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WHO USES SKILL-BASED PAY, AND
WHY THEY USE IT
CEO PUBLICATION
G 92-17 (220)
EDWARD E. LAWLER III
GERALD E. LEDFORD, JR.
University of Southern California
LEI CHANG
University of Central Florida
October 1992
C e n t e r f o r E f f e c t i v e O r g a n i z a t i o n s - M a r s h a l l S c h o o l o f B u s i n e s s
U n i v e r s i t y o f S o u t h e r n C a l i f o r n i a - L o s A n g e l e s, C A 9 0 0 8 9 – 0 8 0 6
TEL (2 1 3) 7 4 0 - 9 8 1 4 FAX (2 1 3) 7 4 0 - 4 3 5 4
http://www.marshall.usc.edu/ceo
Center for
Effective
Organizations
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WHO USES SKILL-BASED PAY, AND WHY THEY USE IT
Skill-based pay has received increasing attention in the management literature during
the past decade. Although the concept is not new, its use appears to be increasing. We
examined data from a broader longitudinal study of employee involvement practices (Lawler,
Mohrman, and Ledford, 1992) to investigate changes in the level of use of skill-based pay, the
types of organizations that use it, its impact, and whether future increases in use are likely.
For purposes of this study, we defined skill-based pay as an alternative to job-based
pay that sets pay levels on the basis of how many skill employees have or how many jobs they
can do. Data were gathered from the Fortune 1000 companies. These companies include the
500 largest manufacturing firms in the U.S. and an industry-stratified set of the 500 largest
service companies in the U.S. A survey was mailed to the chief executive officers of these
companies in 1987 and again in 1990, and typically was completed by a high-level human
resource executive. The first survey was designed primarily by Lawler, Ledford, and
Mohrman of the Center for Effective Organizations, and the survey was conducted by the U.S.
General Accounting Office. Usable responses were returned by 476 firms. A subsample of
323 firms agreed to allow the release of their data to the research team, permitting detailed
statistical analyses. The second study was conducted solely by the Center for Effective
Organizations study team. Usable responses were returned by 313 firms. The full results of
the two surveys have been published elsewhere (Lawler, Ledford, & Mohrman, 1989; Lawler,
Mohrman, & Ledford, 1992). Here, we summarize the key findings concerning skill-based
pay.
Trends in Skill-Based Pay Use
The 1987 survey found that 40 percent of the companies used skill-based pay with at
least some employees. On the basis of the extensive publicity given to skill-based pay since
1987, we predicted that the level of use would be higher in 1990. This prediction was
confirmed. The 1990 survey found that 51 percent used skill-based pay with at least some
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employees, an increase of over 25 percent in the number of companies using skill-based pay in
just three years. The percentage of employees covered by the typical company using skill-
based pay remained the same in 1987 and 1990. The typical user covered less than 20 percent
of their employees with skill-based pay (see Table 1). Overall, skill-based pay appears to be
increasingly popular in the sense that more companies are adopting it, but it tends to be
adopted only for a minority of employees in the organization.
Success of Skill-Based Pay
We must explore the reasons that firms are adopting skill-based pay if we wish to
understand its increased use. The first explanation to explore is rational self-interest. That is,
a company adopts skill-based pay to gain performance improvements. We asked the
respondents to provide an overall rating of the success of their skill-based pay plans. Sixty
percent of the respondents rate their skill-based pay plans as successful or very successful in
increasing organizational performance. Only six percent rate them as unsuccessful or very
unsuccessful, while 35 percent are undecided. Clearly, the overwhelming feeling of the
respondents is that skill-based pay systems are effective in achieving performance
improvements.
The apparent effectiveness of skill-based pay certainly helps account for its increased
popularity. But why do some firms adopt skill-based pay while others do not? To answer this
question, we must look more closely at management practices and organizational
characteristics that may differentiate skill-based pay users and non-users.
Skill-Based Pay and Employee Involvement
The skill-based pay concept has received considerable attention in the literature on
employee involvement in general and work redesign in particular (Lawler, 1990, 1992). Skill-
based pay fits well with employee involvement practices, for two reasons. First, skill-based
pay reinforces employee involvement practices. It increases employee flexibility, which
broadens their perspective on the overall production or service delivery system. This may
lead to more insightful employee suggestions for performance improvement. Rewards for
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learning multiple jobs may also facilitate job rotation and cross-training, which are essential to
self-managing team designs. Second, a high level of employee involvement may be necessary
to fully realize the benefits of skill-based pay. Increased flexibility and greater employee
perspective may be wasted if employees are not give the power to use what they learn through
participation groups and job designs that create greater self-management. For these reasons,
we predict that skill-based pay will be especially prevalent in organizations that are using
employee involvement practices such as participation groups, job enrichment, and self-
managing teams. The survey results confirm this prediction. This result is consistent with the
results of a recent study of skill-based pay of 96 skill-based pay plans, in which the
respondents were at the plant level or the equivalent (Jenkins, Ledford, Gupta, & Doty, 1992).
In light of our argument that skill-based pay is an important component of employee
involvement systems, we examined whether the use of skill-based pay is associated with the
success of employee involvement efforts. The respondents were asked to indicate whether
their employee involvement effort improved organizational functioning and organizational
performance in a number of areas. Measures of organizational functioning included improved
managerial decision-making, movement of decision-making authority lower in the organization,
and increased information flow throughout the organization. Measures of organizational
performance included productivity, quality, employee satisfaction, and profitability. We found
that the adoption of skill-based pay was strongly associated with employee involvement
programs that resulted in improvements in organizational functioning. It was also associated
with the degree to which employee involvement efforts produced improvements in the quality
of products or services and in competitiveness, but not productivity and profitability
improvements.
Skill-Based Pay and Total Quality Management
There is a reason to expect a strong association between the use of total quality
management programs and the use of skill-based pay. TQM practices include organizing
employees into work cells or manufacturing cells, just-in-time inventory systems, self-
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inspection, direct exposure to customers, and so on. These practices often rely on and
encourage greater employee flexibility and cross-training. The study results confirm that
organizations that use total quality management programs are significantly more likely to use
skill-based pay. Indeed, this was the strongest relationship found between the use of skill-
based pay and other management practices.
Competitive Conditions Facing Skill-Based Pay Users
All public corporations may be interested in gaining performance advantages through
innovations such as skill-based pay, but the need for performance improvements will be felt
more acutely in some firms than in others. Skill-based pay, as well as employee involvement
and total quality management practices, represent a substantial change in the basic assumptions
and behavior of management. Thus, performance pressures must be especially strong to
overcome the inertia of conventional practice. This suggests that skill-based pay practices are
especially likely to be adopted by companies that feel strong competitive pressures. Such
pressures not only increase the firm's interest in increasing performance, but also increase its
willingness to rethink basic management practices. Foreign competition is a competitive threat
that is particularly likely to sharpen management interest in workplace innovations that lead to
performance improvements. Consistent with this logic is our finding that firms facing heavy
foreign competition are more likely to use skill-based pay. Because manufacturing firms are
more likely to face tough foreign competition than service firms, we predicted that
manufacturing firms would be significantly more likely to adopt skill-based pay than service
firms. The results confirm this prediction.
Skill-Based Pay and Changes in Organizational Structure
Skill-based pay allows individuals a chance to develop their skills and increase their
pay, even when promotions are not available. Therefore, we expected that skill-based pay
would be attractive to organizations that are downsizing and delayering, both of which
decrease opportunities for promotion. The results confirm that firms that have removed
management layers during recent years are especially likely to adopt skill-based pay practices.
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Skill-Based Pay and Use of Other Reward Innovations
Finally, we found that the use of skill-based pay is associated with the use of a variety
of other reward system practices (see Table 2). The strongest relationship is with the use of
gainsharing. Fifty-nine percent of the companies with skill-based pay use gainsharing, while
only 19 percent of those who do not use skill-based pay use gainsharing. Skill-based pay users
also are more likely to use profit sharing, all-salaried pay systems, and team incentives. There
is a strong tendency for users of skill-based pay to use all other pay innovations to a greater
degree than non-users of skill-based pay. Skill-based pay users differ from non-users most in
the adoption of pay innovations that, like skill-based pay, are associated with the use of skill-
based pay. This suggests global innovativeness as a partial explanation for the adoption of
skill-based pay.
Future Use of Skill-Based Pay
We asked respondents to indicate whether they expected their corporation to increase
or decrease its use of skill-based pay in the future. Overall, the respondents indicate that their
organizations are much more likely to increase than to decrease their use of skill-based pay.
Some 53 percent say that their organization plans to increase its use; 45 predict that use will
stay about the same; and only two percent indicate that their organization plans to decrease use
of skill-based pay.
There is a significant difference between skill-based pay users and non-users in their
future plans with respect to skill-based pay. Among current users, 67 percent plan to increase
their use while 33 percent plan to stay the same. The percentages are reversed for non-users.
Some 34 percent of non-users plan to increase their use, while 66 percent plan to stay the
same. Overall, it is clear that the users of skill-based pay typically plan to increase their use
of it. However, a significant number of non-users do plan to increase their usage.
The data make clear that current success of skill-based pay is related to plans to use it
in the future. Among the successful users, 70 percent plan to increase its future use while 30
percent plan to keep their current use at the same rate. Among the small number of companies
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who regarded their current skill-based pay plans as unsuccessful, 59 percent still plan to
increase future use, whereas 40 percent prefer maintaining their current rate of use. It is
interesting and somewhat surprising that a majority of the reportedly unsuccessful users plan to
increase the use of skill-based pay in the next two years.
The characteristics that are associated with the current use of skill-based pay are
strongly associated with its planned future use. Companies that are subject to foreign
competition, shorter product life cycles and speed to market concerns, and manufacturers are
particularly likely to plan increased use of skill-based pay in the future. Similarly, companies
that are heavily committed to total quality management programs are especially likely to plan
on increasing use of skill-based pay in the future. Finally, companies that are planning to
increase their use of such employee involvement-oriented practices as gainsharing, quality
circles, and self-managing teams are planning to increase their use of skill-based pay as well.
Conclusion
Overall, the data paint a rather clear and positive picture of skill-based pay. It is being
used just where its advocates argue that it should be used, in association with employee
involvement-oriented management practices. Although skill-based pay is not a new idea, its
growth seems to be on an accelerated path. It is still too early to say whether it is going to be
the dominant pay approach where organizations have moved to total quality management and
employee involvement-oriented management systems but this clearly is a possibility.
Finally, the reported success rate of skill-based pay is impressive. The fact that only
six percent of adopters report skill-based pay to be unsuccessful in improving organizational
performance suggests that despite the complexity and newness of the approach, it generally has
a positive or at worst a neutral impact on organizational effectiveness. As more technology
and experience develops to support the use of skill-based pay, it is quite possible that this
success rate will increase.
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REFERENCES
Jenkins, G.D. Jr., Ledford, G.E. Jr., Gupta, N., and Doty, D.H. Skill-Based Pay: Practices,
Payoffs, Pitfalls, and Prospects. Scottsdale, AZ: American Compensation Association,
1992.
Lawler, E.E. Strategic Pay. San Francisco: Jossey-Bass, 1990.
Lawler, E.E. The Ultimate Advantage: Creating the High-Involvement Organization. San
Francisco: Jossey-Bass, 1992.
Lawler, E.E., Ledford, G.E. Jr., and Mohrman, S.A. Employee Involvement in America: A
Study of Contemporary Practice. Houston: American Productivity and Quality Center,
1989.
Lawler, E.E., Mohrman, S.A., and Ledford, G.E. Jr. Employee Involvement and Total Quality
Management: Practices and Results in Fortune 1000 Companies. San Francisco: Jossey-
Bass, 1992.
Table 1
Percentage of Employees on Skill-Based Pay
Notes:
1987 N=476 Fortune 1000 firms
1990 N=313 Fortune 1000 firms
None
0%
Almost
None
1-20% Some
21-40%
About
Half
41-60% Most
61-80%
Almost
All
81-99% All
100%
1990 49 34 11 2 1 1 1
1987 60 25 7 2 2 2 2
Table 2
Pay Practices Related to Use of Skill-Based Pay
Pay Practice
Percentage of Companies
Without Skill-Based Pay
Using Practice Percentage of Companies
With Skill-Based Pay
Gainsharing 19 59
Team Incentives 49 68
Flexible Benefits 51 58
All-Salaried Work Force 53 75
Profit Sharing 54 71
Stock Ownership 59 69
Individual Incentives 86 92
Nonmonetary Incentives 88 94
N=313 Fortune 1000 Firms
