Editor’s note: This blog post is an excerpt of our new whitepaper Variable Pay Playbook.
In a tight talent market, where employees have choices about where they commit their time and talent, variable pay is frequently used as a retention, recruitment and motivation tool. PayScale’s 2021 Compensation Best Practices Report (CBPR) reports that nearly three-quarters of organizations give some of their variable pay.
The prevalence and use of variable pay has increased over time, and this year’s data shows that variable pay continues to be a prominent player in the modern compensation landscape. Approximately 71 percent of all organizations surveyed said that they offer some type of variable pay. That number is even higher among top-performing organizations–where 79 percent offer variable pay (versus 70 percent of typical organizations).
Before you decide whether variable pay is right for your organization, it’s helpful to get a deeper understanding of the variable pay options, and see how other organizations are making choices in terms of who gets variable pay, why and what types of bonuses or incentives they are using.
What is variable pay?
Variable pay is any number of bonuses, incentives, commissions, and other cash compensation that is contingent on employee performance. Depending on who you talk to, this could be either potential pay (“I can earn this money if I just work hard enough for it”) or pay at risk (“This is money I’m not guaranteed, so I don’t trust that I’ll receive it”). People differ in whether and how much they are amenable to variable pay, depending on their job level, job function, life stage, financial goals and personal risk versus reward calculus.
- “Bonus” falls under the umbrella. Bonuses may or may not be tied to a plan, they may or may not be connected to performance, and they are typically backwards in orientation. “Dear employee. You did this thing. This thing worked out well; I liked it. Here’s some money to say thank you.”
- “Incentive” also falls under the umbrella. Incentives are associated with a specific plan, focused on performance and are future-facing. “Dear employee. I’d like to see you do this thing. If you do, I’ll give you some money. And in fact, if you do even better, I’ll give you even more money.” Because they’re tied to a plan, incentives tend to have better return on the compensation investment.
Types of Variable Pay Used
Some organizations will use a mix of bonuses and incentives to complete their total rewards package. Others focus on one or the other. Overall, the most typical type of variable pay awarded is the individual incentive bonus (67 percent), followed by the spot bonus (39 percent) and employee referral bonus (39 percent).
When digging in further, top-performing organizations are less likely to use spot bonuses (32 percent versus 40 percent of typical). They are also less likely to use hiring bonuses (29 percent versus 35 percent of typical), implying that they spend what they have to in order to bring top talent on board, but don’t tend to sweeten the deal as much. Both suggest a more controlled and intentional spend of compensation dollars.
Smaller organizations do less of every kind of variable pay, except profit sharing where small and mid-sized organizations beat out their larger counterparts.
The type of variable pay you choose can send a message about what matters most to your organization. For example, variable pay can be a powerful way to reinforce culture. In the CBPR, we asked a question about how organizations plan to retain top talent: Over one-third (34 percent) of all surveyed respondents said that their organization has a discretionary bonus plan. These organizations are giving their managers the ability to reward their employees as they see fit.
Why not allow your managers to request spot bonuses for individuals who show strong examples of the organization’s core values? If you value collaboration and teamwork, why not set a goal for the team for their next project and reward the team when they meet their goal? If you value boldness and risk-taking, you could even turn some heads by rewarding a failed project, simply because an individual was brave enough to try something new.
Who Gets variable pay?
There is also a fair amount of variability across and within organizations when it comes to who gets variable pay and why. Some jobs more typically receive variable pay. For example, sales roles and leadership roles usually have explicit payouts tied to specific deliverables. By contrast, engineering and accounting roles are less likely to have high amounts of variable pay.
There are both organization-driven and employee-based reasons for this. The types of people drawn to high amounts of variable pay tend to be your risk-takers; risk-takers are often drawn to both sales and leadership roles – roles that chart new territory. Whether or not sales and leaders perform, or even overperform, can make a significant impact to the organization’s bottom line, so often directly linking performance with variable pay can both attract top sales professionals and leaders and positively impact organizations as well.
The prevalence and type of variable pay can also depend on organizational level. Often organizations struggle with how far down to extend their variable pay plan. That choice will ultimately depend on culture and budget, but again it’s worth noting what other organizations are doing. For those who have variable pay, most extend it all the way to non-exempt employees (only 34 percent do not give non-exempt employees variable pay of some sort).
As expected, the higher the level, the more likely the payout is tied to organizational performance, rather than team or individual performance (82 percent of executive variable pay is based on organizational performance versus 43 percent of non-exempt variable pay). While Individual performance is highly utilized at all levels, it’s most likely to form the basis of variable pay for sales employees (73 percent). Directors and managers are most likely to have their variable pay tied to team performance (40 percent).
When considering who should receive variable pay in your organization, ask the following questions:
- How much does this employee’s contributions impact the success of the organization?
- Are they likely to perceive variable pay as potential pay or pay at risk?
The answers to these questions should guide who receives variable pay, and what types of variable pay they receive.
To learn more about how organizations are using variable pay, and how you can create an effective variable pay plan that drives the business outcomes you desire, check out PayScale’s whitepaper Variable Pay Playbook.
Or, attend Compference – our annual modern compensation event – to see how you can get smarter about pay.