Skill-Based Pay -- Topic Information

This material is reproduced from the book, Skill-Based Pay: Design and Implementation, Copyright © 2002, Donald F. Barkman, The Business Center, Oak Ridge, TN, All Rights Reserved. A single copy may be made for the reader's personal use. For additional information, please purchase the book. Thank you.

INTRODUCTION

Skill-based pay (SBP) systems are like snowflakes -- they share some common characteristics, but each one is unique. We will explore the foundations which underlie skill-based pay and many of the options which are available.

Designing skill-based pay is not something which can be done by copying someone else's system. Every company has its own unique products, people, and work processes. What works in one organization may or may not work in another. Much can be learned by studying what has succeeded or failed with other companies, but a sound understanding of the many variables and principles involved in SBP is essential to an SBP design.

This book is the result of my experience with SBP design. It also includes information from researching the literature on skill-based pay. Companies are doing SBP and are talking about it. However, little has been committed to a practical written form which can guide would-be designers.

SBP, like many other workplace innovations, can be subject to the "let's-do-it-ourselves" approach. Organizations must do SBP themselves, but when they do it alone without knowledgeable assistance, they run the risk of repeating mistakes they could have avoided. Getting competent outside assistance is one protection from this problem.

I hope this book provides an inexpensive way to provide a starting point for organizations interested in SBP. It certainly is not sufficient to guide an entire design. There are simply too many variables to explore each one fully, or to identify all the possible combinations which could exist. This book can identify aspects of SBP to be considered in a design and suggest some possible approaches.

Skill-based pay has a purpose -- to promote learning. It is not the only way to compensate employees and it is not a system for all situations nor one which lasts forever. It is very useful in promoting new learning. This accounts for its popularity in start-up organizations and its association with organization redesigns. SBP systems mature as the majority of participants either reach the limits of the system or coast to a stop somewhere along its path. Paying for learning may eventually give way to requests to pay for performance based upon team or total organization results. If higher skills create higher performance, this is a foreseeable development.

Developing a skill-based pay system is not a linear process. The system requires that many items be balanced. Very often what looks promising as a way to handle one part of the system becomes impractical when meshed with other pieces. Original ideas need to be reworked again and again. Designers of SBP can expect to travel the same territory several times before a system takes final shape.

The best systems are deceptively simple. That simplicity is usually the result of untangling a great many hidden complexities. Like snowflakes, a good SBP system is a wonder to behold, but it's hard to tell what went into creating it. This book can help melt away some of that mystery.

Most skill-based pay systems have been instituted in manufacturing and processing plants. SBP is commonly found with team systems or other participative settings. More is known about these types of installations. For that reason, those environments will be the primary focus of examples and discussion in this guide. Many of the ideas and cautions for those systems can be extended into other work environments -- see the section on "SBP in the Office."

Skill-based pay is an incentive to learn for the benefit of the individual and the organization. For many people, learning brings an intrinsic satisfaction from mastering new skills. Rewarding learning monetarily can support that intrinsic motivation with extrinsic reinforcement. However, care should be taken that all learning is not equated with pay.

Employees should expect to learn as part of living. Administered incorrectly, SBP can encourage people to expect all learning will be compensated -- "You want me to learn it, pay me for it." There is a delicate balance between encouraging and recognizing learning with pay and creating a tit-for-tat mentality in an organization. Keeping learning broad and expectations high can help avoid the problem. Trying to assess minute skills and provide pay in small increments may contribute to the problem.

LEARNING THE LANGUAGE OF SBP

In view of the differing use of similar terms, the following definitions are ones we will adopt.

Many of these compensation devices can be combined with each other to pay a single person or to create interlocking compensation systems for different groups within a larger organization.

The major components of a skill-based pay structure include: skill blocks, progressions, and tiers. We'll examine each of these more closely before we proceed.

Skill blocks are the distinct, major units of learning for which an employee earns additional compensation. A block may contain a variety of individual skills within it. Each of these skills may be learned and evaluated separately, but pay is earned only when the total set of skills for the block is mastered.

ADVANTAGES

SBP is adopted because it provides advantages over other types of pay systems. Intended advantages are related both to business performance and employee morale.

Intended advantages include:

a) increased ability to focus personnel on problem areas and avoid idle time waiting for problems to be fixed by others;

b) flexibility in position coverage enabling work teams to cover for absent members for short periods of time;

c) faster adaptation to changes in technology and product mix due to greater skill base;

d) improved participation in problem solving and other participatory activities because of wider perspective on total work flow;

e) lower overall staffing levels caused by incorporation of specialized functions (e.g., maintenance, quality, supervision) into team skill requirements;

f) higher commitment to organizational goals due to broader perspective;

g) increased self-esteem from development of personal talents;

h) improved self-managing abilities;

i) higher minimum hiring qualifications since employees are required to progress through a multiskilled job;

j) overall increases in total productivity.

Organizations using skill-based pay report gains in flexibility and versatility along with enhanced employee motivation and team effectiveness. Accompanying this is an increased use of technology and increased output per hour. About two-thirds of firms in the ACA study reported moderate success in reducing overall compensation costs.

Systems which succeed have good local management support and often originate in the local operation as opposed to being mandated by the corporation. They place emphasis on employee growth and development and honor a commitment to thorough training.

DISADVANTAGES

Skill-based pay also brings with it other requirements sometimes perceived as disadvantages. As disadvantages they are unintended, but as requirements, some are unavoidable.

a) higher individual pay rates: higher skill levels may command higher marketplace wages, and certainly do in the minds of employees; these can be offset by lower total unit costs due to reduced staffing and/or higher total productivity;

b) training investment in both time and money for: learners, instructors, program design, materials, administration, foregone production, errors due to multiple learning curves;

c) skill assessment difficulties including time to conduct assessments, training and knowledge of assessors, poor assessment methods, inadequate peer input, speed of evaluation;

d) difficulty in identifying comparable jobs and wage rates with other employers;

e) administrative complexity and time requirements to track training and evaluation dates and completions;

f) managing rotations within work groups to provide cross-training and to keep skills refreshed;

g) training investment required in the form of overtime or additional employees to provide time for training and learning;

h) acquiring learning to increase pay without concern for true competency;

i) personal reluctance to learn;

j) replacing outdated skills with new ones once original learning progression has been fulfilled and pay earned;

k) "topping out" at the highest pay rate with no more increases;

l) employees' desire for sharing in rewards of high organizational performance created (in part) by increased employee skills.

WHY DO IT? WHY NOT?

Adoption of skill-based pay may be done for a variety of reasons. The system stands the greatest chance for success if it is founded on solid business needs. SBP should be designed and measured to demonstrate that it reduces total organizational costs. If it does not do this, then it will eventually be replaced by a system that is perceived to do so.

A caution is in order. Skill-based pay may likely result in individual pay rates that are higher than pay for similar positions in other firms not using SBP. Organizations using SBP have reported the following rates:

a) starting rates at the 63rd percentile compared to local rates,

b) average rates at the 75th percentile compared to local rates and at the 65th percentile for their industries,

c) top rates at the 90th percentile compared to local rates and at the 80th relative to their industries.

This can be deceptive. The cost of labor is a function of the wages paid, the level of staffing, and the productivity of the workforce. SBP can more than offset higher wage rates by higher productivity.

It has not been clearly demonstrated that overall staffing levels are always significantly changed (either up or down) by using SBP. It has been difficult to document productivity and staffing improvements because finding comparable SBP and non-SBP operations is difficult. Some organizations have measured reductions in staffing of 10% due to removal of backup "utility" workers. Others have measured 30% productivity gains and 30% cost reductions in work systems using SBP as a component.

The key relationship lies between SBP systems and total cost per unit, not just labor costs. Greater efficiencies, quicker problem solving, and less wasted time and material can create significant gains in other cost categories to offset higher labor rates. This is one intent of SBP, not a guarantee.

The intent of SBP is to provide an incentive for employees to learn and apply new skills to increase organizational productivity and profitability while fostering high commitment to organizational goals. With a good system, everybody wins!

Why not use skill-based pay?

Skill-based pay adopted because "everyone is doing it" has a marginal chance for survival. Since pay is an outlay of money by the company, this rationale will not support a system once competitive cost pressures arise.

SBP adopted because it is "good for the employees" or will cause "higher morale" is well intended. However, this logic will not sustain a system that does not demonstrate its business value. In addition, applying SBP to some groups and not others causes resentment by those not included.