Variable Pay: Make It Work for Your Organization and Your Employees

Comprehensive variable pay programs—more “pay at risk” for employees—are a growing trend for 2015 and beyond, notes John A. Rubino of Rubino Consulting Services. Here are some reasons why, and why you could save some serious money by implementing a comprehensive variable pay program at your organization.

Variable Pay: The Future of Compensation

Without question, says Rubino, comprehensive variable pay programs will continue to be the trend in both the United States and globally for those organizations that are culturally ready.

An increasing number of organizations are adopting a simplified market-based salary approach to determine base salary control points and pay increases. From there, employee performance objectives are removed from base salary determination and placed entirely within the comprehensive variable pay program.

The variability approach means, in essence, pay for performance within the variable pay framework. And base salary increases are redefined as across-the-board market adjustments only, determined by competitive position analyses.

The difference between the base salary “merit” budget and the market adjustment factor can be used to partially fund the incentive program. (Note that it will not be fully funded the first year; an investment on the part of the organization is required to get it rolling.)

Additionally, ongoing fixed expenses can be considerably reduced due to the compounding effect of base salary increases. Once a base salary goes up, in other words, it just keeps going up. Variable compensation, on the other hand, is paid in lump sum only when performance warrants—hence, “pay at risk” for employees.

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Little Pressure to Increase Base Wages

The United States is continuing to recover from the recession, but there is still very little pressure to substantially increase wages, Rubino notes. Salary increase budgets will likely remain close to 3.0% and salary structures close to 2.5%, according to WorldatWork and Mercer.

Eighty-four percent of companies surveyed by WorldatWork plan to offer variable pay to all employees. The average payouts forecast as a percent of base are:

• 7.0% nonexempts
• 11.0% exempts
• 15%–38% managers through executives

Who Adds Value—and Who Doesn’t?

There is now greater differentiation in compensation rewards (base and variable) between those employees who truly add value to the organization and those who do not. More employees, says Rubino, are receiving no increases in base salaries for not fully meeting their performance objectives.

As a result, there is much greater pressure on the accuracy, validity, and fairness of performance management systems – the foundation for everything! This means an increased emphasis on training and developing an effective cadre of middle managers.

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Base Salary ‘Merit’ Increases Are Not Effective

Motivating employee performance and managing compensation expenses effectively simply cannot be accomplished by using a base salary “merit” increase program, says Rubino, for the following reasons:

• It’s a zero-sum game—and the budget is small.
• Performance evaluation scores are all relative.
• All employees exceeded their performance objectives—now what?
• Base salary increases are now and forever!

Who—and What—You Need for Success

While senior management is crucial to the success of your variable pay program, there’s another group that’s even more critical. Details coming tomorrow, along with a list of the key factors for success.