Variable Pay Plans

Most organizations have determined that merit pay plans do not provide sufficient reward for employees who consistently perform in an outstanding manner. Indeed, merit pay plans have lost their "merit" and become entitlement plans, wherein all employees are given salary increases. With the pressure to provide salary increases for all employees, there is little left to reward the key employees. As a result, organizations are considering adopting variable pay plans.

Such plans can be individually based, team and/or organization based. Incentives can be developed in the forms of profit sharing, team incentive pools, awards for achievement against defined objectives, gainsharing, cost savings or management discretion. Yet some organizations are designing plans destined to fail, as they have not considered a process for determining the need and value of variable pay plans.

Before implementing a variable pay plan, there are several phases to work through which will assist in its design and focus. Above everything else, a task team should be appointed to consider variable pay as an option and to recommend the form(s) the plan should take. This first step is the Strategy phase. It considers if a variable pay plan will benefit the organization and focus employee attention on the achievement of the organization's goals. During this phase, the following questions need to be considered:

- Why is a variable pay plan needed?
- What behaviors do we expect to change with variable pay?
- How will it assist the organization achieve its strategic goals?
- Is there one plan that we can adapt to our organization's culture?
- What are the business drivers on which we want to focus?
- How do we measure employee success in achieving organization goals?
- Do we have senior-management (CEO) support?

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 team should take these steps:

- Identify if more than one plan is needed based on employee groups.
- Identify plan participants.
- Involve the entire organization in the process to ensure buy-in.
- Determine how the plan will be funded.
- Determine the plan components, weightings and measurement methodologies.
- Develop plan "strawmen" to weigh various design options.

The third, or Analysis, phase narrows the scope of the team into actual design and modeling costs of the plan and develops an actual plan document. Issues and questions here include such steps as:

- Settle on a plan design and develop modeling criteria, methodologies and formulas.
- Develop a plan document with an outline of the plan, policies and procedures.
- Model the proposed plan under various scenarios to identify its impact at varying success levels.
- Conduct focus-group sessions to determine if they understand and feel they can influence the motivators selected.
- Revise the plan based on the focus-group results.
- Determine how rewards will be made to employees' cash, stock or 401K contributions.

The next phase is Documentation. Here the "rules and regulations" are finalized and administrative processing is considered. Steps include

- Finalize the plan document with all aspects of the plan outlined.
- Develop incentive agreements for employees.
- Develop an administrative record-keeping and calculation system for the plan.
- Develop processes with the finance department for valuing the plan cost during the year.

The most critical phase is the last: Communication. An organization can design the best plan, but if employees do not understand how it works, how they will benefit, and what is expected of them, it will fail. Steps to be completed are: - Develop a comprehensive employee communications plan with dates and materials.
- Develop a management communications plan to parallel the employee communication plan.
- Develop a management-training plan on plan communications and goal setting, to provide a thorough understanding of the plan and its operation.
- COMMUNICATE.
- COMMUNICATE.
- COMMUNICATE.
- COMMUNICATE AGAIN.

Remember:

- The first time an employee receives an award, he or she perceives the reward as performance based and greatly appreciates it.
- The second time an employee receives an award, the perception is a reminder and reinforcer of performance.
- The third time an employee receives an award, the perception can be that it is an entitlement.

Organizations must strongly guard against permitting variable pay plans to become entitlement plans.