Variable Pay

What is Variable Pay?

Variable pay is an additional compensation or payment given to employees by companies for exceptional performance or for achieving specific targets. It is usually given quarterly, half-yearly, or annually in the form of a bonus, incentive, or other monetary rewards beyond their regular monthly salary. Some organizations also refer to it as performance-linked pay.

Variable pay plans are designed for engaging or motivating employees for improved work performance and higher retention. Most organizations use a method of goal setting and OKRs (Objectives and key results), on the basis of which the variable pay of the employee is decided.

Why do employers offer variable pay?

Following are 8 reasons why employers offer variable pay to employees:

1. Helps generate accountability: Variable pay leads to increased ownership and responsibility in achieving desired outcomes for employees.

2. Base salary can be reduced: Employers can save money by offering lower base salaries using variable pay methods like performance bonuses and commissions.

3. Retention and attraction: It attracts and retains talented employees by providing additional financial incentives and rewards for exceptional performance.

4. Develops a framework to work progress: The metrics defined by supervisors evaluate progress to incentivize the employees and sets an assessment system in place.

5. Encourages performance-driven culture: Employees are motivated to perform their jobs better and contribute to the organization’s success to receive a bonus or variable pay.

6. Clears work expectations: This benefits both the employer and the employee as there is clarity in what needs to be achieved.

7. Promotes teamwork: Getting incentivized based on team goals and departmental goals encourages employees and their peers to work better in teams for overall growth.

8. Manifests recognition and appreciation: It helps employees feel valued in the company and motivated to improve their skills.

Types of variable pay

The 3 main types of variable pay are as follows.

1. Individual Incentives

The variable pay is dependent on the work done by the individual employee and its result. The compensation or bonus is directly connected to the performance with respect to the predetermined goals.

The various forms of individual incentives are:

• Piece Rate
• Sales Commissions
• Bonuses
• Special recognitions
• Safety awards
• Attendance bonuses

2. Team/Group Incentives

Team variable pays offer equal or varying rewards to the team members based on their contributions. It encourages teamwork and maintains essential team behaviors. It reduces the emphasis on individual performance and necessitates measuring overall team performance.

The various forms of team incentives are:

• Gain sharing
• Quality improvement
• Labor-cost reduction

3. Organizational Incentives

Organizational variable pay is distributing company profits to enhance productivity, morale, and performance. It includes employee stock plans, executive stock options, and deferred compensation. These align employee interests with long-term growth. It motivates and fosters shared success within the company.

• Profit-sharing
• Employee stock options
• Executive stock options
• Deferred compensation

What are the different forms of Variable Pay?

1. Performance Bonus

This contains additional compensation given to employees for achieving predetermined targets set by the organization either monthly, quarterly, half-yearly, or yearly.

2. Sales Commission

This is an additional compensation received by sales employees based on the number of sales they have achieved. The percentage of sales commission is fixed upon the basic pay of the employee.

3. Referral Bonus

It is an incentive, usually a financial reward, received by employees when they manage to recommend a candidate to the company who later gets hired.

4. Profit Sharing

Profit-sharing is a form of compensation received annually, based on a percentage of a company’s pre-tax profits, which is only granted when the company is profitable.

How to calculate variable pay in salary?

The basic formula used in calculating your salary package is

Your package = Fixed Pay (X% of total package) + Variable Pay (100-X% of total package)

You received the fixed amount of your salary package every month but you will receive the variable amount after a certain period of time (quarterly/half yearly/yearly).

Let’s take an example to understand this better.

Imagine you have a monthly salary of Rs. 30,000, where Rs. 25,000 is fixed pay and Rs. 5,000 is variable pay. Let’s say the variable pay is given every quarter.

First, find the percentage of variable pay:
5,000 (variable pay) divided by 30,000 (total salary) = 0.1667 (or approximately 16.67%).

Next, calculate the variable pay for each quarter:
0.1667 or 16.67% (variable pay percentage) multiplied by 30,000 (total salary) = Rs. 5,000.

So, at the end of each month, you will receive Rs. 25,000 as fixed pay.

At the end of the quarter (3 months), you will receive Rs. 5,000 multiplied by 3, which equals Rs. 15,000.

How to create a variable pay plan?

There are 5 crucial steps to follow while creating a variable pay plan.

1. Pay attention to the resources and culture of the organization

The variable pay must reflect the culture promised by the organization to its employees while keeping in mind its financial resources. Fostering trust between managers/supervisors and employees results in a successful variable pay plan.

2. Create easy-to-understand variable pay plans

The rules and regulations mentioned in the plan should convey the information so employees understand clearly. Complicated variable pay plans usually confuse employees and might make them lose their motivational value.

3. Maintain an updated plan

The variable pay plan must be updated with the current organizational conditions. Incentives and bonuses must reflect current market trends.

4. Connect the variable pay with performance

As the most basic factor in variable pay, performance should be the key factor in determining bonuses, incentives, rewards, and recognition. There should be a clear connection between the effort given by employees and the remuneration received by them.

5. Make variable pay inclusive

Effective incentive plans consider individual differences and avoid penalizing high performers who exceed group limits. Different incentive systems may be needed to appeal to other departments within an organization.

Who is eligible to get variable pay?

Every employee working under a registered company is eligible for variable pay. However, there are variable payouts across different departments. The amount of compensation offered to the employee under variable pay might differ based on the role, department, or seniority level.

At higher levels, the payout is more likely to be tied to organizational performance rather than individual or team performance. Individual performance is commonly utilized for variable pay in sales roles, while directors and managers have their variable pay often tied to team performance.

Here is an example for a better understanding of variable pay with respect to a sales representative:

Base Salary: ₹5,00,000 per year.
Commission Structure: The sales representative is entitled to a 5% commission on the total sales revenue.

During a particular quarter, the sales representative successfully closed deals worth ₹2,00,000. To determine the variable pay for the quarter, we apply the commission rate to the total sales revenue:

Variable Pay = Total Sales Revenue * Commission Rate
Variable Pay = ₹2,00,000 * 0.05
Variable Pay = ₹10,000

What are the benefits of variable pay?

The various benefits provided by variable pay to employers are as follows.

1. Increases employee productivity

Performance-based pay motivates employees to work harder. However, it’s only worth it if it actually improves business results like sales or growth.

2. Promotes employee engagement

Variable pay helps talented employees earn more, keeping them happy and engaged.

3. Improves the organization’s performance

Variable compensation, like commissions, directly links pay to performance. Employees can see how their efforts contribute to their income, and the company can recognize their value.

4. Offers financial flexibility to the company

Variable pay allows employers to pay employees based on revenue generated. This means they don’t need upfront cash for new hires and can match expenses to income more effectively.

Challenges and pitfalls of variable pay

The plausible challenges to variable pay in salary are as follows.

1. Unfair at times

When there is an unequal distribution of the percentage of bonuses among employees, variable pay can be seen as a pitfall. Targets being inclined more toward specific departments can also cause an imbalance.

2. Issue of overperformance

The craving for the bonus/incentive may result in some employees being too invested in their performance. For example, employees coming in during illnesses receive an attendance bonus.

3. Additional costs for the organization

Bonuses, incentives, and rewards are not always self-budgeted by employees. An increase in variable pay amounts has to be sometimes borne by organizations.

4. Unsustainability

Engaging employees by means of incentives is not sustainable. They may lose interest with time or when the targets are set higher, a higher bonus with respect to it might not be easy to provide.

Frequently Asked Questions (FAQs)

What is an example of Variable Pay?

An IT project manager earns a base salary of ₹6,00,000 per year. The bonus percentage is set at 10% of the project’s total budget. Suppose the project managed by the IT employee has a budget of ₹10,00,000. Upon successful completion of the project within the deadline, the bonus received would be ₹10,00,000 * 0.10 = ₹1,00,000

Is Variable Pay a take-home salary?

Variable pay is not typically included in the take-home salary. It is an additional bonus or compensation earned based on performance and is usually paid separately from the base salary. Take-home salary refers to the amount an employee receives after deductions, while variable pay is an extra form of compensation.

Is Variable Pay taxable?

Yes, variable pay is generally taxable. It is considered as income and subject to applicable taxes and deductions. variable pay is included in the employee’s total income for the year and is subject to income tax calculations. It is important for employees to consult with their tax advisors or refer to the tax regulations to understand the tax implications of their variable pay.

What are fixed pay and variable pay?

Fixed pay refers to the regular and predetermined salary or wages that an employee receives. Variable pay, on the other hand, is additional compensation that is contingent upon certain performance or achievement-based factors.

Is Variable pay paid in the notice period?

The payment of variable pay during the notice period depends on the company’s policies and practices. Some companies may continue to pay variable pay during the notice period if it has already been earned based on performance or achievement criteria. However, other companies may have specific policies that exclude variable pay during the notice period.

Which is better Fixed Pay or Variable Pay?

Since, variable pay links salary to performance, incentivizes hard work, and improves talent retention, it is sometimes considered better. Fixed pay may not directly reward individual efforts or provide motivation for high performance.

Can we negotiate variable pay?

Yes, variable pay can be negotiated. Negotiation occurs over the total CTC which contains both fixed pay and variable pay. An employee can negotiate during the hiring process regarding the percentage division of fixed pay and variable pay. In negotiations, employees can propose adjustments to the variable pay structure, such as commission percentages, bonus criteria, or targets.