Compensation and Pay Mix: Part 4
By Andy Klose - Associate Partner
In this series of articles, we highlight an aspect of remuneration strategy that is often overlooked: the ratio of fixed and variable pay to total cash compensation (also known as "pay mix").
Pay mix determines what types of employees are attracted by a particular compensation model, which in turn impacts a company's performance and results. Setting the right pay mix, especially for client-facing and sales roles in professional services firms is critical for success.
As a rule of thumb: The higher the influence of a job holder on clients’ purchasing decisions, the higher the variable portion in the pay mix. Lastly, the type of employees being attracted to a particular compensation model will also shape a firm’s culture in the long run.
Pay Mix: A Defining Differentiator in Compensation
In Part 1 of this series, we explained why the pay mix can be the defining differentiator, particularly from an employee’s perspective, when many of the other key elements of compensation across competing organisations are considered to be broadly similar. In Part 2 we discussed how pay mix affects the financials of firms, especially with regards to personnel costs. Part 3 examined how pay mix should be adjusted in relation to the total cash compensation offered and how benchmarked market percentiles are the most effective indicator of competitive positioning. And, in this final Part 4 we will assess how pay mix may influence firms’ culture and performance.
This is the last part (Part 4) of our series on compensation strategy, where we focus on the critical importance of pay mix - the balance between fixed and variable compensation - in shaping employee attraction, firm culture, and long-term performance. In this article, we provide deeper insights into how pay mix influences organizational culture and overall performance.
Challenging Conventional Wisdom
In the midst of debates over the effectiveness of increased remuneration in motivating employees, it is crucial to challenge conventional wisdom. While monetary incentives undoubtedly play a role, our research suggests that sustainable performance depends more on creating a high-performance environment than simply increasing pay.
We propose a paradigm shift captured in our “Performance Mindset Framework” (Exhibit 1), which highlights the link between mindset, behaviour, and performance. Our model suggests hiring individuals who are motivated by intrinsic factors, such as a sense of ownership and commitment, rather than relying solely on external rewards.
behaviour, and performance (Source: Vencon Research)
Attracting and Retaining Top Talent
To attract and retain high-potential candidates, firms must adopt rigorous recruitment processes and leverage advanced personality assessments to identify individuals with the right mindset and soft skills. Additionally, offering well-balanced total rewards packages, including compensation, benefits, and personal development opportunities, enhances the value proposition for prospective employees.
Strategic Pay Mix in Professional Services Firms
In industries like consulting and IT services, where achieving “hard KPIs” such as, e.g., sales targets and margin goals is paramount, offering a competitive pay package is imperative. Consulting companies not in the top quartile of their niche can leverage a slightly higher total cash package with a “riskier” pay mix to attract individuals motivated by performance-driven incentives.
Expected Long-term Effects of Compensation Strategies
Based on the following example, we present the expected long-term effects assuming that the compensation strategy and pay mix are implemented consistently over several years. In simplified terms, the expected results are shown in Exhibit 2:
Firm 1 will attract more 'hunter'-type employees who are drawn to the compensation model, which includes a relatively high variable, performance-related portion with the potential for the highest total cash. This will result in a competitive and dynamic corporate culture. The main challenge for the company will be fostering cooperation between employees rather than motivating them.
Firm 3 is the ideal choice for employees who value a higher fixed base income over a higher total remuneration. Individuals who are less performance-driven or less self-assured may find this option more attractive compared to Firm 1. This situation may result in performance issues for the company in the long term. There is the danger that employees who consistently outperform their colleagues will leave due to the relatively low variable bonus component, which prevents them from expecting a significantly higher salary than their peers. Additionally, these employees may be enticed to work for one of the other two rival types of companies, where they can earn significantly more for the same level of performance.
In the long term, Firm 2 will see long-term results between the two scenarios outlined. Identifying 'over-performers' and motivating them may be a key challenge, but one that can be overcome with the right approach.
Long-Term Implications
Different pay mixes yield distinct long-term effects on a company's economic situation and culture. Companies with a higher variable portion in their pay mix tend to attract dynamic, performance-oriented individuals, fostering a competitive corporate culture. Conversely, companies with a lower variable portion may face challenges retaining top performers and maintaining a high-performance environment.
Tailoring Pay Mix to Market Dynamics
Designing the right pay mix necessitates a nuanced understanding of market comparatives and cultural preferences. Pay mix varies by region and country, with some cultures more receptive to aggressive pay mixes than others. Therefore, companies must align their compensation strategies with local norms while remaining competitive in talent acquisition and retention.
Conclusion
Pay mix is a strategic tool that significantly impacts employee attraction, firm culture, and overall performance. A comprehensive approach to compensation and aligning pay structures with organizational objectives can position companies for sustained success in a competitive marketplace. Optimizing pay mix and remuneration systems to suit individual company needs and objectives is essential for achieving this success.
We are at your disposal for further questions and suggestions regarding how you optimally design pay mix (and/or remuneration systems) for your company.
Andy Klose is an Associate Partner at Vencon Research International and heads the firm’s consulting unit.
Vencon Research International is a leading provider of compensation benchmarking and research as well as of compensation and performance-related consulting services for professional service firms, especially for audit and tax, management consulting, and IT services firms. Vencon Research International provides services to a full range of clients in more than 75 countries worldwide and is proud to name more than 85% of the world’s major consulting and/or professional services firm its clients.