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Employers Turn to Variable Pay Programs, but Are They Effective?

September 26, 2007

A recent salary survey finds that employers are flocking towards variable pay programs in increasing numbers in order to attract and retain talent. But another recent survey suggests that while a large majority of employers say that they connect employee performance and pay in theory, the connection isn’t nearly as clear in practice.

In its survey of over 1,000 organizations, Hewitt Associates found that in response to difficulties finding, attracting and retaining talent, there has been a "sharp increase in employer adoption of variable pay programs." The Hewitt survey reports that over 90 percent of companies now offer "at least one type of broad-based variable pay plan," representing a 10 percent increase from 2006.

"In addition to being attractive to companies, employees react favorably to variable pay programs because there is the opportunity for upside funding potential for outstanding performance, as opposed to fixed merit increases, which don’t fluctuate based on levels of individual contributions," explained Ken Abosch, leader of Hewitt’s Compensation Consulting business.

However, another new survey by Buck Consultants puts into question whether these programs are being used effectively as they could be. The survey found that while 86 percent of respondents took individual performance into account when determining merit increases, the "actual effect of performance on pay increases was modest, at best."

For example, Buck Consultants explained that over half of its survey respondents (55 percent) use a five-point rating scale. The average pay increase for the highest performance rating was 3.5 percent, given to the top 10 percent of performers for these employers. Meanwhile, employees in the next two performance categories--about 75 percent of performers--received an average pay increase of about 2.8 percent.

The "Compensation Planning for 2008" survey asked 415 organizations about their compensation budgets, reward program components, and pay for performance plan designs.

"In our experience, organizations need to re-engineer -- not just tweak -- their reward programs to achieve meaningful pay for performance as well as the return on salary expenditures management expects," said Larry Reissman, a Buck principal who directed the survey.


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