What Is Skill-Based Pay? (With Benefits And Drawbacks)

Updated 30 September 2022

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Skill-based pay is a beneficial compensation model for both employees and organisations. Unlike job-based pay, skill-based pay considers a person's skills and experience, rather than their position or title. If you work for a company seeking to hire more skilled professionals or if you are a candidate looking to increase your compensation, it can be beneficial to understand how skill-based pay works. In this article, we define skill-based pay, explain how it differs from job-based pay, share its benefits and drawbacks and look at a few industries where this model works well.

What is skill-based pay?

The answer to the question 'What is skill-based pay?' is that skill-based pay is a model of compensation in which a person's skills and experience determine their salary. For example, under the skill-based pay model, a team lead with several decades of management experience may earn higher compensation than a less-experienced candidate applying for the same position. The goal of skill-based pay is to attract candidates with more experience while encouraging professionals within the company to continue their self-development and training.

Skill-based pay vs. job-based pay

Here are the main differences between skill-based pay and job-based pay:

Purpose for hiring

Skill-based pay is often suitable for companies that want to build cross-functional teams, which involve employees from different functions or disciplines completing tasks together. This model may also work well for companies that want to introduce more adaptability and self-improvement into the culture. Companies that want to control costs and maintain objectivity may prefer job-based pay. This is because they can pay the industry or company average for a specific position, rather than paying more for an individual with more skills.

Organisational structures

Skill-based pay takes inspiration from flat organisations, a business organisational model with few or no middle management. This means it ranks individuals according to their level of expertise rather than their job title. Meanwhile, job-based pay takes inspiration from a hierarchical organisation, an organisational model where almost everyone has a supervisor or team lead. This compensation model ranks people according to their title, seniority and leadership, which results in a more traditional and authority-based workplace culture.

Area of emphasis

Skill-based pay focuses on a person's abilities and experience in a particular domain when determining their pay. Job-based pay, however, focuses on a person's titles or responsibilities. This means that rather than looking at a person's skills, the company determines the person's salary based on their responsibilities.

Incentives for employees

Since skill-based pay emphasises an employee's knowledge, there is a greater incentive for professionals to train, improve and learn new skills. Companies can benefit from this because employees may continue to grow within their roles. For job-based pay, candidates are usually seeking promotions and the opportunity to handle more responsibilities to increase their pay. This model can also benefit companies because they can pay the same salary per position until an employee moves to a higher-level role.

Evaluation methods

The skill-based pay model evaluates professionals on several factors, including experience, certifications and skills. Typically, the more skills and credentials a candidate has, the more likely recruiters are to offer them a higher salary. In contrast, the job-based pay model evaluates professionals on their responsibilities and overall work experience. Companies using this model are usually looking for candidates with experience in high-profile companies and having completed notable projects and initiatives.

Benefits of skill-based pay

Here are some advantages of the skill-based pay model:

Leads to higher employee retention rates

Companies may increase the average employee tenure by investing in more training resources and skill-based pay models. This is because skill-based pay encourages employees to continue their education and improve their abilities while remaining in their positions. As a result, companies may be able to maintain their workforce size and have higher employee retention rates. If you keep learning and improving yourself in a company that has a skill-based pay system, you are likely to stay there for a long period of time with regular increments in your salary.

Promotes a culture of improvement

When pay focuses on a professional's skills, that professional might be more likely to improve their abilities and undergo more training to receive greater pay. This culture of self-improvement can lead to stronger performances, a clearer understanding of an organisation and greater innovation. When team members see others improve, they may also find the motivation to perform better in their roles. If you like to work on improving yourself continuously, a skill-based pay system may be suitable for you, as you are likely to get increments in salary as you keep improving yourself.

Promotes open-minded teams

Companies that adopt the skill-based pay model are likely to see a shift in their teams' attitudes towards change and innovation. This is because skill-based pay is an inherently innovative and unique compensation system. Professionals may also be more likely to grow, experiment and accept new developments. In an organisation having a skill-based pay system, you are more likely to get rewards and increments in salary for displaying innovation and growth in your work.

Provides a sense of autonomy

When companies pay professionals for their capabilities, those professionals may be more likely to take ownership of their work. They might also focus on how they can better themselves and accept more responsibilities at the company. Autonomy is important in startups and new businesses because it can lead to more efficient staffing. When you work in an organisation having a skill-based pay system, you may take more ownership of your work and get rewarded for it.

Drawbacks of skill-based pay

Here are a few drawbacks of the skill-based pay model:

Larger investment in human resources

Skill-based pay requires experienced recruiters and trainers and potentially expensive training programmes, which may involve a larger investment in human resources (HR). Since there is a greater emphasis on training, companies with this model generally spend more time and money ensuring their employees are gaining valuable skills. If these expenses are within a company's budget, this investment can be worthwhile.

Higher costs for the organisation

Companies with skill-based pay are likely to pay more than their competitors, particularly for high-specialisation positions. As team members gain more experience and skills, individual salaries can also rise. If a company maintains a smaller team size, then pay rates may be lower than competitors with job-based pay. It is important for you to be sure that the company you may be applying to has enough funding to maintain a skill-based pay system. They may claim to follow a skill-based pay model, but may not be having sufficient funding to do so for an extended period of time.

Greater pay inequity

People in the same role at a company may notice a discrepancy between their salaries because of skill gaps. While this is normal within the skill-based pay model, it might also create a sense of competition. This model may also empower candidates to pursue more training and skills so they can earn as much as their more skilled coworkers.

When applying for a job in such a company, it is important that you understand there may be a culture of intense competition there. Being comfortable working in such an environment may be important to succeed there in the long term. You may opt for more training and learning to improve your skills, differentiate yourself from the competition and get a better salary as a result.

More administrative expenses

In the skill-based pay model, recruiters and administrators track individual assessments, lessons, results and salaries to evaluate pay. This can be challenging for young companies that lack the proper tools or resources. As the company grows, there may also be a greater requirement to invest in administrators or applications that can track this progress.

These investments, however, may lead to cost reductions in other areas, such as over-hiring for similar positions. When applying for a job in any organisation that claims to have a skill-based pay model, it is important that you check if they have the necessary tools and applications in place to track such progress. Keep in mind that they may be planning to get these tools at a later date.