Fixed vs. Variable Pay: Finding the Right Balance for Your Team

At its core, compensation is a tool employers use to incentivise certain behaviours. And how you structure compensation in your organisation can have a big impact on your employees’ motivations. In this article, we’ll discuss the differences between fixed and variable compensation, including the advantages of each and our advice on how to strike the right balance. 

‍

Fixed vs. variable compensation: definitions 

‍

Fixed compensation is the amount you pay your employees every pay period regardless of their performance or the company’s financial situation. It’s made up of not just salary but also benefits like health insurance, paid time off and retirement plans. An employee’s fixed compensation is defined in their employment contract and doesn’t change from month to month unless it’s increased as part of the compensation review process. 

Variable compensation is paid in addition to fixed compensation. Depending on your compensation structure and processes, the amount employees receive could be different every month, year or quarter. There are many types of variable compensation, but they are usually contingent on employees meeting certain individual or team-based goals, or the organisation as a whole achieving its objectives. Finding the right balance between fixed and variable compensation is key to motivating, engaging and ultimately retaining employees. 

‍

Types of variable compensation 

‍

Variable compensation can take various forms depending on what you need it to achieve. Many companies need to use more than one type of variable compensation to meet their goals. Here are some of the different options available: 

• Commission: This is a payment that’s directly proportional to the amount of revenue an employee generates for their employer in a given period. For example, sales professionals may receive a 10% commission on every sale they make. Some companies choose to implement tiered structures, where the percentage increases above a certain sales target. 

• Bonuses: A bonus is a lump sum payment, often paid at the end of the year. Bonuses are usually contingent on the achievement of individual, team-based or organisational goals. They may be awarded to the entire organisation or just certain teams or individuals, and usually represent a percentage of each employee’s salary. 

• Profit sharing: Some companies choose to share a portion of their profits with their employees. This is an effective way to align employee motivations with the company’s performance since employees will benefit when the company makes money. Employers can choose how much profit to share and which employees are eligible. 

• Management by objectives (MBO): MBO is a strategic management model that involves setting specific targets for each employee. Managers and employees work together to define goals which are aligned with the company’s objectives. Employees then receive additional pay if they meet or exceed them. 

• Long-term incentive plans (LTIPs): A long-term incentive plan (LTIP) is a strategic compensation programme aimed at employees in senior management or leadership positions. LTIPs reward employees for achieving long-term goals related to the overall success of the business. They usually involve a vesting period of 3–5 years, and rewards typically take the form of equity or stock options. 

‍

The benefits of fixed compensation 

‍

Paying employees a competitive base salary is crucial if you want to attract and retain talent. That’s because fixed compensation provides employees with a secure and reliable income, ensuring they’re able to meet their month-to-month expenses. 

From the employer’s perspective, fixed compensation is simpler to manage than variable compensation, which can involve a lot of admin and calculations. Having a high percentage of fixed pay compared to variable compensation also makes it easier to plan budgets since you’ll have a better idea of how much you need to pay employees over the year. 

‍

The advantages of variable pay 

‍

While a decent base salary is key to effective talent attraction and retention, the right variable compensation structure can drive exceptional performance. When it’s used effectively, variable compensation encourages employees to work to their full potential. It also ties employees’ motivations directly to the company’s objectives, which can lead to stronger organisational performance. 

Variable compensation also allows companies to access top talent without having to commit to paying an expensive salary. Because employees only receive the maximum compensation if they achieve their goals, your investment in employees is directly proportional to the value you get from their work. 

‍

Finding the right balance between fixed and variable compensation 

‍

The right mix of fixed and variable pay is different for every business — and even every employee. Here are some things to consider to find the right balance for your organisation. 

Industry or type of business 

All types of businesses can and do use variable pay to reward their employees. However, it’s much more common in companies that sell products or deliver services, simply because it’s easier to measure the link between employee performance and company profits. In different types of businesses, variable pay is more likely to be tied to the company’s overall success than individual goals. 

‍

Business segment or department 

Roles that are more stable and predictable tend to have a higher balance of fixed vs. variable pay because it’s harder to directly measure their impact on the organisation’s success.  For example, employees working in HR or finance rarely receive a lot of variable compensation. On the other hand, employees in jobs with a direct link to revenue, like sales or marketing, are more likely to have a higher proportion of variable pay. 

‍

Company financial situation 

Companies in stable financial situations can typically afford to attract talent with high base salaries (i.e. fixed compensation). However, those in less secure circumstances may prefer to offer a higher balance of variable pay. Structuring your compensation so that you only have to pay out big sums if the company does well can help you protect your business interests while still driving performance.

‍

Organisational goals

Ultimately, compensation is a tool that businesses use to achieve their objectives. And the right balance of fixed and variable pay for your organisation depends on what you’re trying to achieve. For example, companies that want to push towards short-term goals might opt for a higher proportion of variable pay. On the other hand, those that are more interested in long-term stability might opt for more fixed pay, since this encourages retention.

‍

Employee personalities and preferences 

Some employers also take their employees’ preferences into account when deciding on the right pay mix to offer. For example, some employees are highly motivated by variable pay and prefer to have the option to earn more by performing exceptionally. Others prefer the stability of a fixed salary. 

‍

Key factors to consider when designing your variable compensation plan 

‍

Implementing a variable compensation plan can be a time-consuming process. There’s also no one right way to do it: as we’ve discussed, the ideal setup depends on your business type, organisational goals, financial situation and other factors that are unique to your business.  

Here are a few things to keep in mind as you put your plan together: 

• Pay mix: The right balance of fixed vs. variable pay. This might be different for different teams, departments or even individual employees. 
• Eligibility: Who will be eligible for variable compensation. You may have some forms of organisation-wide compensation and others that are only available to certain teams.   
• Long or short-term objectives: Whether you’re focused on short-term wins or long-term stability. This can impact the type of variable compensation plan you put in place. 
• Team, company, or individual goals: Whether goals are set for individuals or a wider group. Some employers use a mixture to incentivise employees to work towards different achievements. 

‍

A word of warning 

‍

While variable compensation plans can be highly effective at motivating employees, employers do need to be careful when putting them together. That’s because, if you don’t put enough thought into your structure, you could end up incentivising the wrong things. This can lead to employees prioritising short-term wins over long-term success — which can have a negative impact on your business over time. 

Variable compensation plans based solely on individual performance make for an overly competitive workplace where employees are constantly battling to maximise their earnings at the expense of their colleagues. Instead of working together towards a common goal, they might hoard resources and stand in each other’s way. This can easily become a toxic work environment and lead to problems with employee morale, engagement and retention. 

‍

Learn more 

‍

Employee compensation is made up of a range of different elements that together form the total compensation package. When discussing compensation with employees, it’s a good idea to keep the focus on this total package to ensure they understand their salary, bonuses, commission and other rewards in their full context. 

Want to learn more about the different elements that make up total compensation? Dive into these articles from our archive: 

• Understanding Long-Term Incentive Plans: Why They Matter for You
• Bonus vs. Raise: What’s the Best Way to Reward Employees?
• What Employers Need to Know About Equity Compensation
• What Workers Want: The Best Benefits For Every Generation

‍