Variable compensation: when it works and when it fails

Variable compensation is one of the most misunderstood tools in modern companies. Ask ten founders what it’s for and you’ll hear ten different answers: motivation, performance, retention, paying for results. 

Ask investors and finance leaders and you’ll get a quieter, sharper response: alignment.

At its best, variable compensation aligns effort with outcomes that genuinely matter to the business. At its worst, it creates noise, gaming, short-termism, and resentment. This article explains what variable compensation is actually designed to do, why it so often backfires, and how to think about incentives across all roles, not just sales.

Variable compensation is a behavioural design choice. And like any design choice, it only works when it’s intentional.

What variable compensation is designed to solve 

Variable compensation exists to solve a very specific problem: how to direct effort when outcomes matter more than activity.

In roles where the connection between action and outcome is clear, such as closing a deal, shipping a project, or hitting a production target, variable pay can focus attention on what actually moves the needle. 

It’s a way of saying that this outcome matters enough that we’re willing to pay differently when it happens.

What it is not designed to do is:

• Fix unclear strategy
• Compensate for poor management
• Replace trust, autonomy, or good job design
• Motivate people who don’t believe in the goal

This is where many companies go wrong. They reach for incentives when the real issue is prioritisation, resourcing, or leadership clarity. 

The result is a scheme that tries to manufacture motivation instead of removing friction.

A useful test is this: if someone hits the incentive but the business is worse off, the incentive is wrong. That happens far more often than founders like to admit.

Why poorly designed incentives distort behaviour

Incentives shape behaviour as well as driving motivation, sometimes in ways you didn’t intend.

Economists and behavioural scientists have been pointing this out for decades. When you pay for a specific metric, people will optimise for that metric, even if it undermines the broader goal. 

Goodhart’s Law captures this neatly: when a measure becomes a target, it ceases to be a good measure.

In practice, poorly designed variable compensation leads to predictable problems:

• Sales teams chasing low-quality deals to hit commission
• Leaders optimising short-term results at the expense of long-term value
• Teams gaming metrics instead of solving real problems
• Internal competition replacing collaboration

Research from the London School of Economics found that financial incentives can reduce intrinsic motivation and harm performance when tasks require judgement, creativity, or cooperation.

That doesn’t mean incentives are bad. It means they’re blunt instruments. Used carefully, they focus effort, but they can also distort it.

Short-term output vs long-term value creation

This is the central tension in variable compensation.

Most incentive schemes reward outputs like revenue booked, units shipped, or targets hit this quarter. 

However, most businesses succeed or fail based on long-term value creation, measured in terms of retention, reputation, product quality, and sustainable margins.

The closer your incentive is to the final outcome you care about, the safer it is. The further away it is, the more likely it is to misfire.

For example:

• Commission tied to closed deals rewards speed, not fit
• Bonuses tied to quarterly targets reward timing, not durability
• Individual KPIs reward ownership, but can punish teamwork

That doesn’t make these approaches wrong. It means they need context. Early-stage companies often need short-term output to survive. 

Later-stage companies need to protect long-term value from being eroded by over-optimisation.

This is why the same incentive can be sensible at one stage and dangerous at another.

When bonuses, commission, profit share, or equity make sense

There’s no universal best form of variable compensation. Each tool solves a different problem.

Commission works best when:

• The role directly drives revenue
• The sales cycle is well understood
• Quality can be controlled elsewhere (pricing, contracts, churn)

Bonuses are useful when:

• Outcomes are time-bound or exceptional
• You want discretion rather than entitlement
• Performance is multi-factor and hard to formula-ise

Profit share makes sense when:

• Results depend on cross-functional effort
• Collaboration matters more than individual optimisation
• You want people thinking like owners, not operators

Equity is most effective when:

• The goal is long-term value creation
• Outcomes unfold over years, not quarters
• You want alignment that survives role changes

The mistake is treating these as interchangeable. They’re not. Each sends a different signal about what the company values and over what time horizon.

Why the sales vs everyone else model is too simplistic

Many companies default to a crude split: commission for sales, salary for everyone else. That’s convenient, not correct.

Sales roles do lend themselves more easily to variable pay because the link between action and outcome is clearer, but non-sales roles also drive value, and often in ways that are harder to measure but no less important.

The real distinction isn’t sales vs non-sales. It’s direct vs indirect impact, individual vs collective outcomes, and short vs long time horizons.

Applying sales-style incentives to non-sales roles usually fails because it imports false precision. 

Measuring the impact of an engineer, product manager, or ops lead through narrow KPIs often creates more noise than insight. In those cases, team-based incentives, profit share, or equity tend to produce better alignment.

This is where many companies overcomplicate things. If you can’t clearly explain how someone’s variable pay connects to value creation, it probably shouldn’t be variable.

How stage and strategy should shape incentive design

Variable compensation doesn’t exist in a vacuum. It should change as the company changes.

At early stage, incentives often rely on trust, proximity, and shared belief. Simple bonus structures or equity work because everyone can see the impact of their work.

At growth stage, clarity matters more. As teams scale, informal alignment breaks down. Incentives need to reinforce the behaviours the company can no longer rely on culture alone to produce.

At later stage, discipline matters. Incentives that once drove growth can start destroying margin, collaboration, or quality if they’re not re-examined.

Strategy matters just as much as stage. A business optimising for land-and-expand should incentivise retention and expansion, not just acquisition. 

A company prioritising profitability should not be paying purely for top-line growth.

Summary

Well-designed variable compensation does one thing consistently: it makes it easier for people to do the right thing.

When schemes fail, it’s usually because they ask people to choose between hitting the incentive and acting in the company’s best interests. 

Variable compensation is not about paying more or less. It’s about deciding, very deliberately, what you want people to optimise for, and over what time frame.

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