Variable Compensation Program – Types, Pros and Cons

Performance Related Pay is a kind of a payment system which relates the wages and salaries with the performance of an employee. It includes incentive payments, merit pay, etc. Performance Related Pay is also known as Variable Compensation. Variable compensation programs are customized in such an order that, as said before, the performance of the employees depicts their incomes. It does not depend on his/her designation in an organization. These programs are designed to motivate individuals and groups that contribute effectively, as they differentiate between performers and non-performers.

Many companies believe that a variable compensation program enhances productivity and motivates employees. The American Management Association, based on a study of 83 companies, concluded that grievances had dropped by 83%. absenteeism by 84% and lost – time by 64%, after variable pay programs were introduced in these firms. Variable compensation is also one of the employee involvement programs. Such programs make employees responsible for their own pay packages, through their performance and contribution. This motivates them improve their performance.

Some components of variable compensation plans are the production incentives, profit sharing, gain sharing, bonus, etc. These are different systems of rewarding an employee or his performance. Variable pay also motivates individual workers to work effectively in groups. Variable compensation is paid at different levels, the worker level, the manager level and the group level.

Types of  Variable Compensation

There are various types of variable compensation. It can be in different forms and as the name suggests, all of them is directly or indirectly relates to the performance of the employee. Different kinds of  variable compensation are:

1. Performance Pay: The process of providing a financial or financially measurable reward to employees linked directly to individual, team or organizational performance.
2. Individual Performance – related Pay: Any pay scheme which relates the award of a base pay increase or an individual cash bonus to the results achieved by an individual.
3. Merit Pay: A common name for scheme which relates individual base pay increases to the results delivered by each individual, most commonly through an individual appraisal of performance and award of a performance rating.
4. Pay for Contribution: A diverse, comprehensive, high involvement and flexible approach to pay, which employs a variety of tailored vehicles to reward the achievement of significant business, team and personal goals, and how those goals have been achieved.
5. Competency – related Pay: Competency can be defined as the knowledge, skills and behavior of an individual that contribute to a worker’s performance. The competencies of the best performing employee are identified vis – a – vis the job and the employee is compensated for these competencies that he/she brings to the job. The other employees are also compensated based on these competencies. For example, to implement the competency – based pay system in a bank, the best officer is selected and the characteristics that contribute to his performance are identified. In this case, let us say, the officer’s knowledge of IT, his being customer – oriented and his ability to manage a crisis situation, set him apart. Once these competencies are identified, all the officers are compensated based on the extent to which they demonstrate these characteristics. Most typically these systems relate the base pay level and increase of a person to their demonstrated level of competence in doing their job that is the required skills, behaviors and attributes which they need to display in order to perform highly. It relates pay to how well someone does their job.
6. Bonuses/Variable Pay: Non-recurring cash lump-sums related to the performance achieved by an individual, team and/or organization.
7. Pay at Risk: These schemes involve employees giving up a proportion of their fixed base pay or base pay increase, in return for the opportunity to achieve higher pay levels according to the performance of their business. Correspondingly, if performance targets are not achieved, their base pay is actually reduced.
8. Profit – sharing Schemes: Schemes which share a proportion of a company’s profit with employees, on a common basis.
9. Gainsharing Schemes: Bonus schemes which share a set proportion of any performance gains made above an agreed level, for example, in the labor productivity of a factory, directly with employees. The higher the level of performance, the greater the gain for both the organization and employees.

Pros and Cons of  Variable Compensation

Variable compensation programs has many advantages and disadvantages. The advantages of Variable compensation programs are as under;

1. The work study which is done before introducing a wage incentive plan brings about improvements in methods, work – flow, man – machine relationship and so on.
2. Employees promptly share all such problems with management which retard their earnings. Management becomes more alert in areas such as flow of process materials, adequate spares, maintenance of equipment, etc.
3. Employees are encouraged to become innovative in the sense that they are induced to find new methods to increase their productivity.
4. Employees need lesser supervision as they are disciplined and responsible.
5. There are good human relations in the firm as the workers are satisfied with higher earnings and management with increased productivity.
6. There develops a feeling of cooperation between the workers and the management. The morale of the workers in increased.

On the other hand the performance related pay has many disadvantages as well.

1. Jealousies may arise among few of the workers because some are able to earn more than others. In the case of group – incentive schemes, the workers who are fast in their work may be dissatisfied with those who are slow. Where heavy work is involved, older workers are likely to be criticized for being too slow.
2. One of the biggest difficulties with incentive pay system (a part of performance related pay) is that setting up of piece rates and/or bonus rates is time consuming and quite a problematic one. If in case the rates are fixed quite low, workers may not be satisfied and may be unhappy. The workers would work under immense pressure. On the other hand, if in case the rates are fixed quite high, workers may be only interested in increasing the productivity as that would increase his/her income as well. That would increase his/her performance in productivity terms but not in terms of quality, etc.
3. Difficulty also arises in determining the standard performance. Many organizations follow a safe route to fix the standards which is usually the average of past years’ performance. Past performance may not be the ideal basis for fixing production norms.
4. Since preparing incentive schemes is such a complex business, managements usually outwit their employees. For instance, the period over which incentives are payable is an important factor in determining how much a worker earns.

There is an ethical dimension to incentive payments as well. It is unjust to pay extra to the employees when they are already paid their usual wages and salaries. If an employee is paid for eight hours a day, he or she is expected to show better performance for the day. To show increased production, extra payments are not necessary. There are also instances where incentives lead to corruption. Supervisors and workmen join hands, false production figures are recorded and wrong time bookings are made in order to enable employees earn enhanced incentives. The booty is later shared with the supervisors who colluded with the employees in the fraud.

Incentive payments are linked to employees performance. A standard performance is set for employees. The actual performance is then compared with the standard, and depending upon the degree of efficiency, incentives are fixed. Unfortunately, these standards themselves become ceilings on productivity of employees. Workers would be happy to attain a performance near the standards, and may not strive to cross them.

One of the arguments for incentives is that they motivate employees for higher performance. This argument seems to be untenable going by Herzberg’s theory of motivation. According to Herzberg, money is a hygiene factor which, when provided, will help remove dissatisfaction. For motivation to take place, other motivators like opportunities for achievement and challenging job, must be provided in addition to adequate financial rewards.