What is Variable Pay? Pros, Cons, and Types Explained

If you're wondering what variable pay means, it's cash compensation that varies with some event results. Also known as potential pay at risk, this type of compensation is becoming increasingly popular in business and government.

Variable pay is to reward performance by offering tangible rewards for superior results. Many government program leaders are wary of the concept, but some say it can be valuable for improving performance and achieving goals. This article highlights the importance, advantages, disadvantages, and much more!

Did You Know?

If we talk about junior level, variable pay will range from 10-15% of the fixed pay. However, for sales individuals, variable pay and sales incentives will range from 30-40%. At the mid-level, it ranges from 15-30% and at senior levels, it comes from 30 to 50%.

What is Variable Pay in Salary?

In contrast to fixed pay, variable pay rewards employees based on their performance instead of the salary range. In this way, variable pay rewards hard work and performance before a worker misses days.

While this approach has pros, it can be disadvantageous to hard-working employees who may not be motivated by higher pay. Instead of recognising a worker's efforts, it may also be unfair to those who work hard and are compensated equally.

What are the Typical Variable Pay-Outs Across Different Levels?

The table contains the different levels and payouts.

How has Variable Pay Evolved in India?

A new study suggests that variable pay in India can change how companies compensate their employees. Traditionally, companies have rewarded workers based on measurable performance and achievements.

But as India's workforce becomes younger, they are more likely to want their salaries to be based on performance rather than a fixed target. This Mercer India study reflects this shift in mood. But it also predicts that performance-based pay and variable pay defines will continue to be popular topics.

In the past, variable pay was not widely implemented in corporate houses in India. Now, most employees receive variable pay in India, ranging from 6% to 18% of annual income.  

Who gets Variable Pay?

Variable pay is among the five primary elements of total rewards within any business and is typically part of fixed wages. Employers usually offer employees variable pay based on performance related to individual, team, or business performance. The chances of receiving variable pay are higher for some jobs, such as leadership roles and sales roles. 

What is the Difference Between Fixed Pay and Variable Pay in Salary Structure?

What are the differences between variable pay and traditional pay? The primary difference is in how the variable pay scheme is implemented. Non-exempt employees are not usually paid more than exempt employees. 

Executive variable pay is tied to organisational performance, while non-exempt employees are typically not paid more than non-exempt employees. Variable pay is designed to reward employee performance, encourage employee retention and improve employee satisfaction. Unlike traditional pay, it is performance-related.

Suppose you're granted a total monthly salary of ₹50,000. You get a fixed pay of ₹5,000 as a variable payout of this sum. Hence, at the end of each month, you'll get ₹45,000. Now let's consider that your organisation announces the percentage of variable pay to be 70%, which means you'll get 80% of your variable pay. It will be ₹2,100. Hence at the end of each quarter, you'll get ₹2,100 X 3 = ₹6,300.

Advantages and Disadvantages of Variable Pay

Now that you know what variable pay means, let’s have a look at its pros and cons. Variable compensation programs have many benefits and drawbacks. These are the advantages of variable compensation programs:

1. All problems that affect their earnings are shared promptly by employees with their managers. Management is more attentive in areas like the flow of process materials, spares, maintenance, etc.
2. Before introducing a wage incentive program, a work-study is conducted to determine if there are any improvements in workflow, methods, and man-machine relationship.
3. Employees are encouraged to be innovative and pushed to discover new ways to improve their productivity.
4. The firm has good human relations because the employees are happy with their higher wages and the management's increased productivity.
5. As long as employees are responsible and disciplined, they will need less supervision.
6. The workers and management feel more connected. This increases the morale of workers.

However, performance-related pay also has its disadvantages.

1. Because some workers are more financially secure than others, jealousies can arise. Group-incentive schemes can lead to dissatisfaction between workers who work fast and those who work slower. Older workers who are too slow for heavy work will likely be criticised.
2. If the rates are very high, workers might only be interested in increasing productivity to increase their income. This would improve their productivity but not quality.
3. The biggest problem with the incentive payment system (part of performance-related pay) is the time and difficulty involved in setting up piece rates and/or bonuses. Workers may not be happy if the rates are set too low. Workers would be under tremendous pressure. 
4. It can also be difficult to determine the standard performance. Most organisations use the average performance of the previous years to establish the standards. 
5. Managers often outwit their employees when preparing incentive programs. It is a complicated business.

What are the Different Variable Pay Types?

There are several different types of variable pay plans in the business world. There are Bonuses, Gain Sharing, and Profit-Sharing, to name a few. These plans all have a slightly different set of rules, but their purpose is to foster the idea that good performance leads to higher pay. A variable pay plan will tie individual pay to output and larger units. While an objective standard can help create this relationship, less objective measures can weaken the belief in performance-pay relationships. These are the main types of variable pay:

Bonuses

Bonuses on variable pay plans have several advantages. The extra earnings should be sufficient to encourage extra effort. In addition, they should be achievable by most workers. 

While average variable pay workers should expect to earn a bonus of about 25%, the rates will differ by individual worker. This is due to the absence of any ceiling on earnings. However, if this ceiling were set, the incentive value for high producers would decrease.

• While bonuses can be distributed in lump sums or added to each paycheck, they do not affect base pay. 
• The timing of bonuses varies greatly. Some organisations award bonuses immediately after a performance, while others wait years before they can be distributed. 
• While bonuses on variable pay plans may seem attractive, employees may feel like they're being paid for their contribution - not necessarily their output. 
• Some organisations also award sign-on bonuses to new employees, usually for hard-to-hire skills. These are the best of both worlds. 
• Bonuses on variable pay plans should only be given to employees who have excelled in their positions.

The connection between performance and reward is clear in the short term but not necessarily in the long run. For example, an employee may perceive that producing above the standard will lose their job. The employee may also encourage others to work less hard in such a case.

Gain Sharing

The concept of Gainsharing on variable pay plans is an incentive plan that links employee pay with specific company performance. This plan is most often used when production-related quantitative levels are particularly important.

The total gain is divided between the unit and department employees based on the value of productivity gains over labour and other costs. This type of plan rewards teamwork and cooperation in the workplace. 

To get the most out of a gainsharing plan, an organisation must consider a few factors.

• It must consider what kind of gainsharing program it wants to implement. This can be a value-added plan that measures the value of sales and compares employee costs to that figure to determine how much productivity the employees have added to the company's bottom line.
• Then, the employees' value-added index is compared to that figure for future periods to determine whether they have improved their productivity.

The benefits of a gainsharing plan are well-documented. The General Tire plant, for example, has 1,950 employees. Its gainsharing plan generated ₹30 million in savings over five years, of which ₹20 million went to workers as bonuses. 

The remaining ₹10 million was profited by the company. Another example is the Timken plant. Its gainsharing program targeted improvements throughout the plant instead of relying on piece-work operations.

Also Read: All About Special Allowance - its Taxation & Calculation in India

Profit-Sharing

A variable pay plan with profit sharing requires two key decisions: the percentage of profits to each employee and the proportion of base pay to be distributed to each employee. organisations can define the percentage by formula or by a board of directors, but most define it as a straight percentage of before-tax profits. 

The allocation formula typically considers compensation, length of service, and performance. While some organisations have had great success ensuring employee belief in the performance-reward relationship through cash plans, larger businesses may face serious problems with profit sharing.

Conclusion

For a large financial services firm, a variable pay quantum of more than 30% makes sense. But smaller companies may find it hard to make the transition. Changing the way people are compensated may be hard to implement, but this will help employees adjust in the long run. 

Whether you use a cap or any special allowance, the variable component of your CTC plays an important role.

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