Rewarding Individual Employees Through Variable Pay Programs

In deciding what to pay employees, and how to pay them, management must make some

strategic decisions. Will the organization lead, match, or lag the market in pay? How will

individual contributions be recognized? There are many ways to pay employees. The

process of initially setting pay levels entails balancing internal equity, the worth of the

job to the organization, and external equity, the external competitiveness of an

organization's pay relative to pay elsewhere in its industry. The best pay system pays the

job what it is worth while also paying competitively relative to the labor market. Some

organizations prefer to be pay leaders by paying above the market, while some may lag

the market because they cannot afford to pay market rates, or they are willing to bear the

cost of paying below market. Pay is often the highest single operating cost of an

organization, which means that paying too can make the organization's products or

services too expensive. It's a strategic decision an organization must make, with clear

trade-offs.

A variable pay program is a pay plan that bases a portion of an employee's pay on some

individual and/or organizational measure of performance. Earnings therefore fluctuate up

and down with the measure of performance. Variable pay plans have long been used for

compensating salespeople and executives. Recently they have begun to be applied to all

employees. A number of organizations, business firms as well school districts and other

government agencies, are moving away from paying people based solely on credentials

or length of service and toward using variable pay programs. Low performers find over

time, that their pay stagnates, while high performers enjoy pay increases that

commensurate with their contribution. There are several variable pay programs.

Fluctuation of variable pay has made these programs attractive to management. It turns

part of an organization's fixed labor costs into a variable cost, thus reducing expenses

when performance reduces.

Before implementing a variable pay plan, there are several phases to work through which

will assist in plan design and focus. A task team should be appointed to consider variable

pay as an option and to recommend the forms the program should take. The first phase is

the Strategy phase. This phase considers if a variable pay plan will benefit the

organization and focus employee attention on the achievement of the organization's

goals. Once the team feels that variable pay will provide focus, the Planning and Design

phase begins. This phase concerns itself with the overall scope of the plan. The Analysis

phase narrows the scope of the team into actual design and modeling costs of the plan and

develops an actual plan document. The next phase is Documentation. Here the "rules and

regulations" are finalized and administrative processing is considered. The most critical

phase is Communication. An organization can design the best program, but if employees

do not understand how it works, how they will benefit, and what is expected of them, the

plan will fail.

Piece-rate pay plan is a plan in which workers are paid a fixed sum for each unit of

production completed. When an employee gets no base salary and is paid only for what

he or she produces, this is a pure piece-rate plan. Many organizations use a modified

piece-rate plan, in which employees earn a base hourly wage plus a piece-rate

differential.

Merit-based pay plans also pay for individual performance. However, unlike piece-rate

plans, which pay based on objective output, merit-based pay plans are based on

performance appraisal ratings. A main advantage is that they allow employers to

differentiate pay based on performance, so that those people thought to be high

performers are given bigger raises. The plan can be motivating because, if they are

designed correctly, individuals perceive a strong relationship between their performance

and the rewards they receive. Merit pay plans pay for individual performance which

presumably is more directly under the individual's control. Thus, most individuals desire

control over their pay, most individuals desire control over their pay, employees tend to

like merit based pay plans. Merit based pay plans also allow organizations to compensate

for external factors that may have reduced objective performance measures due to no

fault of the employee.