The Next Frontier for Variable Pay: Independent Contractors & "Free Agents"?

Last week, I posted on the (predicted) end of the merit increase (?) and the conclusion by most of the compensation experts presenting at last week's WorldatWork conference that the future of pay for performance lies in variable pay.

In his conference presentation "Projecting the Future of Variable Pay", Ken Abosch of Hewitt Associates also offered the prediction that variable pay would begin making significant inroads in the remuneration of independent contractors and "free agents".  Goodbye straight hourly rate, hello combination of fixed plus incentive pay tied to results.

I find this to be a very interesting forecast.  I imagine that it is already happening out there, and may even be the norm in certain pockets.  (And I'm not talking consultants, or at least those who run or work for ongoing consulting firms - but rather those who market their skills as an independent agent.  And I do realize that the difference can sometimes be a little fuzzy...)  But I haven't run across this practice much in my own travels.

I believe this potential trend, if in fact it comes to be (and I have every reason to think Mr. Abosch is on the money here), has a range of implications and raises a number of questions.  Here are a few that come immediately to mind for me:

• Incentive design for independent contractors will/must be different than for employees; we should not assume we can simply lift the plans used for one population and apply them to the other.  What aspects of this different work relationship must come to bear on incentive plan design?

• If we begin shifting the mix of compensation for independent contractors to a more "leveraged" model (versus straight salary), will we risk running afoul of the legal definition of independent contractor in any way?  Are there particular legal guideposts we need to be aware of?

• Will this trend, if it comes to pass, impact the "independent" talent pool?  In other words, will certain people opt in or out of "free agency" as a result - will this make that particular form of work less attractive to some, more attractive to others?

• Same question as above for employers; will this trend make the use of "free agents" more attractive to some organizations, less attractive to others?

Any with experience in incentive design for independents want to weigh in here? 

What questions does this potential trend raise for you?

Comments

[Don Peppers]

I think incentive compensation, overall, will be pushed more and more to reflect long-term value created, rather than just short-term, because short-termism contributed so much to the financial crisis. So the Gaithner folks are already proposing that TARP recipients (and others, but they don't have the authority) should pay execs incentives in the form of restricted stock rather than cash or options.

It makes sense, in terms of a company's financial health, to align managers' and executives' incentives to the firm's longer term interests. So this is probably a good idea, although I'm still not in favor of enshrining it in a federal regulation.

The problem, of course, is that this will be very difficult to do for independent contractors, right? Any ideas?

[Doug Sayed]

Engaging post Ann. I believe I was at the same presentation, and concur with you on these trends.

I believe this the way most things compensation are heading: limited fixed cost pay growth (base pay), but more $$ devoted to performance-linked variable pay.

One really interesting prediction that came out of the same presentation: this year's salary increase or "merit" increase budgets would be about 3% and an additional 12% devoted to variable pay budgets. 10 years out, he predicted a 2% salary increase budget, but 16% of payroll budgeted for variable pay.

Bottom line: fewer and smaller base pay increases, but more variable pay available. Some will not do well under this new/coming reality, but others (high performers) will likely benefit.

[Ann Bares]

Don:

Great points, all. Neither am I in favor of enshrining much of this in a federal regulation. I also agree that this trend - if it pans out - will be a challenge to apply to independent contractors. Will be interesting to follow!

Doug:

Interesting trends, aren't they? And you're right, that some will do better under this new reality than others. Which may suggest that some form of support and development may need to accompany the shift in pay practices - to help employees understand and position themselves for success as the change occurs.

[Wally Bock]

Great post, Ann. I agree with you and the Hewitt expert on the trends. Let me jump in as one of those independent contractors.

I've always thought that I would do better, both in individual jobs and across a career if the amounts I earned reflected my contribution to my client. For over twenty years now I've been striving to have fixed project fees with incentives and penalties. That's seemed to me to be the way that's fairest for everyone.

I've found very few clients that are willing to do that. They seem to feel more comfortable with time-based fees as if there's something about them that's "right." I've had clients who agreed to a flat fee demand to know the number of hours I based it on.

I've also found that many clients are willing to agree to penalties in addition to a basic fee, but hardly any are willing to agree to incentives, even if those are clearly in their own interest. This seems to me to reflect the human propensity to value protection from loss above increased gain.

I share this as a way of making the point that it's one thing to project a trend based on a small sample, but it's quite a different and more complex matter to change entrenched practice and, even more, human nature.

[E James (Jim) Brennan]

Wonder how many will figure out a new method. Say, if you put independant contractors on an incentive scheme offering generous up-side positive payoffs for specific levels of confirmed output results with minimal starvation-level consulting fees as the failure-level base along with instantly-severable contracts. Then widely publicize the results to your regular employees, offering your confident risk-takers a similar option of low fixed guaranteed base with high re-earnable potential incentive payouts; expiring at certain intervals, with the concept being to mutually re-negotiate new and more equally-productive targets and formulae for future periods.

Letting your security/guarantee-oriented slow-boats drift behind or fall by the wayside would create new challenges, not necessarily good or bad. How to deal with that situation would be a different story altogether and a different blog topic.

Meanwhile, however, you could create an extremely nimble compensation system centered on extremely self-motivated hard-charging high-achievers. They would probably end up self-selecting any number of unique personallized reward and incentive systems, for mutual benefit. It'll take a number of carefully-studied failures before this new "Brennan-nimble incentive system" takes root as a process... (I 1st thunk it & first stated it, then I get to epynomously name it). It will NEVER become a fixed program, nor should it.

[Hugh Elliot]

As an independant contractor, I am willing to work for performance based compensation: hourlry rate plus success fees.

The success fee, however, must be defined prior to the beginning of the engagement in terms of achievement required and amount to be paid. I do not do discretionary bonuses: that strays all too close to the definition of employee.

[Ann Bares]

Hugh:

I totally agree that performance based compensation must be defined (both in terms of achievement requirements as well as payout) on the front end. To my mind, this should be true for all variable pay plans - discretionary bonuses have more than proven themselves to be ineffective motivators ... and in some cases much worse.

Thanks for weighing in!