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Four Ways to Adopt a Pay-for-Performance Compensation Structure

Overview

Every good organization has a primary goal of taking care of its employees, and one of the most common ways of doing that is through pay incentives. The way pay incentives are parceled out and determined tends to differ from company to company. But there’s one way that continues to become more and more prevalent: variable compensation plans.

Also known as “pay for performance” incentive plans, these programs reward employees for adding value to their companies. When these plans are successfully implemented, they’re a great way to encourage efficient, hard work rather than half-hearted performance.

Variable pay plans come in an array of forms. Some companies offer annual bonuses, profit-sharing plans, individual incentives and other forms of payment for growth and new skills.

The most common type offered is an individual bonus, with about 70% of companies saying those are part of their structure. In contrast, only about 39% offer spot bonuses, which are a more informal way of recognizing employee achievements on the spot — hence the name.

Now that you know what variable pay is, let's dive into the "why" behind this payment structure.

The Popularity of Variable Pay Programs

Technology has revolutionized the way jobs are done, as well as the jobs themselves. It has created workplaces and positions that demand specialized skill sets and flexible workers to take on new, more technical positions.

This reality changes what companies expect from the talent market and also what the talent market expects from companies. Competition is more intense, and employees are increasingly seeking to work for places that empower employees and reward them for their contributions. That’s where variable compensation comes into play.

Pay structures like the variable model help businesses minimize risk by cutting down on fixed costs and maximizing variable costs, which are only paid out when specific results are achieved. Because employee pay is the largest expense in most industries, balancing the different costs and different types of pay ends up paying off for organizations, too.

Plus, offering pay-for-performance incentives can be a great way for companies to recruit new employees and motivate the ones they already have. Almost three-quarters of businesses have some form of variable compensation pay plan, and of the top-performing organizations, that number is 5% higher.

Variable Pay Plans Are Popular — But Do They Work in Practice?

Some reports on variable pay show mixed results, but these results depend on the amount of revenue growth organizations see. Let’s break this down.

While companies that saw revenue growth in the single digits felt that the costs of variable pay programs exceeded the benefits, those with double-digit revenue growth had positive things to say. The reason for this? Companies with more revenue tend to have the funds to support good business administration, communication and performance culture. On the other side of that, companies struggling to grow revenue are less likely to have those supports in place.

Organizations that have the right structural supports and enough revenue to sustain pay-for-performance structures can compete with more strength and adapt more quickly. They’ll be able to support their employees with the right tools to learn more and make decisions that advance their professional lives.

So Success Is Possible. How Do You Find It?

Variable pay programs find success when a couple of specific factors are strongly in place, one of the most important being that employees have control over their performance. If the work in your organization is completely dependent on teams and the actions of some affect others, the conditions aren’t ideal to offer pay based on individual performance.

Above all, organizations have to ensure their variable pay structure rewards employees for work and growth that truly advances the company. That said, how do you take this knowledge and actually put variable pay plans into practice in your own organization? Here are four places to start:

1. Know the market value.

If you’re going to pay your employees for their performance and incentivize them with that payment, it only makes sense to know how much that work is worth. Stay constantly tuned in to market trends and changes. When you know the market value of an employee’s contributions, you can take into account the differences in education, work experience and even location to determine the right kind of variable pay for his or her individual performance.

2. Tailor your incentives.

Just having one blanket plan for how you compensate your employees won’t serve you or them. In fact, it might even alienate some workers who go above and beyond and feel cheated when their compensation doesn’t reflect their extra effort. Tailoring your incentive pay to fit the employee will make all the difference in the success of your program.

3. Determine metrics to gauge performance.

There’s a lot of talk about making SMART goals these days. These are specific, measurable, attainable, relevant and time-bound. That principle should also apply to your pay plans. Making sure you have a way to measure the performance of these pay-for-performance incentives is key if you’re going to know whether they’re working for you. Take time to pin down metrics for these plans in the context of your organization, its culture and your goals. Then, build your plan around that.

4. Reward for value.

Above all, make it your mission to know which employees are providing significant value to your business. Talk to managers throughout your organization to find out whose performance stands out. If you take the time to learn which employees are impacting your business the most, you can tailor their pay based on their individual contributions.

Variable pay programs can powerfully impact your business — if they’re the right fit. Understand the nuances of these programs and factor in things like your revenue, what support structures you have in place and how to measure the program’s success. Once you ensure this compensation structure could be a fit for you, you’ll see the benefits for your employees, your culture and your company as a whole.

Action Plan:

  • Check out links within this article to gain additional insight.
  • Utilize Salary.com to research compensation rates.
  • Develop at least one new incentive tailored specifically to your employees' needs.
  • Create an "impact list," outlining where each employee brings the most value to the organization.