Merit-based pay, skill-based pay, and competency-based pay

06/04/2021 0 By indiafreenotes

Merit-based pay

Merit pays, merit increase or pay for performance, is performance-related pay, most frequently in the context of educational reform or government civil service reform (government jobs). It provides bonuses for workers who perform their jobs effectively, according to easily measurable criteria.

Merit pay is the type of compensation a company uses to reward higher-performing employees with ongoing additional pay. Merit pay is sometimes called incentive pay or pay-for-performance, and it involves giving employees base pay increases or bonuses based on their performance. Merit pay may take the place of simple pay raises, compensation increases based on employee seniority or general cost-of-living adjustments.


Companies may choose merit pay as their compensation model based on its potential benefits. These advantages include:

  • Attracting top talent: Offering merit-based pay can help a company attract confident talent. Top employees who know their worth and believe in their skills are generally eager to have their pay tied to their performance.
  • Clarifying expectations: When compensation is related to their performance, employees have clear guidance regarding what their employer considers exceptional work. In that way, merit pay can help differentiate critical tasks and low priority undertakings.
  • Identifying employee rankings: Employers can use merit evaluations to create a ranked list of employees by strength. Top performers receive the highest merit pay and underperforming employees receive less or no merit pay.
  • Making company objectives clear: When companies tie compensation increases to accomplishing goals, they make their business objectives real to their employees. Presenting an actionable to-do list that leads to more pay takes vision and mission statements from concepts to reality.
  • Increasing productivity and efficiency: When employees know there are financial rewards for quality work, they are more likely to self-motivate. Merit pay can help combat workplace complacency.
  • Generating healthy competition: In a positive corporate culture, merit pay can inspire employees to compete to produce the best results. When pay increases are directly related to accomplishing company goals, both top performers and the business itself are winners.


  • Subjectivity of application: Even when merit pay is based on objective goals, managers may still award it subjectively.
  • Perceived favoritism: Employees who are not satisfied with their merit pay may feel like there is manager favoritism toward other employees, regardless of their performance reviews.
  • Use of resources better spent elsewhere: Merit pay systems require a business to develop competencies, determine measurements and create performance baselines in addition to scheduling and holding actual evaluations, so they require a lot of resources. Not all businesses can implement merit pay because they need to use those resources for the profit-driving aspects of the business.
  • Managerial burden: Thoughtful completion of the merit pay process takes a lot of work from managers. Since no two managers are the same, some may be more up to the challenge than others. Managers who have better communication skills, for example, may find it easier to express what employees need to do to qualify for merit increases.
  • Morale implications: Merit pay can have negative implications on company morale. Some employees may be discouraged by what they see as unequal rewards for the same work, while others may feel like they are being compensated similarly to other employees whose work they view as subpar.
  • Unfounded expectations: Merit pay can lead employees to expect the same increase year after year, regardless of budgetary restraints and changes in employee behavior.
  • Unhealthy competition: In less positive company cultures, the promise of merit pay may encourage employees to act selfishly instead of in the company’s best interest.

Skill-based pay

Skill-based pay is a salary system that determines an employee’s pay based on his or her knowledge, experience, education or specialized training. Depending on the company, the employee might also receive a higher salary for earning formal certification in his or her industry.

Skill-Based Compensation Program

  • 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.

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.


  • It enhances productivity and quality through better use of human resources.
  • It facilitates technological change, which may meet with resistance in a purely job-based system.
  • The higher pay levels, continuous training, and job enlargement through the broadening of skills, tend to reduce staff turnover.
  • Elimination of unnecessary jobs can result from a workplace having broad, rather than narrow, skills. It also reduces the need for supervision.
  • Job satisfaction is engendered through employees having greater control over the planning and implementation of their work.
  • Broadening of skills leads employees to develop a better perspective of operations as a whole.
  • It is an incentive for self-development.
  • It provides employment security through skills enhancement.
  • It reduces the need to look to promotion to higher levels (which are always limited) as the only way to enhance earnings, and it facilitates the planning of an employee’s career development path.
  • Since the reward flows from the application of a skill and it does not reduce opportunities for others to similarly increase their skills and earnings, there is likely to be less competition among individuals.
  • Since the pay increases on account of skills are linked to a measurable standard, the criticism of subjectivity often associated with performance appraisals and individual-based performance-related pay, is avoided

Competency-based pay

Competency-based pay has the advantage of being simple to structure and utilizes readily accessible salary tables. One unique disadvantage of the salary structure is it can be difficult to alter during times of economic hardship. Competency-based pay might also be known as skills-based and knowledge-based pay.


  • Individual self-motivation: Instead of basing pay on seniority and job level, the employee achieves as much as they’re willing to and is rewarded for it.
  • Company-wide motivation: Competency-based pay encourages a culture of self-motivation and self-improvement within the company. It can create a company of employees who are actively seeking to improve their skills and finding new ways to contribute to the company. Competency-based pay helps to tie your company’s culture directly to the success of the company.
  • Increased transparency: Employees will better understand what they have the potential to earn with a competency-based pay system and what skills they need to acquire to reach the pay they desire.
  • Reduced turnover: Employee turnover is costly for a company, and a competency-based pay plan curbs that by helping employees feel that their skills and knowledge are important to the company, which improves retention.

Disadvantages of competency-based pay

  • Sometimes competition within the organization can lead to a disjoint in a team, which affects overall output
  • In some cases, competency-based pay can lead to favouritism towards a particular employee


When businesses become flatter eliminating non-value adding activities, competency-based pay may complement the move by assigning value to an employee’s work in terms of the competencies that enable the staff member to perform effectively in his role. It rewards employees by better compensation and benefits for the skills, knowledge and behaviors important for personal performance and organizational success and not just for the activities they perform.

Competency based pay encourages better performance and facilitates lateral career development. It is suitable in organizations where there is an over-emphasis on outputs, fit with a performance appraisal is required, cultural change towards greater flexibility is sought. A compensation based on an employee’s performance is also appreciated by an employee.

Team based pay

Team-based-pay provides rewards to teams or groups of employees carrying out similar and related work linked to the performance of the team. As described by Armstrong and Ryden (1996), team pay is usually paid in the form of a bonus shared among team members in proportion to their base rate of pay. Individual team members may be eligible for competence related or skill based pay, but not for performance related Pay.

In team based pay systems the payments reflect the measurable goals of the team. The aim of team based pay is to strengthen the team through incentives building a coherent, mutually supportive group of people with a right level of involvement. Team based pay promotes team working and cooperation among team members. It promotes multi-skilling.

A team based pay acts as an incentive for the team to improve the performance of the complete team. It also encourages the laggards of the team to improve and meet the team standards.

Sometimes, team members show resistance as they feel recognition of individual effort is more important. The team members do not want to adhere to the group norms and feel pressurized while working. The peer group pressure can also be helpful in raising the performance of the whole team.

Contribution related pay

Contribution Related pay is a relatively new concept that has been developed principally by the pay experts Duncan, Brown & Michael Armstrong. It is complex to manage contribution pay system. As it raises the expectation amongst individuals that if they achieve a set of targets & improve their skills & competencies each year they shall get a continual payout.

Contribution is what people do to bring about a result. As an individual contribute to the achievement of the purpose of their role. In relation to performance management and pay, the contribution is a more general concept, which describes the overall part people play generating results.

Contribution-related-pay can be defined as a process for making pay decisions that are based on assessments of both the outcomes of the work undertaken by individuals and the level of skill and competence required for that level.

Contribution -related-pay can work effectively with a pay structure, which has pay slabs. Here the delivery of the pay should be based on performance. Competence and career progression considerations.

As per (Brown 1998) contribution-related pay means paying for results including competence for the last year’s performance and the expected performance in future. This pay works by applying the mixed model of performance management. It involves assessing the inputs, the outputs and coming to a conclusion by deciding the pay.

The first approach to contribution-related-pay is to collect information regarding the competence of an individual and what he/ she has delivered. Similarly an overview of performance in achieving objectives or meeting the performance standards can be done. The information is then combined and clubbed to be compared with others in similar roles to decide for change in pay.