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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.
