In the past year, many companies have pivoted to variable pay to show their appreciation for employees. In particular, employee stock ownership plans (ESOPs) have gained popularity, with companies like Paytm, Unacademy, Axis Bank, Kratikal, and Vedanta rolling out plans as recently as January 2026.
Variable pay, or variable compensation, is one of the most tried-and-tested methods of employee motivation. However, if a variable pay structure lacks transparency or contains too many caveats, it can confuse employees. Rather than motivating, it can discourage employees, making them feel they are missing out on potential revenue streams.
As such, when implementing a variable pay structure in one’s office, it is imperative to create a framework that offers both clarity and credibility. After all, a functioning and accessible variable pay structure can serve as a true motivator.
Common Variable Pay Plans
Variable pay is far from a new phenomenon in India, though it has changed shapes and evolved over the years. Some of the most common variable pay plans seen in companies across India include:
- Bonus: Perhaps the most well-known example of variable pay, bonuses are often handed out at certain points in the year. Often calculated based on the employee’s performance, they are given in addition to the fixed salary.
- Commission: Traditionally used in sales, commissions are generally a fixed percentage of a deal made by the employee on behalf of the company.
- Stocks: By offering equity or stock options, companies give employees partial ownership of the company. This provides employees with the incentive to see the company make a profit, as it will increase the value of their stocks.
- Profit Sharing: In this plan, companies set a percentage of annual profits to be distributed to employees. Dependent on established clauses, this form of variable pay plan also makes employees more invested in seeing the company earn more.
- Conditional Incentives: In this type of variable pay, a company can set a target for the company/team. If the target is met, the company awards the promised reward to employees.
Each one of the listed variable pay types caters to a different company objective. One might motivate employees to perform well overall, while others might want them to focus on a specific metric. A company’s variable plan need not include just one method of variable pay.
For example, a sales team may regularly earn commissions and their overall numbers through the year can help them earn a yearly bonus as well.
Test the Plan Before You Roll It Out
Before implementing a variable compensation plan across the company, start with a smaller team to see how the policy works in practice. Some of the steps you can take while testing out the plan include:
- The “explain it back to me” test: After explaining the intended plan, ask employees to explain the policy back to you. Made easier with a small group, this step can highlight how the same policy might get interpreted differently based on individual understanding.
- Pilot with a small group: Implementing the plan with a small group first allows the company to observe the resulting changes without significantly affecting workforce dynamics.
- Stress tests: Any policy is only as good as its ability to withstand the worst possible scenarios. As such, stress-test your policy when implemented in a small group, using edge cases and extreme scenarios. High-rush jobs and unexpected workforce reductions are among the many scenarios that can make or break any policy.
- Gather feedback: Once the test run is complete, do not forget to gather feedback from employees and managers alike. Take their suggestions and complainants in consideration when making the final changes to the overall policy before the full rollout.
Why Most Variable Pay Plans Fail the ‘Understanding Test’
While trying to create a comprehensive variable pay structure, many companies fall into the trap of “overloading” their framework with too many variables. Some of the common pitfalls include:
- Over-Complexity: Using overly complex formulas and jargon-heavy documents for a variable pay framework can make employees wary of trusting it, due to a lack of understanding.
- Too Many, Too Much: Having a high number of metrics and weightages to calculate variable pay, especially those that might not even be usually relevant, can be demoralising.
- Constant Changes: The world keeps on changing, but that does not mean that your variable pay structure should change at the same time. Barring true emergencies, revise your variable pay structures annually without moving the goalposts too much.
- Poor Communication: Variable pay structures need to be communicated clearly and easily understood. Sharing the plan only once and never truly reinforcing it makes the policy highly ineffective. shared once, never reinforced
- Policy and Payout Gap: When payouts are delayed or fail to follow the policy’s guidelines, employees’ trust in the initiative and the company in general can erode rapidly.
All these factors can be remedied easily by paying attention to a few key details and keeping a clear purpose in mind. While maximising performance and profit are indeed admirable goals, they should not come at the cost of employees feeling that they are not being compensated as promised.
Start With the Purpose, Not the Percentage
Like with the making of any policy, start by deciding the main objective of crafting a variable pay plan. Is it really all about increasing the percentage of performance improvement, or is there a much bigger fish to fry?
By using variable pay, decide whether you are trying to solve:
- Performance differentiation?
- Sales acceleration?
- Retention?
- Alignment to business outcomes?
- Something else?
The answer you land on will allow you to make the most appropriate decision in the later parts of the policy-making process. Do not fall into the trap of “we’ve always had a bonus” thinking. The purpose of variable pay is never limited to giving employees more money or increasing sales.
Designing Simple, Intuitive Structures
Once you have your core objective in mind, base the metrics for your variable pay policy on it. Keep in mind to have as few metrics as possible. Ideally, you should not rely on only 2 to 3 factors, though this may vary by industry and core objective.
Try your best not to make the variable pay calculator overly technical or complicated. Alternatively, you should strive to find an explanation that can make a complicated process comprehensible to even a layman.
Most importantly, ensure there is a clear, visible link between individual performance and team/business outcomes. For example, establish how achieving a target bonus or reaching a specific achievement band helped the company meet a threshold or goal. Using this, showcase how an employee’s variable pay has been calculated.
Choosing Metrics Employees Can Influence
The metrics that determine an employee’s variable pay should be ones they feel they can influence through their work. If an employee feels their pay depends on factors beyond their control, they can easily lose motivation.
These metrics must be decided based on an employee’s role and their responsibilities. For example, a sales executive’s pay might change depending on how many clients they bring in. If their pay is determined by how many clients the company has actually served, they might feel frustrated, as this is beyond the scope of their job.
Make sure employees understand why each metric is relevant to their job and, hence, their pay. A clear line of sight between the metric and performance can increase employees’ trust in the process.
Communicating Variable Pay Like a Product
When explaining the variable pay structure to employees, treat it not as a basic policy but as a product they should be actively interested in to take full advantage of the available offerings.
During the explanation of the variable pay structure, be sure to communicate:
- How does the process work?
- What does success look like under the structure?
- What happens if the targets aren’t met?
- What happens when employees exceed expectations?
- Use real-life examples and sample payouts to make understanding easier.
Instead of delving into legal language and financial jargon, use a simple language that focuses on commonalities. Have an FAQs section to address anticipated concerns, then open the floor to other questions.
Timing, Transparency, and Trust
More than anything, the proper execution of a variable pay framework depends on timing, transparency, and trust. As such, it becomes imperative that employers always provide clear timelines for:
- Performance measurement
- Review and Assessments
- Payout Calculations
- Payment Dates
Avoid any payout surprises, especially delays or unexplained deductions. If anything is different from the norm, including the payout date, be sure to provide the reasons promptly and explain what the company is doing to resolve the issue. Similarly, be open about how the payouts have been calculated.
The Role of Managers in Making Variable Pay Make Sense
In the execution of variable pay structures, managers play a key role in ensuring fair compensation for their team members. They not only serve as evaluators for the process but also as interpreters who explain why and how different metrics matter.
As such, when instituting variable pay policies, companies should ensure that their managers, especially those who will now have decision-making authority over such compensation, are aware of all the ins and outs of the process.
Managers themselves should strive to provide consistent messages to all team members to ensure no one feels they are being treated unfairly. At the same time, the directions provided by a manager should be similar to those of other managers in similar work areas and teams.
Additionally, managers are often the ones to whom employees turn when variable payouts fail to deliver. In such cases, managers should be equipped to handle tough conversations that uphold the company’s values and policies while also being empathetic to the employee’s concerns.
In the End…
A variable pay structure is doomed to fail if the employees do not understand it. While precision is important, it should not come at the expense of simple comprehension. The policy should be created with human needs in mind, not just business numbers.
For variable pay in particular, clarity should be a mandatory design choice, not a communication afterthought. It should be a plan that feels fair, even with low payouts, thanks to understandable metrics.
