- Economics: The conversion of what have been fixed costs to variable costs is an advantage of some significance. Variable pay awards do not compound the way base pay adjustments do, thereby lowering the escalation of rates over time. Assuming variable pay is tied to performance, it both allocates awards more optimally and is contingent on the organization’s economic ability to pay. Finally, variable pay plans can be customized to fit different business units, providing a localized customization to the unit’s ability to pay and creating a focus on its specific objectives.
- Competitive Practice: Variable pay programs can be an effective tool for attracting and retaining those with critical skills, as well as high performers. Since the existence of a variable pay component in the compensation package offers less of a guarantee but more opportunity relative to income, this type of package will disproportionately attract those confident of their ability to perform well and willing to do make the necessary effort. Leveraging the organization’s strengths via variable pay plans is another opportunity. Also organizations experiencing rapid stock price escalation can include a heavy dose of stock options/grants in its rewards package, thereby giving it a competitive advantage. And the flexibility associated with variable pay plans can enable the organization to emulate the best in its industry in order to say competitive, which is sometimes difficult with only base pay or benefits.
- Motivation: Defined objectives/criteria and standards enable the organization to provide a sharp focus on its priorities, and to do so at every level. Variable pay awards act as reinforcement for those performing at high levels and provide a scorecard to enable people to continuously evaluate results. To the extent that people are provided with a “shared destiny” using group incentives, there can also be a strong motivation to support each other and to work cooperatively rather than competing in a dysfunctional manner. The prerequisites to performance are the ability to perform, being allowed to do what it takes, the desire to perform and the knowledge of what constitutes performance. Variable pay plans can function to ensure these prerequisites are in place.
- Communication: Variable pay, particularly if designed as an incentive, is one of the strongest signals an organization can send to its people as to what is important. By continually measuring results high quality feedback can be provided, enabling people to know how they are doing and how to do better. By making employees eligible for variable pay awards it sends the message that what they do counts and that the organization is willing to show its appreciation tangibly. Finally, the criteria used in variable pay plans can promote the importance of mission fulfillment and of living the defined values while pursuing organizational objectives.
- Sense of Ownership: There are other reasons for considering variable pay. The plans can be used to communicate and direct a change from an entitlement culture to a performance culture, as well as promoting employee engagement. Variable pay can also provide a sense of ownership, even for organizations not able or willing to use stock or share equity. Emotional ownership can produce results even though financial ownership is not possible. By balancing the definition of performance to include both the short-term and the long-term it is possible to elicit a balanced perspective. Short-term maximization at the expense of long-term optimization is a danger that is fueled by having all rewards tied to performance, which many organizations do. Finally, a reason for using variable pay is that it works. On the other hand, damage can result when variable pay plans motivate the workforce to do the wrong things. Much of the irresponsible behavior in the banking industry can be attributed to the reality that the people committing the atrocities were encouraged to commit them and were richly rewarded for doing what they did.
An excerpt from: “Variable Compensation:Good Fit To Turbulent Environments” Email firstname.lastname@example.org to request a copy of the full article.