Variable pay is one of “just a few” major innovations in compensation in the last few decades, according to Ken Abosch, a consultant with Aon Hewitt. He said that a “quiet revolution” saw pay increase budgets declining by 50% over the 1993-2013 time period, while variable pay budgets tripled. Abosch’s remarks were made at WorldatWork’s annual meeting, E-OLVE, May 19-21. The conference, attended was nearly 1,300 compensation professionals, was held at the Gaylord Texan Resort, near the Dallas-Fort Worth Airport.

Variable pay is a fluctuating element of compensation whose delivery is contingent on results. It is not added to base compensation and may or may not impact benefits. According to Abosh, the most popular forms of variable pay are spot awards, used by 52% of companies. Close behind are individual performance plans (44%). Other forms include profit sharing (14%), gainsharing/productivity (4%), and team awards (17%).

Do they work?

In recent years, spot awards in the form of nominal cash awards have grown in popularity. “They don’t cost that much, and impact can be substantial because of the immediacy. They have gained ground in last 10 years,” Abosh said.

The purpose of variable is to improve company performance by motivating employees. Originally, variable pay was only for executives, but now it is becoming much more broad based. 90% of employers have some form of variable pay, although they are most important for exempt employees earning over $60,000 per year.

Abosh said that variable pay does not always work. A recent survey showed that managers believed variable pay plans “helped” achieve goals in 29% of the cases, and “somewhat helped” in 58%. 13% said the “had no effect.” 0% said they “hindered.” The real numbers may actually be lower because this is “self-reported” data which may be exaggerated, he observed. When plans fail to have their desired impact, it is most often because they are not “designed with strategic intent,” Abosh said. “The trick is to make sure you’re picking the right factors to make sure everyone is aligned.”

Other observations

Other observations that Abosh shared included:

• Variable pay is effective because employees think they have more control over their bonus than they do over base pay increases, thus they are more motivated.
• Shareholders like this form of comp because they like to see that employees “have skin in the game.”
• Funding is a surprising problem. More employers that you would think end up not having the funds to pay awards once they come do.
• Plans that are too tough don’t motivate. Those that are too easy become “entitlements.” He said goals should be tough/easy enough to be hit 8 out of 10 years.
• High performers are attached to an organization that pays for performance. Low performers will select themselves out. This is called the “sorting effect.” A case study showed a 44% increase in productivity, but only 22% of that came from people employed at time of inception. The remainder came from improved quality of new hires.
• Plan mechanics are important. If too complicated, not fair, or if employees can’t see how their contribution affects goals, plans can be demotivating.
• Other factors for success include: Support of executive management, effective communication, and appropriate award size.
• Plans for employees lower in the organization should be focused on individual performance. Higher ups should have goals based on the overall organization.