Using Variable Pay – A Compensation Strategy in this Economy

Written by John Sporleder

So there you are in the CEO’s office presenting your recommendations for next year’s salary budget. You have done the analysis, you have all of your facts lined up and your market data to support it. “The costs,” you say, “for next year’s salary increase budget will be … a gazillion dollars.” Well that’s not what you said, but that’s what the CEO heard! In fact, this is probably his fourth meeting that day going over all of the expenses that are needed to run the business and all he sees is spending more money and an eroding margin.

As an HR professional, I know how challenging it is these days for organizations when they try to balance the cost of a salary increase program with their need to recognize employees’ skills and performance. Like many of you, I have faced the challenge of getting caught in the middle and feeling like the two sides of the issue are mutually exclusive. The fact is they are not. Executives and shareholders want great workers who are high performing, but they also realize, and so should we HR professionals, that if labor costs are too high, it will impede on your organization’s financial health. The rising costs of labor, especially in the U.S. is a major concern to organizations that find it more and more difficult to earn the margins that were achieved in prior years – not to mention the fact that customers are looking for deals and that means lower prices.

Can a company in this current economy afford to keep increasing their base salaries and remain financially healthy and competitive? Is there a way HR professionals can help develop ways in which the organization can afford to pay out what is needed in salary in order to attract and retain? I believe the answer to these questions are “yes,” but it does require some “tweaking” of our existing pay programs, specifically, putting more emphasis in variable pay.

Many organizations already have or have used some type of variable pay program such as profit sharing, business unit bonuses (gain-sharing), stock options, performance or retention bonuses, or other varieties of discretionary bonuses. These are a necessary component of pay and always will be. But in this economy, they can be an even more important tool for accomplishing retention and recognition. With base salary increase budgets at their lowest point in 30 years (that’s as far back as I go), variable pay programs can be used as a supplement to recognizing and rewarding performance. The added benefit of variable pay is that they can be more directly tied to corporate performance objectives and only be paid out if corporate goals are achieved. I have watched organizations struggle with how to provide base salary increases to employees in a way that can be directly correlated to business performance. But, things get in the way. Factors such as inflation, criticality of skills, or compression from new hires can all impede on a performance-based salary increase program. Variable pay programs on the other hand can be more directly tied to some aspect of corporate performance such as profit, revenue, or labor efficiency. Variable pay can also offset the negative response that your top performers may have after receiving a “small” salary increase. Yes, it is true that an increase is only the means that is used to achieve the appropriate base pay for the individual – emphasis on pay, not on increase. But employees may still perceive a lower salary increase more negatively than it is intended.

Using Variable Pay to Recognize Employee Performance
Even though you probably already have a base salary increase program that is based on pay-for-performance, you can still effectively use a variable pay program to strengthen your ability to recognize and reward individual performance. Here are some things you can do:

1. If you have a profit sharing plan, allocate payouts that include individual performance factors. This not only recognizes employees’ contribution to the organization’s success, it also provides an opportunity to pay even more to those employees who are your highest performers.
2. Discretionary bonuses are a great way to recognize employees. There is something about getting something when you didn’t expect it that has a sustaining and motivating effect on people. Set up a discretionary bonus plan that pays employees when you observe certain behaviors such as: exceptional performance, the accomplishment of a significant project, the development of a new and innovative process, or exceptional customer services.
3. Develop corporate or organizational quarterly performance goals. This can be integrated into your profit sharing plan, or it could be separate and is dependent upon what your organization wants to accomplish as an overall objective. You can develop goals such as target operating expenses, top line revenue, positive customer responses, quality, or safety measures.

Keep in mind that variable pay programs do require the discipline to not only establish goals ahead of time, but also to manage them if unexpected issues come up that impede on the organization’s ability to accomplish the established goals. Judgment calls will have to be made.

Don’t Forget the Law of Unintended Behaviors
It is important to realize that some unexpected things happen especially when it comes to money so you will need to be mindful and keep a watchful eye. Here are some things to watch out for:

1. Keep in mind that giving out bonuses to employees who are not performing will be and should be hard to stomach and will not go over well with your executives. Good variable pay programs ensure that there is a strong performance component to how the money gets allocated. It is also important to make sure that managers are adequately managing any employee performance issues. But remember, if you leave any employees out, you must have a defensible reason to do so including non-discriminatory practices.
2. In order for a bonus program to be successful, company performance measures must be achievable and realized by all employees. Each employee must be able to see the targets and understand how they can accomplish them.
3. You must have a good communication plan. Employees are going to want to know how things are going on a regular basis. At least quarterly.
4. Acting with integrity from the top to the bottom of the organization. Make sure that checks and balances are in place so that appropriate records are kept and there is good oversight.
5. Don’t forget to change it up every two to three years to avoid the “entitlement” effect that can occur with long-standing bonus programs.

Using variable pay to recognize organization and employee performance not only can have a positive effect on your employees, but it will also be well received by your executives and shareholders. Let’s go back to your meeting in the CEO’s office. You assure him that the cost of the variable pay program is paid only if the organization achieves its stated financial and business goals. Now that’s a much easier “sell” and your CEO is happy that you are thinking of new ways to recognize and reward your high-performing employees. Maybe he’s thinking that you should get one of those discretionary bonuses.