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 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:
Compensation for 2023:
50,000 + 120*25*0.10 + 2000 * 6 [(fixed) + (commission) + (Bonus for selling 6 lots of 20 units)] = $62,300
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.
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.
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.
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.
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, 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.
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.
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.
There are a lot of factors that can be included in the structure of a variable compensation plan. Some of the main elements are:
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 1: 100% Target Completion
Monthly Compensation= $5,000 (base pay) + $3000 (commission)= $8,000
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
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:
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:
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:
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.
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.
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.
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.
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.
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.