How to Structure Offer Letters: Should Variable Pay Be Included in CTC Calculations?

Dear HR Professionals,

I have a couple of questions regarding the structuring of an offer letter for a Sales Manager position:

Compensation Package Structure

1. In the case of a compensation package with a 50:50 ratio for fixed and variable components, should the variable component (such as commissions or bonuses) be included in the Cost to Company (CTC) calculation?

Third-Party Recruitment Agency Fee Calculation

2. If a third-party recruitment agency is involved in hiring for this role, and they charge a fee based on a percentage of the CTC, how would the calculation work? Specifically, if the agency charges 8.33% of the CTC as their fee, would the variable pay component be factored into the CTC for this calculation?

I would greatly appreciate your insights and expertise in clarifying these points.

Understanding CTC and Its Components

CTC means Cost to Company. It includes all costs of employing a person. If 50% of the total remuneration is commission, incentives, etc., these should invariably be part of the CTC. However, recruiters cannot exploit this variable part because if the employee does not earn any commission or incentive, will the recruiter replace them with another person? No.

Variable Remuneration and Its Implications

The variable part of remuneration does not guarantee any payout. It depends on performance, which is linked to the market. Therefore, even if an unreasonable amount is set as variable, it is part of the CTC. It is up to the employee to accept the offer or not, or to counter the structure by questioning, "Is this variable pay really going to accrue based on the existing market conditions?" You may say that it is real and you will earn it, but the employee should focus on the fixed part of the salary. If they achieve the target, the variable pay will come, and that would be a bonus to them.

Fixed Salary and Recruiter Charges

As such, only the fixed part of the salary would be the real salary, the salary on which statutory contributions will be based. This should be the salary on which recruiters should get their service charge. If recruiters charge on CTC, which is often inflated by unrealistic amounts, that is wrong.

I would recommend that you split into Fixed Pay and Variable Pay.

Work out the CTC component to the Fixed Pay and indicate to the employee that he/she will be getting variable pay based on his/her performance.

To the agency that supports you in your recruitment process, explicitly tell them that you will be paying a consultancy fee of 8.33% of Fixed Pay only and not on the Variable Pay as it will neither be consistent nor constant.

As Madhu indicated, if your Fixed Pay ratio to Variable Pay is too low, it may not interest fresh recruits. You need to assess the market value of the candidates and then arrive at the ratio.

On the other hand, if the ratio is high, you may end up paying a high pay package without equivalent revenue generation for the company.

Regards,

MVK

In the case of a compensation package with a 50:50 ratio for fixed and variable components, should the variable component (such as commissions or bonuses) be included in the Cost to Company (CTC) calculation?

Yes, you need to include the variable component in CTC. That is how companies often present it as a good deal for employees. I have seen companies even include the cost of one-time training, unplayable components, and gratuity in CTC. (I have seen this in the recruitment letter of an MNC bank to an MBA college). So, it would not be surprising if the recruitment fee is added to CTC.

Personally, though, I have always considered CTC as somewhat misleading for employees.

If a third-party recruitment agency is involved in hiring for this role, and they charge a fee based on a percentage of the CTC, how would the calculation work? Specifically, if the agency charges 8.33% of the CTC as their fee, would the variable pay component be factored into the CTC for this calculation?

The agency fee would include all items on the CTC.