978-1259532726 Chapter 3 Lecture Note Part 1

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CHAPTER THREE

DEFINING INTERNAL ALIGNMENT

Overview

Chapter Three is the first of four chapters in Part Two, Internal Alignment: Determining the

Structure.

This chapter discusses internal alignment and how it affects employees, managers, and

employers. Internal alignment refers to the pay relationships among jobs/skills/competencies

within a single organization. An internal pay structure—the array of pay rates for different jobs

within an organization—is defined by (1) number of levels of work; (2) the pay differentials

between the levels; and (3) the criteria used to determine the levels and differentials. Pay

structures are shaped by both external and organization factors, including economic, societal,

and organization-specific factors.

Employees judge a structure to be equitable by comparing each job’s pay with the qualifications

required, the work performed, and the value of that work. Acceptance by employees of the pay

differentials among jobs is a key test of an equitable pay structure. Such structures are part of the

network of rewards offered by organizations.

The potential consequences of internal pay structures are vital to organizations and individuals.

The goals of the entire compensation system should guide the design and management of internal

pay structures. There is widespread experience and increasing research to support the belief that

differences in internal pay structures, particularly employee career paths, influence people’s

attitudes and work behaviors and ultimately the success of organizations.

Learning Objectives

Define internal alignment and pay structure and discuss how they should support the

organization strategy, support the work flow, and motivate behavior toward organization

objectives.

Discuss how internal pay structures vary among organizations due to the number of levels

of work, the pay differentials between the levels, and the criteria used to determine those

levels and differentials.

Identify the major external and organization factors that shape internal structures.

Differentiate between various strategic choices in designing internal structures and

identify the consequences of an aligned internal structure.

Lecture Outline: Overview of Major Topics

I. Jobs and Compensation

II. Compensation Strategy: Internal Alignment

III. Structures Vary Among Organizations

IV. What Shapes Internal Structures?

V. Strategic Choices in Designing Internal Structures

VI. Guidance from the Evidence

VII. Consequences of Structures

VIII. Your Turn: So You Want to Lead an Orchestra!

IX. Still Your Turn: (If You Don’t Want to Lead the Orchestra…)

X. Still (yes, still) Your Turn: NCAA

Lecture Outline: Summary of Key Chapter Points

I. Jobs and Compensation

This chapter throws some light on the fact that organizations design their pay

structures around jobs and job levels and that, in many organizations, an employee’s

pay depends on both the nature of the job and the job level (and thus promotion rate).

II. Compensation Strategy: Internal Alignment

Setting objectives is the first issue in a strategic approach to pay.

The second issue, internal alignment, addresses pay relationships inside the

organization.

The relationships inside the organization form a pay structure that should:

oSupport the organization strategy,

oSupport the work flow, and

oMotivate behavior toward organization objectives

Definition: Internal alignment, often called internal equity, refers to the pay relationships

among different jobs/skills/competencies within a single organization.

Definition: Pay structure refers to the array of pay rates for different work or skills within

a single organization. The number of levels, the differentials in pay between the levels, and

the criteria used to determine those differences describe the structure.

A. Supports Organization Strategy

An organization’s strategy needs to support important aspects that go into

maintaining its competitive advantage.

B. Supports Work Flow

Work flow refers to the process by which goods and services are delivered to the

customer.

The pay structure ought to support the efficient flow of the work and the design of

the organization. The text explains this concept by using the example of Merrill

Lynch.

C. Motivates Behavior

Internal pay structures are part of the network of returns: pay increases for

promotions, more challenging work, and greater responsibility as employees move

up in the structure.

The challenge is to design structures that will engage employees to help achieve

organization objectives.

The structure ought to make clear the relationship between each job and the

organization’s objectives; this is an example of “line-of-sight.”

Employees should be able to “see” links between their work, the work of others,

and the organization’s objectives.

III. Structures Vary Among Organizations

An internal pay structure can be defined by:

1. The number of levels of work,

2. The pay differentials between the levels, and

3. The criteria or bases used to determine those levels and differentials

A. Number of Levels

One feature of any pay structure is its hierarchical nature: the number of levels

and reporting relationships.

Some are more hierarchical, with multiple levels; others are compressed, with few

levels.

B. Differentials

The pay differences among levels are referred to as differentials.

If we assume that an organization has a compensation budget of a set amount to

distribute among its employees, there are a number of ways it can do so:

oIt can divide the budget by the number of employees to give everyone the

same amount.

oBut, in most organizations, pay varies among employees. Work that

requires more knowledge or skills, is performed under unpleasant working

conditions, or adds more value is usually paid more.

One intention of differentials is to motivate people to strive for promotion to a

higher-paying level.

C. Criteria: Content and Value

The most common bases for determining internal structures are:

oContent—refers to the work performed in a job and how it gets done

(tasks, behaviors, knowledge required, etc.). A structure based on content

typically ranks jobs based on skills required, complexity of tasks, problem

solving, and/or responsibility.

oValue—refers to the worth of the work. A structure based on the value of

the work focuses on the relative contribution of the skills, tasks, and

responsibilities of a job to the organization’s goals. While the resulting

structures may be the same, there are important differences:

In addition to relative contribution, external market value may also be

included (i.e., what competitors pay for this job).

Or it may include rates agreed upon through collective bargaining, or

legislated rates (minimum wage).



Use Value and Exchange Value

oUse value reflects the value of goods or services an employee produces in

a job. Similar job content in two different companies may be valued differently

based on how it contributes to organization objectives.

oExchange value is whatever wage the employer and employee agree on

for a job. The same work content in the same company may have different

exchange values based on different geographies.

oThe difference between exchange value and use value also surfaces when

one firm acquires another. The text explains this concept by using the example

of IBM’s acquisition of PricewaterhouseCoopers (PWC).



Job- and Person-Based Structures

oA job-based structure relies on the work content—tasks, behaviors, and

responsibilities.

oA person-based structure shifts the focus to the employee—the skills,

knowledge, or competencies the employee possesses, whether or not they are

used in the employee’s particular job.

oIn the real workplace, it is often hard to describe a job without reference to

the jobholder’s knowledge and skills. Conversely, it is hard to define a person’s

job-related knowledge or competencies without referring to work content. So

rather than a job- or person-based structure, reality includes both job and

person.

IV. What Shapes Internal Structures?

Exhibit 3.4 categorizes the major factors that shape internal structures as external

and organization factors, even though they connect and interact.

A. Economic Pressures

Adam Smith was an early advocate of letting economic market forces

influence pay structures. He was the first to ascribe both an exchange value and

a use value to human resources.

Karl Marx said that employers unfairly pocketed the surplus value

created by the difference between use and exchange value. He urged workers to

overthrow capitalistic systems to become individual owners and reap the full

use of their labor.

A countering theory put forth in the last half of the 19th century, marginal

productivity, says that employers do pay use value. Unless an employee can

produce a value equal to the value received in wages, it will not be worthwhile

to hire that worker. One job is paid more or less than another because of

differences in relative productivity of the job and/or differences in how much a

consumer values the output.

In addition to supply and demand for labor, supply and demand for

products and services also affect internal pay structures.

oTurbulent changes, either in competitors’ products/services or in

customers’ tastes, force organizations to redesign work flow and force

employees to continuously learn new skills.

oUnpredictable external conditions require pay structures that support agile

organizations and flexible employees.

B. Government Policies, Laws, and Regulations

In the United States, equal employment legislation forbids pay systems

that discriminate on the basis of gender, race, religion, or national origin.

The Equal Pay Act and the Civil Rights Act require “equal pay for equal

work,” with work considered equal if it requires equal skill, equal effort, and

equal responsibility and is performed under equal working conditions.

An internal structure may contain any number of levels, with differentials

of any size, as long as the criteria for setting them are not gender, race, religion,

or national origin.

Much pay-related legislation attempts to regulate economic forces to

achieve social welfare objectives. The most obvious place to affect an internal

structure is at the minimums (minimum-wage laws) and maximums (special

reporting requirements for executive pay).

But legislation also aims at differentials. A contemporary U.S. example is

the “living wage.” A number of U.S. cities require minimum hourly wage rates

well above what federal law requires.

The anticipated outcome of such legislation is a flatter, more compressed

structure of wage rates in society.

C. External Stakeholders

Unions, stockholders, and political groups have a stake in how internal

pay structures are determined.

Most unions seek smaller pay differences among jobs and seniority-based

promotions as a way to promote solidarity among members.

One specific comparison often used is the ratio of CEO pay to that of the

average or entry level worker.

D. Cultures and Customs

Culture is defined as, “the mental programming for processing information

that people share in common.” Shared mind-sets may judge what size pay

differential is fair.

Historians note that in the 14th-century western Europe, the Christian

church endorsed a “just wage” doctrine, which supported the existing class

structure. Market forces such as skills shortages (higher exchange value) were

explicitly denied as appropriate determinants of pay structures.

Even today, cultural factors play a role in shaping pay structures. Many

traditional Japanese employers place heavy emphasis on experience in their

internal pay structures. But pressures from global competitors plus an aging

workforce have made age-based pay structures very expensive. Consequently,

some Japanese employers are shifting older-employees to lower-paying business

units, emphasizing performance and downplaying seniority.

E. Organization Strategy

The belief is that pay structures that are not aligned with the organization

strategy may become obstacles to the organization’s success.

However, aligned structures today may become an obstacle tomorrow. So

aligned, yet adaptable may be required.

F. Organization Human Capital

Human capital—education, experience, knowledge, abilities, and skills

required to perform the work—is a major influence on internal structures.

The greater the value added by the skills and experience, the more pay

those skills will command.

G. Organization Work Design

Technology used in producing goods and services influences the

organizational design, the work to be performed, and the skills/knowledge

required to perform the work.

The design of organizations is undergoing profound changes. A lot of

people who work in organizations are not employees of these organizations.

They might either be a supplier or a temporary work supplier. Or, they may be

working under a temporary contract for a limited amount of time or on a limited

project.

oThese employees may be supplied by outsourcing specialists. Pay for

these employees is based on the internal structure of their home employer

rather than of the workplace at which they are currently located.

oAnother major work design change is delayering. Entire levels of work

have disappeared. Delayering can cut unnecessary, noncontributing work. It

can also add work to other jobs, enlarging them. Through the use of

self-managed work teams in production work, entire levels of supervisory

jobs are removed and the responsibility for more decisions is delegated to

the teams.

H. Overall HR Policies

The organization’s other human resource policies also influence internal

pay structures.

Most organizations tie money to promotions to induce employees to apply

for higher-level positions. If an organization has more levels, it can offer more

promotions, but there may be smaller pay differences between levels. The belief

is that more frequent promotions (even without significant pay increases) offer a

sense of “career progress” to employees..

I. Internal Labor Markets: Combining External and Organization Factors

Internal labor markets refer to rules and procedures that

1. Determine the pay for the different jobs within a single organization and

2. Allocate employees among the different jobs

External factors are dominant influences on pay for entry jobs, but the

differences for nonentry jobs tend to reflect internal factors.

J. Employee Acceptance: A Key Factor

Employees judge the fairness of their pay through comparisons with the

compensation paid to others for work related in some fashion to their own.

Accordingly, an important factor influencing the internal pay structure is its

acceptability to the employees involved. Employees make multiple pay

comparisons to assess the fairness of an internal pay structure.

Two sources of fairness are important:

oProcedural justice—the procedures for determining the pay structure. It

refers to the process by which a decision is reached. Researchers report that

employees’ perceptions of procedural fairness significantly influence their

acceptance of the results; employees and managers are more willing to

accept low pay if they believe that the way this result was obtained was fair.

This research also suggests that pay procedures are more likely to be

perceived as fair:

1. If they are consistently applied to all employees,

2. If employees participated in the process,

3. If appeals procedures are included, and

4. If the data used are accurate.

Applied to internal structures, procedural justice addresses how design and

administration decisions are made and whether procedures are applied in a

consistent manner.

oDistributive justice—the results of the procedures, i.e., the pay structure

itself. It refers to the fairness of the decision. It addresses whether the actual

pay differentials among employees are acceptable.

K. Pay Structures Change

Pay structures change in response to external factors such as skill

shortages.

Pay structures established for organizational and economic reasons at an

earlier time may be maintained for cultural or political reasons. It may take

another economic jolt to overcome the resistance.

This “change-and-congeal” process does not yet support the continuous

changes occurring in today’s economy.

New norms for employee acceptance will probably need to include

recognition that people must get used to constant change, even in internal pay

structures.