August 13, 2009

Using Variable Pay – A Compensation Strategy in this Current Economy

So there you are in the CEO’s office presenting your recommendations for next year’s salary budget. You have done the analysis, you have all of your facts lined up and your market data to support it. “The costs,” you say, “for next year’s salary increase budget will be … a gazillion dollars.” Well that’s not what you said, but that’s what the CEO heard! In fact, this is probably the fourth meeting that day going over all of the expenses that are needed to run the business and all that person sees is spending more money and an eroding margin. They ‘d probably rather hear about some low-cost salary programs.

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As an HR professional, I know how challenging it is these days for organizations when they try to balance the cost of a salary increase program with their need to recognize employees’ skills and performance. Like many of you, I have faced the challenge of getting caught in the middle and feeling like the two sides of the issue are mutually exclusive. The fact is they are not.

Executives and shareholders want great workers who are high performing, but they also realize, and so should we HR professionals, that if labor costs are too high, it will impede on your organization’s financial health. The rising costs of labor, especially in the U.S. is a major concern to organizations that find it more and more difficult to earn the margins that were achieved in prior years – not to mention the fact that customers are looking for deals and that means lower prices. As HR professionals, it’s our job to come up with innovative salary programs that serve the interests of both parties.

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Can a company in this current economy afford to keep increasing their base salaries and remain financially healthy and competitive? Can HR professionals help develop ways in which the organization can afford to pay out what is needed in salary in order to attract and retain employees? I believe that the answer to both of these questions is “yes,” but it does require innovative salary programs, and can be helped with a specific emphasis on variable pay.

The Benefits of a Variable Pay Program

Many organizations already have or have used some type of variable pay program such as employee profit sharing, business unit bonuses (gain-sharing), stock options, performance or retention bonuses, or other varieties of discretionary bonuses. These are a necessary component of pay and always will be. But in this economy, they can be an even more important tool for accomplishing retention and recognition than ever. With base salary increase budgets at their lowest point in 30 years (that’s as far back as I go), variable pay programs can be incorporated into very effective low-cost salary programs.

The added benefit of variable pay programs is that they can be more directly tied to corporate performance objectives and only be paid out if corporate goals are achieved. I have watched organizations struggle with how to provide base salary increases to employees in a way that can be directly correlated to business performance. But, things get in the way. Factors such as inflation, crucial importance of skills, or compression from new hires can all impede a performance-based salary increase program.

Variable pay programs, on the other hand, can be more directly tied to some aspect of corporate performance such as profit, revenue, or labor efficiencies. Variable pay programs can also offset the negative response that your top performers may have after receiving a “small” salary increase. Yes, it is true that an increase is only the means that is used to achieve the appropriate base pay for the individual – emphasis on pay, not the increase. But employees may still perceive a lower salary increase more negatively than it is intended.

Using a Variable Pay Program to Recognize Employee Performance

Even though you probably already have a base salary increase program that is based on pay-for-performance, you can still effectively use a variable pay program to strengthen your ability to recognize and reward individual performance. Here are some things you can do:

Employee profit sharing. If you have an employee profit sharing plan, allocate payouts that include individual performance factors. This not only recognizes employees’ contribution to the organization’s success, it also provides an opportunity to pay even more to those employees who are your highest performers.
Discretionary bonuses. Special recognitions are a great way to acknowledge employees. There is something about getting something when you didn’t expect it that has a sustaining and motivating effect on people. Set up a discretionary bonus plan that pays employees when you observe certain behaviors such as: 1) exceptional performance, 2) the accomplishment of a significant project, 3) the development of a new and innovative process, or 4) excellent customer services.
Performance goals. Develop corporate or organizational quarterly performance goals. These can be integrated into your employee profit sharing plan, or they could be separate and dependent upon what your organization wants to accomplish as an overall objective. You can develop goals in areas such as target operating expenses, top line revenue, positive customer responses, quality, or safety measures.

Keep in mind that variable pay programs do require the discipline to not only establish goals ahead of time, but also to manage them if unexpected issues come up that impede on the organization’s ability to accomplish the established goals. Judgment calls will have to be made.

In my next post on the topic of using variable pay as part of your compensation strategy, I will offer advice on how to get the most out of a variable pay programs and what pitfalls to watch out for.

Regards,

John Sporleder

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