By Dr. Gary L. Deel, Ph.D., J.D.
Associate Professor, Dr. Wallace E. Boston School of Business
I’ve written previously about how to strategize pay in the public and private sectors. However, alongside questions related to how much employees should be paid, companies must also wrestle with the question of how they should be paid.
The most traditional option for compensation structure is a fixed pay rate that pays employees a set amount of money based on a time interval. If an employee is classified as non-exempt under the Fair Labor Standards Act (FLSA), for instance, then he or she is generally paid hourly.
Also, there may be variations in employee pay associated with certain mandatory provisions like overtime. However, the fixed pay rate is typically a constant. Actual pay may be distributed weekly, biweekly, or at virtually any other time interval, depending upon the agreement between employee and employer.
On the other hand, if an employee is classified as exempt under the FLSA, he or she will commonly be paid on a salary that is most often calculated yearly. That pay will still usually be distributed in time intervals of a week or two, but the amount is a prorated portion of the employee’s annual salary.
Fixed Compensation Has Certain Advantages and Disadvantages
Fixed compensation structures are not the newest or the most innovative pay strategies. They obviously do not consider employee performance or the achievement of key performance objectives.
Instead, the fixed pay model is focused on the time invested in pursuit of organizational goals – not the extent to which those goals are actually met. Variable pay models, by contrast, are predicated on conditions such as performance metrics.
But one key advantage to fixed pay is the security and peace of mind afforded to employees paid under such models, particularly in difficult economic times. For example, the United States is experiencing a period of skyrocketing inflation right now that has driven up the costs of living. As a result, many economists are concerned that our country is headed into a recession in the near term.
Now is a time when a steady job with good pay is particularly crucial to survival for many people. So when these individuals are given a choice between a fixed compensation plan where pay is dependable and predictable or a variable pay model where pay is contingent on several factors that may or may not be totally within the employees’ control, we shouldn’t be surprised if they prefer the fixed pay model.
Fixed Pay Inevitably Changes Over Time through Cost-of-Living Adjustments
Fixed pay cannot remain unchanged forever. Whether economic times are good or bad, the costs of living will still change over time – and the long-term trend is always upward for consumers.
Usually, fixed-pay models have a cost-of-living adjustment (commonly known as COLA) built into the compensation process. For employers, this adjustment involves looking at how the costs of daily living change for employees on a periodic basis (typically yearly) and then increasing the fixed pay rate by an amount sufficient to maintain the buying power of the money those employees earn.
In addition to employees’ financial security, fixed pay models have some ancillary benefits as well. First, when employee pay is fixed and not contingent upon individual performance, there is no incentive for dysfunction or hostility among employees who may otherwise feel a sense of competition toward each other with the variable pay structure.
Similarly, employees in sales-oriented roles don’t feel the need to exert extreme pressure on clients to make commissions. Consequently, customer service can improve in a fixed pay model as well.
As a last point of consideration, it’s worth noting that fixed pay models and variable pay models for employees are not mutually exclusive. They are often combined in different forms. For instance, some employees might have a fixed “base” pay and then a variable component on top of the base, which might be commissions, bonus, or some other type of incentive compensation.
However, it is possible to combine variable pay and fixed pay to optimize employee security, engagement, and productivity. In a time when many employees are resigning and seeking new opportunities, retaining good employees will be key to success for many companies.
Related link: Pay Equity and Private-Sector Employer Accountability