What is Skill-Based Pay?

Three HR professionals working on computers

Skill-based pay is a type of compensation system in which an employee is paid based on the specific skills they possess and the level of proficiency they demonstrate in those skills. This type of pay structure incentivizes employees to develop and use their skills to the fullest, as they can earn more money by acquiring and demonstrating new skills. In a skill-based pay system, employees may be evaluated regularly to determine their proficiency in different skills, and their pay may be adjusted accordingly. This approach to compensation can be used in various industries, including manufacturing, technology, and healthcare, among others.

What is the difference between skill-based and job-based compensation structures?

In a job-based compensation structure, an employee is paid based on the job they hold within the organization. Positions are evaluated and market priced based on the job, while the individual employee is evaluated based on performance. Job-based compensation structures typically use a standard pay scale that sets the minimum and maximum salaries for each job within the organization.

On the other hand, in a skill-based compensation structure, an employee is paid based on the specific skills they possess and the level of proficiency they demonstrate in those skills. This means that employees who possess unique skills and demonstrate higher levels of ability in those skills may be paid more than employees who hold the same job title but have fewer skills or lower levels of proficiency.

What are the advantages for employers who adopt a skill-based pay system?

A skill-based compensation structure can cultivate a company culture prioritizing personal growth and improvement. By incentivizing employees through rewards for acquiring new skills, a skill-based pay system can increase their motivation to improve their abilities and acquire new knowledge continually. There are many perks associated with skill-based pay systems; however, employers need to approach the implementation of a skill-based pay system with a well-thought-out strategy to realize its potential advantages fully.

According to a recent article from Deloitte, now is the perfect opportunity to reimagine how employees are incentivized and rewarded.

“A new operating model places skills and human capabilities at the heart of operational design, fueling a wide range of talent and business decisions, creating continual adaptiveness, and unlocking the full potential of the workforce.”

—Deloitte Capital H. Blog: Breaking from tradition with skill-based rewards.

Additional advantages include:

  • Increased employee motivation: Skill-based pay systems can incentivize employees to develop new skills and improve their performance, leading to increased motivation and engagement in their work.
  • Better alignment with business goals: A skill-based pay system can help align an organization’s compensation strategy with its business goals and objectives by linking an employee’s pay to their specific skills.
  • Improved employee retention: A skill-based pay system can help retain employees with valuable skills, as they are more likely to be compensated for their expertise.
  • More efficient use of human capital: By rewarding employees based on their skills and proficiency levels, a skill-based pay system can help ensure that an organization makes the most efficient use of its human capital.
  • Increased competitiveness: A skill-based pay system can help an organization to remain competitive in the job market by attracting and retaining employees with valuable skills.
  • Improved cost control: By linking an employee’s pay to their skills and proficiency levels, a skill-based pay system can help to control labor costs by ensuring that employees are paid based on their actual value to the organization.

What are the potential risks for employers who implement a skill-based pay system?

  • Legal compliance: A skill-based pay system must comply with all relevant laws and regulations, including equal pay and anti-discrimination laws. Employers who fail to comply with these laws may face legal penalties and damage their reputations.
  • Decreased employee morale: A skill-based pay system can create competition between employees and reduce morale and teamwork.
  • Resistance to change: Employees may resist a skill-based pay system, particularly if they feel that it is not fair or transparent or if they believe that it does not accurately reflect their skills and experience.
  • Increased costs: Implementing a skill-based pay system can be more expensive than a traditional job-based pay system, as employers may need to invest in skills assessment programs, training, and development initiatives.
  • Difficulty in assessing skills: Assessing an employee’s skills and proficiency levels can be challenging, particularly in organizations with complex and constantly changing skill requirements.
  • Inaccurate assessments: An inaccurate assessment of an employee’s skills can result in an incorrect pay determination, which can lead to dissatisfaction among employees.
  • Inflexibility: A skill-based pay system may not be flexible enough to accommodate changes in the organization’s needs, such as new business initiatives or changes in the job market.

Where do I start?

Working with a compensation consultant before implementing a skills-based or pay-per-performance compensation plan can be valuable in ensuring the program aligns with your organizational mission. These experts can assess your current compensation model, assist with benchmarking and pay structure development, and help you make informed decisions about the best approach for your business.

It’s essential to have a clear understanding of your organization’s compensation philosophy before transitioning to a pay-per-performance model. A compensation consultant can help you understand the complexities of skills-based and job-based compensation plans, stay up-to-date on relevant laws and regulations, and make confident choices that benefit your business.

Not sure where to start? At Compensation Works, our experienced compensation consultants can work with you to create a compensation structure that fits the unique needs of your business. Contact us today for more information on how to get started.