Chapter 3 - Defining Internal Alignment

Jobs and Compensation

- Pay varies significantly depending on the job

- Orgs design their pay structure around jobs and job levels
- Thus employee’s pay (and pay growth over time) depends on both the nature of the job
and job level
Compensation Strategy: Internal Alignment

- 1st pay policy issue in a strategic approach is setting objs.

- 2nd, ​Internal Alignment (or Internal Equity) = ​addresses relationships inside the org
- Relationships among diff jobs inside an org form a job structure that should support the
org’s strategy, support the workflow and motivate behaviour toward org objs.
- Pay Structure = ​deciding how much to pay the diff levels of a role

Supports Organization Strategy

- Org’s strategy indicates how it plans to achieve its purpose
- Internal job structures aligned to the strategy help to achieve it

Supports Workflow
- Workflows​ = refers to the process by which goods and services are created and
delivered to the customer
- Pay structure should support the efficient flow of that work and the design of the org

Motivates Behaviour
- Internal job and pay structures influence employees’ behaviour by providing pay
increase for promotions, more challenging work, and greater responsibility as an
employee to move up in the job structure
- Structure should make clear the relationships b/w each job and the org’s objs
- Line of sight = ability for an employee to see the linkage b/w what he or she does
and the org’s strategic goals
- Employees should be able to see or understand links b/w their work, the work of
others, and the org’s obj

Structures Vary Between Organizations

- Internal pay structure is defined by:

1. Number of levels of work
2. The pay differentials b/w the levels
3. The criteria used to determine those levels of differentials
 - These are the factors a manager may vary to design a structure that supports the
workflow and directs employee behavior toward objectives

Number of Levels
- One feature of the pay structure is its hierarchical nature - # of levels and reporting
relationships
- b/c pay structures typically reflect the flow of work in org, some are more hierarchical, w/
multiple levels, and others are compressed w/ few levels

Differentials
- Differentials = ​pay differences b/w levels
- If an org has a compensation budget of a set amount to distribute among its employees,
there are a number of ways to do so
- You divide the budget by the # of employees, giving everyone the same amount
> but few orgs are egalitarian and most pay varies
- Work that requires more human capital (knowledge, skills, and/or abilities), that is
performed under less desirable working conditions, and/or whose results are more
valued is usually paid more than w/ work lesser requirements
- One intention of differentials is to motivate ppl to strive for promotion for a higher paying
level
-
Criteria: Content and Value
- Work content and work value are the most common bases for determining internal
structures
- Content = ​refers to the work performed in a job and it gets done (tasks, behaviour,
knowledge required, and so on)
- Structure based on content typically ranks jobs on the basis of skills required,
complexity of tasks, or responsibility
- Value = r​ efers to the worth of the work: its relative contribution to the org’s obj
- Structure based on value of the work focuses on the relative contribution of the
skills, tasks or respon. Of a job to the org’s goals
- Including relative contributions, value may also included external market
pressures (i.e. skills shortage)
- Value may include rates that were agreed upon via collective bargaining or
legislation (i.e. min wage)
- Use value reflects the value of goods and services an employee produces in a
job
- Exchange value is w/e wage the employer and employee agree on for a job

- Job- And Person-Based Structures =

- a ​job based structure​ looks at work content - tasks, behaviours, responsibilities
 - person-based structure ​shifts the focus to the employee: the skills, knowledge or
competencies the employee possesses, and whether or not they are used on the
particular job the employee is doing
- In the real workplace, it is hard to describe a job w/o reference to the jobholder’s
knowledge and skills
- Conversely, it is hard to define a person’s job related knowledge/competencies
w/o referring to the work content
- Rather than a job or person based structure, reality includes both

What Factors Shape Internal Structures?

- Major external and organization factors that shape internal structures:

- Exactly how these factors interact is not well understood

- No single theory accounts for all factories
- Some theories emphasize certain factors where others omit competing ones

Economic Pressures
- Adam Smith: HR both an exchange value (i.e. w/e wage the employer and employee
agreed on) and a use value (i.e. reflects the value of the goods or services labour
produces)
 - New technologies associated w/ the industrial revolution increased the use value
of labour w/o corresponding increase in exchange value
- Karl Marx: accused capitalistic economic systems of basing pay structures on exchange
value
- Felt employees pocketed the surplus value created by the diff b/w what owners
were willing to pay workers and what owners earned from workers’ efforts
- He urged workers to overthrow capitalistic systems to reap the benefits of their
labour and become owners themselves
- In some sense, broad based stock ownership allows employees to be owners
- Rising wages in the last half of the 19th century, allowed new theories to examine the
demand of labour:
- Marginal Productivity Theory = ​ says that employers do in fact pay use value
- Unless an employee can produce a value equal to the value received in
wages, it will not be worthwhile for the employer to hire that worker
- Pay diff among job levels reflect diff in use value associated w/ diff jobs > one job
is paid less or more than another b/c of diff in relative productivity of the job
and/or diff in how much a consumer values the output
- Hence diff in productivity provide a rationale for internal pay structure

- Supply and demand for labour​, supply and demand for products and services also affect
the internal structures
- Turbulent changes either in competitor’s products and/or services (ex. Rise of the
internet making purchases) or in customer’s taste (ex. Popularity of fuel efficient
vehicles) mean orgs must be able to redesign workflow and employees must be
continuously learning new skills
- Turbulent and unpredictable external conditions require pay structures that support agile
orgs and flexible ppl (ex. Jobs req continuous learning may be paid more than others, as
they are so important for the achievement of strategic goals)

Government Policies, Law, and Regulations

- In Canada, human rights legislation forbids pay systems that discriminate on the basis of
gender, race, religion, sexual orientation, national origins and other grounds
- Pay equity acts require “equal pay for work of equal value” in male- and female-
dominated jobs based on a job evaluation process that considers the skill, effort,
responsibility and working conditions req for the jobs
- Much pay related legislation attempts to regulate eco forces to achieve social welfare
objs > internal structures at the min (ex. min wage) and max (ex. special reporting req for
exec pay)

External Stakeholders
- Unions, stockholders, and even political groups have a stake in est internal pay
structures
 - Unions > seek smaller pay diff among jobs as well as seniority based promotions
to promote solidarity among members
- Aim to seek the ensure the interest of their members are well rep in
decisions about structure
- Stockholders > pay attention to exec pay
- Link or lack thereof b/w exec pay and org performance has come under
public security
- Boards have pressure to reduce exec pay when strategic outcomes are
not being achieved

Cultures and Customs

- Culture is the shared norms and values that a group of ppl have in common
- Such shared mindsets w/in a society may forma judgment of what size of pay differential
is fair
- Ex. Ancient Greece, Plato declared societies are strongest when the richest earn
a max of 4x the lowest paid

- Historians describe how in the 14th century Western Europe, the church endorsed a “just
wage” doctrine, a structure of wages that supported the existing class structure in society
- Goal was to end economic and social chaos resulting from the deaths caused by
a plague > shortage of workers resulted in increased wages for surviving skilled
workers
- Even today, cultural factors continue to shape pay structures around the world
- Canada, pay equity is a way society constitutes what is a just wage
- Japan, had a strong emphasis on seniority for internal pay structures

Organization Strategy
- Ch 2 explained that org strategies influence internal pay structures - diff business
strategies may req diff pay structures to support them
- Basic belief of a strategic perspective is that pay structures not aligned w/ the org
strategy may become obstacles to the org’s success
- Study showed: compensation professionals can substantially improve the effectiveness
of their pay programs by focusing on aligning their reward philosophy, strategy, and
compensation policies, programs and practices w/ their business strategy

Organization and Work Design

- Tech used in producing goods and services influence the org design, the work to be
performed, and the skills/knowledge req to perform work

- Design of work is undergoing profound changes:

- Ppl who work at orgs may not be an employee there (ex. temp contract staff,
outsourcing whole teams) > pay is determined by internal pay structure of these
companies employing them
 - Delayering > reduce unnecessary work that does not contribute to strategic objs
(ex. Removing jobs and adding additional work to other jobs, reducing mgmt
sizes)

Human Capital
- Human Capital = ​the education, experience, knowledge, abilities and skills that ppl
possess - is regarded as a major influence on internal structures
- Stronger the link b/w skills and exp and an org’s strategic obj, the more pay these skills
will command

Overall HR Policies
- Org’s HR policies also influence pay structures
- Most orgs tie money to promotions to induce employees to apply for higher level
positions > if org has more levels, offer more promotions but may result in small pay
differentials
- Belief is more freq promotions (even w/ smaller increases) offer a sense of career
progress to employees

Internal Labour Markets: Combining External and Organizational Factors

- Internal Labour Markets = ​combine both external and organizational factors
- Internal labour markets refer to the rules and procedures that 1. determine the
pay for the diff jobs w/ a single org, 2. allocate employee to those diff jobs
- b/c employers compete in the external market for ppl to full these jobs their pay is linked
to the external market > must be high enough to attract a qualified pool of applicants for
entry level jobs
- Contrast, for non-entry level jobs is buffered from external forces and more
heavily influenced by internal factors such as the org’s strategy, tech, human
capital required and other HR systems

Employee Acceptance: A Key Factor

- Employees judge the fairness of their pay through comparisons w/ the compensation
paid others for work related in some fashion to their own
- Important factor influencing internal pay structure is its acceptability to the
employees involved
- Employees make multiple comparisons to assess fairness of an internal pay
structure:
- Compare their jobs to that for other jobs in the same internal job structure
- Pay for their job in the external market w/ competing employers
- Two factors of fairness are important:
1. Procedural Justice = ​refers to the process by which a decision is reached
(procedures determining the pay structure)
 - Applied to internal structures, procedural justice addresses how design
and admin decisions are made and whether procedures are applied
consistently
2. Distributive Justice = ​refers to the fairness of the decision outcome (results of
those procedures)
- Distributive justice addresses whether the actual pay diff among
employees are acceptable
- Employees’ perceptions of procedural fairness significantly influence their acceptance of
the results
- They are more likely to accept lower pay if they believe the way the decision was
made was fair
- Pay procedures are more likely to be perceived fair if:
1. They are consistently applied to all employees
2. Employees participate in the process (although research suggest an
exception when wages are very low)
3. Appeals procedures are included
4. Data used are accurate

Pay Structures Change

- Pay structures change in response to changing external pressures such as skill shortage
- OT distorted diff become accepted as equitable and customary efforts to change them
are resisted
- Thus pay structures est for org and economic reasons at an earlier time may be
maintained for cultural or political reasons

Strategic Choices in Designing Internal Structures

- Internally aligned pay structures support the way the work gets done, fit the org’s
business strategy and are fair to employees
- Greater alignment - fit is more likely to lead to success whereas misaligned becomes
obstacles
- When you fit/tailor the pay structure to be internally aligned, two strategic choices are
involved:
1. How much to tailor the structure to the org design and workflow
2. How to distribute pay throughout the levels in the structure

Tailored vs. Loosely Coupled

- Low cost, customer focused business strategy (ex. McDonald’s or Wal-mart) may be
supported by ​Tailored Structure
- jobs are well defined, w/ detailed tasks/steps to follow (consistent b/w all
McDonald’s when it comes to how a burger is made)
- The diff in pay b/w jobs is relative small
 - Companies that need very agile, constantly innovating and adapting > need to
accommodate for flexibility > more flexible pay structure = ​Loosely Coupled Structure
to allow for constant change

Egalitarian vs. Hierarchical

- Pay structures can vary from egalitarian to hierarchical (one extreme to the other)
- Egalitarian structures​ > have fewer levels and smaller differentials b/w adjacent levels
and b/w the highest- and the lowest-paid workers
- Can be characterized as delayered or compressed
- Several layers of respon. and supervision are removed so that all employees at
all levels become respn. for broader range of tsks and have greater freedom to
determine how to best accomplish what is expected
- Implies a belief that more equal treatment will improve employee satisfaction,
support cooperation, and therefore improve worker’s performance
- Negatives: equal treatment can result in more knowledgeable and
high-performing employees going unrecognized and under rewarded
- Hierarchical structures​ > multiple levels typically included detailed descriptions of work
done at that level and delineate who is responsible for what
- Consistent w/ a belief in the motivational effects of frequent promotion
- Hierarchies value the differences in ind. Employee skills, respons., and
contributions to the orgs
- Differences b/w Egalitarian and Hierarchical:

- Choices of the two is not either/or but a matter of degree:

- Levels can range from many to few; differentials can be large or small; criteria
can be cased on the job, person or combo of the two

Guidance From Evidence

 - When managers are deciding which pay structure is best for their ogs, we hope they will
look not only at their org (i.e. workflow, what is fair, and how to motivate employee
behaviour) but also to theory and research for guidance

Equity Theory: Fairness

- Employees judge the fairness/equity of their pay by comparing other jobs at their own
employer (internal equity) and to those at other employers (external equity)
- Those higher up in the pay structure perceived the structure is fair and the lowered paid
saw it was for if they worked in a highly paid district
- Past research show that employees are generally often misinformed about their
relative standing in pay structure
- Thus equity might support either egalitarian or hierarchical structures depending
on the comparisons and accuracy of info about them
- Equitable and equal are not interchangeable
- Pay can be unequal across employees but pay can nevertheless be perceived as
equitable/fair
- Equity theory​ says that ppl compare the ratio of their own outcomes (i.e. pay, status) to
inputs (i.e. effort, ability, and performance) w/ the outcome to input ratio of other workers
- These ratios can be similar despite diff in pay if performance diff are perceived to
exist

Tournament Theory: Motivation and Performance

- According to ​tournament theory​, all players play better in tournaments in which the prize
differentials are sizable
- The greater differential of an employee’s present value compared to their boss’s
the harder the employee (and everyone else) will work
- Within limits, the bigger the prize for getting to the next level of the structure, the
greater the motivational impact of the structure
- Hierarchical and tournament structures work best in situations where individual
performance matters most (ex. Auto racing, golf tournaments) or at best in which
demand for cooperation among a small group of individuals is relatively low (ex.
Professors, stock brokers)

- In contrast, team sports provide a setting where both ind. players performance and the
cooperative efforts of the team make a difference
- Study showed that teams w/ egalitarian structures (practically identical salaries)
did better than hierarchical structures (very large differentials)
- On top of affecting team performance, internal structures had a sizable effect on
player’s ind performance
- It may be that egalitarian pay structure reflects more of a flexible and supportive
org culture where players are given training and support that they need
Institutional Theory​: Copy Others
 - Internal pay structures are sometimes adopted bc seen as best practices > orgs copy
what others are doing
- Benchmarking behaviour include outsourcing and competency based pay systems
adopted w/o regard to whether these practices fit the org or its employees/add value
- Institutional Theory​ predicts that very few firms are first movers
- Instead they copy innovative practices after innovators have learned how to
make the practices work
- Unlikely to outperform competitors by simply copying their practices
- But if they are performing worse than their competitors, imitating them can be
useful in achieving competitive parity and create significant improvements

(More) Guidance from the Evidence

- There is no research on the optimal size of the promotional increase or its effects on
behaviour, satisfaction or performance
- Nor is much known whether smaller, more frequent promotions are better or worse than
fewer, larger, less freq promotions
 Consequence of Structures

Efficiency
- Research shows that an aligned pay structure can lead to better org performance
- If structure does not motivate employee to help achieve the org’s objs, then it is a
candidate for redesign
- Size of the pay differential b/w the entry level and highest level in the structure may
induce employees to remain w/in the org, increase their exp and training, cooperate w/
co-workers, and seek greater responsibility.

Fairness
- Researchers agree that departure from an acceptable wage structure will result in higher
turnover, grievances, and diminished motivation
- One group argues fair (i.e. sizable) differentials b/w jobs are not paid > ind. will have ill
will, resist change, change employment, become depressed, or lack enthusiasm at work
- Others argue for small differentials and more egalitarian structures support team
cooperation, high commitment to the org and improved performance

Legal Compliance
- The design and mgmt of internal pay structure must comply w/ the regulations of the
countries in which the org operates