How to create and use Variable Compensation Plans, which include a base wage and a variable performance-based commission or bonus, to motivate and reward employees and help you grow your small business.

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Variable Compensation Plans can be used for specific employees, like Sales or leadership positions, to motivate and reward exceptional individual and team performance. A Variable Compensation Plan includes a base wage component and a variable commission or bonus component as well. Use this type of compensation plan to motivate and reward performance, and to attract and retain the best talent for your small business.

Variable Compensation Plans for Small Business:

• What is a Variable Compensation Plan?
  • An employee compensation plan that includes a fixed base wage (a salary or hourly wage), plus additional variable compensation which may include commissions or bonuses based on performance.
  • They are used to encourage employees, like salespeople, managers, or other key leaders in your company to meet or exceed their goals and help your small business achieve its goals.
  • An effective Variable Compensation Plan program should encourage high performance and provide for increasing income for higher-level performer in your small business.
  • Examples of the variable component can include commissions, goal or quota attainment bonuses, new account bonuses, sign on bonuses, retention bonuses, and project bonuses.
  • Variable pay is typically the reward for success related to the personal, team, or company performance of specific goals.
  • Variable Compensation Plans are ideally communicated in advance as an incentive and part of a formal annual Compensation Plan which is introduced and effective at the start of the year.
  • Compensation plans should align people’s behavior with the company’s strategy to generate greater performance.
  • Realistic and rewarding compensation plans will help you attract and retain the best team members.
  • Variable Compensation Plans are commonly used by larger companies and corporation use to attract and retain the best employees.
• When to use them – who are they best for?
  • You can use them for any position that you want to motivate and reward to superior individual and team achievement.
  • This may include salespeople, executives, managers, and other leaders or individual contributors who you want to keep motivated and well compensated for their efforts.
  • They should also be used when you want to incentivize alignment with specific company goals.
• Basic Components of a Variable Compensation Plan:
  • Base Salary or Rate: The base or fixed compensation paid to the employee, regardless of goal achievement.
  • Projected or Target Sales: The specific goals related to revenue generated for the compensation period. Also may be referred to as the Quota.
  • Commission Rate: The commission amount to be paid on sales generated, expressed as a percentage of the revenue.
  • Bonus Amount: May include the commission, but usually includes other special bonuses like a Quota Attainment Bonus.
• Variable Compensation Plans Best Practices?
  • You must know the margins of the products or services first, to help you determine what you can afford to pay in commissions or bonuses.
  • Make them for a specific period, like annual – for example, the 2023 Sales Compensation Plan, or the 2023 General Manager Compensation Plan. Set the tone that Comp Plans will evolve over time.
  • Special bonuses have the biggest impact in the short-term – think campaigns that last a quarter ideally.
  • Make it easy and transparent.
    • Easy to calculate – both for the business owner and the employee.
    • All relevant numbers are transparent. The employee must be able to track their progress toward achieving the goals, and their commissions or bonuses.
    • Define “Revenues” or “Sales” and when the commission is earned and paid.
  • Pay the variable component at least quarterly if possible.
  • Make it achievable, perhaps with a stretch component.
  • The variable component is most effective when it’s not capped. Avoiding capping commissions if possible.
  • Make sure you are motivating and incenting the right behaviors! Start with the end in mind – what behaviors and actions do you want your compensation plan to incentivize? Does your comp plan encourage your team to perform the best activities or sell the most profitable products or services? Adjust over time.
  • Include a group component if applicable.
  • Should include a goal or quota.
  • Adjust for the cycles in your small business.
  • Club trips or other special incentives are also great motivators.
  • General guidance on structure: 60/40 – 60% fixed compensation, 40% variable (commission and bonuses).
• Key Takeaways:
  • Start simple.
  • Make it easy to calculate (both for you and the employee) and transparent.
  • Understand your margins first.
  • Study the industry – what are other similar businesses compensating?
  • Make it an annual plan.
  • Make sure it’s in alignment. Is it encouraging and rewarding the right behaviors?
  • Use it to motivate and reward performance, and to attract and retain the best talent.

Episode Host: Henry Lopez is a serial entrepreneur, small business coach, and the host of this episode of The How of Business podcast show – dedicated to helping you start, run and grow your small business.

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