Nonprofit Variable Pay

Amount of Pay at Risk

An annual incentive plan must motivate eligible employees to perform at the required level to attain the desired results. The reward must be perceived as worth the additional effort. If the reward is too small, it may not lead to the desired results. The amount of the award or percentage of pay that will be perceived as significant will vary - typically by current job level in an organization.

Let's take a look at two different plans:

• Plan A: The employee is paid a set amount for each client served in a period of time. The entire amount of pay is variable. There's no guarantee of how much the employee will make in a time period; that's up to the employee (assuming an adequate flow of clients).
• Plan B: This plan provides a $50 bonus to all employees when costs are kept at a set percentage of income. In a year in which this goal is not achieved, the plan provides no additional money (beyond base pay) to the employees.

In these two cases the importance of the variable pay plan to the employee, and its motivational effect, are very different. Both situations are likely to be unacceptable to the employee, but for different reasons.

Here are the lessons:

The reward can be managed as a percent of base salary, a flat amount, or even a ratio to base salary. Although using a flat dollar amount as an incentive plan carefully controls the amount of pay at risk and provides consistency from employee to employee, it may not effectively manage compensation among eligible participants as it will not motivate plan participants consistently due to different job levels. A ratio to base salary (such as a 50:50 plan) may be used for sales and fundraising compensation.

Managing an annual incentive plan as a percentage of base salary (or salary range midpoint) ensures all plan participants are treated consistently for the job being held. The plan can be managed more effectively based on the labor market and can thus be more effective in motivating plan participants. When an annual incentive plan is managed as a percent of base salary, it grows year over year based on changes in base salary or when an employee is promoted and becomes eligible for the next higher bonus percentage. Adjustments may also be made in the case of demotion. An annual incentive plan for a non-profit organization might be managed with the following pay at risk:

Threshold, Target, and Maximum Payouts

Setting the threshold, target, and maximum payouts, will encourage the desired plan results. There should be a sufficient reward to reach threshold (minimum performance), and the reward should be high enough to reward for maximum performance without being excessive. For example, a typical formula might be 50% of target as the threshold (minimum) award when threshold performance is attained, and 150% of target as the maximum award when maximum performance is attained as indicated in the table below:

Designing a Plan with More Than One Performance Measure

This represents an example of a plan with two performance measures (revenue and customer satisfaction). Revenue has a 75% weight while the customer satisfaction score has a 25% weight. A threshold, target, and maximum performance levels have been identified to determine payout criteria under the plan.

Payouts can also be designed to be prorated based on amounts between performance attainment levels (e.g., revenue at $45,000,000)

Adding Payouts for Employee’s Performance or MBO Achievements

Another option would be to pay out a percentage of the plan based on either an employee’s performance rating or MBO attainment. In this example, revenue is weighted at 60%, customer satisfaction is weighted at 20%, and each eligible employee’s performance or MBO attainment is weighted at 20%. If the organization does not meet revenue or customer satisfaction attainment, there is still an opportunity to pay out a small award based on performance or MBO attainment.

Another option would be to modify the overall payouts earned for revenue and customer satisfaction based on MBO attainment or employee performance. In this example, no payouts would be made unless incentives were earned for either revenue or customer satisfaction.

In order to prevent excessive payouts, a statement may be added to the plan document that the performance modifier average must be 100% for all eligible employees combined.

Calculating the Overall Cost of the Plan

Calculating the overall cost of the plan at threshold, target, and maximum performance is important to ensure the cost of the plan does not exceed the financial benefit at threshold, target, and maximum performance.

The costs should be budgeted prior to the beginning of the plan year to ensure funds are available. At the end of the plan’s performance period, the costs for payouts are again calculated under the plan for top management/board of director approval and implementation.

Plan Document

A plan document should be developed for each variable compensation plan capturing the plan rules governing the plan. A plan should also include required approvals when an exception to the plan is approved. Examples of an exception might be an acquisition or divestiture of a business. The plan document should also be approved by top management/board of directors prior to implementation.