If you’re looking to attract and retain top talent while motivating existing employees to learn and develop, skills-based compensation may be a payment strategy to consider.

This model is attractive to experienced candidates looking for competitive compensation for their sought-after skills. It also serves to motivate and encourage continuous learning and upskilling within organizations, fostering a more adaptable and engaged workforce.

The potential benefits are clear, but how do you go about implementing skills-based compensation, what kind of results can you expect, and what are the pitfalls to look out for? We've laid it all out for you below.

Key Aspects of a Skills-Based Compensation Model

Organizations with skills-based compensation models pay employees a salary based on their specific skill sets, instead of their job titles. For example, a manager with proven, specific skills would earn more than a manager with fewer skills, even if both people are employed under the same job title and have had identical tenures at the same company. Furthermore, the less experienced manager would receive a bonus or pay raise once they’ve acquired new skills.

As HR experts have commented, “this model is a compelling alternative to traditional compensation strategies, with the potential to significantly enhance an organization’s competitiveness and overall success.” But shifting to this model can be a significant undertaking. If your organization currently has more of a traditional model, implementing a compensation-based strategy may require several changes. Consider the following steps:

1. Skills Identification

The first step in implementing a skills-based compensation model is to identify the key skills that are valuable to your organization. These skills can include technical skills, soft skills, and critical thinking abilities. Employees can work with their managers and function leads to learn how to recognize and articulate their key skills.

2. Competency Assessment

Once key skills have been identified, employees' proficiencies in those skills need to be assessed. This can be done through formal performance evaluation processes like performance reviews, skill tests, or team feedback evaluations. Less formal evaluations, like peer feedback, can also be considered.

3. Skills Hierarchy

A skills hierarchy defines how proficient employees are in a given skill compared to their colleagues. Defining a comprehensive skills hierarchy within your organization is a key step, as it allows for clear and consistent compensation across skill tiers.

4. Career Pathing

Employees should have a clear understanding of how acquiring new skills will help them progress within the company and earn potential salary increases. Make sure to share opportunities for building new skills and advancing—consider using an internal job board or a talent marketplace.

5. Transparency

It’s important to be transparent about skills-based compensation. Communicate regularly and clearly so that employees have a clear picture of the skills that will be rewarded, the levels of proficiency that are required, and the potential for higher remuneration.

6. Learning and Development Opportunities

No skills-based compensation model is complete without a comprehensive learning and development strategy. In fact, nine in ten employees state that they want their employer to offer more training courses to help them develop new skills! Be sure to offer opportunities to develop the skills required for advancement. This can include training programs, eLearning courses, secondments, and mentorship opportunities.

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What to Expect When Implementing Skills-Based Compensation Models

Once you’ve successfully implemented skills-based compensation at your organization, you can expect to see numerous benefits. As with any payment strategy, however, these must be balanced with the inevitable drawbacks.

Skills-based compensation will be most successful if its merits and disadvantages are carefully weighed against your organization's exact needs.

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The Benefits of Skills-Based Compensation

Increased Employee Engagement

84% of employees agree with the statement “learning adds purpose to my work.” So, it's no surprise that encouraging continuous learning and development through skill acquisition leads to higher job satisfaction.

Enhanced Talent Retention

Recognizing and rewarding employee development can foster loyalty and reduce turnover. This is especially important in the rapidly changing employment landscape. Statistics show that the median average worker only stays with an employer for less than four years, and average tenure is trending down.

Improved Workforce Agility

A skills-based payment model necessarily increases visibility over specific skills within your organization. This can help your organization more effectively adapt to market changes. Being able to deploy staff across a business instead of limiting them to a specific department is invaluable, especially in unpredictable industries or times of economic uncertainty.

More Competitive Compensation

Rewarding employees based on their skills and contributions, not merely their job titles, can increase employee satisfaction with their remuneration. Instead of feeling like a cog in a machine, employees can see a direct correlation between their level of experience and their compensation.

Potential Skills-Based Compensation Drawbacks to Look Out For:

• Higher pay rates for specialized skills can increase overall labor costs and have significant financial implications for your business.
• Recruitment, training, and ongoing management of a skills-based system require additional HR resources and effort, causing larger administrative overhead.
• Designing and implementing a skills-based compensation structure can be a lengthy process and require a substantial time investment.
• Staying within budget is crucial, but transitioning to a skills-based pay model can present unexpected challenges, especially if employees are more skilled than anticipated.

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Key Considerations for Making Your Skills-Based Compensation Strategy a Reality

If you decide that a skills-based compensation model is right for you, there's plenty you can do to maximize the benefits and steer clear of challenges.

Be sure to create clear policies and procedures so that employees have peace of mind that their progress will not be overlooked. It’s also crucial to carry out a comprehensive impact analysis and to scenario test how any changes to your compensation model—like rises or bonuses in one area of your business—will affect your organization overall.

Naturally, you’ll also need to build rules and caps into compensation tiers to ensure that you stay within budget and that your rewards ecosystem aligns with your organization’s goals.

Compensation and skills solutions from PeopleFluent can help with all of the above. PeopleFluent Compensation management software empowers you with configurable tools to centralize compensation planning. You can continuously configure workflows to meet different needs throughout the year, allowing you to keep up as your workforce develops. Planning detailed compensation scenarios to assess impact across your business is a breeze too. Combine this solution with PeopleFluent’s Stories—which provides a comprehensive development platform to help you eliminate skills gaps—and you’ll have everything you need to bring your skills-based compensation strategy to life.