Internal and External Equity Comparison

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Total Compensation Objectives Applied to External Equity

Pay structures are based on company’s goals and compensation objectives. “Align, differentiate, add value” is a strategy test recommended for creating efficient and fair compensation strategies (Milkovich, et.al., 2014, p.57). If the company is measuring goals based on industry standards, locations, product compensation, experience and education of the available workforce, then external equity is a beneficial focus for determining pay structure. If the company has objectives focused on creating a competitive advantage, then an external equity plan may work best to achieve goals.

Advantages and Disadvantages of External Equity

Some advantages of external equity focus are that for more productive workers, the market pricing allows the company to entice skilled workers and retain them in a motivating work environment. The external pay structure also creates a competitive advantage for companies as long as it is constantly researching the market. Therefore, it is important to keep ahead of the employment and job competition, which could lead to disadvantages.

Some disadvantages include a higher cost to the company to remain competitive, which is why it is important for companies to research the competition. If a company’s manager feels an employee is a valuable enough investment, they could pay the employee a higher wage based on market competition. Also, the employee may want to negotiate their wage based on an offer from another company, which can create a higher cost to the organization if it wanted to retain them. Another disadvantage is when an internal pay structure creates a differential because the market competition increased. Differentials can cause negative internal competition, lower morale, and a negative reputation for the company as being unfair. As well, compensation fluctuations cause problems with budget forecasting and create cost control issues, which negatively affects the company financially.

Relationship of Financial Situation to External Equity

Financial success is the key to company success. Therefore, it is important to consider how the compensation plan and pay structure affects the company financially. If the company is to produce consistently high returns and growth for shareholders, then the external competiveness focus may prove to be advantageous. Compensation fluctuations can occur which causes problems with budget forecasting and cost control issues, which can result in lost revenue and a low or negative return on the investment. According to Milkovich (2014), external market comparisons are still important to research, as employees assess the fairness of their pay with internal structures and external markets (p. 83).

Conclusion

Whether a company decides to create a compensation plan focused on internal equity or external competitiveness, it is important to research the advantages and disadvantages. It is also important to consider how the pay structure will support the company’s financial and total compensation objectives. In comparison, internal and external equity both have several advantages and disadvantages that could affect any business. Compensation plans should have a mix of both internal equity and external competitiveness to balance out the pay structure plan and to help meet organization and compensation goals. The organization’s compensation plan can be successful, whether internally or externally focused, as long as it is efficient, fair, ethical, and compliant.

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References

Kokemuller, N. (2016). Chron: The Advantages of Internal Equity in a Compensation Plan. Retrieved from http://smallbusiness.chron.com/advantages-internal-equity-compensation-plan-81169.html

Martocchio, J. (2015). Strategic compensation: A human resource management approach (8th ed.). Upper Saddle River, NJ: Pearson

Milkovich, G., Newman, J., Gerhart, B. (2014). Compensation (11th ed.). New York, NY: McGraw-Hill.