The Empuls Glossary

Glossary of Human Resources Management and Employee Benefit Terms

Variable Compensation

Variable compensation, also known as performance-based pay, the compensation fluctuates based on the goals achieved. It is designed to motivate employees to contribute towards the organization’s success. Variable compensation may be reinforced in various forms, such as stock options, profit sharing, or bonuses.

What is variable compensation?

Variable compensation refers to a type of pay that is awarded to employees based on their performance or results, rather than a fixed salary. This form of compensation is designed to incentivize employees to achieve specific goals and improve productivity. It typically complements a fixed base salary, meaning employees receive both a guaranteed amount and additional pay based on their performance metrics.

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What is dual variable compensation?

Dual variable compensation refers to the compensation structure in which employees are eligible for two varied variables pay compensation based on performance metrics.

In a dual variable compensation system, employees may have a chance to earn bonuses from two different sources, which may be individual performance or team performance. This allows a more comprehensive and balanced approach to reinforce employees.

What are the types of variable compensation?

Variable compensation can take several forms, each designed to motivate employees and reward them based on their performance. Here are the primary types:

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Bonuses: These are one-time payments awarded for achieving specific performance targets or milestones. Bonuses can be tied to individual performance, team achievements, or overall company success.

Commissions: Commonly used in sales roles, commissions are a percentage of the sales revenue generated by an employee. This type of compensation directly incentivizes employees to increase their sales performance.

Incentive pay: This includes various forms of additional compensation that reward employees for meeting or exceeding performance goals. Incentive pay can be structured as cash bonuses or non-monetary rewards, such as trips or gifts.

Profit sharing: In this model, employees receive a share of the company's profits, typically distributed at the end of a fiscal year. This aligns employees' interests with the company's financial success.

Stock options: Employees are given the option to purchase company stock at a predetermined price. This type of compensation can motivate employees to work towards increasing the company's stock value, as their financial gain is tied to the company's performance.

Recognition programs: These programs reward employees for exceptional performance through non-monetary means, such as awards, public acknowledgment, or additional time off. While not always financial, they can significantly boost morale and motivation.

How does variable compensation work?

Variable compensation is a dynamic component of an employee's pay that fluctuates based on their performance, achievements, or the overall success of the company. Here’s how it typically functions:

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Performance metrics: Organizations establish specific, measurable performance metrics that employees must meet to qualify for variable compensation. These metrics can be individual, team-based, or company-wide, depending on the role and objectives. For example, a sales representative might have a target sales figure, while a project team might be evaluated on project completion timelines.

Compensation structure: Variable compensation is often structured as a percentage of the employee's base salary or as a fixed bonus amount. For instance, an employee might have a target bonus of 20% of their salary, which they can earn by meeting or exceeding their performance goals.

Calculation of payouts: At the end of the performance period (monthly, quarterly, or annually), the organization assesses the employee's performance against the established metrics. The payout is then calculated based on the level of achievement. For example, if an employee achieves 90% of their target, they might receive 90% of the potential bonus.

Incentivizing performance: The primary goal of variable compensation is to motivate employees to enhance their performance. By linking pay to results, employees are encouraged to work harder and be more productive, as their financial rewards are directly tied to their contributions to the organization’s success.

Flexibility for organizations: Variable compensation allows companies to adjust their payroll expenses based on performance outcomes. This flexibility can help organizations manage costs more effectively, especially in fluctuating economic conditions.

Engagement and retention: When implemented effectively, variable compensation can boost employee engagement and retention. Employees who feel their efforts are recognized and rewarded are more likely to remain committed to their roles and the organization.

What is the difference between variable compensation and base salary?

Base salary and variable compensation are two distinct components of an employee's overall compensation package, each serving different purposes and characteristics.

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1. Definition:

Base salary: This is the fixed amount of money an employee earns regularly, typically paid on a monthly or bi-weekly basis. It is guaranteed and does not change regardless of the employee's performance or the company's financial results. Base salary is determined by factors such as job role, experience, and market rates.

Variable compensation: In contrast, variable compensation is the portion of pay that fluctuates based on performance metrics or company results. This can include bonuses, commissions, and other performance-related incentives. The amount can vary significantly from pay period to pay period, depending on how well the employee meets their goals or targets.

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2. Stability vs. fluctuation:

Base salary: Provides financial stability for employees, as they can rely on this amount for their regular expenses. It is consistent and predictable.

Variable compensation: Offers the potential for higher earnings but comes with uncertainty. Employees may earn more in good performance periods and less during times when targets are not met.

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3. Purpose:

Base salary: Serves as the foundational income for employees, reflecting their role and responsibilities within the organization.

Variable compensation: Designed to motivate and reward employees for achieving specific performance goals, aligning their interests with the company's objectives.

How to calculate variable compensation?

The formula to calculate variable compensation can vary depending on the specific structure and components of the compensation plan. However, here is a general formula that can be used as a starting point:

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Variable Compensation = (Base Salary) + (Performance Multiplier) x (Variable Performance Component)

In this formula:

Base Salary: This represents the fixed salary or base pay that an employee receives.

Performance Multiplier: This is a factor or percentage that determines the level of performance achieved by the employee. It is often based on predefined performance targets or metrics.

Variable Performance Component: This refers to the specific component or components of performance that are considered for variable compensation. It could include factors such as sales revenue, customer satisfaction scores, individual or team performance metrics, or any other measurable criteria.

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The performance multiplier is typically applied to the variable performance component to calculate the additional compensation amount that is earned based on performance. The resulting variable compensation is then added to the base salary to determine the total compensation for the period.

Employee pulse surveys:

These are short surveys that can be sent frequently to check what your employees think about an issue quickly. The survey comprises fewer questions (not more than 10) to get the information quickly. These can be administered at regular intervals (monthly/weekly/quarterly).

One-on-one meetings:

Having periodic, hour-long meetings for an informal chat with every team member is an excellent way to get a true sense of what’s happening with them. Since it is a safe and private conversation, it helps you get better details about an issue.

eNPS:

eNPS (employee Net Promoter score) is one of the simplest yet effective ways to assess your employee's opinion of your company. It includes one intriguing question that gauges loyalty. An example of eNPS questions include: How likely are you to recommend our company to others? Employees respond to the eNPS survey on a scale of 1-10, where 10 denotes they are ‘highly likely’ to recommend the company and 1 signifies they are ‘highly unlikely’ to recommend it.

Based on the responses, employees can be placed in three different categories:

Promoters
Employees who have responded positively or agreed.
Detractors
Employees who have reacted negatively or disagreed.
Passives
Employees who have stayed neutral with their responses.

How to create different variable compensation plans?

Creating effective variable compensation plans involves several key steps to ensure they align with organizational goals and motivate employees. Here’s a structured approach to developing these plans:

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Identify objectives: Determine the specific business goals you want to achieve with the variable compensation plan. This could include increasing sales, improving customer satisfaction, or enhancing team collaboration. Clearly defined objectives will guide the design of the compensation structure.

Define performance metrics: Establish clear, measurable performance metrics that employees must meet to qualify for variable compensation. These metrics should be specific, attainable, and aligned with the overall business objectives. For example, sales targets, project completion rates, or customer satisfaction scores can serve as effective metrics.

Determine the compensation structure: Decide how the variable compensation will be calculated. This could involve setting a percentage of base salary, a fixed bonus amount, or a tiered structure where higher performance leads to greater rewards. Ensure that the structure is transparent and easy for employees to understand.

Set eligibility criteria: Define who is eligible for the variable compensation plan. Consider factors such as job roles, tenure, and performance history. This helps ensure that the plan is fair and inclusive.

Communicate the plan: Clearly communicate the details of the variable compensation plan to all employees. This includes explaining how the plan works, the performance metrics, and the potential rewards. Transparency is crucial for motivating employees and ensuring they understand how their efforts contribute to their compensation.

Monitor and adjust: Regularly review the effectiveness of the variable compensation plan. Gather feedback from employees and assess whether the plan is driving the desired performance outcomes. Be prepared to make adjustments as needed to ensure the plan remains relevant and effective.

Incorporate feedback: After implementing the plan, solicit feedback from employees to understand their perspectives on the compensation structure. This can help identify areas for improvement and enhance employee engagement.

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