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A preferred pay-for-performance program,
variable pay requires much thought and planning.
he past 15 years have
presented more than their
fair share of challenges for
HR and compensation professionals.
A steady economic decline, culmi-
nating in the deepest recession since
the Great Depression, led to plum-
meting revenues, seemingly endless
waves of layoffs and widespread wage
freezes. Base pay salary increases
fell to the lowest levels on record,
from 4.3 percent of payroll in 2001 to
1.8 percent in 2009, according to the
“U.S. Salary Increase Survey 1998-2014,”
conducted by the author’s company.
Struggling to motivate and
engage those employees who
remained — frequently saddled with
extra responsibilities — employers
found themselves drawn to a variety
©iStockphoto.com/Jaap2
By Ken Abosch, Aon Hewitt
© 2014 WorldatWork. All Rights Reserved. For information about reprints/re-use, email copyright@worldatwork.org
11 | 2014
®
The Magazine of WorldatWork ©
of pay-for-performance vehicles
known collectively as variable-pay
programs. Designed to reward
employees for their contributions to
the business, variable pay encom-
passes everything from profit-sharing,
gainsharing and business incentives to
individual performance awards, team
awards and special recognition plans.
Variable pay has long been a
popular vehicle for compensating
executives, whose sizable bonuses
and other perks became a bone of
contention during tough economic
times. In recent years, however,
companies have expanded their
variable-pay programs to encompass
exempt and nonexempt employees
from across the organization. Seventy-
two percent of companies now have
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workspan | 31
 variable-pay programs that cover
the entire company, according to
“Variable Compensation Measurement
Report 2013,” conducted by
the author’s company.
Trending Strong
There has been a quiet but steady
increase in the prevalence in and
importance of variable pay for
nonexecutive employees over the
past 25 years. There’s no denying
its increasing popularity. Ninety-one
percent of organizations had a broad-
based variable-pay program in 2014,
according to the “U.S. Salary Increase
Survey 1998-2014.” That’s a dramatic
increase from the 47 percent reported
in 1990. Even those industries you
would never expect to embrace
variable pay have adopted it — not-
for-profits, higher education and even
the government. Today’s employers
are more reliant on variable pay than
merit increases or other types of pay-
for-performance rewards.
Spending on variable-pay programs
has reached massive proportions.
Figure 1 | Company Spending on Variable Compensation
Variable Pay Awards for Salaried Employees
(as percentage of payroll)
9.7%
9.3%
8.0%
4.2% 4.2% 4.3%
1998 1999 2000
Variable Pay
Source: “U.S. Salary Increase Survey 1998-2014,” Aon Hewit
32 | workspan november 2014
While base pay salary increases are The rationale for adopting variable
projected to reach a paltry 2.9 percent pay strategies is clear. While increases
of payroll in 2014, variable pay is in base salary impact payroll expen-
expected to reach a record-high level ditures every year moving forward,
of spending at 12.7 percent, according variable pay has an impact on cash
to the “U.S. Salary Increase Survey flow for the current year only. A
1998-2014,” conducted by the author’s fluctuating component of compensa-
company. (See Figure 1.) Furthermore, tion that is delivered contingent upon
the “Variable Compensation Measure- results, the reward must be re-earned
ment Report 2013” reveals that the each year. Because it is not an addi-
average amount spent on variable tive to base pay, it does not become a
pay programs by companies with fixed cost for the organization.
revenues of less than $10 billion While many corporate strategies for
was $61 million. For those with reducing costs have proved patently
revenues greater than $10 billion, unpopular with employees, variable
it was $84 million. pay is valued highly by workers at
While it would be easy to assume all levels. Academic research studies,
variable pay is a Western phenom- such as the 2003 “Compensation:
enon, nothing could be further from Theory, Evidence and Strategic Impli-
the truth, as it has become common- cations” by B. Gerhart and S.L. Rynes,
place in virtually every part of the reveal that high performers are more
world. It’s actually most prevalent in likely to join and stay with organiza-
China, Australia, Korea and Singa- tions that have a strong focus on
pore, where nearly 100 percent of paying for individual performance.
companies have embraced the prac- In addition, employee focus groups
tice, according to the “Global Salary conducted by the author have
Increase Survey 2008,” conducted by revealed that employees perceive
the author’s company. they have greater control over the
12.7% 12.7%
11.8% 12.0% 12.0% 12.0%
11.4% 11.6%
11.2% 11.3%
10.8 %
10.8
%
10.5%
9.5%
8.8
%
4.3%
3.6% 3.6% 3.6% 3.7% 3.7%
3.4% 3.4%
2.8% 2.9% 2.9% 3.0%
2.4% 2.7%
1.8%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Proj.
Salary Increase
 size of their variable pay award than 13 percent felt it had no effect and
over the size of their salary increases. not one company said it had hindered
These focus groups also disclosed business results.
that employees feel more aligned to At face value, it sounds like variable
an organization when they participate pay is helping companies achieve
in variable pay given the role that miraculous things. However, half of
organization performance typically “Variable Compensation Measurement
has in bonus outcomes. Report 2013” survey respondents
Motivated to help move the orga- admitted they do not review the effec-
nization in its desired direction, tiveness of their variable-pay plans
employees frequently can be found on an annual basis. Considering the
making suggestions for improve- enormous investments organizations
ment and questioning unnecessary are making in this particular compen-
expenditures. Thus, variable pay sation vehicle, it’s alarming that so
is an effective vehicle for focusing many are failing to analyze how these
employees on results and driving plans work. Yet, 87 percent of partici-
desired behaviors, as it gives them pants in the “Variable Compensation
a clear line of sight between their Measurement Report 2013” claim vari-
actions and their rewards. For this able pay has been at least somewhat
reason, variable pay is favored by effective in helping drive the desired
shareholders and industry analysts, results. How can companies be certain
who like that employees have some they are reaping the desired return on
“skin in the game.” investment if they are not measuring
the program’s effectiveness?
Blind Optimism
By and large, organizations are Reality Check
optimistic about the results they Variable pay is a powerful compen-
are achieving with variable pay. sation vehicle with a practically
According to the “Variable Compen- unmatched ability to drive high
sation Measurement Report 2013,” performance. Many companies have
29 percent of companies said it had variable-pay plans in place that are
helped them generate the desired working quite well and driving the
results, while an additional 58 percent desired results. For a variable-pay
said it had “somewhat helped.” Just program to live up to its potential, it’s
critical that the organi-
zation ensure its plan
Figure 2 |  E ffectiveness of Plan Components focuses on the right
goals and behaviors
Variable Pay Index Scorecard
and has a real pay-for-
Overall Score Effective Zone performance emphasis.
Organizations are
1 Measures Effective zone
increasingly turning to
2 Eligibility Effective zone diagnostic tools to assess
3 Funding Partially effective zone the effectiveness of their
variable pay plans. A
4 Alignment Effective zone
review of a plan’s design
5 Line of sight Partially effective zone characteristics — such
6 Plan mechanics Partially effective zone as measures, eligibility,
funding, alignment, line
7 Targets Effective zone
of sight, plan mechanics,
8 Participation requirements Effective zone targets, participation
9 Communication Effective zone requirements, commu-
nication and plan
10 Plan administration Highly effective zone
administration — can
Source: VCM Report 2013 be quite telling. One
such assessment of plans from 70
companies conducted by the author’s
company revealed an average plan
score of 546 points out of a possible
1,000. Clearly, there is room for
improvement. But just where are
companies faltering when it comes
to designing and administering effec-
tive variable-pay plans? Figure 2
illustrates three critical plan design
components where companies are
consistently falling short.
The first breakdown comes in the
area of funding for at-goal levels of
performance. Simply put, companies
are having trouble coming up with
sufficient funds to cover their plans.
The importance of ensuring adequate
funding cannot be emphasized enough.
It’s not very motivating for an employee
to meet the required objectives, but
then fail to receive the anticipated
payout because the company didn’t
take the time to identify a source of
funding for the plan. Unfortunately,
many companies are losing ground
when it comes to ensuring adequate
funding for their variable-pay plans.
The second failing is with regard
to line of sight. For a plan to be
effective, employees need to see
a direct causality. They must be
confident they have the ability to
affect outcomes. Weak line of sight is
often caused by choosing the wrong
plan types. Stronger line of sight is
achieved when plans focus on indi-
vidual performance. These include
business incentive, individual perfor-
mance awards and special recognition
awards. A weaker line of sight is
found in those plans with an “all
boats rise and fall together” philos-
ophy. Here, we find profit-sharing,
team awards and gainsharing type
plans. Granted, these plans might
have their place for team/cultural
reinforcement, but they accomplish
nothing in terms of line of sight. (See
Figure 3 on page 34.)
The third deficiency can be found in
the area of plan mechanics. Reflective
of a company’s pay philosophy and
culture, plan mechanics entail the
levers on which the plan operates:
november 2014 workspan | 33
 thresholds, maximums, targets and
plan triggers. This component has
to be handled with great care, as
it has the potential to be incredibly
demotivating. Take for example the
organization that set thresholds at
60 percent of target, (paying out
bonuses for a miss of 40 percent from
goal) and maximums at 105 percent
of target. By doing so, this company,
consciously or inadvertently, sent the
message that it didn’t really expect
employees to hit those goals.
Deliberate Design
Variable-pay plans are powerful
compensation vehicles with the poten-
tial to have a significant impact on
employee behavior and business results.
The key to more effective variable-
pay plans lies in assessing what you
currently have in place and ensuring
that you move forward with a plan
that is designed with strategic intent
to accomplish your desired goals.
A crucial first step is to decide what
you hope to accomplish. Are you
Figure 3 | Types of Variable-Pay Plans
Incentive Plan Type
Business incentives — Plans with combined financial
and/or operating measures for the company, business unit,
department, plan and/or individual performance.
Cash profit-sharing plans — Designed to award employees
a percentage of the company’s profits. Plans typically make
equal payment (as a flat-dollar amount or percentage of salary)
to all or most employees based on organizational profitability.
Individual performance plans — Plans whose payouts are
based solely on individual performance criteria. Payout
amount typically varies from one employee to another.
Gainsharing/productivity plans — Plans designed to share a
percentage of cost savings of a group, unit or organization.
The gains are typically shared uniformly among all participants.
Team awards — Designed to reward employees for the result/
improvement in team results. Plans provide incentives to
individuals on a project work team.
Special recognition plans — Plans that are designed to
recognize special individual or group achievements with small
cash awards or merchandise.
Source: “U.S. Salary Increase Survey 2014-2015,” Aon Hewit
34 | workspan november 2014
looking to drive better results from
the employees you have now or are
you focused on building the work-
force of the future? Do you want to
thank workers for good performance
or would you rather take a cause-and-
effect approach to incent the desired
performance? Is changing behaviors
at the heart of your approach or are
you more focused on the end result?
Finally, does your culture support a
plan that rewards individual perfor-
mance or is yours more of a “there’s
no I in team” type of organization?
Once you have addressed these
critical questions, it’s time to begin
putting the requisite components
in place to ensure an effective
variable-pay strategy. Key factors
to be determined include eligibility,
performance period, measures and
objectives, along with the appropriate
amount of plan stretch — too tough
and people give up, too easy and
employees feel entitled.
Funding and allocation must be
given adequate attention to avoid the
% of Companies Surveyed That
Have the Following Plan Type
2014
All Industries
57%
14%
44%
6%
15%
50%
most common pitfalls — and plan
sinkers. Identify the source of funding
and decide how the funds are going
to be allocated. It’s important to
realize that allocation may not be the
same at different layers of the organi-
zation. Thus, you must consider how
much will be designated as organiza-
tional, business unit and individual.
Finally, devising a comprehensive
communication initiative is crucial to
helping employees recognize line of
sight and identify exactly how they
can affect their earning potential.
Looking Forward
Variable pay has emerged as the
pay-for-performance vehicle of
choice and will continue to be for
the foreseeable future. The abysmal
trending in salary increases holds
little hope for improvement, compel-
ling organizations to invest heavily in
compensation strategies that motivate
desirable behaviors, facilitate ideas
and improvements, and create align-
ment around the required outcomes.
It’s been well-established that vari-
able pay’s impact on organizational
results is significant when such plans
are designed with strategic intent
with all critical design components
carefully considered and put into
place. Yet driving the best results
requires a willingness to assess how
these plans are working and readi-
ness to course-correct. Only then
will organizations truly realize the
full potential of variable pay.
Ken Abosch is a partner and broad-
based compensation marketing, strategy
and development leader at Aon Hewitt
in Lincolnshire, Ill. He can be reached
at ken.abosch@aonhewitt.com.
resources plus
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