Once considered the primary focus for attracting, retaining, and (most significantly) motivating employees, the importance of base pay has shifted greatly over the past several years. The traditional method of providing annual merit increases to reward and motivate is fading as companies realize that merit increases do little to drive individual performance and base pay becomes more of a contractual component of the rewards package.

The old model

From 2017 to 2021, merit budget increases were stagnant at 3%. The 2022 US Compensation Planning Survey shows that those same merit budgets increased to 3.9% in 2022, not out of the benefit to employee performance, but as a necessity to combat a fiercely competitive labor market and the rising cost of labor.

Even as exceptional performers receive nearly double the merit increase as an average employee, an extra 3%-4% of base salary has historically done little to drive performance and motivation across the workforce.

This leaves companies asking — How can we motivate and drive employee performance in a significant manner?

Rewarding performance with incentives

Mercer consultants have historically recommended that companies rely on short-term incentives to drive performance and motivation for top performers due to the effectiveness of these initiatives.

The Short-Term Incentive Plan Design Survey indicates that over half of survey organizations are opting for nondiscretionary incentive plans that are directly tied to performance in a clear and transparent manner. Nondiscretionary plans typically employ performance measurements that must be obtained at the individual, team, department, and/or corporate level.

Nondiscretionary plans vs discretionary plans

Nondiscretionary plans offer clear guidelines and promote equity within an organization while directly tying payouts to individual, departmental, and/or organizational performance. The drawback of these plans is that participating employees are held within a defined set of guidelines that can be difficult to navigate in turbulent times.

On the opposite end of the spectrum, discretionary plans are typically not directly tied to performance metrics and rely on the manager’s judgment and team feedback for determining individual payouts. This type of plan is beneficial when leadership needs the flexibility to reward intangible achievements or attributes, but this can lead to inequity, favoritism, and a disconnect with the workforce. There are pros and cons to both plans, but as the world of compensation shifts towards transparency, more firms are opting for clarity over discretion.

The new model

For years, the discussion across HR departments has been on the shift from the traditional ways of work to a skills-focused approach. That shift is no longer a discussion as organizations have become keenly aware of the importance of skills throughout the workforce and are actively developing skills-enabled frameworks to better serve their organizations in the future.

The 2022-2023 Global Talent Trends report found that designing talent processes around skills is a top priority for organizations globally. Despite this high priority, only 11% of companies are utilizing pay to apply a premium or discount for skills, according to the 2021 Skills-based Pay Survey Report.

As our world shifts towards new ways of working, pay-for-skills is becoming a more and more prevalent practice across industries. Despite this shift, there are still obstacles preventing many organizations from making the transition. According to the 2021 survey, 49% of organizations listed the difficulty of managing a skills-based pay system as the primary reason they have not instituted pay-for-skills.

Getting started with skills-based pay

Mercer’s Skills-Edge Suite offers three innovative tools that can ease this burden, but the first step to enabling pay-for-skills is to ensure that the organization’s job architecture is optimally designed and incorporates a skills-based framework.

By aligning individual families, subfamilies, streams, and levels to the Mercer Skills Library, organizations have a sound foundation on which they can build the pay-for-skills system, with direct input from leaders who know what skills are most vital to their functional areas.

Once the skills-framework is developed, organizations can use the Skills-Pricer to determine what crucial skills drive pay in the market. Each skill is assigned a skill premium that can be utilized to determine base pay for each job and incumbent, allowing firms to be more transparent in pay while driving organizational performance through skills that help the organization achieve its objectives.

In addition to our Skills suite of products, Mercer consultants are deeply experienced in developing skills-based frameworks and pay-for-skills programs, currently working with some of the world’s top employers on these initiatives. Pay-for-skills does not have to be difficult to manage, but it does require designing an effective system that is organizationally aligned, market-driven, and transparent in its application.

A case for pay transparency

New York, Washington, California, and Colorado have all passed legislation requiring companies to post salary ranges in their job postings. This has prompted many internal incumbents to begin questioning their position within a posted range.

As the world begins shifting more towards increased pay transparency, it is becoming vital for organizations to have clearly defined criteria within salary structures to promote equity and transparency within their workforce. Transparency can be an advantage or disadvantage to organizations, depending on their current pay programs and how well they are designed. A well-designed system becomes an advantage and leads to an increase in retention and organizational achievement when salary grades and promotion criteria are effectively communicated and pathways to the next level are shown.

The major risk of transparency comes from organizations that fail to design a program that is clear, understandable, achievable, and effective. Organizations need to prioritize the design of their pay programs now, so that they can be clearly communicated in the not-so-distant future. Without a well-designed system, transparency can quickly become more of a liability than an asset.

As the world continues on the path towards complete transparency, it is vital that an organization looks in the mirror and honestly assesses its career framework and compensation model. The old ways of working are being transformed; organizations must also transform to maintain competitiveness in the talent market.

Be transparent and equitable in pay strategy

Take a look at your organization and make sure that you are paying for the skillsets your organization values. Being transparent with what your organization values and fair in the administration can help set your organization apart and enhance the employee value proposition. Transparency is growing more prevalent, so ensure your pay strategy is ready for it.

Build for the future at a foundational level

An initial step in building a workforce of the future is ensuring that the foundation is strong and stable. Without a proper job architecture, skills frameworks cannot be optimally developed. Without a skills framework, pay-for-skills programs are unlikely to be effective. Everything starts at the foundational level, so ensure that your organization has built the talent foundation on which these programs can be built. Mercer consultants can assist in developing your firm’s foundation to ensure your organization is suited for the changing talent marketplace and tomorrow’s workforce.

Looking for more assistance? We’re here to help. Reach out to Mercer at 1-855-286-5302 or surveys@mercer.com.