HR Toolbench


How can self-funded variable incentives be part of a “total cash” compensation strategy that helps motivate employees when merit budgets are limited?
14 December 2016

When merit increase budgets are tight, variable incentive plans are an effective way to supplement modest base salary increases and keep employees motivated. Working with a limited merit budget can be an opportunity to re-think employee rewards. Putting a “total cash” approach in place that clearly defines how incentives will be determined, funded and distributed can offer stronger motivation for employees and managers and drive performance. 

This approach places HR compensation professionals at the center of strategic rewards planning and requires close collaboration with line managers and corporate leadership.  The added employee motivation and retention can be worth the effort.

Traditionally, variable incentive award plans have been applied only to roles that have direct, line-of-sight revenue generation responsibilities, such as business development jobs that are eligible for sales commission.  But opportunities abound to apply variable incentive award plans in non-traditional ways.

Start by identifying roles across the organization that contribute indirectly to increasing revenue or reducing cost. This opens up a greater number of roles that might be potentially eligible for variable incentives awards.  Analyze the work activities performed by roles that indirectly impact revenue generation or cost saving.  Determine which work activities can be measured directly, or measured indirectly by referencing downstream performance indicators. For example:


The work products of the Marketing function support the Sales function.  Increases in sales revenue are an indirect measure of marketing success. A variable incentive award pool could be created based on a portion of increased sales revenue above a pre-defined target level.  The pool could grow in proportion to increased sales revenue above the target.  Distribution of the incentive award pool to marketing staff members could either be discretionary, or based on the achievement of pre-defined, individual objectives.


An example of a variable incentive award plan based on cost reduction might be a Manufacturing operation that consumes significant quantities of raw materials in the process of manufacturing tangible goods.  By eliminating waste of raw materials the cost per unit manufactured is reduced.  A variable incentive award pool could be created based on a portion of the savings derived from reductions in the cost of raw materials required to manufacture goods.  Distribution of the incentive award pool to manufacturing staff members could either be a flat award to each staff member, or in proportion to base salary.

The important point in both examples is that variable incentive award pools should be self-funded.  This means that the incentive award pool is derived from measurable increases in revenue, or reductions in cost generated by incentive eligible employees, either as individuals, as a group, or a combination of both. 

Employees’ awareness level of business considerations and job-related behaviors will change by communicating the award criteria of a variable incentive award plan.  In addition, executive leadership should find self-funded variable incentives more acceptable than when incentive award pools require added funding with no direct, measurable financial gain for the organization.

Be creative when identifying potentially incentive eligible functions and designing variable incentive arrangements.  Make sure that incentive criteria support business objectives, and performance measures are clearly defined and will motivate employee behavioral changes and performance.

A “total cash” compensation delivery system that combines base salary and variable incentive awards can help to mitigate the negative feelings employees may have about modest merit increases, while making the funding of such plans acceptable to executive leadership.