Internal and External Equity Comparison

Internal and External Equity Comparison

HRM/324

Internal and External Equity Comparison

When creating a total compensation plan, it is important to consider the factors that affect pay structure and how it affects internal and external equity.  A strategic analysis of the company’s external market content and internal factors is necessary when designing a pay structure (Milkovich, et.al., 2014, p.129).  Organization’s objectives taken into consideration when developing a pay structure include efficiency, fairness, ethics, and compliance, and with compensation the company is more focused on fairness. It is important for companies to research the advantages and disadvantages of compensation and how it creates a competitive advantage for the company. The organization must focus on how the plans support its total compensation objectives, the relationship of the organization's financial situation to its plan, and the important advantages and disadvantages of internal and external equity for both organizations.

Internal Equity

        Internal Equity is the focus on creating a fair pay structure based on internal alignments.  The organization focused on internal equity will base its pay structure plan on two factors: worker motivation (attain and retain employees) and labor costs (control costs and increase revenues).  These two factors support most company’s objectives because it pertains to employee retention, increased productivity, and meeting financial goals.  

Relationship of Financial Situation to Internal Equity

        A company’s financial goals are one of the main factors in success.  With an internal equity pay structure, the company can organize a pay scale that works within its budget and can spread out fairly among the various positions. “Compensation is often a company’s largest controllable expense,” Therefore, the company needs to base a compensation plan on the return on investment and the return value to the company (Milkovich, et.al., 2014, p.56).  

  Advantages and Disadvantages of Internal Equity

The advantages of internal equity may include an employee’s or potential employee’s possible view of the organization to have fair leadership based on an equal pay structure.   Also, current employees most likely will associate their leader with fair pay and have more respect for them, listen better to their guidance, perform better, and produce a homogenous work environment.  Fair pay is important for team structures since peers have a general understanding those they work with are equal to them; Therefore, collaboration creates unity, and reduces negative competition.

However, some disadvantages of an internal equity focus include a perception of working harder than their equally or higher paid colleague, missed opportunity for competitive wages, and a potential for high turnover. If an employee perceives themselves to be performing at a higher standard than an equally or higher paid colleague, an internal equity pay structure may create animosity or tension in the workplace, which results in lower morale and lower performance. Also, if the company is not paying attention to the market competition, internal pay equity can cause employees to leave for higher wages at another company, which can lead to high turnover in certain positions. High turnover can become a financial burden on the company and can also create a bad reputation for employee retention, which could lose the interest of potential employees.
Total Compensation Objectives Applied to Internal Equity

Equal pay is beneficial to other total compensation objectives, such as ethics, compliance, and efficiency.  Equal pay provides ethical benefits and compliance requirements as well, such as better protection against discrimination lawsuits and removes the possibility of paying different wages to the workers in the same job, especially if they happen to be in a protected class (Kokemuller, 2016). Stability provides opportunity to maintain performance standards that are consistent, which creates a clear guideline for expectations and justification for demotions or terminations.  When a company is comparing internal pay levels, it is important to determine the value and content of the work, and how it relates and contributes to the organization’s objectives.  

External Equity

        External equity includes focusing on external market competitiveness and how the company compares to other pay levels outside the organization.  Many companies focus on the market and how to attract and retain qualified employees.  Companies collect data and analyze the benefits based on the company’s profile, long-term growth prospects, financial conditions, functional capabilities, and industry profile; otherwise, the compensation professionals would have to use guesswork to create the compensation system (Martocchio, 2015, p.17).