Variable Compensation and Its Relevance in the ‘New Normal’
All organizations value their human capital which is the most critical part of any organization’s success. In order to attract and retain talent in a tight volatile market, it’s imperative to offer compelling compensation and benefits packages to its employees. In most of the organizations, employee cost forms a larger part of the operational expenses. And the pandemic of COVID19 has made many companies to struggle for paying monthly salaries to its employees. Every organization is keenly watching the worldwide situation and taking appropriate cost containment measures to survive through this difficult time.
It’s been three quarters the whole world is struggling to fight with this crisis and the battle is still on. This unprecedented turmoil in the world’s economy has severely impacted most of the industries globally and some of the organizations are trying every bit to survive. The pandemic of COVID19 has introduced us to the ‘new normal’. This ‘new normal’ is going to change a lot of things, the business models, the workforce planning strategy, the employee experience, and the employee compensation strategy too.
What is Compensation?
As we all know, compensation is a very generic and vast term in an HR language, refers to monitory payment to employees in exchange for work they perform. So, in this context what change we can expect in the ‘new normal’? Let’s first understand the components of compensation. Typically, employee compensation is divided into three components – fixed compensation, variable compensation, and benefits & perks, a total of which constitutes cost to the company of an employee. Some organizations may add up other non-cash components as a part of the total cost of an employee.
Fixed compensation is the one which is guaranteed and has no linkage to the performance of the individual or the organization. Variable pay on the other hand constitutes all cash compensation that is paid to employees above or in addition to their fixed pay. Variable pay includes any type of bonus, incentive pay, or sales commission that is based on performance and is not guaranteed.
“Unlike the western world, the concept of variable pay as a part of the compensation package is still not so widely accepted in India. However, progressive organizations strongly promote it and the new generation is also getting used to it.”
The objective of including variable pay in employee compensation is to safeguard the organization during bad times at the same time give flexibility to employees to earn corresponding to their and organizational performance.
A typical combination of fixed and variable salary can be seen as below (Fig.1). However, this may vary from organization to organization and especially for the sales-oriented staff as they may have more percentage of variable pay in the form of incentives
Defining the right mix of components is a very critical aspect of a compensation strategy. The variable component of the CTC also takes into account how a company performs and not just an individual employee’s performance. Hence, it makes sense to add an increasing quantum of variable pay in the upward hierarchy. This also safeguards the company from increasing fixed costs year on year irrespective of variation in the individual and company performance.
The Relevance of Variable Compensation in the ‘New Normal’
“To avoid adding to fixed costs with large annual salary increases, companies are regularly relying instead on bonuses to reward employees for superior performance,” said Don Lowman, a global leader of consultancy Korn Ferry’s rewards and benefits practice. “CEOs are quite willing to pay for solid results, but only if those results are attained.” Correlating this to the current financial situation of many companies it wouldn’t be a surprise if they increase the variable portion of the compensation to protect the financial condition of the organization.
“Variable pay will play a stronger and broader role in compensation. Existing bonus programs will extend to more workers, and bonus targets will increase slightly. This is done in recognition of the speed and agility of today’s workforce”, he added.
As companies deal with cost pressures, linking variable pay or the performance-based component of the compensation of senior management to the company’s performance is becoming an alternative. Many organizations are reviewing their compensation strategy to increase the percentage of variable pay for mid and senior-level employees. Organizations that do not have any variable component in the salary for junior staff may introduce it to remain competitive.
“The crisis has highlighted the inelasticity in compensation costs and there will be a move towards making these more variable over the coming years,” said Anandorup Ghose, partner at Deloitte India.
“We believe this impact will be more pronounced in middle management compensation, which, across most industries, represents the largest component of the overall pay cost.” These are levels where employees are also decision-makers and, therefore, increasing performance orientation is a more logical message, he said.
Learning from the experience of uncertainties like the COVID19 pandemic, the organizations may revise their distribution of fixed and variable pay as below. (Fig. 2) However, it may not be easy for organizations to sell this idea to their employees. Junior staff may be reluctant to accept this change as it can reduce their monthly take home. Also, most of the time they are not the ones who influence the performance of the organization.
Arvind Usretay, director of rewards at risk management advisory Willis Towers Watson, said “Companies may evaluate the potential introduction of long-term incentives in addition to existing short-term incentives for middle and senior levels, in order to closely link the variable payouts to company performance over a longer duration then just the immediate results,” he said.
As we enter into the ‘new normal’, some of the equations are going to change and the compensation strategy is going to be part of it. More and more organizations will be turning to higher variable pay to reward performance and differentiate on the employee experience. Allocating a more variable percentage by way of salary restructuring can be seen in many organizations. While this may not impact junior levels much, the mid and senior-level will see this change to bring greater accountability and survive through this tough time.
*The views and opinions expressed in this article are those of the author and do not reflect the official policy or position of the organization he is working for.