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Does your salary have a variable component?
Onkar Tiwari
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December 21, 2006

Calculating your exact salary was never easy. With taxes, allowances and sundry deductions, the end of the month was the only time you knew exactly what you got. And, if your salary has a variable component, this calculation becomes even more complex.

Known variously as performance bonus, profit sharing plan, pay for performance allowance, etc, the variable component in  salaries has grown rapidly.

"It essentially involves being paid a certain part of your salary when certain predefined business goals are met," says Vaibhav Jha, practice head at HR strategy firm H-Strat. "The amount paid depends on the extent to which the goals are realised. An upper limit is clearly defined."

Naturally, for companies, it brings great value; they pay depending on the performance they get. If you are an employee, though, it can be confusing. However, it is possible to reduce this uncertainty by remembering a few simple pointers.

Understand the business... and your role in it

In business, the closer you are to the source of the profit, ie the customer, the more clearly understood your impact is. Consequently, departments such as marketing and sales have the largest and clearest variable component plans.

As the distance from the customer increases, this gets blurred. So, finding out where and how you fit in the business value chain is critical. If you are working in an area such as operations or support roles such as HR and finance, it is important to understand how the firm measures your efforts.

Typically, firms will evaluate non-marketing and sales functions on the basis of time and resources saved, along with some growth targets. "In a support function, thumb rule is -- if you can do more and more with less and less, you are more valuable and therefore deserve a higher variable pay," says Jha.

The actual measurement method varies with the company and concepts such as EVA (Economic Value Added), Profit Centre Analysis, etc, are widely used. It is thus a good idea to read up more about them.

Clarify the goal setting and appraisal process

The variable portion of your pay is triggered only when very specific goals are met. This is why it helps to have written-down targets with clearly quantifiable benchmarks. The targets need to be communicated at the start to allow you time to reach the goals that have been set for you.

Most misunderstandings that occur later are because of the initial ambiguity, which should be avoided. A classic example of this is when sales targets are met at unprofitable prices.

During appraisal, this results in the sales team defending itself with reasons such as they are building business, or that the competition is offering lower costs. The finance team, which releases the payment, will usually disagree.

The clearest goals not only spell out what is to be done, it also spells out the boundaries that cannot be exceeded.

Identify the dependencies

Even if goals are clear, your variable payment still depends on many other factors. Ensure you are aware of what these are.

"Our annual performance bonus was divided into three parts," says Nikhil Sinha, a product manager with a leading bank. "One part depended upon your individual rating, another on the performance of your unit, and the last on whether the company as a whole meets its targets."

Besides, your own performance may depend on the other units you interact with. Add to that issues such as the relative rankings of employees against each other and one begins to understand the complexity of variable pay.

Having a holistic picture of your unit and its interactions with other teams is, thus, critical.

The different types of variable components

Ranging from the good old cash bonus to travel and shopping offers, firms are trying a wide variety of ways to create the ideal incentive structure for their employees.

The variable component of the salary is delivered in many different ways. Like other parts of the salary structure, they can be grouped into five common types, namely cash bonuses and allowances or coupons, reimbursements, tie-ups with other firms for discounts, stock option plans and prizes.

The only difference of course is that you receive it when certain conditions are fulfilled.

Understanding this helps during the initial negotiation stage, when the variable component is being decided.

"Our sales team was given a budget of Rs 5,000 for the prize of the top sales executive in the month," says Sinha. "We chose to give a mobile phone in that range as opposed to a paid holiday which was proposed by the finance team initially. Given the fact that most of our team members are in their early 20s, a mobile phone was definitely a better motivator."

Fringe Benefit Tax

This directly follows from the earlier point.

Besides offering the variable compensation, many companies, especially in the IT sector, allow you a choice of how you want it delivered. For example, assume your team won itself a bonus for exceptional performance. This bonus will be 20 per cent of the base salary.

You may then get the choice to accept this amount as cash, which is heavily taxable, or in the form of coupons or reimbursements, depending on what is more tax efficient.

For all of these handouts as well as your regular allowances, the rulebook is the new fringe benefit tax. "If you have good knowledge of the FBT and a company programme where you can choose the way you receive your salary components, your savings can increase very significantly," says Ramesh Menon, a chartered accountant.

Plan with scenarios

It is typical of the company to show you the best case scenario when it comes to the variable components of your salary. However, with the often-unrealistic targets you may be set, it is unlikely most of us will achieve this figure.

It is important, therefore, that when you do financial planning for the year ahead, the amount considered is based on the average of a best case, most likely case and worst case scenario.

"Generally, people with variable pay components will receive about 50-80 per cent of the promised amount," says Menon. So, if you are receiving a 20 per cent variable salary on a base pay of Rs 1 lakh per year, you can expect a payment of Rs 10,000-16,000.

This is a good reality check and helps in planning expenditures reasonably, based on the earnings.

Negotiate smartly

All the above points are only the homework. You still need to negotiate the variable component of your salary.

The most important thing is finding how much room there is to negotiate. Understanding HR policies with respect to rewards and promotions is vital. If these are one-size-fits-all, there will not be much space for growth.

On the other hand, if the firm measures people and actively rewards the top 10 per cent, you can greatly improve your variable pay component. The key is to remember the word 'variable'. "In discussions, there should be repeated stress on the fact that if you do not meet the target, the company does not have to pay you. This usually gives comfort to the paymasters, ie the company," Jha reminds.

Variable compensation plans are here to stay

Last year, salaries in India grew the fastest in Asia, according to Hewitt Associates -- a leading HR consultancy firm. If they are paying such high salaries, companies will literally demand their pound of flesh and will differentiate between top performers and the rest.

Data from their annual survey supports this; variable pay as a percentage of total compensation has risen sharply across all business sectors. In the banking and finance sectors in particular, it amounts to almost a quarter of the total salary.

Like a double-edged sword then, the increasing role of the variable component of pay cuts both ways. For top performers, there has literally never been a better time with even million dollar salaries becoming commonplace in India.

On the other hand, for those hoping for a slow and steady increase in pay by just hanging around... well, it's unlikely to happen. Either way, you can be sure your corporate journey is not going to be dull.

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