Employees are often a company's biggest resource, both in terms of cost and value. Yet employees continue to be dissatisfied with their compensation plans — just 58% of people are satisfied with their income, according to Ipsos' Consumer Tracker Survey. 

Variable compensation is particularly relevant for GTM (Go-to-Market) leaders, given their impact on revenue. It aligns the sales, customer success, marketing, and other GTM team’s financial incentives with organizational goals. In this guide, we'll explore the concept of variable compensation, its types, advantages, disadvantages, industries where it thrives, and how to implement it effectively to drive employee satisfaction and organizational performance.

Variable Compensation 101

Variable compensation refers to a compensation structure where a portion of an employee's pay is contingent upon achieving specific performance metrics or targets. This pay structure is common for sales reps and is an incentive pay in addition to the base salary (the fixed amount of compensation that an employee receives regularly). This includes sales commissions, bonuses tied to individual or company performance, incentive programs, and recognition rewards.

Data shows that variable compensation plays a significant role in modern compensation strategies. More than half of sales reps say they have variable compensation plans at their organizations, according to the State of Sales Compensation Report. 

Types of Variable Compensation 

These compensation plans come in various forms, each suited for different roles, industries, and organizational objectives. Commissions, bonuses, incentives, and recognition are most common among sales teams, whereas profit sharing and stock options are less common types of sales compensation.  

Commission

Commission is a common sales compensation where employees receive a percentage of the value of sales they generate. This type of plan incentivizes employees to drive revenue and creates a performance-driven sales culture. Commission structures can vary widely, from straight commission plans to tiered or hybrid models based on sales volume or margin.

Bonus

Bonuses are additional payments awarded to employees for achieving specific performance targets. These goals may be individual, team-based, or tied to company-wide objectives. Bonuses can be one-time lump-sum payments, profit-sharing arrangements, or discretionary bonuses based on overall company performance.

Incentive

This form of variable pay offers rewards, such as cash bonuses, stock options, or other incentives, for achieving specific performance objectives or milestones. These objectives may include sales targets, customer satisfaction metrics, or operational efficiency goals. Incentive plans are designed to motivate employees to focus their efforts on key strategic priorities.

Recognition

Recognition-based compensation programs acknowledge and reward employees for outstanding individual performance. These rewards may take the form of public recognition, awards, certificates, or non-monetary incentives such as additional time off or flexible work arrangements. Recognition programs reinforce desired behaviors, foster a positive work culture, and boost employee morale and engagement.

Profit Sharing

Profit-sharing plans distribute a portion of the organization's profits among employees, typically based on predetermined formulas or allocations. These plans align employees' interests with the company's financial success. They often distribute profits annually, quarterly, or at other intervals, depending on the organization's performance and financial health.

Stock Options and Equity Grants

Stock options and equity grants provide employees with ownership stakes in the company, so the company's success is every individual's success. Stock options grant employees the right to purchase company stock at a predetermined price within a specified period, while equity grants offer outright ownership of company shares. These forms of compensation are common in startups, high-growth companies, and publicly traded corporations, where they serve as powerful incentives for employee retention.

The Advantages of Variable Compensation

Variable compensation offers numerous benefits for both employees and organizations:

Boosts Employee Engagement

By tying compensation to performance, variable compensation plans motivate sales reps and managers to actively engage in their work and strive for excellence. This can help create a culture of performance and excellence within the organization, where employees are motivated to excel to receive higher compensation.

Improves Productivity

The potential of earning additional rewards fosters a culture of productivity in which employees have their eyes on performance targets. Since their performance directly impacts the amount of compensation they receive, they're likely to work harder, be more productive, and continuously improve their performance to earn higher rewards.

Provides Financial Flexibility

Variable compensation allows organizations to adjust compensation expenses based on performance outcomes. When there's economic uncertainty, this can be helpful for a company to adjust its compensation. Three out of five sales managers adjust compensation plans to reflect the latest economic and industry trends, according to the State of Sales Compensation Report. 

Aligns Employees' Activities and Company Performance

When companies align employees' actions with organizational goals, that directly ties individual efforts to the overall company success. This can result in more motivated and engaged sales teams, as they have a clear understanding of how their efforts impact both their own compensation and the company as a whole.

Encourages Continuous Improvement

Variable compensation plans promote a culture of continuous improvement and innovation by rewarding employees for exceeding performance expectations and achieving stretch goals. This fosters a results-driven work environment where employees are encouraged to seek growth opportunities.

The Challenges of Variable Compensation

However, variable compensation also presents challenges and potential drawbacks:

Potential for Increased Costs

Variable compensation plans can result in unexpected overall labor costs. If performance targets are set too high, it can be discouraging to employees, and if they’re set too low, the benefits of variable compensation may be lost when the target is always achieved. If employees consistently surpass performance targets, organizations may incur higher-than-anticipated compensation expenses.

Difficulty in Managing a Complex Compensation Plan

Implementing and managing a complex variable compensation plan can be challenging and time-consuming. Organizations must track and analyze performance metrics, calculate payouts accurately, and communicate plan details effectively to employees.

Risk of Negative Work Environment

In some cases, variable compensation plans may foster a competitive and high-pressure work environment. This can lead to stress, burnout, and decreased employee morale. Employees may prioritize hitting performance targets over collaboration and teamwork.

Potential for Bias and Favoritism

Subjective performance evaluations inherent in variable pay can introduce bias and favoritism into compensation decisions. This can erode trust in the fairness and transparency of the compensation system and negatively impact employee morale and engagement.

Difficulty in Setting Meaningful Metrics

Setting performance metrics that align individual contributions with company goals can be tricky. In some cases, performance metrics may be too subjective or difficult to measure objectively, which can lead to ambiguity and confusion among employees.

Industries That Are Well-Suited to Variable Compensation

Variable compensation thrives in industries where performance metrics are easily quantifiable and sales performance directly influences revenue generation and profitability. Here are some industries where variable compensation makes sense for sales teams:

• Technology: For software, hardware, and IT solutions, variable compensation plans reward sales teams for achieving revenue targets, closing deals, or upselling additional products or services.  
• Financial Services: Sales professionals like financial advisors and brokers can earn bonuses based on the value of assets under management or the number of successful transactions, motivating them to achieve optimal outcomes for clients, the organization, and themselves.
• Manufacturing: In manufacturing, variable compensation plans incentivize employees based on performance metrics like production output, quality levels, and cost reduction.

How to Successfully Implement a Variable Compensation Plan

Implementing a variable compensation plan requires careful planning and execution:

• Set Clear and Measurable Goals: Define specific performance goals and metrics that align with organizational objectives and can be objectively measured.
• Communicate Effectively: Clearly communicate the details of the variable compensation plan to employees, including how performance will be evaluated, what rewards are available, and the timeframe for achieving targets.
• Provide Training and Support: Offer training and resources to help employees understand how the variable compensation plan works and what they need to do to maximize their earnings.
• Monitor and Evaluate Performance: Continuously monitor employee performance and adjust the variable compensation plan as needed to ensure it remains effective and aligned with organizational goals.

Variable compensation can be a powerful tool for motivating and incentivizing sales employees to perform at their best, driving productivity, engagement, and organizational success. By understanding its various forms, advantages, and disadvantages and following best practices for implementation, organizations can create effective variable compensation plans that boost employee satisfaction and contribute to long-term business growth.

Learn more about trends impacting variable compensation today by downloading our latest report.