Article: Is there a variability paradox in the variable pay plan?

#Appraisal Season

Is there a variability paradox in the variable pay plan?

Compensation is an important issue and Variable pay is an integral part of total compensation, both for employees as well as employers. How does it affect employee performance, growth and retention?
Is there a variability paradox in the variable pay plan?

Variable pay, also known as incentive pay, refers to pay earned beyond an employee’s normal weekly, monthly or annual salary. It’s not a guarantee; it is paid out only if an individual or team achieve a goal. Typically, these goals relate to profit, sales growth, productivity or customer service improvement. Individual performance awards are most prevalent in Indian companies and frequency is typically annual. At senior management levels, the executives could have a much higher weightage for corporate performance, rather than individual performance. Variable pay typically constitutes a sizable portion of the wage bill. Administration and proper planning of the variable pay plan are qualifiers for the success of a good plan. 

Both employees and employers have distinct expectations when it comes to variable pay Plans. Management is looking at drawing the right equilibrium between the capacity to pay vs. need to pay. It is imperative that the variable pay plan should drive the right alignment with the strategic organizational objectives. Employee expectation, on the other hand, is to have a plan that is fair and equitable and is driving them to achieve their targets, stretched as well. 

According to Mercer’s 2017 Talent Trends Study, 93% of employees in India want to be recognized & rewarded for a wider range of contributions. These are strong words, as employees are asking organizations to “simplify decision making”. There is clearly a shift in what employees’ value; as 2017 was the year when employees clearly spelled out ‘fair & competitive pay’ and ‘opportunities for promotion’ as top priorities for the year. 

If we try and segment fair and competitive pay, we need to dive deeper into what all does it entail. Does it only mean guaranteed cash or even includes areas such as variable pay as well as recognition and rewards, for a wide range of contributions? Employees are clearly saying “Show me the money”. They are looking at not just increased salary percentages, they are also expecting a bigger share of the variable pay kitty, for better-delivered performance. There is a clear demand for performance differentiation and related pay differentiation. All of this could be delivered in the form of higher increases for better performers or higher-and-much differentiated performance bonuses.

How are CEOs reacting to the current situation? 

According to KPMG Disrupt-and-grow-India-CEO-Outlook-2017, 88% of Indian CEO’s believe in better growth prospects for India, compared to that of the global economy in the medium term. Majority of the CEOs are upbeat about the growth of the Indian economy. Optimism about India’s growth is higher than that for the global economy.

75% of the CEO’s say that building greater trust among external stakeholders and customers is one of the top three priorities for their organizations. Technology is high on CEO agenda, as 84% CEO’s plan to invest in significantly in cybersecurity and as 85% plan on high investment towards IOT and data analytics tools, over the next three years. It is very clear that CEOs are looking at ways to optimise their budgets, to be future ready and to ready their business to be a disruptor, rather than to be disrupted. 

In view of the above, HR is walking the tight rope of balancing employee expectation of differentiated rewards as well as managing CEO expectations. According to KPMG India Annual Compensation Trends Survey 2017-2018, the average projected variable pay across sectors is 15.4%, which is 0.4% higher than 2016-17. The same survey also states that nearly 20% of companies view performance-based variable pay as one of the top three compensation levers for talent retention. 

This clearly indicates a trend whereby organizations are continuing to move towards a higher percentage of performance and variable pay. This is an interesting trend, in the backdrop of companies either projecting a decrease in average increments in certain sectors or will be stagnating at same levels. 

According to Mercer's 2017 India Total Remuneration Survey, companies are likely to dole out 10 per cent salary increase across industries in 2018, consistent with 2016 and 2017.

Aon Hewitt is forecasting that the upcoming appraisal season will see employees getting a projected average increment of 9.6%, up from 9.4% this year, albeit marginal increase. The Aon survey reveals that maintaining the competitiveness of pay continues to be a top reward challenge for firms, especially given that 71.9% companies reported salary increase budgets to be same as 2017. Even during the 2009 recession period, while a large majority of companies chose to freeze increments, they continued to proceed with variable bonus pay-outs. So, is variable pay recession proof?  

Variable pay is clearly emerging as a bigger differentiator. Variable Pay is defined as rewards based on individual, group, or organizational performance rather than time spent on the job or the job’s value. It is a powerful tool that is linked to clearly stated objectives. Why are variable pay plans emerging as a much more successful tool? There are multiple factors. One such factor is that these plans are effective in getting employees to pay attention to key company goals and initiatives since part of their compensation is tied to results. 

Moreover, when compared to variable pay, increments are viewed as an entitlement and as a given. And with shrinking budgets, the difference between the increments for ‘meets expectations’ and ‘exceeds expectations’ is only marginal. 

From an organizational perspective, variable pay is an important lever, which provides organizations with greater flexibility in managing their compensation costs during unpredictable business periods. Variable pay budgets would hit the company balance sheet, only when the company performance warrants it. This is exactly where employee agenda meets the CEO agenda.

From an organization perspective, organizations that have been able to establish clear and concise performance metrics, with clear linkage with organization performance, have been able to use variable pay to their advantage. For such organizations, variable pay is one of the top three compensation levers for talent retention. 

From an employee perspective, many high achievers, eager to be part of a dynamic work environment, view variable pay as an important factor when choosing an employer. As the pressure on the balance sheet continues, variable pay will continue to be a preferred lever.

Topics: appraisalseason, Life @ Work, Talent Management, Compensation & Benefits

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