Variable Pay

Abstract

The main two reasons for the companies to implement variable pay plan are: motivating employees and reducing cost. In this paper we try to point out the challenges the organizations might face when they apply variable pay system by reviewing related literature. We find that it is difficult for the company to have a reliable measure for the variable pay system. In addition, the focus of the variable pay plan should be on motivating employees or cutting cost and how to strike a balance between these two is also an essential issue. Finally we conclude that we always have to assess the circumstances of the organization before applying the plan.

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Variable Pay Plan: One Way to Motivate Employees and Cut Cost.

The companies which try to implement the variable pay system are increasing. More and more American employees who in the past are used to receive fixed pay with annual raises now work under pay systems with uncertain elements. (William M. Mercer Inc., 1999). Kristine and Mark's study (2002) showed that even though the predicted values of the variable pay plan were lower than the offered fixed pay, generally most of the employees would choose the variable pay as long as it was linked to individual performance. Like Paul (2007) said in his article, the employees who perform better want to know their productivity will be appropriately rewarded and the variable pay system can satisfy their needs. On the other hand, to implement the variable pay plan has some obstacles as well. The most mentioned problem in published literature I have reviewed is the lack of a sound performance measure of variable pay plan. Besides, the cost of the variable pay system is also a critical issue. Thomas (2003) proposed that the variable pay plan can transfer more compensation cost from fixed to variable which means that the company can have more control over the cost. He also mentioned that it is better for the company to emphasize employees' performance rather than reducing cost. Therefore, how the company can balance motivating employees and controlling the cost of variable pay plan is an issue too.

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These problems are important for the organizations because the employees would lose confident in management and the company would waste money on the variable pay plan if they do not consider these issues carefully. Here we try to review related articles to see what the solutions are for these problems existing in the variable pay system and how the companies could do better when they want to implement the variable pay plan.

Before we talk about the advantages of the variable pay plan, we take a look at the definition of the plan first.

Variable pay plans are compensation programs that deliver lump-sum payments to employees based on their performance of preset objectives of the organization, business unit, and/or individual. (Thomas, 2003)

Variable pay is any form of direct pay that is not folded into base pay and that varies according to performance. (Jay& Patricia ,1992)

Why Do We Use Variable Pay:

Since the use of variable pay in organization is increasing, there must be some reasons for the firms to choose this program. Thomas (2003) stated that variable pay creates a stake in the performance of the organization. Also, variable pay encourages a performance focus, either for an individual or for a team. In addition, the program

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supports change efforts within the organization by linking their success to the payouts. Furthermore, variable pay raises company competitiveness and total compensation. Finally, variable pay also shifts more compensation costs from fixed to variable expenses. Lawler (1981) described the advantages of using the program are: motivating effective performance, retaining good performers and making employees

more satisfied with their pay and thus leading to lower turnover rate. In Benefit

Quarterly Jessica and Kathy (2004) suggested the advantage of implementing variable pay plan is: guiding employees to adjust their behavior by rewarding them for performance that has positive outcome. Besides, Jessica and Kathy (2004) also stated that 63% of those companies which have variable compensation plan believe that the benefits of the plan outweigh the costs. What is more, 57% of those companies had unexpected favorable results such as increased productivity.

Challenges of using variable pay

However, it is not easy for an organization to apply a variable pay program. Like John& Traci (2004) stated in their article that if the companies do not manage variable pay plan effectively, the outcome could be less than stellar. There are several concerns for the organization to think about. Thomas (2003) suggested that first concern is about the performance measures. It is difficult

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for many jobs to measure performance in an objective and reliable manner. Second issue is the general rejection to variable plans because of having previous bad experiences. This is also mentioned by Paul (2007) that variable pay received bad reputation because of many companies' bad experiences when they failed to have supporting information or they had other organizational problems which need to be emphasized. The third issue is that the employees may feel the performance measures are not in control or their suggestions are not taken by the organization. The last one concern is that employees will fix on earning their variable pay and they will not make changes or take actions that are not related to the goals of variable pay program. Besides, Jeffrey and Robert (2006) proposed that the variable pay is based on some assumptions which are usually taken on faith rather than on evidence. For example, the assumption that employees would become more productive to receive more rewards. However, increased motivation can not influence employees' ability. The employees can improve their performance only when they have the channel to get the information about how to work effectively. The other flawed assumption is that performance is under the employees' control. Jeffrey and Robert (2006) also mentioned the hazard of variable pay. One is that the use of variable pay increases pay dispersion and this dispersion can destroy performance. Furthermore, variable pay

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make employees apart