A common refrain is that compensation is an art and a science. In other words, while compensation management relies on hard numbers, making a compensation plan that works requires flexibility.
This flexibility is necessary because compensation professionals must strike a balance between forces inside and outside the organization. With too much focus on internal forces, the organization could lose touch with the market. Likewise, too much focus on external forces could lead to uneven compensation throughout the organizational structure.
Internal pressures may include things like compression, budget realities, and compensation strategies. External forces could be market rates for various occupations. A compensation professional’s job is to strike a balance between realities within an organization and the external marketplace.
If we think of compensation as a balance, it is important to consider where our dollars will be best spent in achieving that balance.
Some occupations may be more sensitive to market forces than others. If this is the case, occupations that are more sensitive to market forces may need to be paid closer to market rates. This trend is common in organizations. Employees are generally hired into a few positions and then promoted from within the organization. The positions where employees are hired from outside are called “Ports of Entry” (Lazear & Oyer, 2004a). A study of the movement of employees within organizations found that 57.15% of employees in the first level of each job structure were hired from outside the organization, whereas 11.57% of hires at the fifth level were hired from outside (Lazear & Oyer, 2004b).
Consider the point of reference for the employee in each of these situations:
Individuals who were promoted from within will likely use their previous compensation rates as the most salient frame of reference, whereas individuals hired from outside the organization do not know anything about internal practices and will attend to the market more closely. For this reason, a compensation professional may want to pay extra attention to internal equity for positions that are hired from within and give more attention to the external marketplace for occupations that are hired externally. Thus, when a compensation professional needs to adjust structures to balance internal equity, it is advisable to make those adjustments to the positions that are promoted from within the organization. Likewise, market-focused adjustments will have a greater impact when they target jobs that are primarily filled externally.
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Lazear, E. & Oyer, P. (2004a). “Internal and external labor markets: a personnel economics approach.” Labour economics 11 (5):527-557.
Lazear, E. & Oyer, P. (2004b). “The Structure of Wages and Internal Mobility.” American Economic Review 94 (2):212-216.