Variable pay programs


Piece-rate plans, wage incentives, profit sharing, bonuses, and gain sharing are all forms of variable-pay programs. What differentiates these forms of compensation from more traditional programs is that instead of paying a person only for time on the job or seniority, a portion of an employee’s pay is based on some individual and/or organizational measure of performance. With variable pay, earnings fluctuate up and down with the measure of performance.

It is precisely the fluctuation in variable pay that has made these programs attractive to management. It turns part of an organization’s fixed labor costs into a variable cost, thus reducing expenses when performance declines. So, when the US economy encountered a recession in 2001, companies with variables pay were able to reduce their labor costs much faster than companies that had maintained non-performance-based compensation systems. In addition, by tying pay to performance, earnings recognize contribution rather than being a form of entitlement. Low performers find, over a period of time, that their pay stagnates, while high performers enjoy pay increases commensurate with their contribution.

Four of the more widely used variable-pay programs are piece-rate wages, bonuses, profit sharing, and gain sharing.

Piece rate wages have been around for more than a century. They have long been popular as a means for compensating production workers. In piece-rate pay plans workers are paid a fixed sum for each unit of production completed. When an employee gets no base salary and is paid only for what he or she produces, this is a pure piece-rate plan. People who work in ball parks selling peanuts and soda pop frequently are paid this way. They might get to keep $1.00 for every bag of peanuts they sell. If they sell 200 bags during a game, they make $200. If they sell only 40 bags, their take is only $40. The harder they work and the more peanuts they sell, the more they earn. Many Organizations use a modified piece-rate plan, in which employees earn a base hourly wage plus a piece-rate differential. So a medical transcriber might be paid $7 an hour plus 20 cents per page. Such modified plans provide a floor under an employee’s earnings, while still offering a productivity incentive.

Bonuses can be paid exclusively to executives or to all employees. For instances, annual bonuses in the millions of dollars are not uncommon in American corporations. For example, Henry R Silverman, CEO of Cendant, the travel, real estate, and direct marketing concern, received a $13.8 million bonus in 2003 to reward him for increasing total shareholder return by 113% over the previous year. Increasingly, bonus plans are taking on a larger net within organizations to include lower-ranking employees. Many companies now routinely reward production employees with bonuses in the thousands of dollars when company profits improve.

Profit-sharing plans are organization-wide programs that distribute compensation based on some established formula designed around a company’s profitability. These can be direct cash outlays or, particularly in the case of top managers, allocated as stock options. Executives like Sanford Weill, the CEO at Citigroup earning over $50 million in one year, almost all of this comes from cashing in stock options previously granted based on company profit performance

A variable pay program that has gotten a great deal of attention in recent years is gain sharing. This is a formula-based group incentive plan. Improvements in group productivity—from one period to another—determine the total amount of money that is to be allocated. The division of productivity savings can be spilt between the company and employees in any number of ways, but 50-50 is pretty typical.

Isn’t gain sharing the same thing as profit sharing? They are similar but not the same thing. By focusing on productivity gains rather than on profits, gain sharing rewards specific behaviors that are less influenced by external factors. Employees in a gain sharing plan can receive incentive awards even when the organization isn’t profitable.

Do variable- pay programs increase motivation and productivity? The answer is a qualified Yes. For example, studies generally support that organizations with profit-sharing plans have higher levels of profitability than those without them. Similarly, gain sharing has been found to improve productivity in a majority of cases and often has a positive impact on employee attitudes. The downside of variable pay, from an employee’s perspective, is it unpredictability. With a straight base salary, employees know what they’ll be earning. They can finance cars and homes based on reasonably solid assumptions. That’s more difficult to do with variable pay. Your group’s performance might slip this year, or a recession might undermine your company’s profits. Depending on how your variables pay is determined, these can cut your income. Moreover, people begin to take repeated annual performance bonuses for granted. A 15 or 20 % bonus, received three years in a row, begins to become expected in the fourth year. If it doesn’t materialize, management will find itself with some disgruntled employees on its hands.