Pin Me

Pros and Cons of Variable Pay Plans

written by: N Nayab•edited by: Ginny Edwards•updated: 10/16/2010

In a variable pay scheme, an employee earns rewards additional to his or her basic pay depending on what he or she has achieved vis-à-vis what he or she is supposed to achieve. Read on to find out the pros and cons of a variable pay plan.

  • slide 1 of 5

    Pros and Cons of Variable Pay Plans Basic pay is entitlement in return for the time put in by the employee at work. Variable pay on the other hand anchors to a measurement of performance such as units produced, customer satisfaction scores, attendance records, performance evaluation results, profitability, and other factors, with the employee needing to re-earn the pay each time. The most common types of variable pay schemes include piece-rate wages, sales commissions, bonuses, profit sharing, gain sharing, stock-option plans, and others.

    Image Credit: picasaweb.google.com/George Wiman

  • slide 2 of 5

    Benefits from Organizational Perspective

    Among the biggest benefits of variable pay for organizations is conversion of a portion of the wage bill from fixed cost to variable cost, thereby reducing the wage bill when performance declines. This approach suits the increasingly competitive nature of business, and makes investors prefer companies with variable pay.

    Even without converting a portion of the wage bill into variable cost, variable pay boosts profitability and competitiveness by making employees stakeholders in organizational performance. Employees in the front line of company activities remain best suited to solve problems creatively, generate new workable ideas, streamline processes, and improve products and/or services to satisfy customers better, all which directly translate to better organizational performance.

    Variable pay makes possible pay for performance and thereby supports the shift towards a flat organization with flexible job descriptions and flexible work arrangements. Linking rewards with performance and results help forge a better employer-employer contract in a scenario where the employee either performs a wide range of activities, or opts for the level of effort or time invested in the job.

  • slide 3 of 5

    Benefits from Human Resources Perspective

    Among the biggest advantages of variable pay for employees is that it increases their earning potential, and provides a more equitable reward based on efforts.

    Variable pay plans motivate employees to perform to their potential, for the higher and better their performance, the higher their rewards. It helps in establishing a competitive performance oriented work culture and an environment of continuous learning, improvement, and innovation where employees take responsibility for the outcome of their work. Variably pay also makes it easy to identify the extent of commitment displayed by workers.

  • slide 4 of 5

    Drawbacks

    A review of the pros and cons of variable pay plans indicates that the major problem with variable pay is in the administration of such plans.

    Most variable pay plans tend to focus on quantity over quality, with tangible units of measurement such as quantity produced or number of customers served being the basis of measurement rather than factors such as customer satisfaction, which are qualitative and difficult to measure.

    Incentive plans designed without much planning or thought, and without the constant monitoring by top management lead to employees manipulating the system. For instance, a straight commission method of variable pay may lead to mechanics selling unnecessary repairs to customers.

    Variable pay, while rewarding performers also punishes non-performers who may not meet the desired targets due to genuine reasons or owing to factors beyond their control. For instance, an employee on a genuine sick leave might fail to match the production quota, leading him or her to miss the variable pay.

    Variable pay, while creating a culture of performance can also lead to cutthroat competition among employees that ruin relationships and retards teamwork. Excellence depends on effective teamwork where everyone learns from each other. Distributing rewards on an individual basis creates competition and destroys cooperation. Some organizations try to overcome this fallacy by offering group incentives, instead of individual incentives.

    A far greater risk of variable pay schemes however is that it discourages risk taking. Incentive comes when employees adhere to stipulations, and critics contend that most incentive plans are manipulative and steer workers to a desired behavior, treating employees like a cog in the machine. The prospect of offering group or even individual incentives make supervisors force employees to work unpaid overtime or skip breaks.

  • slide 5 of 5

    A review of the pros and cons of variable pay plans suggests that proper planning, good administration, and a system to ensure rewards only on accomplishment of both quantitative and qualitative targets help eliminate most of the drawbacks associated with variable pay schemes.