According to Competency Based Pay, an employee is paid for the skills and knowledge he possesses and not according to the job or position he is currently holding. This kind of pay structure motivates employees as the employee feels he is being paid for the worth he/she has. The entire structure of the company revolves around this then. The motivated employees rise and get promoted. The employees are not paid by the virtue of their position but competency, hence competency based pay.
When businesses become flatter eliminating non-value adding activities, competency-based pay may complement the move by assigning value to an employee’s work in terms of the competencies that enable the staff member to perform effectively in his role. It rewards employees for the skills, knowledge and behaviors important for personal performance and organizational success and not just for the activities they perform.
Competency based pay encourages better performance and facilitates lateral career development. It is suitable in organizations where there is an over-emphasis on outputs, fit with a performance appraisal is required, cultural change towards greater flexibility is sought.