Paying for knowledge: Does it pay?

A look at the trend toward competency-based pay

Employees’ pay has traditionally been based on the specific jobs they perform. However, another model of pay is gaining popularity in recent years, one based on the capabilities of employees rather than on the characteristics of their jobs. It is often known as person-based pay, in contrast to job-based pay, and goes by various names, including pay for knowledge, skill-based pay and competency-based pay.

There are many advantages of using pay for knowledge. It improves employee engagement and increases workforce flexibility as workers learn the skills to perform different functions. When properly designed and effectively implemented in the right circumstances, pay for knowledge systems can improve company performance. However, effective use of such systems can be complex, raising questions as to the overall benefits to many employers.

Nonetheless, many Canadian firms are adopting these systems for at least some of their workforce. A recent survey of 261 firms revealed that about 22 per cent of medium to large Canadian firms currently use pay for knowledge, with the average user implementing it for about half of its workforce. Industries with above-average usage include wholesaling/retailing, manufacturing, resources and communications, but examples can be found in almost every sector. Neither company size nor union status seems to affect the incidence of pay for knowledge, but company growth is a significant factor, as more rapidly growing firms are more likely to use the system.

The premise of these systems is employees are paid according to the package of skills, knowledge and competencies that each possesses — regardless of the particular job they are doing at any given time. It should be noted that skill-based pay (SBP) and competency-based pay (CBP) are really two distinct types of pay for knowledge systems, with different characteristics and different costs and benefits. Skill-based pay systems tend to focus on the production or service provision level, while competency-based pay focuses on the managerial or professional level.

Skill-based pay for the front line

Skill-based pay systems typically involve the use of a skill grid, which is comprised of a number of skill blocks, usually a dozen or so. The horizontal axis on the grid might include all the different types of functions required to keep a particular production or service process operating, while the vertical axis would represent the depth of skills needed for each function.

The horizontal axis in a chemical plant might include process operator, quality control, packaging and maintenance functions, while the vertical axis would depict the depth of skill that the employee has achieved in each of these functions. When an employee is certified as possessing the specific skills identified in a particular skill block, he is given a raise in base pay to reflect this new capability. Every skill block has a specified pay raise associated with it.

Generally, employees are expected to acquire skills horizontally before increasing their depth of skills. The ultimate goal is to have all employees capable of performing all job functions, thus creating a highly skilled and flexible workforce.

Flexibility is especially beneficial for organizations in which various parts of the production or service process peak and ebb at different times, or for which there is a high degree of unpredictability in the production/service operations or in customer demand. For example, a big order may need expediting, or there may be parts shortages or breakdowns in certain production processes, requiring employees to move from an idle function to one of high activity. Skill-based pay also makes it easier to cover for employee absences.

Although the earliest adopters of skill-based pay tended to apply it to production employees, firms are also applying SBP to service employees. Knowledgeable customer-service employees performing broader jobs can handle a wider range of customer issues without having to pass them off to other employees. An SBP system also tends to be more motivating and enjoyable for employees, increasing employee satisfaction and reducing turnover.

Another advantage of skill-based pay is that it supports the behaviour needed by a firm attempting to practise high-involvement management. The system allows employees to be more effective in decision-making, and to be able to exercise judgment and take quick action when the situation requires it. It allows individuals and teams to be more self-managing. Because of the more efficient use of the workforce, a firm using skill-based pay should be able to operate with a smaller labour force. Part of this reduction will come from a reduction in managerial, supervisory and inspection positions, as well as some specialty positions, such as maintenance mechanics or electricians.

Downsides to skill-based pay

Of course, a skill-based pay system has many disadvantages and will not pay off for all firms. A major disadvantage is that it may give rise to situations where employees are overpaid relative to what competitors are paying for the specific job currently performed. In fact, this is quite likely, especially if SBP has been in place for some time, resulting in most employees achieving the top pay grade. In general, employees operating under a pay for knowledge system earn considerably more than employees not working under this system.

Also, once an individual is at the top grade, what is the incentive to continue learning and updating skills? There must be some system that requires re-skilling as certain skills become out of date. Furthermore, if employees are not rotated through jobs regularly, skills may atrophy. But senior employees may resent having to spend some of their time doing the less-advanced jobs in order for less-senior employees to perform the more advanced jobs.

In addition, pay for knowledge systems lead to increased training costs, both in terms of the cost of training and the need to take employees off the job while training takes place. Skill-based pay is more complex to administer than job-based pay, due to the need to identify and administer certification procedures, which determine whether an employee actually possesses a given skill and is entitled to be paid for it. Adjusting the system to the market may also be more difficult than for job-based systems if there are no other firms with skill-based pay systems to use as a comparison. Moreover, it may not be feasible to apply SBP to all jobs in a given firm, creating a need to maintain both skill- and job-based systems.

Skill-based pay is more complex for employees to understand, and not all employees may have the ability or desire to learn multiple jobs. Unions may resist pay for knowledge systems because wages are based on skill levels, not seniority. Finally, pay for knowledge systems may appear to be inconsistent with some pay equity laws, which generally stipulate that employees should be paid for what they actually do rather than for their capabilities. However, most pay equity laws do allow for factors such as skill levels and relevant experience to be factored into the pay equation, as long as these are applied consistently to both male and female employees.

Given all of this, when does a skill-based pay system pay off for an employer? The key factors are a high need, hence a high payoff, for flexibility, and the extent to which the employer is willing and able to practise high-involvement management. High involvement management entails a whole set of inter-related human resource practices, including extensive training, open communication and information sharing, participative management, and pay practices that tie employee goals to those of the firm, such as profit-sharing.

Competency-based pay for management

Many firms are attempting to apply the concept of pay for knowledge to their professional and managerial personnel through the use of competency-based pay systems. These systems are much more problematic than skill-based systems and virtually nothing is known about their effectiveness. This is partly due to the enormous confusion and lack of precision about just what constitutes a “competency-based system.” (For more on competency-based pay for managers and professionals, go to www.hrreporter.com, click on “Advanced Search” and enter Article #3707 or click on the related article link below.)

Overall, given all these problems, it is not at all clear that competency-based pay — unlike skill-based pay — is a practice from which many employers would benefit.

Richard Long is a professor of human resources management at the University of Saskatchewan in Saskatoon. He is the author of Strategic Compensation in Canada, published in Toronto by Nelson Thomson Canada. He can be reached at (306) 966-8398 or [email protected].

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