Why Variable Compensation is a must in 2022

In a competitive market, organizations should do everything they can to be as efficient and productive as possible to succeed. And here, variable compensation can be of immeasurable value. Organizations can use it as a powerful tool to retain, recruit, and motivate the best talent. In fact, about three-quarters of organizations use some sort of variable compensation and as a result, it’s a prominent player in the modern compensation landscape.

In 2022, with competition for top-performing sales talent higher than ever, it’s even more critical for organizations to motivate and retain the best employees. Simply put, variable compensation is a must in 2022. But why is variable compensation necessary? This post looks at this question in more detail and illustrates some of the benefits organizations can gain if they implement a variable compensation system.

What Is Variable Compensation?

In simple terms, variable compensation is an incentive that employees receive on top of their base salary. Its main aim is to motivate and retain employees while at the same time contributing to the success of an organization. Probably the most common example of variable compensation is the commission a salesperson receives when they meet their targets.
Variable compensation plans can be made up of a variety of different compensation methods. Some can, for example, include lump-sum payments, technical achievement awards, or cash profit-sharing plans. Others can also include small group incentives, gainsharing, or incentives for any new skills or knowledge that an employee acquires.

To understand how variable compensation works, let’s look at some examples:

• Commission. This is the form of variable compensation most often used by sales organizations. In this model, the employee, for example, receives a commission on every sale they make. So, if one looks at an auto salesperson, they’ll receive a base salary and then a commission for every vehicle they sell. 
• Percentage. With this model of variable compensation, employees receive a percentage of every sale they make. For example, if a salesperson sells insurance, they’ll receive a percentage of each monthly premium a customer pays. Also, they’ll receive that percentage for as long as the customer keeps that policy. This not only motivates them to make more sales but also to keep their existing customer base satisfied.
• Bonus. Both the above models are easy to implement in processes like sales, where performance is directly measurable against sales made. But what happens where it’s not a sales position? This is where a bonus comes in. Here, employee performance is measured against variables like whether they meet their deadlines or the level of quality in their work. As such, if they do meet deadlines and deliver quality work, they’ll be eligible for a bonus. This incentivizes the employee to deliver better work.
• Peer driven. This model is based on employee feedback. In other words, employees are awarded increased remuneration based on the feedback they receive from their peers. This form of variable compensation improves teamwork and collaboration between employees.
  

Keep in mind, though, that these are just some forms of variable compensation and that there are many more which can include anything from individual incentive bonuses and commissions to profit sharing, retention bonuses, hiring bonuses, and team incentive bonuses.

Who Should Use Variable Compensation?

Now the question is who should use variable compensation? Fortunately, the answer is simple. Any organization that wants to improve its performance and base this performance on measurable productivity increases can use variable compensation.

Employees want the opportunity to increase their base salary, and they want to do this based on their performance. So, if their performance is rewarded, the organization will not only encourage them to perform better but also retain valuable employees. This, in turn, improves the organization’s performance.

Some examples of companies using variable compensation include:

• Sales organizations that want to increase their sales and offer their salespeople commissions on the products or services they sell.
• Food service organizations that want to increase the sales of certain menu items and offer their employees incentives to promote these items to customers.
• Home service businesses that want to get more referrals and offer incentives to their employees to deliver prompt and efficient service to make these referrals possible.
• Business services organizations that want to increase their client base and offer their employees incentives to acquire more clients and keep them satisfied to retain them.
• Healthcare companies that want to reduce costs and incentivize their employees to work more efficiently to achieve this.
• Marketing organizations want to increase their revenue and incentivize their employees to deliver the highest quality work.
• Manufacturing businesses that want to shorten the time to market and incentivize their employees to work faster and more efficiently in order to achieve this.
  

How Variable Compensation Benefits Organizations

So, for these organizations that use variable compensation, what are the benefits? Well, as said before, the main advantage of variable compensation is that it improves the organization’s performance by encouraging employees to, in turn, improve their performance.

It does this, in the first place, by encouraging employee productivity and efficiency. In simple terms, if employees know that they’ll be paid more if they work faster, better, and more efficiently, they’ll make the effort to do this. But it goes further than this, for example, where employees are incentivized to learn new skills and gain knowledge that will allow them to be more productive.

This improves an organization’s performance and increases their return on investment on any new hire they make. And speaking of return on investment, variable compensation also allows organizations to reduce their fixed costs.

In simple terms, for any employee that a company hires, there is a fixed cost that increases as an employee’s salary increases. This is especially true when it comes to management, who earn far more than other employees in the organization. So, if a company implements a variable compensation system and, in effect, lowers its base salaries, it’s able to reduce its fixed cost of wages.

Ultimately, when an organization implements variable compensation, it establishes a culture of achievement under its employees. By receiving incentives, employees know that the company values achievement and will therefore strive for more. As a result, high-performing employees will thrive because they earn more for the extra effort and results they bring to the organization.

In turn, average-performing employees will be inspired and strive to be more productive. For one, they’ll see the benefits that high performers have but also which behavior is the organization rewards. As a result, they’ll focus more on the aspects of their job where they can be rewarded.

Are There Any Downsides to Variable Compensation?

As with most things in life, variable compensation has downsides too. These include:

• It can be complex to manage. For organizations to implement variable compensation, they need to have the right systems in place to manage it. If they don’t, it can become very complicated very quickly because they need to keep track of all the metrics necessary to incentivize employees. That’s where the right incentive management software can save a lot of time and hassle.
• Organizations need to budget for it. Although it can reduce an organization’s fixed costs, it’s still necessary to budget for it. For example, if 20% of employees’ compensation comes from bonuses, commissions, and other incentives, organizations need to set an amount aside to cover this.
• It could have unwanted effects. When organizations implement variable compensation, they need to be very clear on what they’ll incentivize. For example, if employees are incentivized for the number of sales they make, this could lead to them giving customers larger discounts than expected to make more sales. So, although this may increase sales, it could lead to decreased profits. Another unwanted effect could be unhealthy competition between employees, which reduces their productivity.
  

Implementing a Variable Compensation System

For organizations that want to implement a variable compensation system, there are several factors to consider that would ultimately make the system more successful.

For example, for the system to work, employees must have control over their performance. In other words, if their performance relies too much on other employees or the organization, they have little control over it and won’t feel empowered to strive for better performance.

Also, the system should be transparent enough and clearly defined so that employees can see how performance impacts what they earn. If they can’t see that average and high performance are not rewarded equally, the system won’t succeed. As such, there must be a clear system on how performance is measured and how employees are incentivized based on their performance.

Finally, organizations should make sure their variable compensation plan aligns with the goals of the business. In other words, employees should be incentivized only for actions that actually improve the performance of the business.

The Bottom Line

For organizations to improve their performance and ensure success for the foreseeable future, after the devastating year that was 2020, they need the right tools to motivate and retain the best talent. 

One of these tools is variable compensation, which allows organizations to motivate their employees, retain the best talent, and attract new talent. This ultimately improves the organization’s performance as a whole and lays a solid groundwork for success.