Chapter 3 Defining Internal Alignment McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Chapter Topics Compensation Strategy: Internal Alignment Structures Vary Among Organizations What Shapes Internal Structures? Strategic Choices in Designing Internal Structures

Chapter Topics (cont.) Guidance from the Evidence Consequences of Structures

Internal Alignment Internal alignment, often called internal equity, refers to the pay relationships among different jobs/skills/competencies within a single organization

Compensation Strategy: Internal Alignment (cont.) Supports organization strategy Supports work flow Work flow refers to the process by which goods and services are delivered to the customer Motivates behavior Line-of-sight Structure must be fair to employees

Structures Vary Among Organizations An internal pay structure can be defined by: The number of levels of work The pay differentials between the levels The criteria or base used to determine those levels and differentials

Number of Levels Pay structure is hierarchical in nature, based on: Reporting relationships

Differentials The pay differences among levels are referred to as differentials Pay is determined by: Knowledge/ skills involved Working conditions Valued addition to the company The same basic structure of percent differentials can be paired with different pay level policies

Exhibit 3.3: Pay Structure at Lockheed Martin, Under Two Alternative Pay Level Policies

Criteria: Content and Value Content refers to the work performed in a job and how it gets done Structure ranks jobs on skills required, complexity of tasks, problem solving, and/or responsibility Value refers to the worth of the work; its relative contribution to the organization objectives

Criteria: Content and Value (cont.) Structure focuses on relative contribution of skills, tasks, and responsibilities to the organization's goals Can include external market value

Use Value and Exchange Value Use value reflects the value of goods or services an employee produces in a job Exchange value refers to the wage the employer and employee agree on for a job Difference between exchange value and use value surfaces when one firm acquires another

Job- and Person-Based Structures Job-based structures rely on the work content – tasks, behaviors, responsibilities Person-based structures shift the focus to the employee Skills, knowledge, or competencies the employee possesses Whether or not they are used in the particular job

Job- and Person-Based Structures (cont.) In reality, both job- and-person-based structures are included

Exhibit: 3.4: What Shapes Internal Structures?

What Shapes Internal Structures? Economic pressures Early advocates: Adam Smith, Karl Marx Marginal productivity Supply and demand for labor and products and services Government policies, laws, and regulations Equal Pay Act and Civil Rights Act Living wage

What Shapes Internal Structures? (cont.) External stakeholders Unions seek smaller pay differences among jobs and seniority-based promotions Stockholders are interested in pay differences between executives and others in the organization The AFL-CIO uses information on pay differences to rally support for unions and influence public opinion

What Shapes Internal Structures? (cont.) Cultures and customs Shared mind-sets may judge what size pay differential is fair Global competition and an aging workforce has made age-based pay an expensive affair Organization strategy Aligned, yet adaptable pay structures may be required

What Shapes Internal Structures? (cont.) Organization human capital Education Experience Knowledge Abilities Skills The greater the value added by the skills and experience, the more pay those skills will command

What Shapes Internal Structures? (cont.) Organization work design Technology used in producing goods and services influences: Organizational design The work to be performed The skills/knowledge required to perform the work

What Shapes Internal Structures? (cont.) Temporary work suppliers Outsourcing specialists Pay for employees under both practices based on internal structure of home employer Delayering Cuts unnecessary, non-contributing work Adds work to other jobs, enlarges them, changes the job’s value and structure

What Shapes Internal Structures? (cont.) Overall HR policies If an organization has more levels, it can offer more promotions, but there may be smaller pay differences between levels More frequent promotions (even without significant pay increases) offer a sense of “career progress” to employees

What Shapes Internal Structures? (cont.) Internal labor markets: Combining external and organization Factors Internal labor market refers to rules and procedures that: Determine pay for different jobs within a single organization Allocate employees among those different jobs

Exhibit 3.5: Illustration of an Internal Labor Market

What Shapes Internal Structures? (cont.) Employee acceptance : A key factor Procedural justice refers to the process by which a decision is reached Distributive justice refers to the fairness of the decision

What Shapes Internal Structures? (cont.) Pay procedures are more likely to be perceived as fair: If they are consistently applied to all employees If employees participated in the process If appeals procedures are included If the data used are accurate

What Shapes Internal Structures? (cont.) Pay structures change “Change-and-congeal” process Pay structures established at an earlier time may be maintained for cultural or political reasons May take an economic jolt to overcome the resistance New norms form around the new structure

Strategic Choices in Designing Internal Structures Tailored versus loosely coupled Tailored Well designed jobs with detailed steps or tasks Very small pay differentials among jobs Loosely coupled Requires constant innovation Pay structures are more loosely linked to the organization to provide flexibility

Strategic Choices in Designing Internal Structures (cont.) Egalitarian versus hierarchical Egalitarian structures send the message that all employees are valued equally Advantages Fewer levels and smaller differentials between adjacent levels and between highest- and lowest-paid workers Disadvantages ‘Averagism’ brings to light that equal treatment can mean more knowledgeable employees feel underpaid

Strategic Choices in Designing Internal Structures (cont.) Hierarchical structures send the message that the organization values the differences in work content, individual skills, and contributions to the organization Multiple levels include detailed descriptions of work done at each level Outlined responsibility for each

Exhibit 3.6: Strategic Choice: Hierarchical versus Egalitarian

Exhibit 3. 7: Which Structure has the Greatest Impact on Performance Exhibit 3.7: Which Structure has the Greatest Impact on Performance? On Fairness?

Guidance from the Evidence Equity theory: Fairness Research suggests that employees judge fairness by multiple comparisons Comparing to jobs similar to their own Comparing their job to others at the same employer Comparing their jobs’ pay against external pay levels

Guidance from the Evidence (cont.) Results from these comparisons depend in part on the accuracy of employee knowledge Tournament theory: Motivation and performance All players will play better in the first tournament, where the prize differentials are larger

Guidance from the Evidence (cont.) Greater the difference between an employee’s salary and the boss’s salary, the harder he/she will work Does not directly address turnover Institutional model: Copy others Very few “first movers” Copiers have little concern for alignment and innovative pay practices

Exhibit 3.8: Some Consequences of an Internally Aligned Structure

Guidance from the Evidence (cont.) Impact of internal structures depends on context in which they operate More hierarchical structures are related to greater performance when the work flow depends on individual contributors

Guidance from the Evidence (cont.) High performers quit less under more hierarchical systems when: Pay is based on performance rather than seniority When people have knowledge of the structure

Guidance from the Evidence (cont.) More egalitarian structures are related to greater performance when close collaboration and sharing of knowledge are required Impact of any internal structure on organization performance is affected by other dimensions of the pay model: Pay levels (competitiveness)

Guidance from the Evidence (cont.) Employee performance (contributions) Employee knowledge of the pay structure (management)

Consequences of Structures Importance of internal alignment Efficiency Pay structures imply future returns Fairness For fair (sizable) differentials Against fair (sizable) differentials Compliance Comply with regulation of the country