What Is Variable Compensation? Definition, Examples, and Benefits

Definition of variable compensation

Variable compensation is the portion of an employee’s pay that depends on performance results rather than a fixed salary. It’s designed to motivate employees to achieve specific business goals—whether that’s closing deals, hitting quotas, or driving company growth. Unlike fixed base pay, variable compensation flexes with outcomes, rewarding top performers and aligning effort with results.

Types of variable compensation

• Bonuses: One-time or periodic payments tied to performance metrics or milestones.

• Sales commissions: Percent-based payouts per sale, often tiered or with accelerators.

• Equity incentives (stock options): Offer long-term alignment, especially in startups.

• Profit-sharing: Company-wide payouts based on overall profitability.

• Performance contests or SPIFs: Short, focused incentives to drive behavior around specific outcomes.

For most SaaS sales roles, variable compensation is part of on-target earnings (OTE)—the total expected annual pay if a rep meets quota. OTE is often split between a fixed base salary and variable pay, with common ratios like 50/50 or 60/40 depending on role and seniority. Understanding how OTE works sets the stage for another important question: who benefits most from variable compensation?

Who benefits from variable compensation? 

Variable compensation is particularly effective for roles with quantifiable outputs—like Sales, Customer Success, and RevOps. These roles benefit from transparent, outcome-driven pay. For more collaborative functions, carefully structured bonuses or equity can still motivate aligned behaviors.

Variable compensation isn’t just extra pay—it’s how high-performing companies incentivize performance, align teams around growth goals, and attract/retain top sales talent. Designed well, it delivers motivation without capping budgets. When mismanaged, it breeds mistrust, turnover, and overspending.

Types of variable compensation explained

Variable pay comes in various types. Multiple options enable firms to choose the most suitable plan for their staff and firm philosophy. 

The three primary kinds of variable compensation programs you can find include:

Bonuses

You give variable pay as bonus programs for completing a job. Thus, bonuses depend on whether or not you finish a task. It also requires you to meet set conditions, which a firm defines in advance.

 The following are examples of bonus plans companies use:

• Retention bonus: Firms offer these bonuses to encourage their staff to remain in the business. Employers primarily use this variable compensation type for retaining key staff. In aspects involving a plant or sector shutting down, it incentivizes the team to stay up to a set date.

• Project bonus: This pay can come in a discretionary or non-discretionary form. Firms offer this bonus to staff for finishing a project. The projects involving a bonus often include successfully meeting the budget and time given.

• Referral bonus: A staff member earns a referral bonus after referring an applicant the venture successfully hires. It can differ depending on the position level involved. Companies typically pay this bonus type after the recruit is employed for a particular period. For example, employers using 90 days as the onboarding period will give their reward at the end of the given time.

• Sign-on bonus: Prospective new hires receive this type of bonus as a motivation to accept an offer. Businesses primarily utilize a cash bonus to propose a more competitive offer and to close the candidate. They also rely on the sign-on pay to bridge certain losses potential new hires may face. The bonuses cover the compensation they would lose by vacating their current jobs. 

Incentives

This variable pay plan uses specific performance targets to boost revenue. A firm establishes these goals in advance for the relevant performance period. As such, an employee gets payouts by meeting the set criteria.

Also, the criteria can initiate higher or lower compensation, depending on how well the staff met the expected targets.

Short-term incentive plans

These incentive pay plans depend on the realization of short-term performance objectives. They typically range for a year or less to facilitate short-term output. Some examples include:

• Management programs: These plans are for middle and senior management. Meeting specific firm output goals decides the incentives.

• Profit-sharing programs: These plans occur when a firm meets a preset financial goal. The enterprise can contribute to a non-qualified or qualified retirement program as an award. Alternately, employers can also offer their staff rewards in cash.

• Gainsharing programs: These programs seek to share productivity gains outcomes with the staff collectively.

• Sales incentive programs: These variable pay plans are designed for sales managers or sales agents, with awards based on achieving sales goals. They can include sales bonuses, straight commissions, SPIFs (short-term contests or bonuses to drive focus), and salary-plus-commission plans.

Long-term incentive plans

Unlike the short-term types, a company bases this sales compensation plan on attaining performance objectives during a multi-year period. It generally lasts three to five years and aims to propel longer-term output.

You can find two types of long-term incentive plans to use for an employee's variable pay:

• Cash-based programs: Cash awards depend on realizing goals over a multi-year period. Some firms prefer paying cash incentives to the alternative option, the equity-based plans. Besides, the cash method helps investors avoid share dilution management. They also prevent using up shares.

• Equity-based programs: These long-term plans come in the form of equity. They increase during a specific period.

The plans base success on the stock market and company performance. They aim to align with investors’ interests.  

Recognitions

Unlike the previous plans with set criteria, these plans generally feature broad guidelines before execution. Thus, the resulting awards may also vary depending on the nature of these guidelines.  

Below are three examples of recognition plans available:

• Managerial: These awards recognize incredible performance. A firm executes this plan publicly. For instance, it can post the reward in a newsletter or on the staff's portal. Managerial procedures might or might not include cash rewards.

• Spot awards: A venture offers this award to staff on the spot. These types of awards can be won by an employee who is successful in raising the firm’s sales.

• Nomination plans: Leaders and the staff might nominate a team or worker who largely contributed to the business. Typically, it uses a committee to review the nominated persons before deciding on the award's recipient. Also, the firm announces the awards publicly via staff meetings, an employee portal, and a newsletter. The award package may or may not be in cash.    

Why is variable compensation beneficial to businesses?

Variable compensation offers several benefits that make it enticing for many firms. They boost various company aspects, ranging from staff output to sales revenue. Variable payments provide four primary advantages that facilitate a firm’s growth:

Improves employee engagement and retention

Work-related compensation offers one of the best ways to motivate staff and realize the firm’s growth objectives. The benefit means you provide more money than an employee's base pay. Thus, it encourages your sales reps to work better and harder to improve their outcomes with each reward.   

The fixed pay gives a safety net that helps staff maintain engagement during difficult periods. The workers do not have to panic about poor results stranding them economically because of the base salary. Hence, you retain your workers. You also avoid the extra expenses you would otherwise incur via recruits and training.   

You want to be wise and have strategic goals when executing these programs. Poor management of these plans can lead to the opposite result. You have unhappy staff who can quickly leave for greener pastures.

Boosts productivity

Offering variable pay enables a rise in output through motivated workers. It provides the team with an incentive to better their production. Also, you retain talent in your sales team, enabling you to rely on proven expertise for the firm’s growth.

Correctly applying a performance-based salary enhances a firm’s output. It aids you in creating the right conditions to achieve the team’s goals. You get your desired outcomes via growth in users and revenue.

If your variable compensation plan does not ease profitability, it is best to look for a new plan. A failing incentive program is a waste of resources. 

Offers financial flexibility

The variable pay structure enables financial flexibility. Firms can tie rewards to financial and revenue performance in the market. Thus, companies appreciate this aspect since it lets them pay their crew after revenue generation. Besides this, employers do not necessarily require cash to award new sales reps upfront.

Additionally, the flexibility assists firms in aligning income with expenditure. It enables them to equalize staff base salary by balancing out pay. This benefit delivers an ordered system, easing efficiency and transparency to improve financial planning and administration.

Correlates with job performance

Variable pay correlates with staff performance, enabling workers to identify the specific ways they add value to the venture. They can quantify the worth the employer adds to them and vice versa. It can offer a quality chance to encourage the team to up their game in the firm.

Is there a challenge in implementing variable compensation?

As with everything in life, this program has a few downsides. A firm that offers a commission-only base salary struggles to retain talent. Fixed pays offer a safety net for staff, enabling them to keep fighting, even during tough economic times.

Although a fixed salary may not boost sales output, it allows the team to focus on improvement. Commission-only payouts create doubts, increasing the chances of the crew quitting for more stable options.   

The other variable pay challenge lies in improper execution. It is complex to implement successful incentive plans. Besides, firms offering a variable pay plan often manage many programs manually.

The last pitfall firms can face via these plans is increased expenses. It can cost ventures when they offer this type of compensation and don't plan the variable compensation payout accurately. The higher budget and poor execution can lead to erroneous results for your finance team.

What can you do to create an effective variable compensation plan?

It is vital to know the best approach for effectively setting these programs. Generally, you can get some key aspects necessary to achieve effectiveness. These include:

• Presentable – Open communication is vital to creating an effective pay plan. You also want to document the plans for reference.

• Precise – Quality executions of these plans require clarity. The pay programs should be clear to all the staff members. They should also be in accord with the enterprise’s compensation philosophy.

• Tiered – Variable pay plans differ between various organizational departments. For example, the pay for the sales department is different from that of the executive management. A tiered system helps incentivize sales reps according to their roles, from managers to leadership.  

• Controllable – The team should have control and authority over the activities the firm uses for evaluation. They also must have control over the results. Controllability means you have realistic goals that the crew can achieve. It is useless to set tasks beyond a workers’ reach and capability.

• Metric-based – This is another factor to include in your strategic goals for effective variable pay plans. It is best to facilitate measurable performance that supports regular reports. You also want it to be pertinent to the business and overall aims. The metric-based aspect can refer to an organization’s profitability initiatives or goals to enhance company culture.  

You can design an effective plan that benefits your business using these factors. Besides avoiding the challenges presented above, effectiveness helps workers use the programs positively while boosting sales.

The lack of an effective variable pay program can lead to staff focusing on the rewards as personal goals. Hence, they put more effort into quantity rather than quality. The aspects listed here allow you to achieve viability and balance company and staff output. 

Conclusion

Variable pay plans offer multiple pros to satisfy employees and the firm’s goals. However, these complex programs require appropriate execution to ensure success. As a result, it is wise to find a proper system to help you address your compensation needs.

Variable compensation is only one piece of the puzzle. Performio brings commissions, bonuses, and OTE together in a single, intuitive platform. Built to handle the complexity of variable pay, Performio makes compensation management simple, scalable, and reliable. Explore Performio’s approach ›