Variable pay programs are an increasingly popular mode of compensation in today's business world. These programs, which are also sometimes referred to as "pay-for-performance" or "at-risk" pay plans, provide some or all of a work force's compensation based on employee performance or on the performance of a team. Variable pay proponents contend that providing tangible rewards for superior performance—a true merit system—encourages hard work and efficiency and serves as an effective deterrent to mediocre or otherwise uninspired work performance.
Variable pay programs can take a range of forms, including annual incentives or bonus payments; individual incentive plans; lump-sum payments; technical achievement awards; cash profit-sharing plans; small group incentives; gain sharing; and payments for skill and knowledge. Some analysts disagree about whether some of the above offerings are true variable pay programs, but most agree that all of the above share a common emphasis on recognizing achievement, which is the ultimate goal of variable pay plans. (All agree that standardized merit programs, in which individual performance is a negligible factor in determining compensation changes, do not qualify.) Business experts say that small business owners seeking to increase productivity should consider variable pay as an option, but they are also discouraged from implementing a plan without first engaging in an appropriate examination of current company issues and future company goals. "In establishing merit increase programs or any other cash bonus incentives, companies should keep in mind the type of work force they have, what the competition in their industry is doing, what the company philosophy is—and have a strong plan in place to set company goals and ensure all business units or departments of the organization are clear about the goals," wrote Brenda Paik Sunoo in Personnel Journal.
Indeed, businesses that adopt variable pay have to recognize the importance of tailoring the program to account for different circumstances. Factors that have to be considered, said Sunoo, include:
"In a pay-for-performance environment, we expect true differentiation based on these types of factors," wrote Sunoo. "Managing a performance-based salary program requires a strong commitment to goal setting and measurement."
The growing prevalence of variable pay alternatives in business compensation strategies has been attributed in part to a couple of other business trends. "Employers are facing up to a new reality about the way jobs should be valued and compensated in an age of rapid technological change," wrote Paul J. Williamson in Small Business Reports. "Gone are the days when employees' skills lasted a lifetime and companies could predict the future value of jobs—and thus a fixed pay increase—based on past performance. Today, as customer needs shift rapidly due to advances in technology, the skills you need to make a profit may change almost before the ink is dry on your job descriptions." At the same time, business observers point out that increased emphasis on quick reactions to changing competitive conditions have triggered a growth in movement toward employee empowerment. And as employees become more empowered, employers have had to find new ways to compensate them for their contributions to the overall enterprise.
Other analysts of variable pay frame the issue in terms of return on investment (ROI). "To minimize today's heightened business risk, you must reduce your investment in fixed costs and maximize the use of variable costs, which the company incurs only if it achieves certain results," stated Williamson. "No-where is this mandate more essential than in the balance between fixed and variable pay, since compensation often is a company's single largest expense."
Most criticisms of variable pay can be traced to concerns about the nature, implementation, and execution of such programs rather than the theories upon which they are based. Inc.' s Jack Stack, for instance, argued that many companies fail to make variable pay programs meaningful to individual employees, which in turn robs the program of much of its power to facilitate increased productivity. "Most [variable pay] programs provide no incentive to anyone and never deliver the promised results," he charged. "Why not? Because in 9 cases out of 10, they are not true bonus programs at all. They are simply profit-sharing programs, and there is a world of difference between the two." By profit-sharing, I mean the practice of taking a percentage of a company's profits, putting it into a pool, and disbursing it to the company's employees, usually sometime after the close of the year." Stack and other analysts contend that such distribution plans are unlikely to encourage employees toward greater productivity because they do not get an adequate sense of how their personal contributions helped generate the business's profits. "Many of the failures to date [in variable pay plans] have occurred because companies simply reshuffled the same amount of compensation in a new plan, offering some through fixed pay and some through incentives," commented Williamson. "But they didn't use the plan to create reach change in the way they organize and value work."
But business consultants agree that variable pay programs that truly reward individual performance can be helpful. The purpose of a good bonus program, Stack said, should be "to make the company stronger, more competitive, able to survive and prosper in the months and years ahead…. A good bonus program draws people into that process. It drives the value of the company by educating people, not with formal training programs but through the work they do every day on the job. It gives them the tools they need to make and understand decisions. It provides them with business knowledge they can use to enhance their own standard of living and job security as they're making a measurable difference to the company as a whole."
Proponents of variable pay programs contend that implementation of such a system is far more likely to be successful if the following conditions are met:
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