Skills Based Compensation: What is all the fuss about?
August 2023
Context
The advent of AI and other new technologies is rapidly changing how work gets done in organisations. This is having, and will have, significant implications for the jobs of many employees. While some jobs will inevitably become redundant, for the majority, it is likely to result in significant change. For organisations and employees to adapt and support the new ways of working, it is going to be critical for employees to acquire new skills and for organisations to support their employees in doing so. It is likely that the successful organisations of the future will be those who can adapt and cultivate a culture of continuous learning and agility – part of becoming a “skills based organisation”.
The days of the “static” job with a defined list of responsibilities are numbered. This has been the case for some time in many industries and functions (e.g., look at the evolution of software skills over the last 20 years and how this landscape has changed). What’s different now is that the changes which AI will inevitably drive will result in significant changes in how work gets done across nearly all businesses and functions. Change is coming, and as the cliché says, it will be constant!
Organisations have significant work to do in preparing their organisations to take advantage of these new technologies. Everything from organisational re-design to addressing the people change and upskilling implications. To become a skills based organisation, skill models will have to be designed, tested, piloted and implemented. Which brings us to the reason for writing this article. Do we need to re-think the traditional reward model in order to support the objectives of a skills based organisation? But what exactly does this mean, and what could it look like? In this article, we attempt to provide a basic explanation and an example of such a model.
What is Skills Based Compensation?
Under a Skills Based Compensation model, employees are essentially rewarded for achieving levels of competence / capability on a specified list of skills. For example, employees at a certain level could receive the same core base salary, with additional increments being awarded based on competence / capability on a defined list of relevant skills.
As the employee’s capability level on this list of relevant skills increases, their salary also increases. We have set out a simplified example below:
It is clear that there are a number of significant challenges to operationalise this pay model:
The organisation needs to have defined the skills that are relevant within each business area / division / function / discipline
Decisions need to be made around what “reward value” to attach to each skill? At the time of writing this article, we are not aware of any mainstream compensation survey provider which produces market data broken down by skills, although this may very well change in the future
Execution of this model will require significant manager capability as well as employee training and education
It is worth noting that examples of such pay models in action already exist. For example, in manufacturing operations, we have seen many organisations implement skills based pay models whereby pay increments are applied where operators upskill and take responsibility for managing and fixing some of the problems which arise on the production line - skills which previously would only have resided with maintenance engineers or technicians. We have also seen it play out within the tech sector – though not always as explicitly as the example laid out above.
How does it differ from Job Based Compensation?
Under the traditional Job Based Compensation model, compensation is based on the job responsibilities and the individual’s level of proficiency and performance in that job. The list of responsibilities, skills and experiences are typically defined in a static or rigid job description.
The base salary for the role is generally determined by reference to the responsibilities of the role and competitive rates of pay for similar sized roles in the external market. Organisations will then adjust this benchmark salary to take account of the level of proficiency and performance of the individual.
Of course, it is possible that the decision around an individual’s pay positioning may implicitly reflect the skills which the employee has acquired. An employee who has mastered more relevant skills compared to peers may well be achieving higher levels of proficiency and performance in the role, which is likely to be reflected in their pay positioning.
But where an organisation deliberately decides to transition to a skills based organisation, is the linkage under the traditional compensation model sufficient to support the change? Does it sufficiently incentivise employees to acquire and master the required new skills?
Does Skills Based Compensation have a future?
Undoubtedly there is much work to be done for an organisation to become a skills based organisation. It will take time and significant effort for an organisation to:
Define which skills are relevant in each area of the business and how this may change over the coming years
Develop a capability model which allows employees and managers to rate themselves relative to these relevant skills
Build or acquire the learning and development tools and programmes needed to help employees acquire new skills
Enhance manager and employee capability to adapt in this new skills-based environment
Even when all of this work has been done, there are significant decisions to be made about how an organisation will redesign its compensation model. Examples include:
What is the market rate of pay for each skill?
Does the organisation pay for lower levels of competence on skills and how would this work?
Is there a limit to the number of skills the organisation will pay for?
How do you ensure consistency around how managers apply this framework across the organisation?
All of the above is undoubtedly a little daunting, but given the complexity of moving to a skills based organisation, the most likely path is that organisations will phase in such change over time. At Citris we believe that the future of reward will gradually evolve to a Skills Based Compensation model. Why? Because the productivity gains achievable by businesses in adopting new technologies and ways of working are likely to be so compelling (or the consequences of not doing so are so severe) that executives will do what is necessary to prioritise the upskilling of the organisation. To do so without adapting the compensation model would likely delay the pace at which change, and results, can happen.
The decision to become a skills based organisation comes well before any decision about compensation philosophy. We believe that the latter is important to sustain and support momentum on the former. For organisations who adopt this path, there will be much work to do and it is likely that any such change would be piloted in areas of the business where more urgent change is needed. In the short to medium term, the most likely pathway for many organisations will be a hybrid approach whereby both models will be needed, or at least until such time as the skills based approach becomes more mainstream and is supported by robust reward models and data.
Please reach out to us at Citris if you’d like to discuss further. We’d love to hear your views!
