What is Competency-Based Pay?

By Abhishek Kathpal | Updated 16 August, 2022

The ultimate objective of any payment system is attracting, motivating, and retaining good employees. There's no one-size-fits-all compensation system for companies - only what works. However, competency-based pay is gaining traction in organizations as the need for customer retention increases.

What is Competency-Based Pay

Competency-Based Pay meaning and definition

Competency-based pay is a performance-based compensation model where workers are paid based on competencies - skills and knowledge for performing specific tasks - rather than any hierarchical system. It is modeled to drive motivation in employees by recognizing their inputs and rewarding them accordingly. Employee satisfaction and high customer retention are critical features of this model as it considers what each individual has to offer instead of their job titles.

Competency-Based Pay vs. Traditional Pay?

The traditional pay system involves allocating grade levels to positions based on certain set criteria. Emphasizing hierarchy paves the way for evaluating pay equity because comparison of staff earnings is easier. Although employees may not be delighted with their pay, they won't consider the structure to be biased, giving it an objective appearance. The traditional model also makes the market and staff salary comparison easier using surveys. Total control of compensation in a company, as seen in this model, gives companies criteria to evaluate if their employees are being overpaid. This centralized control makes budgeting relatively easy as managers can predict salary expenditures effortlessly.

Conversely, competency-based pay, informally referred to as Paying the Person, gives control of how much compensation an employee receives to the employee. With no concern for stratification, compensations are rolled out according to the inputs from individual workers.

The traditional compensation model, unlike its counterpart, fuels inefficiency. Workers channel efforts into moving up the ladder to receive higher pay instead of working diligently to achieve goals. Although the payment by competency does not have those disadvantages, it itself is not without discrepancies. It leads to high pay rates because employee salaries increase as they update their skills. Companies can ensure this salary increase does not affect the overall payroll by using their fewer but qualified staff more effectively. Also, since most available survey data are related to the traditional payment systems, salary comparison and market comparison may be difficult.

Designing Competency-Based Pay System

Identification of vital behaviors, skills, knowledge, and other personal attributes gives a clear picture of the work that needs to be done. With this analysis, a clear connection between a job description, candidate's skills, and the optimum job performance form the basis of a payment system, and effective employee management is determined. Based on the analysis result, skills, qualifications, and attributes needed to carry out the tasks should be identified to develop assessments with which these competencies can be measured in employees. Using survey data, companies can then price the competencies to establish a salary structure for employees depending on the skills they use on the job.

What Are the Benefits of Competency-Based Pay?

Employees are more engaged and motivated when rewarded for their competencies as against the use of titles - subordinates can earn more than superiors based on proficiency. In this model, organizations get the most out of employees through constant personal development and loyalty. In addition, competency-based pay systems are more equitable, as they reward employees based on their skills and abilities, not seniority or other arbitrary factors. Companies can also retain their best talents and reduce turnover rates, avoiding the cost of recruitment.

The Employee Angle

The key to retaining employees might be recognizing their inputs and compensating them accordingly. Since competency-based pay is not conventional, employees must be ready to meet up with such systems. Learning about the skills and knowledge a company seeks is the first step candidates must take in their job search before demonstrating how they can offer them. Keeping a portfolio of your work and highlighting your accomplishments in each area is an excellent way to start. Current employees must be willing to take on additional responsibilities to broaden their skills or risk falling down the pecking order.

Other Pay Systems

Merit pay is extra compensation for outstanding employee performance used widely because of the general belief that pay motivates people and increases productivity. Companies can achieve this aim if the pay is accurately linked to actual performance. The major demerit with this pay structure is that employees keep receiving extra compensation for past performance even if there has been a drop in recent years.

Practice-effectiveness pay, on the other hand, is a combination of fixed and variable payment systems. It combines salaries with bonuses depending on how employees achieve success in certain areas. For example, if a company wants to measure customer satisfaction, customers are given a customer-satisfaction survey to determine how much an employee meets the demand and is rewarded for it. However, companies should be careful not to encounter the same challenge in the merit pay system by rewarding teams instead of individuals.

About the Author

Abhishek Kathpal

Abhi is the co-founder at Longlist.io. Funded by US based OnDeck, Longlist is currently enabling 50+ businesses to increase their candidate and client reach outs, automating the workflow across stages.