Proper incentivization is the fuel that pushes business goals to completion.
A survey conducted by the Society for Human Resource Management (SHRM) revealed that 70% of employees are motivated to work harder when they feel their efforts are recognized and rewarded.
In the current era of unnerving competition, it is essential to keep your employees motivated and focused on achieving business goals.
Target variable incentive refers to the total compensation that can be linked to 100% goal completion in performance-based roles. It is the total amount, other than base salary, that is up for grabs if an employee, for example, a salesman, achieves 100% of his targets.
This blog will take you through the different types of target variable incentives, some practical examples, and help you understand ways to structure them to drive greater sales motivation.
Variable Incentive: How it Works
Variable incentive or compensation, as the name suggests, is the part of an employee's total compensation package that is dependent on certain specific goals or performance criteria. They don’t receive this part of their compensation package if they don’t perform accordingly.
Essentially, variable incentives function on the premise of ‘The more you give, the more you get’, signifying their performance-oriented nature.
For example: John is a salesman whose base salary is $50,000 per year. On top of that, he receives a commission of 10% on each unit sold by him and a bonus of $2000 for every 20 units sold by him. 1 unit of the product he sells is priced at 25$.
Suppose he sells 120 units of the product in 2023, then:
Now in this example, $50,000 is the fixed compensation, which John would have received no matter his sales performance, and $12,300 is the variable compensation, which depends on his sales performance.
Purpose of Variable Compensation Plans
Variable compensation plans and the total target variable incentives are usually designed with certain goals in mind. It is to push the employees towards certain goals and align their efforts with the organizational objectives. Financial incentives work best to incentivize employees, as they directly link company growth with an employee’s income.
How to Link Variable Pay to Performance Goals: An Example
Company X wants to do $400,000 in sales revenue in 2024. To facilitate achieving this target, the company has increased sales commissions from 2% to 4% for its salespeople.
An increase in sales commission provides a direct financial incentive to salespeople to work harder and sell more.
How to Link Variable Pay to Specific Goals: An Example
There are two products, A and B, being sold by Company X. The CEO wants to push Product B faster as it is newer and market penetration is low. The CEO decides to put a bonus of $2000 on every 5 units of B sold, while no such bonus exists for A.
This will push the sales team to try and sell more of B, to maximize their earnings, thereby also achieving the organizational goal.
Types of Variable Compensation and Variable Incentives
Variable compensation takes many forms. The best way to implement variable compensation can depend on the exact goals your organization is pursuing. Short-lived incentives to react to market trends can also be a good option to stay agile and responsive.
Let’s look at the different types of variable incentives that you can implement at your SaaS organization, based on your business goals.
Commission
Commissions are the most direct way to encourage better performance. They are common elements of sales compensation plans. A commission is usually a fixed percentage of the sales value a salesperson generates.
Example: John sells goods amounting to $50,000. His commission rate is 10%. Therefore, his commission earnings will be $5,000. This is a variable component added to his fixed base compensation if the base pay is fixed.
Bonus
A bonus is an additional payment added on top of compensation for meeting one-time or specific goals or objectives. Bonuses you can leverage to incentivize your sales representatives could be retention bonuses, target completion bonuses, performance bonuses, etc.
Example: John has a sales quota of $100,000 in a financial year. In that year, he ended up selling goods amounting to $150,000. He is given a $2000 one-time bonus for achieving 150% of his sales targets.
Profit Sharing
Profit sharing, as the name suggests, divides a portion of a company's profits among the employees based on specific predetermined calculations. Some methods of profit sharing are tenure-based, role-based, base compensation-based, etc. Profit-sharing incentives are hugely preferred by organizations because they link a company’s growth directly with the performance of its employees.
Example: From total profits of $1,000,000, Company X sets aside 10% for profit sharing. Profit is apportioned based on 10% of the base salary in Company X. John is a salesperson in Company X with a base salary of 20,000$. Therefore, his share will be [10% of 20,000 (base salary) / 100000 (Sharing Pool) ] = 2% of the profits, which amounts to $2000.
Additional Incentives
Other incentives such as SPIFFs (Sales Performance Incentive Funds) for salespeople, spot incentives for exceptional performance, etc. can also be a part of a variable compensation structure. These depend on the target variable incentive that a company is willing to provide.
Example: Maya, a salesperson, closed 3 key accounts in the same quarter. Her company has a SPIFF of $1000 per key account closed. As a result, she gets an additional $3000 at the end of the quarter.
Target Variable Incentive and On-Target Earnings
We know that the complete variable pay amount an employee can expect to earn if they meet 100% of all their targets is called the target variable incentive. It is the complete variable portion dependent on performance.
Meanwhile, OTE or On-Target Earnings is the total amount an employee can expect as compensation if they meet all of their performance-based targets. It includes the fixed component or base salary as well.
Therefore,
Base Compensation + Target Variable Incentive = On-Target Earnings
This equation aptly describes the meaning of target variable incentives. It is the total variable component of an employee’s income, and they can reach the entire amount (On-Target Earnings) if they achieve 100% of their performance-based targets.
Pay mix refers to the ratio of fixed pay to variable pay. Companies usually decide the target variable incentive based on the fixed pay. In SaaS, a pay mix of 50/50 is common, i.e., 50% of the on-target earnings are fixed compensation or base salary, while the rest is variable.
Factors That Influence How Target Variable Incentives Are Structured
There are a lot of factors that can be included in the structure of a variable compensation plan. Some of the main elements are:
Payout Structure: Payout structure refers to the decisions regarding the frequency of payment, and how the payment is calculated. It also includes deciding the total amount of variable pay.
For example, a salesperson has been given a monthly sales quota and gets his commission and bonus accordingly, at the end of each month.
Commission Rate: As the name implies, this refers to the decisions regarding fixing a commission rate for performance-linked variable incentives. For example, A salesman gets a commission of 2% of the sales revenue he generates.
Completion Tiers: The target variable incentive may also have different payouts based on completion percentage. Such increases for crossing targets incentivize going beyond the target.
For example, a base variable payout for 100% completion, 120% payout for 150% completion, 80% payout for 80% completion, etc.
Caps and Floors: Usually, companies keep a cap on the maximum amount you can earn through variable pay. Similarly, a minimum payout is also decided.
For example, a company may set a cap of $50,000 irrespective of how much further you exceed the target.
A Case Study to Understand Target Variable Incentives
Name: John Smith Role: Account Executive Base Salary: $5,000 per month Target Variable Incentive: $36,000 per year or $3000 per month Sales Targets: $30,000 in sales revenue every month Commission Rate: 10% of sales revenue generated Bonus: Commission rate increases to 12% for revenue above $35,000 Cap: Variable earnings are capped at $6,000 per month
Scenario 2: 150% Target Completion ($45,000 in sales revenue)
Total Compensation= $5000 base pay + $3,500 (normal commission) + $1,200 (commission @12%)= $9,700
How to Set Effective Variable Compensation Plans
Setting an effective target variable incentive that actually pushes employees to perform better requires solid groundwork. The steps you can take to implement to deploy effective variable compensation plans are:
Set clear, achievable targets: Ensure that company objectives are clearly aligned with employee goals. The targets should be clear and actionable. Keep the individual targets challenging, but always achievable.
Ensure timely payouts: Maintain accuracy in payouts, and always deliver payouts on time. Inaccurate and delayed payouts can shatter your sales team’s confidence, impacting revenue targets.
Communicate and take feedback: Set effective communication processes with employees and take their feedback on compensation plans. They should be well aware of how their plans are structured and what they’ll be earning.
Be competitive and ensure transparency: Keep your payouts competitive according to the industry, and be fair and approachable in terms of compensation. Employees who trust their organizations work harder.
Benefits of Variable Compensation Plans
Including variable compensation as a part of the total compensation package serves many benefits, the most apparent one being a boost to sales performance. By directly linking an employee’s performance to their earnings, you’re tapping into their drive and desire to perform better. On the other hand, incorporating variable compensation is one of the most cost-effective ways for a company to motivate its reps to attain specific goals.
The major benefits of having a target variable incentive component as a part of the total pay are:
Boosts Employee Productivity: Variable incentives directly link individual performance to compensation. Hence, employees are more motivated to perform their duties. They are also more engaged with their roles and with overall company objectives.
Cost Effective for Companies: Variable compensation plans are very cost-effective. If the performance targets are met, they are paid in full, whereas if not, then the company saves money. It ensures that in performance slumps, the company’s costs are also low.
Allows Flexibility in Comp Plans: Variable compensation components allow the company to flexibly control compensation. Organizations can give special recognition and rewards through incentives to encourage performance but also hold the right to not pay any performance-linked incentives if performance is unsatisfactory.
Transparent Goal Setting and Benchmarks: Employees get a clear idea of the expectations from them, while also knowing exactly what to do in order to fulfill those expectations.
The Drawbacks of Target Variable Incentives
Despite all the performance-boosting capabilities of variable and target-based incentives, they are not without flaws. Excessive usage of goal-based compensation may lead to negative behavior and a loss of confidence in the organization.
Summed up, the drawbacks of using target variable incentives are:
Focus on Short-Term Goals: Variable incentives promote the attainment of short-term (monthly or quarterly) goals. Employees may focus excessively on attaining these short-term goals to maximize their earnings, potentially ignoring long-term objectives and overall organizational goals.
Risk of Unethical Behavior: The motivation provided to meet targets may come across as pressure to the employees. They may use shortcuts or unethical practices to meet those targets in such scenarios. Similarly, an excess focus on maximizing earnings can also lead to the usage of unfair practices.
Loss of Cooperation and Team Camaraderie: Individual performance goals being tied to variable earnings can lead to a selfish attitude in employees. Employees might become less motivated to help others in their team perform well and focus only on their performance.
Administrative Complexities: The design and implementation of variable compensation plans is no easy task. The goals have to be tailored to each individual or team and monitored effectively. On top of that, addressing disputes in connection to variable compensation plans also requires a lot of time and energy on the administrative front.
Wrapping Up
The target variable incentive part of a compensation plan allows companies to adapt to the modern landscape as and when it changes. It facilitates the adaptation of incentives to market conditions such as competitive pressures, employee poaching, etc. Meanwhile, it gives employees room to grow and room to run as fast as they can, satisfied in knowing that the more they give, the more they get.
A thing to keep in mind is that variable pay, in most cases, is backed up by a base fixed compensation. This is because you cannot expect to retain and fulfill employees if you cannot provide a sense of security. Motivation comes from a place of desire to perform exceptionally, not to ensure survival.
FAQs
What is target variable pay in CTC?
Target variable pay, or target variable incentive, is a part of an employee's compensation package that is contingent on them meeting certain goals or performance criteria.
What is the target variable bonus?
A target variable bonus is a specific component of a target variable incentive. It is the additional amount that will be awarded to an employee if they meet certain performance criteria.
What is a target-based incentive?
A target-based incentive will only be awarded to an employee if they meet the targets or goals set for them by their company. Such targets may be tied to sales revenue goals, closing key accounts, wrapping projects in predetermined timelines, etc.
Is variable incentive part of CTC?
Yes, the target variable incentive is a part of the CTC (Cost To Company). The CTC includes both the fixed and the variable components of an employee’s compensation package.
What are the disadvantages of variable pay?
Although variable pay is based on the premise of encouraging performance, some of its drawbacks can be increased stress to perform well, complexity to implement, demotivation due to variability in income, etc.
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