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The Pros and Cons of Variable Compensation

variable compensation

Variable compensation, also known as performance-based or incentive pay, can be a valuable tool for organizations looking to incentivize high performance, hit revenue targets, and attract and reward top talent. According to a 2022 survey by the Nonprofit Resource Hub, 49% of companies enhanced recruitment offers with sign-on bonuses and equity/long-term incentive awards. 

The following are four types of variable compensation:

  • Bonuses
  • Commissions
  • Stock options
  • Profit-sharing plans


While variable compensation can be a win-win for companies and their employees, it is essential to carefully consider the potential drawbacks and ensure that the program is structured to promote teamwork and fairness. An effective variable compensation plan should balance motivating employees and aligning their efforts with company goals while ensuring fairness and transparency. HR should be intricately involved in defining, structuring, and overseeing your variable compensation plans. 

Beneficial Aspects of Variable Compensation 

Motivation and Performance

Variable pay can be a great addition to your compensation management plan. It can motivate employees to perform at their best because it offers the potential for higher earnings based on their performance, leading to increased productivity and better results. Because incentive pay encourages employees to strive for excellence, overall company performance and competitiveness will be enhanced.


Alignment with Goals 

When variable compensation is tied to specific goals or targets, it aligns employees' efforts with the company's strategic objectives. This alignment can help the company achieve its objectives more efficiently and effectively. It also encourages the whole team to work toward the same goals and increases the likelihood of achieving them.


Retention and Loyalty

Today’s tight labor market can quickly turn acquiring and retaining talent into a bidding war. Performance-based pay, in addition to a base salary, can keep your organization competitive. Additionally, variable compensation can increase job satisfaction and loyalty, especially if employees have the opportunity to earn significant rewards. According to the Society for Human Resource Management (SHRM), on average, it costs a company 6 to 9 months of an employee's salary to replace an individual. Retaining effective employees can be worth the cost of variable compensation. 

Drawbacks of Variable Compensation

Stress and Uncertainty

Employees may experience stress and anxiety due to the unpredictability of their earnings, especially if they have to rely heavily on variable compensation. High stress levels can lead to burnout and decreased job satisfaction, impacting overall morale. If incentive pay programs aren’t managed well, they can result in too much focus on quantity of work rather than quality, causing additional stress. Work stress negatively affects employees' performance, which may negate the benefits of incentive pay.


Short-Term Focus

Employees might prioritize short-term gains over long-term goals, which could lead to neglect of important but non-immediate tasks. Additionally, overemphasis on short-term results can undermine the long-term strategic planning and sustainability of the company.


Administrative Burden

Managing variable compensation programs can be administratively complex, requiring time and resources to monitor and calculate payouts accurately. Many factors need to be determined, including the following:


  • Variable compensation budget
  • Types of compensation pay that suit your business
  • The roles that qualify for variable pay
  • Criteria to use for measuring performance
  • The percentage or amount to be awarded to employees
  • How to evaluate each employee’s performance 


The drawbacks of performance-based compensation can be avoided by being thoughtful and precise when implementing your variable compensation plans.


Cura HR Has Modern HR Solutions

Variable compensation programs can be complex and require appropriate execution to ensure success. As a result, it is essential to have the expertise and best practices to implement your variable compensation needs.


If you’re looking for project-specific support or need help setting up and evaluating variable compensation programs, get in touch with Cura HR and learn how we can create a solution that works for you.

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