How to use Variable pay to retain your employees
pay for performance

retention variable pay compensationSay aye, if you read the post’s title and thought to yourself that it has to do with Sales team’s performance based incentives. While you’re not alone, this cannot be further away from the truth; employees of almost any department (marketing, HR, operations and more) can be included in a company’s variable incentive plan.

The Society for Human Resource Management (SHRM) , defines Variable Pay as “direct compensation that does not become a permanent part of base pay/salary and which may vary in amount from period to period”. In the recent past, the option of variable incentives did not work too well since most employees wanted the security of a high base pay and meeting targets was largely unpredictable.

How has the world changed now then, you ask?

Today, the economy is on an up-swing again and the people you hire are willing to take greater risks and work towards meeting targets that increase their income.

As a business, it allows you to keep your fixed costs in control. Your CFO will probably love you for this change.  Not only this, the variable pay plan can help you retain high performers as you compensate them for over achieving on the targets.

Also, there is a need for variable pay plans to reward aging with the organisation; retention of your people is achieved through incentive based on performance and longer tenures with the company.

Since performance and compensation go hand in hand, variable pay provides a win-win situation for both the employee and you, the employer. But importantly, here is how it aids in employee retention:

  • Pay bonuses, based on performance, encourages your employees to clearly demarcate goals and achieve better results thus keeping them focused and motivated towards the goals. This results in a heightened level of engagement at work, which is key to creating a loyal employee base.
  • The system of variable pay enables identification of high performers who become eligible to enter the lucrative succession pipelines and get next in line for key senior level positions at your company

Long Term Incentive Plan

Retaining good employees saves your business money, time and effort. In order to increase employee retention, your organisation would need to structure compensation in the form of long-term incentive plans (LTIP); instead of handing out bonuses on completion of short-term-goals.

  • Under a LTIP, the goals and corresponding employee profits are fixed for a three to five year period, based on the duration of your company’s larger projects
    • Your employee is assured a large bonus at the end of the stated period, on achieving specified goals and/or completing a fixed tenure at the workplace. This acts as a means to reduce employee attrition, since the bonus would be payable only on continuous service at the end of the long term plan duration.
    • Your company could also choose to pay the large bonus in advance. This amount will have to be forfeited in case your employee decides to separate before end of the period stipulated within the LTIP. Again, since employees don’t want to return huge sums of money, this strategy becomes a disincentive for employees to leave your company.

Mega brands like Philips have adopted a long-term incentive plan that allows for awarding of performance-related shares; to board members, senior management and key employees. Here, the annual reward size, which is a combination of stock options and restrictive shares, was set at a multiple of the employee’s base salary. And this featured a minimum holding period of three years for the shares, although they also offer an incentive to hold them longer.

Here is a list outlining some of the LTIP examples:

 Long Term Incentive Plans  Examples
 Retirement  Benefits  You match employees’ contributions up to a  percentage of their salary; they are encouraged to  remain in your company until retirement.
 Paid Sabbatical  Give your employees a six month sabbatical, for every  decade or so completed.
 Stock Options  1.Make greater stock options available, at a  discount,  to employees who have stayed with your  company for  more than five years.2. Your company can  gift shares  to the employee, under the clause that s/he forfeits all  gifted stock if a resignation is submitted by them  within two years of receipt
 Bonus Vacation Time  For every five years an employee completes at your organisation, add a week of additional leave to their  kitty.
 Cash rewards  For every 3-4 years spent at your company, and certain  performance targets met, the employee gets a bonus.

As with any HR tool, it may or may not work for your company owing to a host of reasons. Before you go all buhaha on LTIPs, use the following checklist to see if you’re prepared to benefit from the program:

  1. The long term goals of your LTIP tie-in with the larger strategic business plans
  2. Measurable targets can be identified for each of these goals, which have a clear line-of-sight. This is process is easiest to complete with the sales team, as the targets can be measured in revenue growth, but with some effort can be achieved for other departments also.
  3. The LTIP is tailored to fit the culture of your organisation and your employee generation
  4. The employees are educated on the methodology adopted in goal setting
  5. Employees are made aware that:
    • If the variable pay component is introduced, there could be a certain reduction in the fixed pay
    • Variable bonus can be withheld or retracted in case the employee leaves the firm before the stipulated period
  6. The compensation process is transparent with respect to goal setting, benchmarking employee performance and determining the eligibility for LTIP
  7. There is an efficient means to track performance related to these goals over a long time period
  8. There is a healthy mix of engaging and non-financial means employed in your company’s retention strategy. A survey by American Express Incentive Services, L.L.C indicates that loyalty of 63 percent of respondents would increase if the employer offered on-going incentive programs that allowed employees to choose rewards that were personally relevant
  9. Integration of variable incentives payout with the payroll software in a timely manner
  10. It addresses the personal tax impact on the employee along with the company’s tax return

Compensation from LTIP, if implemented effectively, encourages employees to continue in your establishment for a definite period; while aligning business targets with the strategic goals of your company. Unfortunately the real problem is that most companies still look at such incentives as expenses and not as capital investments. This organisational mentality needs to change towards building a dedicated workforce that will provide greater ROI in the long run.

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