By Andrea Gabor
The New York Times
May 17, 1992
While many shareholders and management experts have been training their critical spotlight on executive compensation in recent months, a number of companies are engaged in a quiet but momentous revolution that is redrawing paychecks — and careers — much lower on the organizational chart. At the heart of the new pay scheme is the notion that people should be paid not for how many people they supervise or how much power they have, but for how much knowledge they bring to their work. The concept is variously known as “pay for skills,” “skill based pay” or “knowledge based compensation.”
“Pay-for-skills values learning instead of control,” said Marc Sternfeld, a managing director at Salomon Brothers, which is instituting such a system at a new facility in Tampa that will handle much of the investment banking firm’s back-office paperwork. Under the Salomon pay plan, which will begin in January, pay will reflect an employee’s specific job skills and a team’s success in achieving performance goals that they have hammered out with their “customers,” the traders in New York whose stock, bond and currency trades the Tampa group steers through clearance processes.
Until recently, pay-for-skills had been largely confined to the factory floor, mainly in the Rust Belt. But now many companies are beginning to apply the principles to salaried employees, like accountants and computer experts.
The growing popularity of skill-based pay reflects an ongoing search for better ways of motivating and rewarding employees, especially as companies flatten their organizational charts to respond more rapidly to market changes. Another goal is to improve quality and productivity, especially in the service sector.
The new pay system is leading to a reshaping of career tracks at many levels of a corporation. “Traditional career tracks have disappeared,” said Edward E. Lawler, a management professor at the University of Southern California. “Yet traditional pay systems penalize employees for making horizontal moves.” Increasingly, he contends, career advancement will entail acquiring expertise in a wide range of areas, rather than climbing a corporate ladder.
At Salomon, Mr. Sternfeld said, traditional pay schemes give individual bosses wide latitude in determining pay, which can lead to inequities and byzantine compensation structures in which salaries for similar jobs vary widely. That can make it difficult to move employees into different positions.
“What we want is to pay for a set of social skills and the ability to learn,” Mr. Sternfeld said, noting that Tampa employees will have to pass competency tests and peer reviews. “We’re going from an subjective system to an objective one.”
According to a recent study by the Wyatt Company, a human resources consulting firm in New York, less than half of about 5,000 employees surveyed believe there is a clear link between good job performance and pay. One reason, said Marsha Cameron of Wyatt, is that merit raises have been declining in the last decade. Just as more and more companies embrace teamwork as a key to improvement and innovation, the merit system has turned into a zero-sum game in which one employee’s raise comes at the expense of his co-worker’s.
“Companies spend all this time and energy on merit programs and all they do is make employees angry,” said Craig Cantoni, a former director of human resources at Mars Inc., the candy maker. The biggest shortcoming of traditional merit pay systems, he contends, is that they substitute “phony rewards” for a meaningful approach to developing management talent.
Mr. Cantoni attributes Mars’s strengths in quality and market share to a management system that pays about the same salary to all employees at the same level, like vice presidents. While Mars does not have a pay-for-skills system, its compensation scheme is intended to achieve the same result: cultivate well-rounded employees who are expected to learn every part of the business by taking a wide range of jobs.
Concerns that have embraced knowledge-based pay are gambling that a system which steers all employees through a curriculum of skills will do a better job of improving overall performance than a merit-pay system. To educate their troops, companies are doubling and tripling their education budgets because each employee gets training in a variety of disciplines. To take some of the sting out of the lack of merit raises, most companies also offer employees a share of profits, or “gain sharing,” a sum often based on how well a team meets productivity targets, improves quality or expands market share.
Reports from companies that have used skill-based pay for an extended period show some striking results. For example, in the late 1960’s labor unrest at a General Foods pet food plant in Kankakee, Ill., led the company to open a factory in Topeka, Kan., and organize workers into teams.
New employees at the plant, which is now owned by Quaker Oats, earn $8.75 an hour, and can reach a top rate of $14.50 when they master 10 to 12 skills, like operating lift trucks and factory computer controls. Five years ago, the average worker in Topeka, a non-union plant, earned $1 an hour more than his union counterpart in Kankakee. But labor costs per pound of dog food were 35 cents less. Now that most workers are at or near the top pay level, Topeka’s management is considering gain-sharing.
Such stories caught Salomon’s attention. Mr. Sternfeld said it plans to transfer some seasoned employees to Tampa and keep a skeleton staff of 35 in New York. The rest of the Tampa staff will be local hires, including former lifeguards, air traffic controllers and MBA’s — most with no brokerage experience — who have “a different way of thinking about themselves, their careers and how they get paid,” Mr. Sternfeld said.
Salomon plans to use the knowledge-based pay system to turn these financial neophytes into well-rounded product experts and inspire them to work in teams. Each employee’s pay is determined in much the way college students gather credits. While those with high-level degrees or special expertise “transfer” into the company at higher pay levels, most new employees are treated as freshmen and get the same base pay.
Employees will no longer specialize in areas like accounting or data management. Instead, they are organized into about a dozen product teams, like foreign exchange or corporate bonds. To earn a raise, an employee must complete an assignment on, say, the foreign exchange team and demonstrate a certain competency in a dozen skills.
Once the employee completes the assignment, which takes about 6 to 18 months, he would typically move to a more difficult assignment on the same team. Peer review — not management hierarchy — will help control the system, Mr. Sternfeld said.
Salomon has not yet determined the value each “assignment” will carry in raises. But at many companies, the increase is greater than the typical 5 percent annual merit raise because the teams are more efficient.
To be sure, by moving back-office operations to Tampa, where there is little competition for employees with brokerage skills, Salomon expects to slash payroll costs. Only 17 “coaches” will advise some 500 team members — down from 135 managers who supervised 670 employees in New York. And about half of Tampa’s new hires are temporary employees expected to work themselves out of a job in two to five years. This means there will be little traditional upward mobility for Tampa employees. But the payoff is likely to be gain-sharing bonuses.
Salomon’s new “experts” are expected to speed the clearance process and ultimately improve the quality of the firm’s financial products themselves. Some of the initial productivity improvements will come from automating clearance functions.
But Salomon thinks the biggest payoff could come in how new-product decisions are made. For example, emerging markets in international securities and foreign currencies hold enormous potential. Highly skilled back-office personnel should be able to help evaluate a new business, said Michael Dimino, a foreign exchange expert at Salomon.
Take Thailand’s currency, the baht, which the firm began trading about two years ago. Mr. Dimino, who left a job as supervisor in New York to join the foreign exchange team in Tampa, explained that because of Thailand’s strict regulations it can take two weeks to move money after a trade, a delay that can eat up the profit on a transaction.
If the decision to trade in bahts were being made today, New York would probably tap the expertise of clearance experts in Tampa. It’s too early to tell how successful skill-based pay will be in improving white-collar productivity. Experts note that while a typical factory worker might need to master a dozen skills, a financial- services employee might have to wrestle with scores of skills and nuances of subject matter. But if it works,Mr. Sternfeld says, he can envision a day when his most well-rounded team members earn more than the coaches.
Tensions of a New Pay Plan
The quest for a customer-oriented culture is one factor driving Polaroid in an ambitious effort to apply a version of knowledge-based payto all jobs — from the factory to the board room.
Winning over a boss is no longer enough to move to the next pay level. Instead, an employee and a supervisor must convince a review board and the employee’s internal “customers” that he has demonstrated the requisite skill for his next position.
But a big challenge in a pay-for-skills program is to keep employees who are more used to competition than collaboration focused on the team’s needs rather than on passing tests and winning raises.
At IDS Financial Services, a Minneapolis-based subsidiary of American Express, the pay plan created a tug-of-war between employees who wanted recognition for individual performance and IDS’s conviction that the best improvements come from teamwork.
The problem surfaced when IDS began replacing departing employees with a younger, better-educated work force. More than half of its employees now have college degrees, up from about 10 percent in 1988, the year it began a pay-for-skills experiment in its mutual fund business.
“It got to be a disaster,” said Bill Scholz, a vice president for IDS. “People were acquiring skills that we didn’t have an opportunity to need. And it was penalizing individuals who stayed behind to do the work while the rest of us went out and acquired skills.”
As a result, IDS has backed away from a formal pay-for-skills system but not from its commitment to teamwork. Today, raises are based on a 50-50 split between a gain-sharing award and an assessment of an employee’s performance.
Copyright 1992 The New York Times Company