What Is Variable Compensation aka Variable Pay?

Work Apr 18, 2021

One form of variable pay, known as a performance bonus, is a tool employers use as an incentive for great performance at work. It is perhaps the most well known and comprehensible type of variable pay, where you are directly rewarded for the amount of work you do – at least in theory.

Commission is another type of variable pay similar to bonuses. The both of them share some similarities in profit-sharing, and as incentives for future growth. Commission most often comes in the form of sales commission where a portion of sales' revenue is passed back to the sales people to encourage getting more sales.

Variable pay comes with two goals: offering recognition for past successes, and incentives for future growth. It's also a way to share risk and profits between the employer and the employees. Theoretically this is a good thing, under the assumption than employees that are well rewarded for it can affect the bottom line.

However, at a certain scale bonuses often become a hand-waving game of allocating money to the whims of management. Oftentimes it is a zero-sum situation between rewarding individual performance and having less money to share among the team.

Spot Bonuses, Annual Bonuses, and Referral Bonuses

Before diving into the problems with variable pay, it helps to recognise some of the more common varieties.

Spot bonuses are one-time recognition bonuses for going beyond your normal scope of work. They can sometimes be large, but they are often token amounts. For instance I've received several gift cards for going above and beyond at work.

Annual bonuses are the most familiar form of bonuses. They are often tied to both the company's performance overall and an individual's performance, which allows for both sharing in profits and incentivising stellar work. They are part of a compensation package, though because there is no guarantee on them you can't rely on getting it like you could with a salary.

Referral bonuses are another type of one-off bonus, where you are rewarded for recommending someone who is hired and proven competent. These bonuses tend to be significant since they are one-offs, and because people are unlikely to take the risk of referring someone without a generous amount on the table.

Signing bonuses are a one-time reward for agreeing to a contract for a position. Companies offer it to lure you away from other options. In my case I was offered a signing bonus as part of my employer's acquisition to stay with them during the tumult of the change.

Some Problems With Variable Pay

The most obvious problem with variable pay is its uncertainty – you can't rely on receiving any specific amount of income. Black swan events may come at any time and disrupt bonuses or sales commissions. Lean times will hit hard and variable pay can be considered compensation at risk of being lost.

This uncertainty is not just dominated by external factors like the market, however. One of the closest and most prominent factors is management. Managers are only human, which offers all sorts of problems: recency bias when evaluating performance, favouritism, and unawareness to name a few.

Relying on managers to determine your variable pay amount is rife with wasted effort. You need to effectively champion your successes to them, which requires time and political capital better spent on improving the bottom line.

Worse still, many bonus structures are designed in a way that promotes unhealthy competition between colleagues. This aforementioned zero-sum game where you receiving a larger bonus requires someone else to receive a smaller bonus.

This makes sense when there are over performers and under performers in a company, but usually this game is played within a team – like my own team at work. Our team as a whole might command exemplar performances, but our team manager only has a small pool of bonus money for all of us. They are forced to play the sum-zero game even if everyone is doing great.

In the worst case of competition this would lead colleagues to be focused on their individual performance, to the detriment of team cohesion and helpfulness. Why help a struggling coworker when it will end up costing you bonus money in the long run?

Of course, the idea behind this bonus structure is not to punish teamwork – the idea is to avoid shirkers in a team. Also to reward merit, as in a meritocracy. As with many things in life though, this becomes a trade-off with plenty of implications. You will never have a solution that is all benefits with no downsides.

I like to think that my coworkers are more helpful than they are interested in the bonus money. They certainly have supported me thus far! So perhaps this bonus structure is equitable enough to serve me.

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