Author: ERI

Ensuring that employees are competitively compensated relative to the external marketplace and their peers is an essential two-part function of the compensation plan. This analysis reflects two sides of the same coin: equity.  Equity pay entails ensuring that all employees in an organization receive unbiased total rewards based on permitted internal and external factors. Equitable compensation has many benefits: reducing turnover, increasing cooperative behavior, decreasing counter-productive behavior, and ensuring legal compliance. The General Fair Pay Act provisions allow employees to disclose, discuss, and ask about their wages. Both employers and employees have a vested interest in making sure that pay is fair and that differences are not based on sex, race, ethnicity, or other protected categories.  Ensuring an equitable pay strategy is a complex issue.  Internal and external equity analysis allows an organization to evaluate its compensation plan based on the fairness of employee compensation.

What’s the Difference? 

Internal equity refers to fairness of pay among current employees working for the same company and performing the same or similar jobs. An analysis of internal equity ensures that fairness is maintained throughout the organization based on similar responsibilities, performance, knowledge, skills, and experience.  A good review is contingent on accurate job analyses and descriptions, not just job titles (which may be inflated), to provide the appropriate comparators.  Pay grades are an example of a process that is designed to ensure internal equity. These structures ensure that individuals in an organization are compensated in a consistent manner relative to their peers, supervisors, and reports.

External equity refers to fairness of pay against the external market.  External equity compares what the company is willing to pay for talent versus what outside organizations competing for the same talent are willing to pay.  It provides a basis for competitive job offers, salary adjustments, and salary structures. Equity exists when employees are rewarded fairly in relation to those who perform similar jobs in other organizations. 

Both internal and external equity factors are important tools used to define and implement a solid compensation strategy, resulting in effective management of employee total rewards. With the majority of expenses attributable to labor costs, consideration of both is vital to providing fair, equitable compensation and the ability to attract and retain the best talent. 

Why Do Internal and External Pay Equity Matter?

Internal equity looks inside the organization to compare salaries and wages of employees in the same jobs.  Analysis determines if the differences in pay are attributable to legitimate factors, such as performance or experience.  If analysis reveals that a protected group is paid at a lower rate than the norm, further analysis is required to determine if pay practices (intentional or not) are creating disparate treatment.  Perception is a key factor in internal equity.  Employees often compare themselves to others who they believe are in comparable positions, but HR must know the jobs that they are comparing.  This can create tension and lower morale.  The result may be regrettable turnover or employees interviewing and receiving job offers in order to force the employer to evaluate and perhaps make a counteroffer, leaving the employee wondering, “Why not just pay me what I’m worth from the very beginning?”  This can cause resentment in an otherwise effective and productive employee.

External equity looks at factors such as market, company size, revenue, sales, location, and industry to compare salaries for qualified workers. This is typically accomplished using compensation surveys.  The average salary for benchmark positions provides information to help determine if companies are paying their employees competitively.  It is important to pay attention to market changes and stay current because failing to keep up with the competition can lead to the loss of valuable employees.

A review of all jobs on a regular basis (at least annually) helps to keep an eye on compensation, to make necessary adjustments, and to ensure the compensation strategy remains fair and equitable.

Having access to salary survey data and the resulting analyses, as well as taking the time to review your jobs, the organization’s needs, and strategic goals, are all critical to developing a solid understanding of the current labor force, both internal and external.

Both internal and external equity warrant consideration; one is not more important than the other. Both should be considered when determining and maintaining a pay strategy that supports the organization’s strategy.  The perception of fair pay is an important factor which can have a positive or negative effect on morale, productivity, and employee engagement. 

It is important to communicate regularly and honestly with employees about total rewards.  Provide total rewards statements to educate employees, highlight perquisites, and explain benefits, in addition to base pay.  Communicate the entire compensation package.  Employees are savvy when it comes to their salaries and want to know that they are getting the package that meets their needs and expectations, just as the company does.   For more information about total compensation and how to calculate total pay while taking into account internal and external equity, utilize ERI’s Salary Assessor.