What is Variable Pay?
Variable pay refers to the payment made by an employer to its employee for their contribution to the organisation’s growth and success. It is popularly known as performance-linked pay.
It is usually paid in the form of incentive pay, bonus, or commission. It is determined based on two main factors – the employee’s performance and the company’s overall performance. Most companies include the process of goal-setting, based on which the variable payments are made.
Example of Variable Pay
Let us look at an example to understand how variable pay works in the real world.
A company has an incentive scheme, over and above the fixed pay, which states that a sales representative will get a flat 2.5% of any sale they execute. Further, to encourage employees to go for larger deals, the company declared that this figure would become 4.5% and 7.5% for sales exceeding Rs. 15 lakhs and Rs. 25 lakhs, respectively.
|Employees||Sales achieved||Variable pay|
|Emp 1||Rs. 10 lakhs||Rs. 25,000|
|Emp 2||Rs. 20 lakhs||Rs. 60,000 (2.5% of Rs. 15 lakhs + 4.5% of Rs. 5 lakhs)|
|Emp 3||Rs. 30 lakhs||Rs. 1,20,000 (2.5% of Rs. 15 lakhs + 4.5% of Rs. 10 lakhs + 7.5% of Rs. 5 lakhs)|
Hence, a representative achieving Rs. 10 lakhs of sales will get a variable pay of Rs. 25,000. On the other hand, a representative with Rs. 20 lakhs sales will get Rs. 60,000 and someone with Rs. 30 lakhs sales will get Rs. 1,20,000 as variable pay.
Variable Pay Across Levels
Typically, variable pay is expressed as a percentage of fixed salary. At the junior level, the component of variable pay usually falls in the range of 10% to 15% of the fixed pay. As the employees get promoted, their variable pay component increases. So, the figure increases and falls from 15% to 30% at the middle level, which goes up between 30% to 50% at the senior level.
Types of Variable Pay
The three most common forms are:
1. Incentive Plan
In this type of arrangement, specific performance targets are set for a particular period, and the payouts are done if the specified criteria are met. Examples of incentive plans include profit sharing, gain sharing, stock options, sales incentives, etc.
2. Bonus Program
In this case, the payouts are contingent on completing specific tasks and fulfilling related conditions. Examples of bonus programs include retention, referral, project bonuses, etc.
3. Recognition Program
Here, broad guidelines are established before implementing the program, and the awards vary based on these guidelines. Examples of recognition programs include spot awards, nomination programs, managerial recognition, etc.
A usual question that arises at this point is how fixed pay and variable pay are different from each other. Let’s look at the table below to understand.
Advantages and Disadvantages of Variable Pay
|Motivates employees to perform better and achieve their goals||Can be unpredictable, as it depends on the employee’s performance and the company’s financial performance|
|Aligns employee goals with the company’s goals and objectives||Can cause stress for employees, as they may feel pressure to perform at a high level in order to earn a good income|
|Can help companies save money on labor costs||Can lead to inequality among employees, as it rewards those who perform well more than those who do not|
|Can be seen as a fair way to pay employees, as it rewards them for their actual performance||Can be complex and difficult to administer|
|Can help to attract and retain top talent||Can lead to short-termism in decision-making|
|Can be used to reward employees for specific achievements||Can be difficult to measure and manage performance|
|Can be used to reduce fixed labor costs||Can be seen as unfair to employees who do not have control over their performance|
Fixed Pay vs Variable Pay
|Basis||Fixed pay||Variable pay|
|Definition||It is paid out to the employees regardless of them achieving their goals.||It is paid only when the employees achieve their goals.|
|Frequency||It is paid to the employees every month.||It may not be paid every month, but rather quarterly, half-yearly, or annually.|
|Factors||It is independent of any factors.||It is dependent on the individual as well as the company’s performance.|
|Components||Basic pay, dearness allowance, house rent allowance, other special allowances, etc.||Sales incentive, profit sharing, retention bonus, project bonus, spot award, etc.|
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Is variable pay taxable?
Yes. Like fixed pay, variable pay is taxable in the hands of the employee.
Why do employers use variable pay?
Variable pay provides flexibility and allows employers to reward the employees based on their performance and the company’s profit.
Is variable pay mandatory?
No. The organization may not pay the variable component if the employee fails to meet the set conditions, if the broader team doesn’t meet its targets, or if the company is at a loss. So, it is not mandatory.