Business Psychology - Latest Findings

Article No. 206
Business Practice Findings, by James Larsen, Ph.D.

Skill-Based Pay

A new pay plan reveals a remarkable impact.

Pick an entry-level job in your company, and think of the factors that determine the base pay. If you're like most employers, you'll think of an hourly rate determined by bargaining and/or labor availability.

Here's a new idea: base pay determined by skill level. Here's how it works.

Imagine owning a factory that fashions and assembles components for a product. You employ machine operators, welders, assemblers, painters, packers, and so on. Now imagine a problem in the factory that causes a back up. Suddenly, a sizeable portion of your workforce either stops working entirely or slows down while a few workers frantically struggle to solve the problem and relieve the bottleneck. That's a manufacturer's nightmare.

In a company with base pay determined by skill, workers master skills necessary to do many jobs and can quickly move from one job to another. In the factory described above, these skilled workers would arrive quickly and resolve the problem.

This solution is so practical that everyone desires multiskilled workers to perform such rescue missions, and job rotation practices aim toward this result. In practice, however, employers often encounter two serious obstacles: 1) employees are unwilling to learn skills for jobs which they don't regularly perform, and 2) employees are unable to keep unpracticed competencies sharp. Employees such as these may make matters worse when they arrive at a trouble spot. Many companies face this difficulty, and for some of them, skill-based pay is an answer.

Much has been written about skill-based pay, but few researchers have examined its effect in careful studies. Brian Murray from the University of Texas at San Antonio recently carried out such research to fill this need.

The factory Murray examined organized skills into groups of five blocks of increasing complexity which required increasing amounts of knowledge. Each production process had a different set of skill blocks which formed a complete function and were unrelated to other production processes. Individuals progressed from one block to another, through the five-block sequence for their function. Higher skill blocks indicated the ability to perform a greater variety of tasks, and individuals certified in these skill blocks earned a higher base pay.

This increasing base pay motivated employees to master new skills, and formal on-the-job training and limited classroom training fulfilled their instructional demands. Certification exams could be completed after spending a minimum time in a skill block and were required at regular intervals to retain an advanced skill rating.

Employees varied in their participation. Some pursued advanced certification, some chose not to participate, and some chose to reduce their certification.

Murray examined the impact of this pay plan on productivity, labor cost, and scrap. He found a 58% rise in productivity, a 16% fall in labor cost per part, and a scrap rate that increased at 1/5 the rate of a comparison factory. These improvements occurred in spite of increased overall employment and increased average pay. Productivity improvement offset these costs.

Murray has advice for executives who wish to try skill-based pay plans. He cautions us to commit adequate resources to training and certification tests, to provide timely and unbiased appraisals, and to employ flexible production scheduling. He also believes jobs need to be designed so they are interesting and varied.

Murray believes skill-based pay plans work best in organizations in a start-up or growth phase that practice participative employee involvement and offer other incentive programs to complement skill-based pay.

Skill-based pay causes a thirst for learning for many employees, and it allows employers to mold this learning and to combine it with flexible scheduling to produce an adaptable, responsive factory.

Reference: Murray, Brian and Barry Gerhart (1998). An Empirical Analysis of a Skill-Based Pay Program and Plant Performance Outcomes. Academy of Management Journal, 41 (1), 68-78.

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