One way to maintain a high retention rate is to offer a good salary. 

However, it might be challenging for small or medium-sized organizations to keep up with the base salary offered by big corporations.

As your business grows, you need a better compensation plan to suit your needs, such as competency-based pay.

But is it worth it?

Learn everything you need to know about competency-based pay in this article to make an informed decision.

What Is Competency-Based Pay?

The term ‘competence’ first appeared in the USA in the early 1980s. Back then, it meant “an underlying characteristic of an individual related to superior performance.” 

Now, competency refers to a unique payment method that motivates employees to improve their performance and efforts to achieve their desired pay rate.

Skill-based pay is a great fit for businesses that put an emphasis on outputs and want to build a company culture geared toward increased flexibility and appraisal.  

It’s also suitable for companies that want agile teams and better adaptability to change. 

However, is it different from traditional pay plans? Let’s see how these two terms compare in the next section. 

Competency-Based Pay vs. Traditional Pay Plans

The main difference between competency-based pay and traditional pay is employee potential. 

Traditional pay plans weigh pay increases on an employee’s position and the years of experience and education the job requires. 

In other words, a business determines a worker’s pay by their ability to gain seniority in a company. In addition, this traditional compensation system serves as a cost-control tool that establishes each employee’s worth in a business. 

With a competency-based pay system, on the other hand, employees can increase their pay potential by gaining knowledge and new skills related to their field. 

This type of compensation encourages self-improvement and is an incentive for employees to develop the competencies needed to accomplish business objectives. 

However, knowledge-based pay has its pros and cons. 

In the next two sections, we’ll talk about the advantages and disadvantages of a competency-based pay plan.

Advantages of Competency-Based Pay

Measure the following advantages of competency-based pay to determine whether it’s a system worth considering. 

Motivates employees

How you treat an employee motivates them to search for ways to improve their productivity and carry out purposeful work. 

A Gallup study emphasizes this point, showing that an employee works 20% better when motivated and engaged.

If you’re looking to boost an employee’s performance, competency-based pay encourages two types of motivation: 

• Individual self-motivation: Self-improvement creates workers with high levels of autonomy since the employee achieves as much as they’re willing to. 
• Company-wide motivation: Competency-based pay encourages a culture of improvement in the business as employees actively seek new ways to contribute to the company’s success. 

Higher transparency

Most employees want to work on meaningful projects with a clear purpose that directly impacts the company’s bottom line. 

However, when an organization’s mission and values are unclear, people might leave the company for better options. 

With knowledge-based pay, you can increase transparency as employees will better understand their potential and how their performance levels influence their reward. 

A sure way to make goals clear right from the start is to create a successful onboarding or orientation process. 

Aside from new hire kits, onboarding is critical to helping employees adjust to the new work environment while also making objectives clear through an onboarding video. 

Boosts employee retention

Another common HR challenge competency-based pay structures solve is boosting retention rates by allowing employees to be more in control of their pay. 

Employee retention refers to a company’s ability to retain current staff and prevent employee turnover. Because you reward employees for improving themselves, they’ll likely stay with your company longer. 

Author’s Tip: Aside from increasing pay grades, human resource management can use brand marketing or welcome letters to increase loyalty and establish an emotional connection with their audience. 

Creates a learning culture

According to a Workplace Learning Report by LinkedIn, 94% of employees would stay at a company longer if it invested in their career development. 

So, competency-based pay not only increases the retention rate due to a culture of improvement but also helps employees get out of their comfort zone to acquire new skills. 

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But all good things have their downsides. Let’s explore the disadvantages of performance pay together.

Disadvantages of Competency-Based Pay

The cons of competency-based pay include the following: 

May lead to team dissensions

A possible drawback of competency-based pay is the false perception of favoritism. 

Here’s a scenario: imagine you have an employee who believes their pay raise is more valuable than another’s. Not knowing this, you reward other co-workers with a significant pay increase. Your employee sees that and might come to a wrong conclusion (unfair treatment) which in turn creates dissension. 

That’s why competency-based compensation requires careful consideration of all employee efforts. 

Inaccurate pay estimation

It’s hard to measure knowledge and skill sets linked to performance, such as leadership or the ability to multitask, when it comes to pay estimations.

It might unwillingly introduce subjectivity in the evaluation process, which results in inaccurate ratings when calculating rewards.  

Negatively impacts teamwork

If employees feel like they’re competing with each other all the time, it might harm teamwork. 

While some competition is beneficial to encourage employees to perform at their best, some people might be too competitive and can distract the team from objectives. 

Managing this competition requires careful reward planning and a continued emphasis on collaborative work. You can do this by calling attention to each worker’s contributions and rewarding goals that a team achieves together.

Now Over to You

Competency-based pay systems contribute to staff retention and can lift your company to new heights.

If you feel like this payment method fits your company, it might be time to look into your options. 

Want to discover more helpful terms? 

Then sneak a peek at our HR glossary to unearth more ways to boost your business.