What Is Variable Compensation? Examples and How It Works

For many employees, a predictable deposit hits their account every payday. But for those who receive variable compensation, the amount fluctuates. Unlike a fixed salary or set wage, variable pay can go up or down based on performance or results.

Employers often use variable pay alongside base salaries to incentivize workers to improve their performance or achieve specific outcomes. It typically rewards results, not just time or effort, linking company wins to individual success. 

Below, find a primer on variable compensation, including how it works, common variable pay types, and what to consider when managing these programs for a global team.

What is variable compensation, and how does it work?

Variable pay is a non-guaranteed form of compensation employees earn by achieving certain performance goals. In contrast, fixed compensation stays consistent regardless of performance. 

A variable compensation program typically incorporates quantifiable objectives, such as key performance indicators (KPIs), profitability, or sales growth. When employees meet these goals, they’re rewarded with additional compensation on top of their base pay, like a bonus or commission percentage.

The variable portion of an employee's on-target earnings (OTE) varies depending on the program. Direct revenue-generating roles (like sales representatives) often have a higher variable share. Employees in operational or administrative roles tend to rely more on fixed compensation, with variable pay perhaps making up a little of their total OTE salary.

Types of variable compensation

While variable compensation programs all act as incentives, they can serve different business goals. The right pick for your organization depends on your industry and the role of each employee, as well as the behaviors you want to encourage. Routine compensation reviews can help you determine if you need to adjust variable pay. This is particularly important for companies with a global workforce, since reviews can ensure ongoing compliance with varying employment regulations by region.

Here are some common variable compensation plan examples.

Commissions

Commission is a popular performance-based variable pay structure, especially in sales-based industries. With commission, employees earn a percentage of the revenue they generate. This way, their extra earnings are directly proportional to the outcomes they produce. 

The more deals the employee closes or services they perform, the higher the compensation, which can be a major driving force but requires careful sales tracking to ensure commission is awarded correctly and consistently. Otherwise, if the total compensation (both variable and fixed combined) falls below minimum wage in that jurisdiction, you may face penalties and damage workplace morale.

Commission is best suited to businesses with short sales cycles and employees who directly impact business revenue, such as sales representatives for B2B companies or hair stylists at salons. It can act as a motivating force, driving them to bring in more clients.

Performance bonuses

Performance bonuses are lump sums that reward employees’ contributions to the business. In many cases, companies award bonuses each quarter or at the end of each year, and the amount is generally proportional to performance quality or business revenue.

You can structure these as a set amount or percentage of earned revenue, and they might go to individuals, teams, or the entire company. Organization-wide bonuses can foster a strong sense of teamwork.

Profit-sharing

Profit-sharing programs distribute a percentage of a company's profits among employees. Some plans include quarterly distributions, but annual payouts are more common to align with yearly accounting cycles. Profit sharing may take the form of cash or retirement contributions, and the amount is based on the company’s overall success as opposed to individual employee metrics.

Unlike many other compensation structures that are related to revenue, profit-sharing is about the bottom line. This encourages employees to prioritize waste reduction and cut costs rather than just increasing revenue. It’s generally ideal for mid-sized businesses and established organizations where individual employee contributions are difficult to measure.

Equity and stock options

Equity compensation provides employees with a small share of ownership in the company, usually through stock options. Often the number of shares reflects the employee’s tenure or level within the company.

While many large, publicly-traded corporations use this structure to prioritize employee retention, equity compensation for startups also helps growing organizations preserve cash flow and attract top talent.

Spot bonuses

Spot bonuses are discretionary bonuses or rewards (e.g., extra paid leave or spa vouchers) companies give employees or teams for exceptional performance. Instead of following predictable cycles like traditional bonuses do, employees receive these bonuses outside of formal recognition periods.

Companies often offer spot bonuses to reinforce certain behaviors. For example, if a sales manager saves a deal from falling through at the last minute, you may reward them with a one-time discretionary bonus in the form of a lump-sum payment. This approach is super flexible; you can apply it to any individual across the company. 

Goal-based incentives

Goal-based incentives are directly linked to particular objectives, like completing a project or reaching a predefined KPI goal, and can be paid in cash or in non-monetary rewards such as travel or extra time off. Goal-based incentives include any bonus tied to achieving a goal, including performance bonuses, which are typically tied to hitting an explicit goal.

How to build a variable compensation plan

A thoughtful variable incentive compensation plan aligns individual performance with overall business objectives and attracts and retains talent. Variable pay programs also help keep labor costs aligned with revenue. When teams perform well, both the company and the employees are rewarded. When they don’t, your labor costs scale down with your reduced revenue.

To fully reap the benefits, establish a compensation program with clear, measurable goals. You may decide that your team is best served by using a mix of compensation types, with each program tailored to the needs of specific roles. Managers, HR, and finance teams can all help ensure programs are sustainable and balanced.

Here’s a step-by-step framework for designing a variable compensation plan:

1. Define measurable goals. Identify the key metrics that matter most to your organization (revenue growth, customer acquisition, operational efficiency) and map each goal to an incentive structure that motivates particular behaviors.
2. Set the pay mix. Use salary benchmarks in your industry to determine the ratio of fixed versus variable compensation for each role.
3. Choose the right structure. Choose incentives for the behaviors you want to drive, such as commission for hitting sales targets.
4. Establish a regular review cadence. Audit your variable pay plans routinely so your compensation structures evolve alongside business goals.

Manage variable compensation for global teams with Pebl

Variable compensation plan implementation can get complex, especially when it comes to payroll and tax compliance. For companies with a globally distributed workforce, conflicting jurisdictional regulations further complicate matters, leaving you without key features such as automatic currency conversion or localized tax- and payroll-compliance tools. You may need tailored variable compensation software to create global mobility compensation packages. Many traditional, domestic payroll systems aren't designed to address these administrative challenges. 

Pebl’s Global Payroll platform runs payroll across more than 185 countries with 99.9% accuracy. Manage international statutory deduction regulations, currency conversions, and compliant reporting in one place. And if you’re operating internationally, Pebl’s Employer of Record solution can simplify your hiring and workforce management processes. Plus, Pebl is rated #1 in compliance on G2, so you know you have a vetted tool for navigating complex regulatory structures. 

Contact Pebl today and book a meeting with one of our international payroll experts.

FAQ        

Is variable compensation the same as commission? 

No, variable compensation is a broad category that encompasses commission alongside a variety of structures, including profit-sharing, equity programs, and performance bonuses. 

What is the difference between a bonus and a variable salary?

A bonus is a one-time payment awarded to employees for achieving certain performance goals, while a variable salary refers to the portion of an employee's earnings that fluctuates based on performance. Performance bonuses can be a type of variable pay, particularly when employers give out the bonuses in consistent cycles.