Performance Management

The Effectiveness of Skill-Based Pay Systems

Performance has long been at the core of compensation management. The desire to pay more productive employees a greater salary is, in fact, a strong business strategy, but with the multi-faceted nature of jobs today, a simple measure of ‘performance’ is often very difficult to justify. More and more it is not just the effort put forth by the employee that makes them desirable, but also the amount of job based skills the employee possesses.

The Wide-Spread Use of Skill-Based Pay Systems

Some of the potential outcomes of skill-based pay systems include a flexible workforce, lowered labor costs, and increased quality and productivity. Considering the merits of skill-based pay systems, it is obvious why about half of the Fortune 1000 companies use them (estimates are between 30 and 67 percent of the Fortune 1000).

Implementing Skill-Based Pay Systems

Skill-based pay systems are based on the idea that employees will be proactive in obtaining new, job-related skills if they are compensated for such efforts. This is a basic principle of behavioral psychology: Actions that lead to rewards will be repeated. The underlying concept behind a skill-based pay system is relatively simple: increase an employee’s compensation as he or she acquires and becomes more proficient with job-related skills. Newly implemented skill-based pay systems can be met with resistance, especially from long-tenured incumbents who have continuously received pay increases based on tenure. This can be challenging to overcome, but in most cases the tenured employees have a great deal of job-related skills, allowing them to enter into the new pay system with a high level of compensation. To correctly implement a skill-based pay system, it is important for the skills in the system to be job-related. For example, a welder being rewarded for learning to use a larger, more powerful welding machine is appropriate, but the same individual should not be compensated for learning to fix a plumbing system. Another important aspect of a well thought out skill-based pay system is that the amount of compensation increase should be relevant to the difficulty of the skill: Learning to construct a basic spreadsheet in Excel is not as difficult as learning to write macros in Visual Basic, so the former should not be associated with as large of a pay increase as the latter. The final important characteristic of an effective skill-based pay system is regular testing of skill proficiency. When incumbents initially learn skills, they should be tested for proficiency. In most cases an incumbent will not be as proficient with a newly acquired skill as with a skill they have possessed for an extended period of time. Additionally, employees who do not use a skill for a long period of time may lose proficiency. In light of both of these factors, it is important for skill proficiency to be tested at least every year. This will allow for the pay system to more accurately reflect skill proficiency.

Increased Effectiveness of Skill-Based Pay Systems

Skill increases at the individual and workforce level result from the implementation of a skill-based pay system, both of which lead to a more productive workforce. However, some changes to the structure of skill-based pay systems can allow for greater effectiveness. Some of these changes include: Skills learned early in the system should be easier to learn Employees who have early success with skill-based pay systems are more likely to continue gaining new skills.
  • The first reward an individual receives should be relatively large
Larger rewards early in the pay system motivate employees to continue working hard to obtain more skills, which is the ultimate goal of skill-based pay systems. Put simply, the first skill learned, regardless of difficulty level, should be compensated at a high level, and every skill learned after that should be compensated based on the difficulty level of the skill. While this   may  seem   contradictory   to   the   earlier mentioned rule about making sure the size of the pay increase is related to the difficulty of the skill, the two ideas are mutually exclusive. If every employee received the same bonus after obtaining his or her first skill, it will not seem unfair that an easier skill is rewarded at a greater level.
  • Management should encourage employees to obtain new skills as much as possible
Skill-based pay systems put the responsibility of earning pay increases in the hands of the incumbents. Some employees, especially those new to skill-based pay systems, may not work as hard to obtain new skills. As such, it is important for management to be supportive in giving employees the time, encouragement, and resources necessary to obtain new skills. Skill-based pay systems, as with any compensation management strategy, can be ineffective if used incorrectly. It is important to consider the suggestions outlined in this article before implementing a skill-based pay system. Ultimately, the implementation of a skill-based pay system can lead to greater profits as employees become more skilled and more proficient, allowing for them to perform their jobs more effectively.

Interpretation by:

David Daly

DeGarmo Group

This was a summary of the research and practice implications from:Dierdorff, E. C., & Surface, E. A. (2008). If you pay for skills, will they learn? Skill change and maintenance under a skill-based pay system. Journal of Management, 34(4), 721-743.