MODULE IV -

EXTERNAL
COMPETITIVENESS :
DETERMINING THE
PAY LEVEL
(A module — compiled and summarized contents are based from the book
titled Compensation 11th ed. by Milkovich, George, Jerry Newman & Barry
Gerhart (2014) and other electronic references for classroom discussion only.)

HRM 307
Compensation
Administration
Ms. Jennifer Buenviaje Atienza
INSTRUCTOR
 MODULE INTRODUCTION

External competitiveness is equally important as internally aligning the pay

systems. Looking at the market and deciding as to lead, match or lag in the
industry will likewise determine a pay level. Pay levels and pay forms are on the
aims of controlling costs and increasing company revenues while attracting and
retaining talents. This module deals with the identification of factors shaping the
external competitiveness which affect design of a pay level, mix and structure.
This eventually leads to its consequences on the company objectives.

COMPENSATION STRATEGY AND

EXTERNAL COMPETITIVENESS

While internal alignment as one of the policy choices is about the comparison of jobs
within a single organization, external competitiveness as another policy looks at
comparing jobs outside the organization, particularly within the industry where the
company is playing. External alignment focuses on the comparisons of jobs with
other employers who look for talents of the same skills as their employees. This
results in either being the market leader in the industry as a strategy, or to simply
imitate or mirror other companies in terms of their pay systems. External
competitiveness according to Milkovich, et.al may be expressed in practice through
setting a pay level which can either be above, below or equal to other organizations
in their given industry and determining the pay mix relative to other employers as
their competitors.

topic outcome
~IDENTIFY AND DESCRIBE WHAT SHAPE THE
EXTERNAL COMPETITIVENESS
HRM 307 - COMPENSATION ADMINISTRATION
 COMPENSATION STRATEGY AND
EXTERNAL COMPETITIVENESS

Pay levels and pay forms are on the aims of controlling costs and increasing
company revenues while attracting and retaining talents. Following the ceteris
paribus in economics, i.e. all things being equal, “the higher the pay level, the higher
the labor costs.”

If one company is paying higher than the other competitors, the greater that relative
costs that company would entail in selling their goods and services. This strategy can
sometimes be effective and ineffective as well.

Now, what shapes external competitiveness? Milkovich, et.al explained three major
factors affecting the company decisions on pay level and mix as shown in Exhibit 4.1.

EXHIBIT 4.1

Factors shaping the External Competitiveness

HRM 307 - COMPENSATION ADMINISTRATION

WHAT SHAPES EXTERNAL
COMPETITIVENESS?

01
Labor Market Factors
There are theories of labor markets being considered.
Employers always seek to maximize profits.
People are homogeneous and therefore interchangeable; a business school
graduate is a business school graduate is a business school graduate.
The pay rates reflect all costs associated with employment (e.g., base
wage, bonuses, holidays, benefits, even training).
The markets faced by employers are competitive, so there is no advantage
for a single employer to pay above or below the market rate.
Organizations often claim to be “market-driven”; that is, they pay
competitively with the market or even are market leaders. Understanding
how markets work requires analysis of the demand and supply of labor.
The demand side focuses on the actions of the employers: how many new
hires they seek and what they are willing and able to pay new employees.
The supply side looks at potential employees: their qualifications and the
pay they are willing to accept in exchange for their services.

02
Product Market Factors
It is a given that labor demand and supply is a determinant of a pay level.
However, it is also equally important to consider how the company is
generating revenue to cover their expenses which include labor expenses
such as compensation. Therefore, we can derive that the ability of
companies to pay their employees is dependent on their ability to compete
in the product/service market. Under this factor, the product demand and
the level of competition can affect the pay level. This is true in an instance
wherein if a company will not be able to increase their products without
any decrease in sales, setting a higher pay level becomes challenging.

Organization Factors

03 While both labor and product market determine the pay level,
organizational factors likewise shape company’s policy on external
competitiveness. For instance, the use of high-end technology in some
industries can affect the compensation system. It may require less skills of
employees as other tasks can already be performed by the existing
technologies. Also, bigger companies apparently are able to pay higher than
smaller ones. Further, the company strategy and the employee preferences
can likewise result in a variety of pay levels and mix

HRM 307 - COMPENSATION ADMINISTRATION

 WHAT SHAPES EXTERNAL
COMPETITIVENESS?

“Economists take ‘the market’ for granted—as in ‘The market determines wages.’“
However, some organizations have started defining what they call “relevant market”
as a big part of determining how to pay, and how much to pay the employees.
Company managers should define which markets are relevant for pay purposes and
establish the appropriate competitive positions in the market. The three factors
usually used to determine the relevant labor markets are the occupation
(skill/knowledge required), geography (willingness to relocate, commute, or become
virtual employees), and competitors (other employers in the same product/service
and labor markets). According to research, managers look at both competitors -
products, location and size and the jobs - skills and knowledge required to attain
organizational success.

RELATIONSHIP BETWEEN EXTERNAL

PAY POLICY AND OBJECTIVES

External alignment influences the company’s ability to achieve its objectives which can
eventually affect performance. Shown in Exhibit 4.2 are the probable effects of pay
policy alternatives.

EXHIBIT 4.2

Probable Relationships Between External Pay Policies and

Objectives

HRM 307 - COMPENSATION ADMINISTRATION

 RELATIONSHIP BETWEEN EXTERNAL
PAY POLICY AND OBJECTIVES

Companies are left with the choices as to whether to lead, match or lag, yet the most
common is to match rates paid by competitors. When a company fails to match the
rates given by other employers, it could limit their recruitment ability. A pay-with-
competition policy tries to ensure that an organization’s wage costs are approximately
equal to those of its product competitors and that its ability to attract applicants will be
approximately equal to its labor market competitors.

On the other hand, lead pay level policy increases the recruitment and retention rate
of talents and lessens the dissatisfaction on pay level. Research also confirmed that
higher pay leads to reduced turnover and greater performance. However, lead policy
may also impose some negative effects on the organization. This pay policy may force
the employer to likewise increase the salaries and wages of current employees to
avoid internal misalignment and issues. Also, when turnover increases but is not due
to compensation issues, this may result in negative job attributes as there are more
managerial problems than compensation problems in the organization.

Lastly, one alternative is to pay below-market rates, i.e. lag pay level policy. However,
this is a very challenging approach as it hinders the company’s ability to attract
potential employees. Although, when this is coupled with a promise of a high future
returns, this can influence the employees’ commitment and performance. This will
then increase productivity.

PAY MIX STRATEGIES

Pay mix policies now have alternatives including performance driven, market match,
work/life balance and security. Compared to the aforementioned three factors
shaping external competitiveness, in performance driven policy, incentives and stock
ownership make up a greater percent of total compensation. While in market match
policy, the pay mix of competitors are being imitated. How managers actually make
these mix decisions is a ripe issue for more research.

HRM 307 - COMPENSATION ADMINISTRATION

 PAY MIX STRATEGIES

EXHIBIT 4.3

Pay Mix Policy Alternatives

Today's manager's decision as to pay is changing. Other alternatives now focus on the
total returns, recognizing other choices aside from financial returns.
As stated by Milkovich, "rather than 'flexible,' perhaps a better term would be 'fuzzy'
policies." Exhibit 4.3 shows the pay mix policy alternatives.

On the other hand, some organizations compete on the basis of their overall reputation.
This is beyond their pay level and pay mix. In other words, this corresponds to sort of
company brand or image known as "employer of choice". Some companies position their
pay "among the best" and leads the market as they emphasize performance. Shared choice
meanwhile is the "“employee-as-customer” perspective " whereby employers offer
employees choices (within limits) in the pay mix.

HRM 307 - COMPENSATION ADMINISTRATION

 DESIGNING PAY LEVELS, MIX, AND
PAY STRUCTURES

In setting externally competitive pay and designing its corresponding pay structures,
the following are the major decisions.
1. Specify pay-level policy
2. Define the purpose of survey
3. Specify relevant market
4. Design and conduct survey
5. Interpret and apply result
6. Design grades and ranges or bands

The guideposts are the major decisions you face in designing a pay structure. Don’t
forget to end with, So what? “So what” means ensuring that pay structures both
support business success and treat employees fairly.

Surveys are being conducted (1) to adjust the pay level in response to changing rates
paid by competitors, (2) to set the mix of pay forms relative to that paid by competitors,
(3) to establish or price a pay structure, (4) to analyze pay-related problems, or (5) to
estimate the labor costs of product/ service market competitors.

Further, when in comes to specifying relevant market, to create decisions about pay
level, mix, and structures, a relevant labor market must be defined that includes
employers who compete in one or more of the following areas: (1) same occupations or
skills; (2) employees within the same geographic area and; (3) the same products and
services.

On designing the survey, the following are the guide questions: (1) Who should be
involved in the survey design? (2) How many employers should be included? (3) Which
jobs should be included? and (4) What information should be collected? Shown on the
next page is the possible survey data elements and rationale as Exhibit 4.4.

HRM 307 - COMPENSATION ADMINISTRATION

 DESIGNING PAY LEVELS, MIX, AND
PAY STRUCTURES

These days, surveys are often conducted online and survey data are likewise being
exchanged online. It is the technology that has made convenient and easy to generate
and process data. The concern on how to evaluate the information is posted as the
biggest challenge of total compensation surveys. In the best total compensation
projects, each firm sees the survey as a customizable database project where they can
specify the characteristics of the employers and jobs to analyze. After the survey data
are all collected, the next step is to analyze the results and use statistics to construct a
market pay line.

EXHIBIT 4.4

Possible Survey Data Elements and Rationale

HRM 307 - COMPENSATION ADMINISTRATION

 DESIGNING PAY LEVELS, MIX, AND
PAY STRUCTURES

Lastly, in developing grades and ranges, base pay data is being considered along the
process as the base pay reflects the basic value of work rather than performance
level of employees. Grades and ranges offer flexibility to deal with pressures from
external markets and differences among organizations. These include:

Differences in quality (skills, abilities, experience) among individuals

applying for work (e.g., Microsoft may have stricter hiring requirements
for engineers than does FastCat, even though job descriptions appear
identical).
Differences in the productivity or value of these quality variations (e.g.,
the value of the results from a software engineer at Microsoft probably
differs from that of the results of a software engineer at Best Buy).
Differences in the mix of pay forms competitors use (e.g., Oracle uses
more stock options and lower base compared to IBM).

In addition to offering flexibility to deal with these external differences, an

organization may use differences in rates paid to employees on the same job. A pay
range exists whenever two or more rates are paid to employees in the same job. Hence,
ranges provide managers the opportunity to:

Recognize individual performance differences with pay.

Meet employees’ expectations that their pay will increase over time, even
in the same job.
Encourage employees to remain with the organization.

While the first step in building flexibility into the pay structure is to group different
jobs that are considered substantially equal for pay purposes into a grade. Grades
enhance an organization’s ability to move people among jobs with no change in pay.

“The use of grades and ranges or bands recognizes both external and internal pressures on pay decisions. No
single “going rate” for a job exists in the market; instead, an array of rates exists. This array results from
conditions of demand and supply, variations in the quality of employees, and differences in employer policies and
practices. It also reflects the fact that employers differ in the values they attach to the jobs and people. And, very
importantly, it reflects differences in the mix of pay forms among companies. “

HRM 307 - COMPENSATION ADMINISTRATION

 END OF MODULE TEST

Answer the following review questions.

1. Analyze the differences between policies on internal alignment and external
competitiveness. Why is external competitiveness important?
2. Think of companies that pay higher (lead) or below (lag) the market rates. Why
do these companies believe that it pays to pay differently? You may do research
on the internet on this.
3. Which competitive pay policy would you recommend to an employer? Why?

References
Book
Milkovich, George, Jerry Newman & Barry Gerhart (2014). Compensation 11th ed. New York, McGrawHill International.

HRM 307 - COMPENSATION ADMINISTRATION