Competency-based pay, also known as skill-based pay, is a pay structure in which compensation, including raises, is determined in accordance with an employee’s performance. The use of competency-based pay is an alternative to traditional pay structures that reward people based on what job title they might hold and how much time they spend with an organization.

The process for designing a competency-based compensation system includes ways to encourage employees to continue improving themselves and increasingly contribute to the success of an organization.

As such, competency-based pay is a well liked system by organizations hoping to spur increased competition among employees, increased innovation and increased initiative among the staff to proactively deal with organizational issues.

An example of competency-based pay is found in any workplace where a person is rewarded for either meeting the metrics of their position or going above and beyond those metrics. In businesses, managers and administration can put into place a general set of performance criteria that they want employees to meet within a certain time frame in order to qualify for raises. Depending on how well these criteria are met, administrators can then determine the size of the raise that they are offering. Just how much they might offer depends on the established minimum and maximum pay grade range that the employee qualifies for.

Competency vs. Performance

The difference between performance-related pay and competence-related pay is small, and the definitions overlap depending on whom you consult. The most consistent difference between performance-related pay vs. competence-related pay is that competence-pay models focus on the skills acquired by an individual without regard to outcomes. Performance-based pay, true to its name, integrates skills acquired along with outcomes achieved to determine whether a person’s pay should be increased.

In actual practice, few people make this distinction and the two pay models nearly entirely overlap.

While some may consider competence-pay models to be models in which outcomes are not used to gauge an employee’s salary, others consider outcomes to be a critical aspect of the competence-pay model. As such, it is difficult to find agreement on what the distinction is between the two.

With that said, employers adopting a competency-based pay model would do well to integrate outcomes into their assessment of employee competence. Without integrating outcomes into competence assessments, it can be difficult for employers to truly gauge whether an employee is competent in performing her work duties.

Advantages to Competency-Based Pay

There are numerous advantages to competency-based pay. It is a motivational tool that can foster a positive environment in which employees are encouraged to be problem solvers who take the initiative to address issues within the organization. This payment model is helpful when employers are trying to attract and retain talent that believe in their ability to improve the performance of the organization.

As such, there are very few disadvantages to implementing this payment model, though the competition that arises in this kind of work environment needs to be carefully monitored.

A Motivational Tool

When appropriately implemented, competency-based pay can serve as a motivational tool within an organization. Because pay becomes dependent on performance in the workplace, it encourages people to work harder and more effectively.

A competency-based pay structure incentivizes workers to take more initiative to address problems within the workplace and to innovate creative solutions to an organization’s struggles. Organizations that lack a competency-based structure – instead increasing pay for only the most senior of employees – fail to motivate the work of those who are lower down the hierarchy of an organization.

Fosters a Self-Improvement Culture

The focus on improving the motivation of employees using competency-based pay creates a culture of self-improvement. Workplaces with this environment reward the employees who are constantly working to improving their skills, building not only on their technical skills but also their leadership skills and ability to cooperate with others.

Employees who put in additional effort at growth and improvement are those who are most likely to be rewarded in the competency-based environment.

Sometimes, this focus on self-improvement can drive incredible efforts from employees. Employees who know they will be rewarded for their efforts will put in more time improving themselves and the workplace, even when that means working outside of the traditional 40-hour time frame.

Having a staff focused on self-improvement can only lead to long-term positive outcomes for an organization. Letting employees know that they will be recognized for their efforts makes it more likely that employees will take the initiative in becoming better at their jobs.

Can Improve Staff Retention

There is the potential for an organization to improve its staff retention rates when it implements a competency-based pay structure. Individuals enjoy feeling rewarded for the work that they do, and workers feel appreciated when their work is recognized by their employers.

Employees may want to stay on when their work is being rewarded in this way, with a higher chance of a raise than if they were employed in other organizations. That incentive alone may be powerful enough to keep workers with the organization.

It should be noted that a competency-based pay structure isn’t alone enough to retain talent, particularly the top talent within an industry. However, it’s an important start in creating an environment in which employees want to stay.

The competency-based pay model is still one of the least-used pay models in most industries, and it provides an attractive starting point from which to retain talent.

Promote Corporate Transparency

One issue in other forms of pay structures is the increased likelihood that there may be some corruption and lack of trust resulting from those payment models. While seniority in an organization is valuable, so is performance.

A competency-based pay structure clearly establishes what is needed for a raise, with specific metrics used to gauge who deserves to be paid better. This avoids any chance for people to be chosen for a raise on the basis of favoritism.

Disadvantages of Competency-Based Pay

One of the bigger problems that arises from competency-based pay is the fact that competition within an organization, while often healthy, can sometimes become unhealthy. Leadership needs to encourage a healthy amount of competition without letting it become toxic.

It’s important for organizations to monitor their environment to ensure that employees are competing in a way that remains respectful and encourages cooperation with one another. Without a sufficient amount of team camaraderie, it can be easy for an organization to begin splintering.

When handled poorly, a competency-based pay structure is also vulnerable to the same sort of favoritism that plagues other pay models, though competency-based pay includes controls that can prevent this sort of favoritism. When specific metrics aren’t put in place to gauge an employee’s performance, it can be easy for leaders to judge certain employees as outperforming their peers even without objective evidence that this is the case.

To ensure that competency-based pay is used appropriately, leaders should use established metrics for judging performance rather than relying on their own intuition.

Competency-Based Pay and Pay Structures

While competency-based pay establishes a means for gauging who deserves a raise – and even suggests the amount of that raise – it only fits into a business’s payment structure in some cases. Some pay structures are consistent with using competency-based pay while other structures are not, so attempting to adopt a competency-based approach will only work in some cases.

Three models of pay structure – the traditional, broadband and market structure – help to highlight how competency-based pay can be adopted into existing business structures.

Competency-Based Pay in Traditional Structures

The traditional salary structure is the second most commonly used form of salary structure. It awards raises to employees based on the metrics an organization settles upon. These metrics may include performance, tenure with the company or both. Typically, raises are small but frequent enough to incentivize employees to continue meeting goals established by the organization.

This structure is perfectly tailored toward accommodating a competency-based pay structure.

Since the traditional salary structure includes performance as a potential metric for gauging raises, the competency-based pay model can be used to determine whether or not a person is performing well enough for a raise. Consistent with the traditional salary approach, organizations need to establish various pay grades that employees can aspire to.

Increasing performance metrics can be established to drive continuing improvement that in turn earns an employee their way into higher pay grades.

Competency-Based Pay in Broadband Structures

The broadband pay structure is among the least used pay structures in the United States, but it’s consistent with competency-based pay.

The broadband structure still uses pay raises, but these raises are fewer and their range spread is further apart. In other words, a person may get pay raises less often and the amount of money they make after the raise will typically fall into a wider range. This gives employers more flexibility in determining how much an employee will make.

Deciding who can get a raise can still depend on metrics, such as performance, as a means of gauging who will get a raise. As such, competence can still be used to revisit an employee’s salary. Because of the wider salary range, employers can reward a higher amount of money when employees perform particularly well and outperform the metrics used to gauge their effectiveness.

Competency-Based Pay and Market Structures

The market-based structure is the most widely used salary structure in the United States, but is almost entirely incompatible with the competency-based approach to payment.

Market-based pay structures are designed to pay individuals based on what employees in similar roles at other businesses are making. While this makes sense from one perspective – since employees get raises to match their payments according to what the competition pays – this can also lead to raises that aren’t necessarily justified on the basis of performance. This may lead to some individuals getting paid more than what they are earning according to objective metrics.

Summary of Competency-Based Pay

What exactly constitutes competencey-based pay is debated by various individuals. However, the general consensus is that this form of pay scaling depends on the skills of those being considered for a raise. While some distinction has been made between competency- vs. performance-based pay, competence needs to be gauged in some way in either model, and the performance outcomes are a concrete way of determining whether someone is contributing sufficiently to their organization.

While managers may gauge competence in other ways as well – such as observations of employees going beyond their expected duties – it is best to have objective metrics by which to gauge competence. By doing so, leaders can prevent the chance that they give raises on subjective observations that aren’t grounded in actual performance.