Why More Companies are Turning to Skill-Based Compensation Programs

Published: December 2019


Transforming your business to compete in the digital age may require rethinking your rewards system. Many tech firms are implementing programs that reward employees for acquiring hot skills.

Traditional rewards models are under pressure due to the disruptive nature of technology. Employees with hot skills are in high demand as companies plan for current and future skills gaps in their organization. One way to ensure your workforce has the skills it needs today and into the future is to adopt a skill-based compensation program, which encourages employees to acquire new training for specialized skills by offering temporary bonuses.
Manufacturing companies are no stranger to skill-based compensation programs, having utilized them to help advance employees’ skills throughout various sections of a factory. Now, skill-based compensation systems are grabbing the attention from technology companies that want to evolve their workforce to meet rapid advancements in technology. Many of these organizations need to expand headcount to fuel their growth strategy and acquire employees with knowledge and mastery of the latest technological advances. By adopting a skill-based compensation program, businesses are better able to upskill their current workforce rather than rely exclusively on hiring new talent with desired skills.

Skill-Based Compensation vs. Traditional Rewards Models

Broadly speaking, compensation is primarily set by benchmarking pay against comparable jobs among a custom peer group. Recruiters are often given a pay range, and along predetermined ranges, employees are being hired.  Where someone lands on that range often has to do with their experience as well as their ability to negotiate. Once an employee has started with a company, the process of determining pay and matching the current skill level is less clear. It is not uncommon to have very well-paid, longstanding employees whose current skill levels and pay seem to be out of sync.
Currently, the vast majority of companies go through an annual performance process that often consists of a merit increase, bonus review and a talent review. For most employees, the performance process ends with a modest pay increase (it has stayed around 3% in the United States for decades) and a bonus that may, or may not, meet the individual’s expectations. For a few employees, the annual processes may come with a promotion and a significant higher base pay or higher overall salary package.
Obtaining additional education, training and certification is not always compensated in the annual review process. Generally, additional training has a small impact on an individual’s career advancement, unless it’s a university degree or major certification that is required after multiple years of study. 

For an employee, a promotion is probably the best opportunity to receive a substantial salary increase. Not surprisingly, a lot of employees are more concerned about advancing along the career ladder than improving their skills if the company’s compensation system isn’t set up in a way to recognize and reward for upskilling behaviors. Sometimes, companies believe promoting a very talented technical individual contributor is the only way to substantially boost the individual’s pay and keep them with the company. However, not all employees have the desire or skills to manage a team. That’s why it’s important for companies to have a compensation system that rewards employees that acquire new skills to encourage their personal development and to ensure the company has talent that is keeping pace with changing technology. We should note that companies also need to maintain a job architecture that enables lateral career moves instead of only moving vertically up the chain. You can learn more about creating a flexible job architecture in our whitepaper here.

Six Steps to Prepare for a Skill-Based Compensation Program

Before moving to a skill-based compensation model, a few steps need to be observed.

Identify the skill profiles you have in your company. We differentiate between three different skill profiles as outlined below:
  • Breadth: Being able to perform in different work settings and environments and have transferable skills that can be used in an agile work environment. In the past, this was oftentimes associated with a unionized environment where skills to work across different machinery were rewarded. In today’s digital world, this may be comparable to a full stack developer — someone with broad technical skills that can work across multiple platforms. This could also be a software architect who understands how different aspects of an application interconnect. 
  • Depth: Becoming a deep expert in a subject matter. An example today would be a software engineer who develops deep understanding of one programming language but also is able to write a code that is non-repetitive, efficient, maintainable and dependable.
  • Self-management and management of others: Optimizing self-management or management of others; for example, software development teams that organize themselves effectively and efficiently. In an agile software development environment, the developers’ teams not only ensure information flow between themselves but also to the outside world (e.g., the client or the business sponsor). This can also mean the team is able to absorb new business requirements that may impact various aspects of the development process.
Identify the specific skills your company needs. As a first step, the business needs to assess their skill requirements and measure their current skill base against their internal benchmark. This can be done internally or with outside help. Figure 1 shows the skills that our technology survey clients identify as hard to attract and retain by career level. Not surprisingly, it’s the “specialist” career level where most of these skills are in highest demand.

These hot skills require a substantial amount of training in many cases. However, it’s not realistic to expect many employees to embark on a multi-year rigorous training schedule for skills that are outside of their core job duties. Therefore, employees with adjacent skills that complement desired new skills will have an easier time acquiring new knowledge. For example, it may be possible to train a statistician in the concepts of machine learning algorithms and programming languages as the statistician was surely exposed to some of the programming languages in their university training. A certification program can build on these skills.

Assess your current workforce. Once you take time to evaluate the current skills among your workforce, you’ll be able to identify and map out skills gaps. When considering a skill-based compensation model, it may make sense to look outside your organization to determine how readily available talent with the skills you need are and what it will cost to bring them into the organization vs. upskilling and retraining your current workforce. If there’s a need for hiring new talent, there a few things to be considered:
  • How much will the talent cost to the company?
  • Will there be compression issues to hire new talent with the skills you need?
  • What is the risk of losing new talent in the next two years?
  • How much will it cost the company to train employees with adjacent skills to get up to speed instead of hiring new talent?
Establish a skill-based bonus system with internal and external certification. Training and certifying employees are key to a skill-based compensation model. This can be done through your own training departments or with the help of external online certification centers or universities. Traditional manufacturing companies that used skill-based compensation models had an easier time identifying the training employees needed as they were often geared around a process and machinery. In the digital world, determining the necessary training requires an in depth understanding of your business goals in the future and what skills are needed to meet these demands.

Determine which path of skill-based compensation to follow. When moving to a skill-based compensation program, a company can choose between a more traditional path or a progressive one. The traditional approach, as illustrated in Figure 2, combines your pay band methodology with skill-based compensation by allowing employees a better positioning within the pay band. However, in a traditional pay band, there are usually two pay bands that overlap. This means that salary points in the upper quartile of the lower pay band overlap with the lower quartile with the higher pay band. 
The basic pay approach as shown in Figure 3, is a more progressive version of the traditional approach. Everyone gets the same basic pay and any movement on the pay band is due to someone’s skill level and the deployment of these skills. Someone with many valuable skills and the deployment of these skills can reach the basic pay level of someone on a pay band several grades above. In a changing work environment with more highly skilled specialist and fewer managers, this approach can make sense with specialists able to advance themselves financially by acquiring and deploying critical skills. This will prevent employees from seeing promotion as the only way of significantly improving their earning potential.

Establish a monitoring system. Establishing a monitoring system for a skill-based compensation program is essential to ensuring that digital skills move along with the development of the technology. This means that re-certification does not simply ensure there is a skill upkeep but that skills move along with the technology. In some instances, technology may become obsolete and the skill may not be worth anything to the company. This also means that the company should stop paying a bonus to employees with this skill. Alternatives can be offered that may require a different certification.

Next Steps

Skill-based compensation is designed to drive digital skills into an organization, strengthen the individual contributor role and allow companies to adapt to technology changes. It also takes pressure off employees that feel the only way for them to advance in the organization is to seek higher management roles, thus allowing some specialists to focus on developing technology, products and services that their customers want.

However, companies shouldn’t implement a skill-based compensation program without being prepared to invest time and resources into training managers and HR leaders properly and communicating the program to employees. Without laying the proper foundation, the new compensation model won’t be effective or receive buy-in from employees and managers.
In the era of rapidly evolving technology, companies can benefit from adopting a skill-based compensation program as way to ensure they are maintaining current and cutting-edge skills in their organization and upskilling current employees instead of constantly replacing the workforce in a competitive hiring environment. However, adopting a skill-based compensation program requires constant upkeep. Given the prediction that in 15 years 40% of jobs may be replaced by artificial intelligence, new compensation models that are linked to innovation may lead the way.
To learn more about how to implement a skill-based compensation program, please write to rewards-solutions@aon.com

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