According to a 2025 survey, almost two-thirds of employers are already using skills-based hiring. For those companies, the traditional ways of determining employee salaries — i.e. by assigning a salary range to each role and level — may no longer be fit for purpose.
In this article, we’ll discuss an alternative compensation model that rewards employees directly for their contributions to the organisation: skills-based compensation. Read on for the pros and cons and our tips for implementation.
What is skills-based compensation?
Skills-based compensation is a compensation system that rewards employees based on their skills and competencies rather than their job title, seniority, work history or qualifications.
This is seen as a fairer, more effective way of determining pay, since it ties compensation directly to the employee’s value to the business. It can also help create a culture of continuous improvement as employees are motivated to build on their skills to earn more.
Skills-based compensation should reward employees for the range and depth of their abilities. For example, a professional with proficiency in project management, data analysis and people management would earn more than someone with just one of these competencies under a skills-based pay model.
Benefits of skills-based pay
Skills-based compensation comes with many benefits for an organisation — here are some of the main advantages you can expect to see under this model:
- Creates a culture of improvement: Skills-based compensation encourages employees to actively work to improve their skills in order to increase their pay. This can lead to greater organisational performance and innovation, giving your business an edge over your competitors.
- Drives employee engagement and retention: Explicitly linking pay with contributions also gives employees a greater sense of ownership over their work. This can help them feel connected to the organisation and its mission — and make them more likely to stick around for longer.
- Helps attract motivated talent: Skills-based compensation demonstrates your commitment to fairness and employee development, and your willingness to invest in your employees’ future. This can help attract highly motivated employees who are always looking for opportunities to improve and develop their skills.
- Promotes flexibility and adaptability: Under a skills-based pay model, employees are encouraged to develop additional skills alongside their core job responsibilities. This can make it easier for companies to quickly pivot and adapt to new technologies and market demands when needed.
- Helps build a fairer work environment: Skills-based compensation rewards employees for their actual contributions to the company instead of relying on outdated job titles and potentially irrelevant factors like tenure and qualifications. It can also reduce the impact of things like bias and favourism — making for a fairer system overall.
Downsides of skills-based compensation
Although skills-based hiring has many advantages, there are also some drawbacks to be aware of. For example:
- Increased administrative costs: Skills-based compensation means developing effective ways of assessing competencies over time, as well as making regular adjustments to salaries to account for new skills. This adds up to a significant administrative load — which can be overwhelming for some organisations.
- Difficulties with measuring and benchmarking: Setting the right pay level for different skills and competencies is also a key challenge of skills-based compensation. That’s because, unlike with traditional, job-based compensation, accurate market pricing for specific skills is difficult to gauge.
- Potential for pay inequities: In theory, evaluating employees’ skills should be an objective process — but there’s always room for subjectivity and bias. Ensuring everyone has equal access to learning and development opportunities is also essential to provide a level playing field.
- Resistance to change: Some employees might have a hard time adjusting to skills-based compensation. For example, those who are accustomed to receiving an automatic raise each year might not like the idea of having to actively improve their skills to earn more.
- Risk of stress and burnout: Feeling pressured to constantly renew their skills can lead to stress and potentially burnout for employees. Over time, this can have a significant impact on morale and productivity across the organisation.
How to implement skills-based compensation: top tips
Introducing skills-based compensation for the first time is a big undertaking for an organisation — and represents a big cultural shift for employees. Here are some best practices to ensure your implementation is as smooth and effective as possible.
Rethink your skill evaluation methods
To implement skills-based hiring, you first need to identify the skills you value as a business. Performing a skills gap analysis can help you determine which skills are in short supply (and therefore more valuable) within your organisation.
You’ll also need to put thought into the methods you use to evaluate different skills, which will help you to assign them a monetary value. To do this, you’ll need to break down each skill into different levels of proficiency, establishing clear criteria for each level.
Skills-based compensation is all about rewarding skills and competencies, not qualifications and experience. This can make the recruitment and selection process much more difficult — you’ll need to find effective ways to measure and assess candidates’ skills to ensure you’ve found the best person for the role.
Develop a consistent compensation structure
The idea behind skills-based pay is to make your compensation structure fairer and more transparent. To achieve this, you need to be consistent in how you reward skills across your organisation. This will mean establishing a compensation range for each of the skill levels you’ve defined.
There’s more than one way to do this, but one method is to break down job functions into salary bands, with each one correlated to a higher skill level. To keep things fair, you’ll need to determine clear criteria for each level.
Assess skills regularly to maintain fairness
If you’re going to reward employees for their skills and competencies, you need to ensure you’re increasing the reward when they gain new skills or develop their existing ones. That means you’ll need up-to-date information about their skills and knowledge.
It’s important to ensure you have consistent, objective assessment methods to give you a clear picture of how employees’ skills are developing over time. Bonus: keeping such a close eye on skill levels will help you identify both areas where individual employees could benefit from extra training or mentorship, and emerging skill gaps on an organisational level.
Provide learning and development opportunities
Organisations that implement skills-based compensation need to offer ample opportunities for their employees to improve their skills. Not only does this help employees to increase their paycheques, but it can also lead to a stronger, more productive workforce where everyone is motivated to continuously improve.
This might involve delivering training, investing in online courses, or even providing opportunities for things like job shadowing and rotation. Offering paid time off to complete training is also an important part of the picture, since it helps level the playing field by giving everyone the opportunity to gain new skills and certifications.
Be transparent about pay criteria
Skills-based pay is supposed to be a fairer compensation system that rewards people for their actual contributions to an organisation. To get the full benefits of such a system, it’s important to be transparent about your pay structure.
Being more open and honest about your pay policies helps employees to understand the reasoning behind their salaries and what they can do to increase them. On a more general level, it also helps to build trust with your employees, improve morale and engagement — and generally create a more pleasant place to work.
Is skills-based compensation compatible with pay equity legislation?
When it comes to implementing new pay structures, legal compliance is a top concern for employers — especially right now. That’s because the EU Pay Transparency Directive is set to come into effect across all member states by 2026 (it’s already been implemented in a handful of countries).
Among other things, the directive requires employers to be transparent about the criteria they use to determine pay — which must be fair, gender-neutral and objective. So, the big question is, will skills-based compensation be acceptable once the directive is in force across Europe?
In a word, absolutely! An employee’s skills and performance levels are completely legitimate factors to take into account when determining pay. However, employers may need to justify the differences between employees in the case of any equal pay claims — which means objective, consistent and documented processes for assessing and measuring these factors will be essential.
Learn more
Want to find out more about the different ways employers can structure pay and progression? Check out these articles from our archive:
