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Terms and Definitions

What is competency-based pay?

Updated: May 22, 2024

Competency-based pay is a structure that employers use to base an employee’s compensation on skills, knowledge, and experience rather than solely on their job title or tenure. This approach is designed to incentivize the personal and professional development of employees by rewarding individuals when their growth directly benefits the business.


More about competency-based pay

Companies are always looking for innovative ways to motivate, empower, and retain employees, beyond providing the basic benefits and perks employees ask for, and competency-based pay is becoming an increasingly popular option. But before introducing any changes to an organization’s compensation structure, employers should be prepared to clearly communicate to their employees when the change will occur, who it will affect, and how the coming change is to their advantage.


Companies may want to consider a competency-based pay structure for the following reasons.


Fuels ambition

Competency-based pay can help employees broaden their horizons by empowering them to discover innovations that can make business-wide improvements rather than narrowing their focus on the next job title.


Fosters self-discovery

When properly executed, a program centered around competency-based pay encourages employees to discover new areas of interest related to their company, their career, and even their personal goals.


Independent thinkers can become thought-leaders

Giving employees the chance to “flex their muscles” and learn new skills that contribute to their company’s success fosters a work culture that values learning and growth. Furthermore, it sends the message that each employee has unique value, quantifies individual contributions, and can help organizations discover emerging leaders.


Improves pay transparency

Competency-based pay can also increase transparency around employee compensation. Employees are able to better understand what their earning potential can be and which skills they need to acquire in order to reach (or exceed) a target pay level. This generally leads to less turnover.


Reduces turnover

When employees realize their employer is a source of opportunities for professional and personal growth, they’re less inclined to explore other job opportunities. And if they do leave, they’re more likely to return to the organization after learning even more skills.


That being said, competency-based pay isn’t a magic wand, and there are risks that companies should consider if they want to use this strategy successfully.


The ambiguity of change

When a company introduces competency-based pay to their organization after using a more traditional pay structure, it’s natural for employees to have concerns about this new reward system. Some may feel it’s overly complicated, vague, or even a little unfair. To avoid this, employers should create (and add) a clearly defined compensation policy to their company’s employee handbook, and communicate it to all employees well in advance of the change.


Poor implementation

The new pay policy should be introduced (or “rolled out”) to all employees through the normal channels of communication an organization uses. Moreover, employers may want to set up a forum where employee concerns can be addressed (this could be online or even during a company town hall). Finally, employers should keep in mind that competency-based pay may be a new concept to job applicants and newly hired employees and should consider introducing such policies in their candidate interview strategy, and reiterating them in any company offer letters.


Measuring impact

As an organization shifts from a traditional pay system to competency-based pay, it can be unclear how to gauge how well this new approach translates to productivity. For example, how do you measure if an employee’s new skills translate to increased retention? One method is through stay interviews.


Depending on a company’s goals and current culture, a competency-based pay model might be worth a closer look. If implemented thoughtfully, it could have benefits for both the employee and the employer. Ambitious employees have the opportunity to be rewarded for embracing their passions and taking their work to a new level. And it so happens that it also brings new opportunities for innovation and company growth to the business as a whole.


Using competency-based pay in a sentence

“I was pretty concerned last year when HR announced our communications firm was moving to a competency-based pay system, but in just the first few months of the change, I’ve had so many opportunities to learn new skills and influence how much I earn, I wish we’d done this years ago!”

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