Variable Pay: What Is It and How It Works?

Variable pay is a portion of employee’s compensation that’s determined by their performance. For instance, whenever employees hit their goals, a variable pay is offered as compensation or reward for their efforts. This is otherwise known as a commission or incentive pay that’s given by an employer. Variable pay differs from an employee’s base salary, which is a fixed amount that’s paid to an employee regardless of their performance or their ability to reach their targets. 

Along with the fixed base pay, and incentive compensation makes up an employee’s pay mix, with many companies operating within the US offering some form of variable and base pay program to their employees. 

How Does Variable Pay Work?

Variable pay is used by any company operating within the US which wants to incentivize their employees fairly. The variable pay incentive is based on factors such as, sales revenue, amount of clients, units sold or customer service scores. As mentioned earlier, it is a way in which employers reward high achievers in their staff. Keeping that in mind, variable pay can be calculated as a dollar amount or a percentage, and is based on an individual’s or a business’s criteria. For instance, profits made or targets achieved. 

Variable pay is designed to be paid to a company’s employees in addition to their base salary. It is also common for variable pay to be included in the overall compensation package of the employee. As a result, variable pay calculations use a more complex formula as compared to the salary or hourly pay formula. This includes the number of sales made per month and the percentage of business earned. 

For employees to receive steady compensation for their time spent at a company, employers also provide a base pay. The variable pay is then included on top of the employee’s base pay. This serves as an incentive to the employee so they can perform at peak levels throughout the year. Variable pay is also a great way for employees to share the profits of a business. 

Is Variable Pay Right for Your Business?

The variable pay plan is right for any company that is looking to improve the performance of their employees by offering them a compensation that’s performance based, and acts as an incentive for their efforts. Keeping that in mind, variable pay is based on measurable productivity. The following are some examples of variable pay;

  • Companies that are focused on sales and want to increase their sales output
  • Food service establishments looking to increase their sales of certain items of the menu
  • Domestic services companies that are looking to get more referrals
  • Business services wanting to increase their customer base
  • Healthcare facilities looking to reduce their costs
  • Manufacturing companies looking to streamline processes and shorten their time to market
  • Companies looking to increase their revenue

Setting up a variable pay system will require some thought and investment since it’s going to need a software system to calculate the variable pay of your entire staff. The following are some questions to keep in mind while setting up a variable pay compensation plan for your company;

  • Is your variable pay compensation system fair?
  • Have you got the time to properly manage the data?
  • Do you have the appropriate software to manage the sales and revenue data?
  • Does the structure of payment comply with minimum wage requirements in your state?
  • Is the incentive going to motivate your staff to perform better?

While some businesses might not find variable pay amusing, others tend to use only variable pay. A good example of where variable pay is widely used is the real estate industry, where offering variable pay to real estate agents is quite commonplace. But, if you are a businessowner looking to create your own variable pay system that suits your needs, then you will want to make sure that you have a proper way to manage the various complex calculations that are needed to determine the variable pay portions of each employee in your organization. A good place to start is by finding out what are the best practices of other similar companies within your specific industry. 

By providing a compensation for hard working employees, variable pay serves as a way to obtain and retain top talent in an industry. The main challenge that businesses that want to use variable pay find themselves in is their ability to align their variable pay system with what is going to motivate their employees, as well as what will help drive the company’s goals as well. This is the main reason why considering a variable pay system, companies need to first determine the “why” of their decision, then when, whom and how much. All these questions are important and need to be answered before implementing the variable pay system in an organization. 

Costs and Benefits of Variable Pay

The cost of the variable pay plan will mainly depend on the type of variable pay a company chooses, along with the amount or percentage of pay, and how it is going to impact the profitability of a business. That being said, there are multiple ways in which businesses can set the variable pay system up for it to function smoothly. As a rule of thumb, it is not advised to look strictly at the cost of the variable pay alone, but rather, consider its benefits to the employees and the company. For instance, companies that incentivize cross-selling additional services to clients drives up sales and helps increases the overall revenue generated by the company. In this way, the variable pay component practically pays for itself in the long run. 

Variable Pay vs. Benefits

In case you were wondering, the following is a breakdown of how variable pay methods could cost a company as compared to its benefits: 

Flat Rate Amount

For instance, if a company pays a flat rate of variable pay, they will need to estimate what that’s going to cost their company every month based on the company’s sales projections, along with other data. The best way for companies to provide this incentive without losing their profit targets is by making sure that the incentive of bonus is not coming in the way of making a profit on each item. It’s best to have a software system that keeps track of each employee’s productivity or how much they are able to sell. Otherwise, you will have to guess the estimate total and plan ahead in order to pay out the variable pay to your employees.


Oftentimes, employers find it difficult when they decide to pay their employees a percentage as a variable pay package instead of the traditional dollar amount. In this case, employers need to figure out in advance what that these variable payments is going to cost a business. Companies that offer a percentage of all products sold in their inventory will run into a brick wall if their sales revenue increases by 20%. 

The good thing about percentages is that they can easily be calculated on a company and departmental level to figure out how much it will cost the company. To make you don’t run into any trouble when offering a percentage, it’s important for businesses to learn from previous years and estimate the possible increase in certain revenue streams that could have a negative impact on your variable pay system.


Employers can also provide weights for their variable pay if they want to get really specific about what they value. For instance, a company might want to offer its staff a certain incentive which is based on a variable such as overall sales volume, while another can be based on customer retention, or client feedback. Each of these different variables can then be weighed to find the appropriate amount of variable pay for your employees.

An Ad-Hoc Approach

Also, instead of using a dollar or percentage to give variable pay, employers can also make their variable pay random, which basically means they get to choose what to pay, and which criteria to use in determining the variable pay for each of their employees. For instance, one month a company can choose to incentivize its employees based on customer feedback, while the next month, the company can incentive their employees based on some other factor, which has resulted in an increase in sales. Using the on-the-spot bonus system also falls within this category, where employees are rewarded for their efforts on-the-spot. 

When it comes to going the random route with your variable pay, you might want to budget how much you are willing to give as an incentive to your employees in advance. A good indicator of whether these efforts to incentivize employees are paying off is by monitoring the change in an employee’s behavior and the company’s ability to achieve its short-term goals. Another important factor of using a variable pay program is deciding its cost and using a proper CRM system to administer the variable pay system based on different variables. 

Features of Variable Pay

Variable pay is one component of a compensation program in an organization. While it can take many forms, the following are the different types of variable pay programs for employees;


This is the most common type of variable pay. Incentives that are used as part of a compensation program is typically designed to motivate employees not just to complete certain important tasks, but to reach the company’s goals on various assignments. Incentives are also commonly used in a project management setting, and are usually explained in the employee’s offer letter, employment agreement or contract.

To find out if you can pay an incentive to your employees, it is important for businesses to first determine what projects or goals are important for them to complete. Once you’ve figured that out, those are the projects or goals you will want to offer incentives for to your employees. This is so your employees remain focused on the goal and perform at optimum levels in order to achieve that goal. It is also important to keep in mind that the incentives you offer as an employer does not have to be in the form of cash payments. They can be in the form of gift cards, prizes or trips that have a monetary value to the employee. 


Bonuses are often offered as part of an employee’s compensation program. Usually, bonuses depend on the performance of an employee. For instance, if a business employs a sales staff, some form of variable pay will have to be paid to them for achieving their targets. This will oftentimes be in the form of a bonus, which is based on how much revenue each of the employees bring into the company. The bonuses can also be based on certain scores that are predetermined by the organization. 

To get an idea of what you would like to offer your employees as a bonus for their efforts, businesses first need to realize which products or services they want their employees to focus on more, or a key result area that all employees need to work towards. 

Recognition and Rewarding

Offering employees rewards and recognition for their efforts is also another form of variable pay that’s offered by businesses. This type of variable pay can also help in boosting the overall engagement and performance level of the employees and can also help increase retention in a company. While the rewards or recognition might not have any monetary value, it will have to be of some value to the employees so they are motivated to perform well. 

For instance, the IT department within an organization is not tasked with selling products or services, but can receive rewards for other aspects of their job description, such as, internal customer support, or the number of days the company’s system has not crashed, or their swiftness in dealing with IT issues. 

Ending Note

At the end of the day, variable pay is a tool that companies can use to help motivate their employees into performing better. Variable pay tends to keep employees engaged as they work together to reach a common goal in the best way possible by working harder and being better at their job. Keeping that in mind, variable pay is a great choice for incentivizing your employees.