Competency-Based Employee Rewards

Overview

Selecting rewards is an important part of any organization's overall HR strategy. The world of work is rapidly changing, and rewards must keep pace if an organization intends to attract and retain exemplary performers who can contribute to sustained competitive advantage. This is a powerful reason, it seems to us, to give attention to this topic.

Let's frame the issues as succinctly as we can, recognizing that competency-based employee rewards is a most complicated topic, that we cannot address all these issues in this chapter, and that a book could easily be written on this topic alone.

Historically in the U.S., we would argue, most compensation systems—a key part of a larger total reward system—have been focused on achieving fair pay. Since some work is regarded as difficult to measure, the common business practice has been to pay individuals holding the same job about the same pay. A secretary, for instance, is placed in a pay range where he or she is paid about the same as any other secretary in the organization. HR practitioners in the U.S. have been sensitive to such issues as equal pay for equal work, well-publicized gender disparities in pay practices, and compliance issues associed with the Equal Pay Act. The tendency has been to err on the side of caution and to try to pay everyone about the same, with monor differences (small percentage differeences) recognized in so-called merit pay or pay for performance.

But competency-based rewards may provide another perspective on rewards. It recognizes that three time periods should be considered: (1) before the performance is undertaken (incentives); (2) during the performance (concurrent rewards); and (3) after the performance has been demonstrated and measurable results have been achieved (rewards). It reecognizes that incentives and rewards may be financially oriented or nonfinancially oriented, that competencies are only the means to the end of achieving measurable outputs or results, and that one-size-fits-all approaches to reward systems do not work effectively because individuals vary in what they perceive to be incentives and rewards of value to them. Finally, the fact is that not all individuals are equally productive if their work is measured objectively. Exemplary performers may outperform their fully successful counterparts by as much as twenty times. So, how can people be fairly incented to achieve quantum leaps in productivity improvement if everyone is paid roughly the same? How can fully successful performers be incented to become exemplary performers or at least bring their measurable performance to levels closer to those achieved by the exemplary performers? How can exemplary performers be fairly rewarded for outstanding results that may be as much as twenty times as great as those achieved by others in the same job categories? These, and similar, difficult questions are raised by competency-based employee rewards.

This chapter briefly examines reward systems by addressing the following key questions:

Employee Rewards and Total Rewards

An employee reward is any recognition in the form of a tangible or intangible award, prize, or incentive that acknowledges an employee's contribution to organizational success. Making decisions about employee rewards is key to establishing a total rewards strategy and aligning HR strategy with the organization's strategic objectives. It may be particularly important to reward exemplary performers, who can be as much as 20 times more productive than their fully successful counterparts.

Total rewards can be understood as an employee's salary, benefits, and short- and long-term incentives, and rewards or recognition for achieving specific performance goals (Schiffers, Young, & Shelton, 1996). Although CEOs and other senior executives are most interested in those total rewards that directly affect the financial bottom line, salary and benefits are only part of a much broader range of incentive and reward methods. Total rewards could be regarded as everything employees perceive as valuable that results from their relationship with an organization and which the organization uses to attract, retain, and motivate them. Total rewards vary greatly from one organization to another, since it is important to develop a strategy that fits within the corporate culture.

Rapid changes in the business environment have prompted many decision makers to examine the effectiveness of their reward systems. Lawler (2000) suggested moving away from a one-size-fits-all philosophy and using individualized systems, which enable organizations to offer incentives in forms that appeal to employees.

Traditional Total Rewards

The following discussion covers the components of a total rewards system: compensation, alternative compensation, incentives, and recognition and rewards.

Compensation

Compensation is critical to an organization's total rewards system. According to WorldatWork, compensation comprises the elements of pay—such as base pay, variable pay, and stock—that an employer provides to an employee in return for services rendered (Worldat Work Glossary, n.d.).

Traditional approaches to compensation rely on information about what people do, their length of employment, and the relationship between their pay and that of others in the organization. In managing compensation, employers usually weigh three factors: external equity, internal equity, and individual performance. They ensure external equity by considering labor market conditions that exist outside the organization and preserve internal equity by assessing relationships among jobs based on the relative worth to the organization. In evaluating individual performance, employers determine an employee's effectiveness at achieving results. This often creates a threefold challenge for HR practitioners who must establish externally competitive wages, salaries, and benefits within a system that also recognizes the different value of various jobs and provides incentives and rewards for individuals. This view was verified by a study of nearly 750 HR and compensation managers with U.S. organizations (O'Neal, 1996). The same study found, however, that employers are beginning to shift their compensation programs toward more flexible systems that allow managers to reward employees for applying competencies, achieving higher performance levels, and making more contributions to organizational success.

The existence of so many different pay plans demonstrates the widespread dissatisfaction among many managers with traditional approaches to compensation management. It also shows a great willingness to experiment with new approaches. And yet, despite so much experimentation, few managers are satisfied with any one approach.[1]

Job-based pay

There are a number of different approaches to compensation, but perhaps the most familiar is job-based pay. Two approaches to job-based pay, automatic step progression and the merit range, are perhaps the most traditional methods of providing pay changes within a grade (Bremen & Coil, 1999). Automatic step progression calls for a series of incremental increases within the pay grade. The merit range sets a minimum, midpoint, and maximum within a range, and workers are eligible for periodic pay increases, often on an annual basis. Merit pay is sometimes called "pay for performance," although that would not be an accurate description at most organizations, where job outputs have not been made clear or explicit. True pay for performance, which rewards genuine productivity, is not possible unless job outputs are known and measurable.

Job-based pay is not a perfect solution to compensation. One important drawback is that it often does not reward workers for improving their skills or knowledge. In addition, it does not support the corporate culture, encourage worker participation, or enhance worker flexibility (Sherman, Bohlander, & Snell, 1998).

Skill-based pay

HR practitioners have been experimenting with many new approaches to wage and salary administration. One such approach is skill-based pay, for which organizations create levels based on the acquisition of skills linked to the mastery of various work processes (Bremen & Coil, 1999). In this approach, pay corresponds to a worker's demonstrated ability to perform the processes. Organizations may analyze the work and then determine the knowledge and experience needed to perform it. As skills are acquired, individual pay is adjusted. This approach very often fosters an increased interest in skill acquisition and is helpful for workers who enjoy their jobs but are interested in new challenges (Tyler, 1998).

A skill-based pay system presents HR practitioners with many challenges. One centers on establishing a method of measuring skill acquisition and deciding how much to pay for it. Organizations must also determine exactly which skills should be acquired in order to receive increased pay (Tyler, 1998). Other challenges include limited advancement available for an employee who has acquired all the indicated skills, pay tied to skills that either are not used regularly or are no longer used, and the costly updates required as work processes change (Bremen & Coil, 1999).

Broadbanding

Another innovative approach to compensation is broadbanding, which combines many salary grades into a lesser number of wide salary bands.[2] As noted by Sherman, Bohlander, and Snell (1998), "Paying employees through broadbands enables organizations to consider job responsibilities, individual skills and competencies, and career mobility patterns in assigning employees to bands" (p. 368). Broadbanding may be used in conjunction with skill-based pay, which can add an additional dimension by linking increases in base pay to the acquisition and demonstration of new skills (Leonard, 1994). This combined approach has the potential to offer individual workers encouragement for personal and career growth (Hofrichter, 1993). Broadbanding is often linked with a performance-based approach to pay, with performance level determining the band placement for workers.

In a research study, the American Compensation Association (now WorldatWork) surveyed 116 organizations that use broadbanding. The findings suggest that broadbanding offers more flexibility, creates an interest in lateral development, provides for a focus on business goals, generates an emphasis on skill development, and enhances team focus (Abosch, 1995).

Careerbanding

Careerbanding is similar to broadbanding but emphasizes career development rather than advancement to the next grade (Tyler, 1998). This approach often establishes pay based on market surveys and does not use minimums and maximums within a range.

Alternative compensation

The meaning of this term seems to be evolving. Nadel (1998) interprets it as processes that meet the intrinsic needs of workers, develop strategies that appeal to workers while meeting strategic business needs, and communicate to workers that they are valued. He includes many initiatives within this category, such as employee training; tuition reimbursement; flexible work arrangements; worker-friendly environments, perquisites, amenities, and conveniences; and a positive management attitude (Nadel, 1998).

Incentives

Incentives, which are meant to encourage desired performance, are either monetary or nonmonetary. Monetary incentives are sometimes called "extrinsic rewards," and nonmonetary incentives are often referred to as "intrinsic rewards" (Rothwell & Kazanas, 1998).

Monetary incentives

A true pay-for-performance plan attempts to link job results with pay. Incentive pay is one such approach.

Profit sharing is a form of incentive pay in which a percentage of a company's profits is shared with workers. Another form is gainsharing, in which workers share in the money derived from achieving particular goals. Small group incentive pay and team-based pay apply to specific groups that attain desired results and achieve their goals. With long-term incentive pay, workers who reach set goals are usually rewarded through some type of stock program, and a lump-sum payment plan distributes incentive pay, usually to high performers, for achieving desired results. Incentive pay may also be stock based. Stock-based pay is sometimes linked to the overall performance of the organization.

Lump-sum bonuses are a one-time incentive. Bonuses can be used for a variety of reasons, including fostering skill development or encouraging workers to relocate for a lateral move (Tyler, 1998).

Nonmonetary incentives

Nonmonetary rewards for good performance include sincere praise, organizational and employee partnerships, learning and development opportunities, time off, task force or other assignments, assistance with personal chores, gifts, and recognition of achievements in company or industry publications. This type of incentive can be applied to groups, teams, or individuals and may become project based as well.

Nonmonetary awards help to create a working environment in which employees are truly engaged and feel good about themselves and their work for what is often very little cost (Coil, 1999). In the past, nonmonetary and low-cost incentives were used by a limited number of organizations, but today's workers are less inclined to want pay increases and bonuses and may prefer incentives of greater personal value. In virtually every chapter of this book, we have mentioned change and its impact on HR management systems. Change has affected workers' values and consequently their reward preferences. Organizations must recognize these changes and adapt to them.

Recognition and Rewards

Recognition can be a very effective means of rewarding behavior and emphasizing the importance of both contributions and performance. Informal employee recognition can be of little or no monetary value and includes praise, certificates, plaques, news articles, and ongoing programs such as employee of the month. Formal recognition is often more organizational in nature, usually requires management approval, and costs substantially more than informal recognition (Bowen, 2000). Gainsharing, short- and long-term incentive programs, and stock option programs are examples of formal recognition awards.[3]

Traditionally, some organizational leaders have held that a "fair" salary and a "good" benefits package are sufficient compensation for employee contributions to organizational success. In a similar manner, the traditional HR management approach—probably driven in large measure by the opinion of senior leaders—has been to focus on providing employees with a competitive compensation and benefits package. In addition, traditional reward strategies are not always well defined or geared to measurable outputs or results. Instead, leaders and their direct reports tend to become caught up in the performance of work activities. Strange as it may seem, a major success factor in any reward process is whether the organization has developed and communicated the expectation that its employees produce concrete, observable results.

A traditional system often does not single out exemplary performers for special recognition or reward. On the contrary, exemplary performers may be punished for their achievements. Exemplary performers stand out from their peers because they accept difficult challenges or achieve outstanding results with the same or less resources than others. Supervisors recognize the ability of exemplary performers and their willingness to go the extra mile and consequently assign more work to them than to their peers. A high-performing employee recently summarized this situation by saying, "The better I perform, the harder I'm expected to work. I think there's something wrong with that, don't you?" There seems to be some truth to the saying that the reward for exemplary performance is not more money but more (or harder) work! Providing more work could be seen as punishment, not reward.

Reward programs are administered in various ways by organizations that have a formal reward system in place. In some cases, and especially in team-based organizations, a committee of peers reviews accomplishments. Other reward processes may be managed by a single decision maker, a committee of decision makers, the CEO or president, or an executive committee.

[1]Additional resources on the fundamentals of establishing and managing compensation systems, whether traditional or competency based, include Flannery, Hofrichter, and Platten (1996); Hale (1998); Kochanski and LeBlanc (1999); Manas (2000); O'Neal (1998); Risher (1999); Tropman (2001); Weiss and Hartle (1997); WorldatWork, at http://www.worldatwork.org; and Zingheim and Schuster (2000).

[2]For more information on broadbanding, see Abosch and Gilbert (1996).

[3]For more information on recognition programs, consult Bowen (2000) or Nelson (1994). For a criticism of such programs, see Kohn (1999).

Making Employee Rewards Competency Based

Every employee reward process must have a sound philosophical base that is aligned with the organization's corporate culture, business objectives, and strategies. Senior leaders must spell out specific objectives that are consistent with the organization's strategic objectives. An important issue here is the organization's reward philosophy.

Although the term philosophy may create the wrong impressions in some business circles—conjuring up an image of bearded philosophers contemplating how many angels can dance on the head of a pin—philosophy is critical to such fundamentally important strategic questions as the following:

Since allocating employee rewards in a competency framework depends on verifiable delivery of observable and measurable results, decision makers must be clear on the results they want to reward. It is not enough to reward activities. It is not enough to permit managers to decide who should receive what rewards. In a competency-based process, achievement of the desired work results is objectively measurable and verifiable. This means that competencies must also be identified and their appropriate use specified.

Before beginning a project, HR practitioners must obtain work analysis information, create performance standards, and develop metrics for determining the extent to which those standards are met. Standards could include customer or client requirements, quality level, and time frames.

A competency-based process requires an administrative infrastructure. A person must be assigned to manage, either full- or part-time, such details as completing the tasks for system development. Other functions that require support include reward decision making, a communication system that keeps all employees informed on the reward process, and ongoing evaluation of the overall outcomes of the program and its contributions to the organization's competitive success.

When an organization establishes a competency-based reward system, decision makers are declaring that rewards will be based on the following criteria:

If the goal of a competency framework is to make decisions about employee rewards, it is natural to wonder why the appropriate use of key competencies is important. What does it matter how the outcomes were achieved? To explain, we offer the following scenario.

An organization with a competency-based reward system has specified that long-term cooperative relationships must be established among the work units that are essential to achieving the desired outcome. The lead worker, a candidate for a reward, achieved the result but, in doing so, alienated several other work groups. The employee either did not have the necessary competency or did not use it appropriately, or the competency may have been poorly defined in the first place. In any case, decision makers decided not to present the reward. Under the conditions of a traditional process, this same employee probably would have been rewarded.

There are several reasons not to reward this worker under a competency-based system. First, the employee won the battle, but the organization lost the war. Relations across work units were damaged, which could compromise the organization's ability to achieve similar goals in the future. Second, had the employee been rewarded, workers might infer that the organization is interested in performance only and that senior managers have falsely endorsed competency requirements as a foundation for reward decisions. This creates the impression that they value the result more than the means or process of achieving it. Yet, competencies and their appropriate use are pivotal to both individual and organizational success beyond the major output or result.

The Advantages and Challenges of Competency Based Employee Rewards

There are numerous advantages to using a competency-based employee reward process.

Competency-based employee rewards offer major support to other competency-based HR management practices. The approach serves as a mechanism for raising the performance bar in a fair and equitable manner, specifies clear performance requirements and the rewards for achieving them, and can easily be aligned with a competency-based performance system as defined in chapter 7. It is highly desirable to encourage everyone to perform at the level of exemplars, but since not all competencies can be developed and instead some must be acquired through selection, the goal of this approach is to raise the productivity of existing staff closer to the level of exemplars.

The unified communication strategy, which keeps employees informed of the conditions for rewarding exemplary performance, acts as an informal performance contract between the organization and its employees and encourages participation in setting higher performance standards. Under a competency-based system, employees are rewarded for achieving results in productive ways rather than simply for carrying out work activity. Job candidates who are highly motivated to do exemplary work will view this type of reward process as an employment incentive.

A competency-based approach improves an organization's bench strength. It stimulates employee development. Ultimately, clients or customers who receive exemplary-quality outputs will be more satisfied with the organization's products or services.

At the same time, a competency-based reward process also presents challenges.

The development, implementation, and maintenance of a competency-based approach demand significant commitment of organizational resources. The business benefits to be derived from a highly structured process such as the one proposed here must be weighed against the long-term investments required.

Rewards must be allocated or matched to measurable results. Organizations with secretive or untrusting corporate cultures will probably not be able to apply standards in such a way. The reason is that measurable results must be clarified and communicated to employees.

Performance requirements, competency acquisition and assessment plans, and decision-making guidelines and practices must be specified and consistently applied to employee reward decisions. An organization cannot accomplish this without first identifying and validating competencies and developing measurable specifications for the work outputs or results. The necessary technical resources must be available, sourced either internally or externally, to complete this work and maintain its accuracy as rewards are administered. Without this capability, the organization cannot operate a competency-based employee reward system.

Monetary employee rewards should be funded well before rewards are given. The organization must be able to incorporate these costs into its existing budget.

Deciding on Competency Based or Traditional Employee Rewards

A successful competency-based approach requires senior managers who understand that competencies are a prerequisite for all performance and who are willing to embrace an innovative system for rewarding exemplary employee performance. In addition, they must be prepared to commit resources to designing, establishing, implementing, and maintaining the process even as organizational circumstances change.

A traditional process is advisable when senior managers are not interested in exploring a competency-based reward process or cannot articulate the business case for using competencies. In certain organizations, senior managers may be unable to justify the expenditure of resources because of their company's size or corporate culture or for financial reasons.

Implementing Competency Based Employee Rewards

The model depicted in Figure 11 can be used to guide the creation and implementation of a competency-based employee reward process. It is essential that HR practitioners remain flexible in interpreting this model and use the following instructions as guidelines only. Successful employee reward processes are tailored to conform to each organization's values and corporate culture.

Figure 11: Competency-Based Employee Reward Process

Step 1: Discuss process design and implementation with senior management and secure initial endorsement

Typically, the organization's HR director or manager initiates this discussion as a strategic partner on the senior management leadership team. Discussions could also begin informally and evolve to a more formal basis if a manager or other respected person is willing to be a change champion. For example, an operating manager who has experienced the benefits of using competency-based HR practices to manage a work unit or division might initiate the discussion. The point is to communicate the possibilities of a competency-based approach to the organization's decision makers.

The discussion could proceed as follows:

  1. Define incentives and employee rewards and explain how they fit into the organization's total rewards strategy.

  2. Define the terms used in competency-based HR management and explain why a competency-based approach makes sense for the organization.

  3. Explain why the organization should have a total rewards strategy and make the business case for such a process.

  4. Give examples of rewards that might be valued by the organization's employees.

  5. Describe the steps involved in designing and implementing a competency-based approach to employee rewards.

  6. Identify some ways of implementing the new approach and offer to pilot test it.

  7. Specify the time and money needed to plan and implement a pilot study and secure agreement on a method of monitoring productivity while it is being conducted.

  8. Propose timelines and milestones for each stage of design, development, and implementation.

  9. Ask senior managers if they support the plan. If they do, determine whether their endorsement includes provision of the necessary resources. If resources are not part of their endorsement, solicit their proposals for accomplishing the start-up phase of the initiative.

  10. Double-check collective bargaining agreements to confirm the legality of conducting a pilot test with the targeted group.

  11. Collect evidence, through benchmarking, of the potential benefits of competency-based HR management and communicate it to senior leaders.

Another approach is to make a formal proposal to management. The content of this kind of proposal is well known to external consultants but may be less familiar to internal practitioners. For this purpose, a good proposal identifies the key challenge or problem to be solved, including, perhaps, those associated with the current reward philosophy, and explains the business need and justification. It should contain a solution to the problem and the justification for the solution. A good proposal lists the tasks to be accomplished in implementing the reward system, deliverables or measurable outputs for each step, and accountabilities for results. It also provides a timeline for completion of each task, a budget based on the tasks, an estimate of the likely financial benefits deriving from the project, and a list of individuals who should be involved.

Upon project approval, the senior leadership team should appoint an employee rewards task group. It may be desirable to staff the task group with exemplary performers. Leaders should agree to notify the managers and supervisors of task group members and inform them of the possible benefits of these employees' participation.

Step 2: Communicate information about the process to all organization members

In this step, the HR practitioner communicates senior management's endorsement to those who will be affected by the decision. The person who prepares this information should define the implementation environment well. Introducing competency-based employee reward processes is a major undertaking for some organizations and must be handled with care. Task group members should be identified to the organization at an early stage of the project.

Step 3: Brief the employee rewards task group

Next, the HR practitioner briefs task group members on the discussion with senior managers (Step 1) and describes the group's mission. Since task group members, with extensive support from the process manager, will be responsible for completing the work described in Step 4 of this model, they should learn about the tasks they are expected to complete. The HR practitioner should present and discuss timelines for the reward processes and completion of a draft work plan with task group members.

Step 4: Task group members prepare a philosophy, objectives, operational guidelines, and project plan

The first step toward formulating a philosophy is to state the business case for having a competency-based employee reward process. Why does the organization need an employee reward process, and why must that process be based on competencies and their appropriate use in the performance environment? The objectives for any employee reward process must align with the organization's strategic plans and support achievement of its business objectives. This alignment fosters a vision of the employee reward process, its mode of operation, and the returns the organization will realize by investing in it.

Next, task group members must identify the objectives for the employee reward process and articulate these outcomes so that they can be understood clearly, especially by the organization's management. For example, objectives could be stated as strategic or tactical results, highvalue-added tasks needed for improved business performance, or employee competencies that must be appropriately applied in order to achieve critical business results (Armitage, 1997). At this point, some managers may want to request information from other organizations about the costs and benefits of competency-related reward programs, but such information is not readily available and the efforts to gather such information may cause substantial delays in implementation.

In preparing operational guidelines and a project plan for the competency-based employee reward process, task group members should consider questions such as the following:

Step 5: Brief senior management and obtain endorsement to proceed

Along with the endorsement of senior management, the purpose of this briefing is to obtain commitment of resources for implementing the process. Senior managers must be given every opportunity during the briefing to clarify any of the information presented or modify the plan to meet their requirements. Maybe more so than any other HR management process, an employee reward program clearly belongs to the organization's senior managers, and their buy-in is critical because of the sizable financial investment that is involved.

Step 6: Appoint a process manager and an employee rewards panel

If a decision is made to proceed, senior managers should name a person to spearhead the effort. They should also appoint three to five exemplary performers to serve on an employee rewards panel. Panel members will represent senior managers in making decisions on rewards for exemplary performance. They will also set the standards for each employee reward and ensure that sufficient evidence to support reward decisions has been presented by the process manager.

Step 7: Implement the competency-based employee reward process

This stage will go smoothly if the process manager has developed and communicated a project plan and timetable to those individuals who will be affected by the process. At this point, the process manager acts on agreements that have been made with senior managers and confirms completion of the following major tasks:

After the process has been operating for 6 to 12 months, its internal and external workings should be evaluated.[4]

[4]For more extensive discussion on planning the process evaluation, see Stufflebeam (1974a, 1974b) and Stufflebeam et al. (1971).

Summary

In this chapter, we introduced important ideas about competency-based employee reward strategies and the organizational requirements for formulating and implementing such strategies. Employee rewards are clearly critical to encouraging exemplary performance. The reward processes we discussed provide a means of rewarding employees not only for possessing a competency but for achieving measurable results. Conclusions regarding the design and use of competency-based compensation may not yet be definitive, but in our minds, the benefits of using a well-designed competency-based employee reward process are not in doubt. It simply makes sense to reward people in proportion to their measurable productivity, thus motivating them to become exemplary performers.

But great care should be taken to individualize rewards so as to match individual contributions while ensuring internal equity and legal compliance.

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