From beginner to architect: Learn the essentials and build your first variable pay plan.
Are you considering implementing a variable pay plan at your company? It’s an excellent tool for boosting revenues and performance, but it’s not something you can immediately put in place. You need to know the basics first.
This guide helps you understand the fundamentals of variable pay and even gets you started building your plan.
✅ We want to help you put your learning into action, so we’ve included workbook exercises at the end of each section. Go ahead and open a file on your computer or pull out a piece of paper now so you can follow along with the workbook exercises in this article.
What Is Variable Pay?
Also known as “variable compensation” or “variable comp,” variable pay is typically classified as anything above and beyond an employee’s base pay. However, many companies compensate their employees solely with 100% variable pay. It is a very flexible form of compensation.
Variable pay is tied to performance goals achieved by an individual, a team, or the whole company. It can also be tied to a specific project. You can choose to pay variable comp when a predetermined target is met or pay a percentage of the full pay as target percentages are met – such as paying 25% of the full variable pay amount when 25% of a sales quota has been achieved.
Historically, variable pay has been an integral part of a salesperson’s compensation package, but many companies are now expanding variable compensation plans to other departments as well.
✅ Write down what you would like your company’s variable pay plan tied to when you first set it up. Salespeople? The customer service team? The entire company? Or maybe the team members who are working on a challenging project? Whatever you choose, don’t overthink it. The point is to get something down on paper and then move on.
Common Types of Variable Pay Plans
When people think of variable pay, they usually think of one of the five most common types. Keep in mind, though, that variable pay can be structured with nearly infinite variety. When building your variable pay plan, you are only limited by your imagination. (But do make sure you structure your plan correctly.)
- Commission – a payment made for selling products or services, typically as a percentage of revenue.
- Bonus – a one-time, lump-sum payment based on individual or team performance. A “referral bonus” is a one-time lump sum paid to an individual after successfully hiring a candidate they recommended.
- Profit sharing – payment of a portion of the company’s profits, if any, into a pool contributing to employee retirements. This differs from a 401(k), which an employee contributes to (and you may choose to match). Note that employer-contributed plans are subject to limitations in the U.S. As of this writing, an employer may only contribute up to 25% of an employee’s salary to an employer-contributed retirement plan.
- Royalty – an ongoing payment made to a patent or product owner to license their property. Royalties are often paid for books, music, patented innovations, franchise rights, or mineral rights.
- Rebate – a partial refund given to the consumer after they purchase a product. Rebates are a powerful tool to attract customers, drive bulk purchases, or incentivize prompt payment, and it’s extremely unlikely that 100% of the customers eligible for a rebate will actually redeem it. This differs from a “discount,” which is a partial refund applied at the time of sale. (Note that a rebate lowers the transaction price and revenue earned, so it would also typically lower the commission earned on that sale.)
✅ Write down one type of variable pay your company might want to begin with. Variable compensation can get complex fast, so starting slow here is best. Pick one… and move on.
Getting Started with Commissions
Those five types are common, but when people think of variable pay, they usually think of commissions. So, we’ll go out on a limb and guess you are, too.
In that case, you’ll want to know about the most common commission structures. We’ll list those below, but before that, you should know that a 20-30% commission rate is standard in the U.S., and most companies rely on a base + commission split of 60:40. However, you should always tailor your compensation plan to your unique needs.
Most common commission structures:
- Straight commission: no base salary, 100% commission
- high performers like this, but it can be scary for some
- Relative commission: a percentage paid that matches the percentage of quota met + base
- Straight-line commission: same as relative, but includes rewards for going beyond 100% of quota
- Absolute commission: flat-rate pay per accomplishment + base
- Tiered commission: different commission rates at different milestones
- Example: 5% until $50K, 7% for $50-100K, 10% over $100K
- Gross margin commission: based on a percentage of the sale’s profit
- Territory volume: splits total territory commissions equally among salespeople in that territory
- Recoverable draw: you pay your salesperson their expected commissions in advance, and they pay back any extra if they didn’t meet their quota
- Residual commission: your salespeople earn additional commissions as long-term clients they closed continue to generate revenues
- Multiplier commission / accelerator: a set multiplier increases commission rates once initial quotas are met
Additional ideas to boost your structure:
As we said earlier, your variable pay structure is only limited by your imagination. But as a beginner to variable pay, you may not even know what to start imagining!
To jumpstart your thinking, here are some additional ideas you can use to boost your variable pay plan’s effectiveness:
- Maintain motivation with Manager Overrides, which are extra compensation paid to managers based on their team’s high performance.
- Offer managers quarterly bonuses based on their team’s consistently improving performance. This and the previous idea promote strong leadership from your managers, which can increase staff retention.
- Compare commission calculations based on invoice totals vs. gross profits from the sale. It is worth playing around with the fundamentals of how your team can earn commissions. You never know what will motivate them more until you offer it as an option.
✅ Choose one commission structure that appeals to you and write it down. Then, look at a single invoice from today and calculate the total commissions the sale would have earned under that specific structure. Is the additional amount you would have to pay your team reasonable? Do you think that structure would boost your bottom line over time?
Practice Makes Perfect for Your Variable Pay Plan
We know we just gave you a lot of information – and this is just the tip of the iceberg regarding your variable compensation options. Fortunately, you don’t have to use all this information to come up with your perfect plan, and, in fact, it’s guaranteed that you will not come up with your perfect variable pay plan on the first try.
Perfection will take fiddling on your part, so it’s one of those tasks you need to start … and then just adjust along the way. Hopefully, your workbook notes will give you a good starting point, but if you’d like to work with experts, EthoTech can help you sort out the details.
Saving Time with Your Variable Compensation Calculations
Also, you probably noticed how much time it took for you to calculate those hypothetical commissions on that one invoice. If you choose to implement variable pay at your company, you’ll have to do this on every invoice, every day. Can you handle that kind of time investment?
Consider dedicated commission processing software like Commission Plan for Microsoft Dynamics GP to streamline your calculation process. This software automates your calculations based on your rules and structure, provides nearly unlimited flexibility for processing commissions quickly, and delivers unparalleled accuracy and transparency in your calculations because it draws all your invoice data directly from Dynamics GP without you having to copy and paste.
It can also handle all the most common types of variable comp processing, and it transforms even the most complex commission calculation process into one in which you’re done in just a couple of clicks.
Learn More About Commission Plan
Since 2002, companies across every sector have relied on EthoTech for the right tool for tracking, calculating, and paying variable compensation. We provide solutions, integration, and support that is focused solely on integrated variable compensation software for Microsoft Dynamics GP. It’s all we do, and we do it better than anyone. Contact EthoTech to learn more.