow uncertainty. Therefore, it’s important to weigh the pros and cons of this pay structure instead of choosing it for its increasing popularity.

What is Variable Pay?

Variable pay refers to the compensation earned based on performance or results. This payment model aims to motivate employees to perform their best by directly linking their earnings to their accomplishments. It is commonly used for sales teams, executive compensation, and any other roles where performance directly impacts organizational revenue or success.

It’s also worth noting that variable pay is not synonymous with variable salary. Variable salary means that performance influences each paycheck while variable pay is usually additional alongside the employee’s base pay.

Variable Pay Examples

Sales commissions are the most well-known type of variable pay. However, many other forms also exist to reward employees in different roles and industries.

• Bonuses:
  Typically awarded annually, bonuses are lump-sum payments given for meeting or exceeding particular goals.
• Profit Sharing:
  This involves distributing a portion of company profits to employees, usually calculated as a percentage of each one’s base salary.
• Stock Options:
  Allows employees to purchase company stock at a lower price, so they may potentially profit from the company’s future growth.
• Performance Incentives:
  These are specific payments designed to encourage and reward exceptional performance in specific projects or tasks.

Variable Pay Structure: Pros

Enhanced Motivation

When employees know that their financial rewards are directly linked to their achievements, they’re likely to focus more on their goals and work harder to exceed expectations. However, it is only more likely to improve performance for simpler tasks. Conversely, it may worsen motivation for more complex, less quantifiable tasks.

Better Employee Alignment with Company Goals

By implementing variable pay, companies can align employee efforts with overarching business objectives. This setup ensures that they are aware of what the company aims to achieve and motivates them to work towards these goals.

Increased Earnings Potential

Variable pay offers the potential for higher earnings that are not capped by a fixed salary. If an employee excels in their role, they can significantly increase their overall compensation through bonuses and other incentives-based rewards.

Flexibility for Employers

For employers, variable pay provides a flexible payroll solution where compensation is based on actual business performance. During times of lower business performance, payroll costs are naturally lower without the need for layoffs or salary cuts.

Variable Pay Structure: Cons

Financial Uncertainty

One significant drawback of variable pay is the financial uncertainty it introduces. This variability can be stressful and be a demotivator instead of a motivator. In fact, 63% of employees report that feeling financially insecure makes them less motivated to work.

This drawback is particularly risky in roles where outcomes are heavily influenced by external factors that employees have little to no control over.

Potential for Unhealthy Competition

While variable pay can motivate employees, it can also foster a competitive environment that might lead to conflict and unhealthy workplace dynamics. If not managed carefully, this system can encourage employees to prioritize personal gains over team collaboration.

Complexity in Understanding Pay Structure

Variable pay systems can be complex and difficult to understand, especially when they involve multiple metrics or calculation methods. This complexity can lead to confusion and dissatisfaction among employees. It’s crucial for employers to maintain transparency and provide clear communication to mitigate these issues.

Dependence on Clear Metrics & Fair Implementation

The success of a variable pay system heavily depends on the existence of clear, measurable performance metrics and their fair implementation. If the criteria for earning variable pay are not transparent or are applied inconsistently, it can lead to unfairness and decrease employee morale.

Fixed Pay vs. Variable Pay: Ideal Use Cases

There are certain instances where fixed pay is simply a better option than variable pay. There are a wide variety of reasons for this, and unique circumstances can override our recommendations. Nonetheless, here is an overview of the ideal use cases for each structure.

Implement Your Variable Pay Structure Fairly With Consultants

There are certain instances where fixed pay is simply a better option than variable pay. There are a wide variety of reasons for this, and unique circumstances can override our recommendations. Nonetheless, here is an overview of the ideal use cases for each structure.

To get all the pros of variable pay while minimizing the cons, you need to carefully implement and communicate your variable pay structure to your employees. This requires a careful strategy that experienced compensation consultants can help you plan.

JER HR employs such compensation consultants. We have over 30 years of experience in HR in varying industries and would be happy to look at your organization to see if and how variable pay can benefit you.

Reach out today to learn more about what we can do.