Chapter 9: Wage and Salary Structure Concepts

Overview: An examination of how wage structures are set: by committee, job evaluation, society, the labor market, and organization tradition.

THE WAGE STRUCTURE DECISION

  • "How many different jobs do we have?"
  • "How can they decide to pay that job over there more than our job?"
  • "What criteria should we use to decide what different jobs are worth to us?"
  • "How do we decide what to pay this job when there is no market rate?"
  • "How many and what kinds of pay grades should we have, considering the kind of organization this is?"
  • "I have a lot more responsibility than she does. Why aren't I making as much as she is?"

The wage structure decision has to do with determining the wage rates for jobs, and in some cases, workers. It combines the external marketplace with the relative value that different jobs have to the organization. The organizational value of a job is determined through job evaluation, which in turn relies on job analysis to provide the information required for the evaluation. The organizational and market values of jobs are integrated through the development of a wage structure, which defines job levels or grades, and assigns wage rates to those grades by reference to market rates.

The concepts of the wage structure decision are covered in this chapter. Chapter 10 covers job analysis, and chapter 11, job evaluation. Chapter 12 describes how all the information and decisions collected thus far are combined into a wage structure that sets the wage rate or range for each organizational job. Chapter 13 and 14 examines the translation of the structure into individual wages rates for employees. Chapter 15 covers a different form of structure and basis for pay, that of the person’s knowledge, skill and abilities.

In most organizations, wage and salary rates are still assigned to jobs. The relationships between the pay for jobs involve pay structure decisions. Although organizations often make pay level decisions (how much to pay) and pay structure decisions (pay relationship) at the same time, these decisions and the process by which they are reached require separate treatment.

Actually, wage structures represent wage relationships of all kinds. Analysis of wage differentials of any kind (geographic, industry, community, or occupation) deals with wage structure issues. But because our primary focus is on pay decisions in organizations, our concern is with pay differences between jobs. In fact, determining the pay structure of an organization may be usefully described as putting dollar signs on jobs. Decisions on wage relationships among jobs within an organization are largely within the control of the organization's decision makers. Wage level decisions are usually influenced more by forces external to the organization than are wage structure decisions.

One way of looking at this is that the wage level decision is primary in attracting employees to the organization. Wage structure decisions, then, are intended to achieve retention of employees through prevention of dissatisfaction and encouragement of employee cooperation.1 Then the wage system decision is designed to provide employee motivation and performance.

DETERMINANTS OF THE WAGE STRUCTURE

Chapter 3 (economic theories of wages) contained a number of explanations of occupational differentials. Chapter 4 (behavioral theories of compensation) used a number of suggestions from psychologists and sociologists to explain occupational pay differences. This section of the chapter focuses on these factors in wage structure decisions.

Economic Determinants

Adam Smith explains occupational wage differentials in terms of (1) hardship, (2) difficulty of learning the job, (3) stability of employment, (4) responsibility of the job, and (5) chance for success or failure in the work. This is a theory of wage structure.2 But his standards of worth are equally useful in explaining the complexity of wage structure decisions.

He goes on to describe two different concepts of value:

  1. Market Value The market value of an item is the price it brings in a market where demand and supply are equal.
  2. Use Value Use value is the value an individual buyer or seller anticipates through use of the item. Use value obviously varies among individuals and over time.

These two concepts of worth and the concept of internal labor markets combine to explain important differences among employers in wage structure decisions. Organizations with relatively open internal labor markets (organizations in which most jobs are filled from outside) make much use of market value. They also make much use of wage and salary surveys in wage structure decisions.

Conversely, organizations with relatively closed internal labor markets (most jobs are filled from inside) emphasize use value. Their analysis of job worth relies more heavily on perceptions of organization members of the relative value of jobs arrived at through job evaluation.

Some other wage structure determinants derived from economic analysis may be noted. Training requirements of jobs in terms of length, difficulty, and whether the training is provided by society, employers, or individuals constitute a primary factor in human-capital analysis and thus job worth. The interaction of ability requirements with training requirements can yield different job values depending on the scarcity of the ability required and the number of people who try to make it in the occupation and fail.

Employee tastes and preferences are another economic factor. People differ in the occupations they like and dislike. In like manner, occupations have non-monetary advantages and disadvantages of many kinds. Worker expectations of future earnings strongly influence occupational choice and thus labor supplies. Unfortunately, labor-market information is far from perfect, and responses to labor-market shortages are likely to be more prompt than responses to oversupplies.

Industrial as opposed to craft unionism has also been shown by economic analysis to affect wage structures. Industrial unions, with their heavy proportions of semiskilled members, are more likely to favor absolute increases. Although large organizations where employees are represented by industrial unions may have a highly differentiated wage structure, they pay less attention to percentage differentials than they would in the presence of craft unions.

Another economic determinant is discrimination. Although wage differentials based on sex or race are unlawful, they still exist. The extent to which such differences are based on productivity differences or represent discrimination is very much a wage structure issue.

Industrial Relations Explanations

Industrial relations scholars' explanations of wage structures tend to be different from those of labor economists. For instance, an employer concerned with the status of his or her organization as a dependable supplier, a considerate employer, or a wage leader is more likely to base wage structure decisions on organization criteria than on economic forces. A short list of non-economic considerations on wage structures emphasized by industrial relations scholars would include organization goals, the health of employee-management relations, employee attitudes, employee comparisons, communication of pay decisions, and seniority policy. Also emphasized by these analysts is the force of custom.

One powerful analysis of considerations in wage structure decisions argues that wage structures keyed solely to the labor market are likely to be few, to result from very tight labor markets, and to be characteristic of organizations well insulated from product-market competition, unions, and technological change. One author classified organizations as having wage structures that are primarily oriented toward unions, markets, internally, or union-and-product. Union-oriented organizations basically have craft unions, and union-and-product oriented organizations basically have industrial unions. This classification suggests that in only one of the four market-oriented organizations, does the labor market drive the wage structure.3 It should be noted that in today's economy more and more organizations fall into the market-oriented classification.

Social Determinants

In chapter 3, we saw that the just-price theory advocated setting wages in accordance with the pre-established status distribution: wages were to be systematically regulated to keep each class in its customary place in society. The theory emphasized equity, the tying of wages to status, and the preservation of customary relationships.

Although we have described the just-price theory as historical, an eminent labor economist, E. H. Phelps-Brown, has made a similar argument.4 Brown argues further that one determinant of the fair rate is the requirements of the work. He interprets job evaluation as a painstaking application of the way in which people continually think and argue about relative pay.

Another sociological view of wage structure is that different jobs have different statuses to which the structure of pay should conform. Generally a group is ranked according to the difficulty of attaining proficiency in the job. By this reasoning, the criterion of a fair wage is that it shall enable the recipient to keep up a position in the class to which the job assigns him or her.

Since both the assessments of the requirements of a job and the esteem due incumbents can only be subjective, in practice they lean much on custom. When rates of pay remain unchanged for a century and differentials between two jobs remain proportionately constant over even longer periods, the force of custom rather than supply and demand seems a better explanation.

In fact, to those involved in pay decisions, social forces may be more apparent than economic ones. The arguments used are mainly ethical. A wage is claimed because it is fair and just. A differential is justified because it is right and proper.

But whereas social forces generally operate to maintain what is customary and accepted, market forces have been operating to narrow differentials. Market forces usually operate through the shifting of labor supplies. One reason that social forces seem to predominate is the slow reaction of supply to price. Supply shortages are more effective in raising pay than supply surpluses are in lowering it.

Organizational Determinants

Organizations develop jobs to get their work done. Labor services acquire specific economic meaning only in relation to the particular jobs in which they are performed. In our economic system, the organization typically designs jobs and selects employees to fill them. The jobs the organization designs are the source of the contributions provided by employees and a primary determinant of their rewards. Through these jobs and pay decisions about them, the organization is structuring the market for labor services.5

Other organizations differing in technology, management competence, competitive economics, and collective bargaining are also designing jobs. As a consequence, it is quite unlikely that the jobs designed by one organization will be identical to those of other organizations. Furthermore, the decisions that go into job design are not made once and for all, but are subject to revision, as market conditions, technology, and institutional influences change.

One of the strongest influences on job design is technology. But technology seldom provides rigid job boundaries. Although it may be useful to assume that organizations in the same industry have designed jobs and job structures similarly, they have not necessarily done so. On the other hand, if two quite similar jobs are found in different industries, it would be safe to assume that they hold different significance or value to their respective organizations. In one industry, it may represent an organization's most essential task. In another, the job may be peripheral.

The degree of structure in an organization influences the way jobs are organized or whether they are organized at all. Job evaluation flourished when organizations were highly bureaucratized. In the past twenty years, as competition has driven companies to be more efficient, they have become smaller and less structured. People often are hired not to fill a job, but because they have skills or abilities that can be utilized in a number of ways. This has moved organization from an internal orientation to an external, market driven, orientation.

Employee Acceptance

The discussion in chapter 4 of the employment exchange and of equity theory suggests that a primary criterion of organization wage structures is employee acceptance. Both the employment exchange and equity theory strongly suggest that employees' decisions to acquire and retain organization membership are based on their perception of a favorable ratio of rewards to contributions. The most visible employee contribution is the job to which he or she is assigned.

Most organizations base wage structures primarily on the work content of jobs and the value of that work to the organization. Work content is determined by job analysis. Relative value of work is determined by job evaluation. Equity theory postulates that employees must accept both processes as fair if the system is to achieve its purpose.

There is some tendency to equate pay fairness or equity with pay satisfaction. This is unfortunate because, although related, they are quite different concepts. It has been shown that people can believe that their pay is fair but not be satisfied with it. Also, people can be satisfied with their pay but believe it to be unfair.6 Pay satisfaction has been shown to be a multidimensional concept in which satisfaction with pay level is independent of satisfaction with benefits. Satisfaction with pay structure, although apparently another dimension, is not independent of administration of compensation.7

Expectancy theory emphasizes a different aspect of compensation, that of performance. As competition has become more intense, organizations are focusing more on performance as a determinant of the wages paid to the individual worker. This has changed the balance of what organizations pay for away from the job and more to the person.

INFLUENCES ON THE WAGE STRUCTURE

From the last section, it is clear that organizations determine the pay for jobs by taking a number of considerations into account. Furthermore, they have considerable choice as to how much emphasis to place on various determinants. These choices lead in turn to variations in the wage structures that organizations create. But organizations do not have total freedom in the design of wage structures. Besides the determinants so far considered, there are a number of other influences on the design of wage structures that will be considered in this section. These influences are often indirect in that they influence the design of jobs and therefore the way the organization is likely to evaluate them in relation to other organization jobs. These influences are society, the labor market, unions, and the organization structure.

Society

People and institutions both have a hand in designing jobs and wage structures. Craft unions, for example, determine the kinds of work their members do and expect employing organizations to adjust to these decisions. Jobs for clerical workers are structured by the institutions that train them, with the result that clerical jobs are often quite similar in different organizations.

Professional employees and managers insist on having a say in the design of their jobs, and the result is influenced in part by the institutions that train them. At the other extreme are semiskilled factory employees. Organizations employing these workers are subject to little influence on job design by either employees or unions, except in job-redesign decisions. Unions of semiskilled factory workers typically insist, however, on participating in the latter decisions. This participation is guided by customary relationships among and within employee groups. Custom also operates in nonunion situations, causing resistance to change in job design.

A further societal influence on jobs and wage structures is the technology used by the organization and changes in that technology. But technology seldom provides rigid boundaries. It typically provides choices within which management, unions, and competitive pressures can operate in designing jobs and job relationships.

The Labor Market

The labor market influences the wage and salary structure through the supply of and demand for labor. But organizations differ greatly on how many of their jobs are highly market-oriented, particularly in those organizations in which the labor supply is mostly provided from within the organization. As discussed in chapter 6, to the degree that organizations replace the external labor market with an internal labor market they make decisions by administrative means rather than according to supply and demand. These organizations have restricted ports of entry, which are highly sensitive to the labor market but rely on the organization's internal labor supply to fill most job openings.8 The exception occurs when there is an internal and external shortage of people to fill vacancies for specific skills. In fact, any job for which qualified people are in short supply becomes a market-sensitive job. But given relatively adequate labor supplies, the labor market determines wages only if the labor market is structured by unions, is otherwise well organized, or the organization chooses to fill openings from outside the organization.

Shortages in the labor market provide those who are qualified to fill the jobs an opportunity to negotiate better terms of employment. A part of this negotiation is for a relative increase in pay greater than other groups are obtaining. This, of course, runs into the problem of customary relationships already discussed. But another part of the negotiations is for a "better job." Workers in jobs where there is a shortage of qualified workers will demand changes in job content that will increase the job's value to the organization and in the eyes of other workers. Computer programmers are an example of a group of workers with a skill in short supply in a new and expanding industry. The independence of action and discretion allowed this group of employees is based, at least partially, on the continuing shortage of this skill.

The product market also affects wage structures through cost-oriented jobs. Such jobs exist where profit margins are sensitive to changes in unit labor cost. If the ratio of unit labor cost to price is critical, the jobs involved become cost-oriented jobs, and organizations will strongly resist changes in their wage rates, especially changes not made by other organizations. Organizations that compete in the same product market, those whose prices are interrelated, or those experiencing or anticipating increased competition or decreased demand may regard any increase in unit labor costs as a threat, especially when labor cost is a significant proportion of total costs. On the other hand, employees in these areas often recognize the advantageous position they are in and seek maximum advantage.

Unions

Unions affect wage structure, but the differential effects of craft and industrial unionism and the type of bargaining relationship are considerable. Craft unions tend to determine craft rates as well as the design of craft jobs for all organizations employing members of the craft. The limit of craft rates is the cost-price resistance of employers. Industrial unions, on the other hand, are more concerned than craft unions with employing organizations, but less concerned with product markets because they often bargain with organizations in many product markets. Thus, industrial unions may attempt to impose a common wage structure on organizations, even if the wage structure clashes with product-market realities.

Within organizations, industrial unions are concerned with equalities and differentials among particular groups of jobs. They often serve to reinforce custom and tradition in jobs and wage structures, while they resist changes that might decrease employee security. If the industrial union deals with organizations in a common product market, it may attempt to impose a common job design and wage structure by comparing rates of a number of reasonably comparable jobs. But even in such cases, the influence of industrial unions on wage structure is light compared with that of craft unions.

Unions also affect wage structures by resisting lower wage rates for jobs downgraded by technological change and by demanding that increased productivity arising from any source results in wage increases. Typically this means that wages of changed jobs are not cut but often increased when the changes result in increased productivity. Such job rates distort rational job and wage structures, and a series of them can so impair an organization's cost-profit position that management is forced to fight for a revised, rational wage structure. Union strategy, with respect to general increases, can also affect wage structures. Flat cents-per-hour or dollars-per-month increases maintain absolute differentials, but compress the structure in relative terms, whereas flat percentage increases maintain relative differentials and increase absolute differentials. Industrial unions especially may follow a policy of cents-per-hour increases because most of their members are in lower-paid groups. But unions cannot maintain this strategy in the face of opposition from higher-paid groups. In fact, worker preferences and resulting labor-supply shortages force restoration of relative differentials in both union and nonunion situations.

But probably the strongest influence of unions on wage structures is the quality of the union-management relationship. For example, some unions take an active part in job evaluation, and their interest in a rational wage structure results in reduced grievances over wage inequities. Other unions, most of them craft unions, seek to preserve customary relationships and job security, resist changes in job content and structure, and are uninterested in the employer's problems of maintaining economic efficiency. Still other unions seem totally uninterested in job designs and the wage structure of the organization and (1) insist on no wage cuts when job content changes, (2) demand wage increases for all increases in job productivity, (3) strongly resist job-content and other changes calculated to increase productivity, and (4) encourage wage-inequity grievances. In such cases, job and wage structures become chaotic, and correcting the irrationalities may require long and bitter strikes which are often prolonged by political struggles within the union resulting from the wage inequities.

The Organization

Organization decisions on job and wage structures represent a balancing of the aforementioned forces. But the strength of these forces varies by organization type and within organizations by job clusters. Organizations made up largely of members of craft unions have wage structures almost completely determined by the union. Organizations in construction, printing and publishing, the railroads, longshoring and maritime work, and entertainment offer examples of union-oriented wage structures.

Organizations whose members come largely from a well-organized and competitive labor market but are not unionized have what might be called market-oriented wage structures. Organizations of this type have only limited choices, because jobs are easily identified and are quite uniform throughout the market. Banks, insurance companies, department stores, and restaurants are organizations with primarily market-oriented wage structures. Professionals are groups of employees whose jobs have been designed largely by the educational process they have been through. This makes for a commonality between organizations in the design of professional jobs.

Organizations having many specialized jobs, dealing in labor markets too disorganized to provide adequate grading and pricing, and lacking unionization have primarily internally determined wage structures. Such wage structures may be influenced by product markets, but only if labor cost is high relative to total cost. Internally determined wage structures result from management decisions and may range from highly rational structures flowing from job evaluation to a system of personal rates. Organizations in small towns, isolated locations, or nonunion communities provide examples, as do unique organizations in larger communities, and government employment.

Most large, unionized organizations have what might be called union-and-product-oriented wage structures. In these organizations, wage structures represent management decisions shaped and restrained by technology, unions, and cost-price relationships, and the product market. Technology provides some uniformity in job structures in organizations engaged in common lines of production. Unions, through their insistence on traditional relationships, establish some key jobs and job clusters and provide an upward thrust to the entire structure. Cost-price relationships and the product market compel the organization to resist this upward push and to make changes in jobs and job relationships in line with such resistance. Low ratios of labor cost to total cost and inelastic product demand, however, reduce competitive pressures on organizations. Organizations in many branches of manufacturing, in mining, and in some service industries are examples of organizations with union-and-product-oriented wage structures. Organizations with this kind of wage structure can eventually get into a competitive bind.9

Organizations with internally determined or union-and-product-market-determined wage structures leave large portions of wage structure decisions to management. Wage structure determination in these organizations follows closely Dunlop's theory of key jobs, job clusters, and wage contours (see chapter 3). Key jobs acquire their status from labor markets, product markets, and comparisons with other organizations, often fostered by unions. Job clusters come from technologies and employee skill groupings. Wage contours originate in customary comparisons with other organizations, again often fostered by unions. Custom strongly influences all three.

But although organizations can be classified as having wage structures that are oriented primarily in one of the four ways just outlined, organizations of any considerable size have job clusters that fall more comfortably into one or more of the other categories. Organizations employing artisans, unless they are members of an industrial union, are usually forced to develop a union-oriented wage structure for this job cluster. All organizations employ clerical workers, and the wage structure of the clerical job cluster is largely market-oriented. Professional employees (such as engineers and scientists) have salary structures that combine market orientation and internal determination, regardless of the major activity of the organization. Managerial salary structures are primarily internally determined except in very tight labor markets, without regard to organization type.

Thus the typical organization develops and administers at least four or five of the following separate wage structures: shop, clerical, craftsmen and technicians, administrators, engineers and scientists, sales, supervision, and executives. Although, obviously, there will be relationships among these separate wage structures, the strength of these relationships varies by organization and over time.

THE CHANGING WORLD OF COMPENSATION

The past twenty years have seen dramatic changes in the economy, labor markets, business organization, technology, job design, and in the employment relationship. These changes in turn have had a dramatic impact on compensation systems and practices. In terms of wage structures, this has brought forth a number of changes in the way wage structures are developed and the resulting structure. Some of these changes include market pricing, broadbanding, competency pay, and a change in the relative importance of the job in comparison to performance and personal characteristics.

The Economy

Today business operates in a global economy. Products and services can be produced around most of the globe and likewise sold throughout the world. This has increased the competition in the market place, on both the supply and demand sides. At the start of this trend, American business found itself in competition with foreign companies with lower total cost structures. Part of this lower cost structure was based upon lower wage rates in other countries. But it also was a result of more efficient operating systems being developed in those countries. So American business had to re-think its operating systems and organization structures to be able to withstand this new competition. One result has been outsourcing. At first this was outsourcing manufacturing of products. More recently, it has involved the sophisticated outsourcing of services worldwide. Outsourcing goes in all directions. There are companies moving their back room operations overseas while foreign companies are establishing manufacturing plants in America.10

Labor Markets

The above discussion brings forth one of the major changes in labor markets, that they are becoming international. As the U.S. has experienced shortages in highly technical skills American business has searched the world over for parts of its workforce. With newer developments these workers can now stay in place and the work can move to them.11 At the other end of the labor market, the U.S. has experienced a mass and often illegal immigration of unskilled workers to fill positions at the bottom of the workforce.

What these two trends have exacerbated is an increasing degree of wage inequality in the U.S. While wages for the top levels of the workforce have risen dramatically in the past twenty years, those at the bottom of the wage scale have at best broken even, and for the most part, are worse off today than twenty years ago. This is seen by many as a very dangerous trend in our society that squeezes out the middle class and destabilizes society. While much of this disparity in wages can be measured in the differences in education of workers and the change in the demand for labor, our economic policies have tended to exacerbate the problem.12 For a more comprehensive discussion of this problem, see ERI's Distance Learning Center Course 84.

Technology

The effect of technology on wage structure at both the level of the national economy and at the firm level matches the above discussion of the labor market. There has been increasing wage disparity in the U.S. New forms of technology change the type of skills required, and in many cases the level of skill required. Higher levels of education and training are required of those workers associated with the new technology, and this drives up wages for this group.13 Industries that rely on a high level of technology have shown higher overall wages and more wage disparity than other industries.

Technology is making different forms of compensation more practical. A major problem in performance-based pay systems is the measurement problem. New technology makes keeping track of both work outcomes and processes easier and with less judgment than before. It is also possible to monitor performance away from the central location of the organization, making the workplace less of a requirement.14

At a much more personal level, technology has greatly changed the amount of information available about wages and the access to this information. This now allows organizations to use this information directly in designing wage structures and not rely on surrogate measures of job worth that job evaluation may be seen as representing. In addition, most of this wealth of information is available to the employee, making the job of setting wages more difficult.

At a much more personal level, technology has greatly changed the amount of information available about wages and the access to this information. This now allows organizations to use this information directly in designing wage structures and not rely on surrogate measures of job worth that job evaluation may be seen as representing.15 In addition, most of this wealth of information is available to the employee, making the job of setting wages more difficult.

Organization Design

The past twenty-five years have witnessed what might be called the de-bureaucratization of business organizations. The new term is the "boundaryless organization."16 This emphasizes that organizations today, in order to be successful, need to be flexible, quick to change, integrate operations and be innovative. Organizations are created to coordinate large numbers of people to accomplish goals. In the process, various boundaries are developed, and these need to be broken down or reduced in importance to achieve the kind of flexibility required today. The vertical boundaries of levels and status are being reduced as organizations downsize and remove layers of organization. Horizontal boundaries create silos of functions and divisions. These are giving way to such arrangements as temporary teams of workers assigned to specific interdepartmental tasks. The line between the organization and its customers on one end and suppliers on the other end represents the external boundary. This boundary is being breached by programs such as just-in-time inventory that pulls the supplier into the organization and custom products that allow the customer to order individually designed products. Geographic boundaries are being reduced by technology so that work can be performed just about anywhere in the world.17

What all this does is make many of the compensation programs built on bureaucracy obsolete, or at a minimum, in need of overhaul. Primary among these may be job evaluation that has come to represent the essence of the bureaucratic organization.18

Job Design

There was a time that when a worker was laid off from his job he would be re-employed at the same job when the economy got better. Not today! When you lose your job, it disappears. And this does not happen only to the worker on the production line. It includes office staff, supervisors, professionals, managers and executives. Jobs come and go with the changing organization. Old jobs are disappearing more rapidly than in the past, and new ones are appearing at a rapid rate.

With jobs becoming so fluid and workers moving rapidly from task to task or group project to group project, defining and using the job as the base unit of pay comes into question. Organizations who find this is true are moving to make the person the unit of pay. In this way, roles and competencies are used as the measures. Roles are defined as organizational expectations of behavior, and competencies are the inputs of the person to the work, their skills, knowledge, abilities and other characteristics that have been found to be related to job performance.

The Employment Relationship

Not too long ago, the employment relationship for most workers was one in which they could expect to go to work for an organization, be promoted from within and possibly retire from that same company. While this was an idealized picture of the situation, it was close to reality for most workers. This employment relationship is gone now for the most part. Organizations have fewer levels and are in a constant state of change. They hire, not by promoting people, but by recruiting from outside. This results in them being more conscious of external labor market figures than internal equity concerns. There are no longer career paths within the organization. Organizations focus on performance and develop plans to tie employees into the success of the organization. This has been called a market-driven employment relationship.

Employees for their part are on their own. It is up to them to figure out what skills they need and where to find them. Loyalty to the company is not part of the equation. Keeping up with the labor market and taking advantage of the marketplace is the way to go. Much of this can be seen as a return to an employment relationship of almost a hundred years ago.19

More and more, the work of the organization is being done by people who are not employees at all or whose relationship to the organization is tentative. Organizations are engaging in a great deal of outsourcing. This can take many forms. The current concern is with outsourcing functions to other countries, but organizations have been outsourcing many functions for a number of years to contractors or temporary placement organizations. One of the central tenets of some organizations today is to carefully examine their own competitive advantage and see what functions they perform that creates this advantage. Other functions that the organization must have done are then outsourced in some manner or form.

In summary, much of "traditional" compensation practice is built upon and supports the bureaucratic organization structure. These changes have called into question a number of compensation practices:

  • The emphasis on internal equity rather than market pricing as the basis for the wage structure
  • The basis of pay being the job instead of the person
  • Wage structures that have many levels that make promotion the major method of obtaining higher wages
  • The focus on fixed base pay adjusted for cost of living and seniority rather than variable pay based upon performance. This has led to a number of innovations and changes in compensation practices including market pricing, competency pay, broadbanding and variable pay.

Market Pricing

Market pricing is defined as the process of using wage surveys to determine job worth based upon the comparison of the survey jobs with those of the organization. This market value judgment is made independent of any consideration of internal equity. The process of collecting wage data from wage surveys was described in Chapter 8. In thinking about using just wage data remember what the process is like and the ways that this data can be manipulated. Regardless, this method requires a good knowledge of the organization’s jobs and requires careful comparisons to the wage survey descriptions. Surveys show that up to 80% of companies use market pricing as their primary input into developing a wage structure.20

In market pricing, wage rates for jobs are set based upon the organization’s analysis of wage surveys to determine the typical wage rates for their jobs. Ordinarily, only some jobs, called benchmarks, are used to develop the structure. This is because:

  1. The total number of jobs would be cumbersome, and/or
  2. Not all jobs have a market comparison.

So benchmark jobs are ones that are important to the organization and have a market equivalent. The benchmark jobs are then ordered from bottom to top and divided into grades by examining the clusters of jobs. From there, all other jobs for which there is a market rate are placed into their appropriate grade. Jobs for which there is no market rate are placed into grades using a slotting process. This is a primitive form of job evaluation.21

Market pricing represents one end of a continuum of the combining of internal and external influences on wage structures. The process described in most of Chapter 12 on wage structures where the structure is developed from job evaluation and then priced by the market represents the other extreme.22

Broadbanding. The WorldatWork glossary defines broadbanding as:

"A pay structure that consolidates a large number of pay grades and salary ranges into much fewer broad bands with relatively wide salary ranges, typically 100 percent between minimum and maximum or more."23

Developed in the 1980's, broadbanding collapses groups of jobs or the hierarchy into a few wide bands. This compression of the structure was to align the wage structure with the flatter, more horizontally oriented re-organizations taking place. In addition it has allowed a new form of career growth.

Traditional wage structures have as many as 15-20 grades with a range of 30 to 50% from minimum to maximum and considerable overlap between grades. These grades make promotion the major form of advancement and method for the individual to increase his/her pay. Broadbanding collapses these grades into 3-5 very broad "bands" with little or no overlap. From a promotion standpoint, a worker would most likely stay in the same band all or most of his career.

In addition, broadbanding does away with range midpoints and other references to the market rate for a particular job. The responsibility for placing the worker within the band falls on the supervisor and the budgetary process. Instead of the job worth and the market value of the job being the criteria, the worker’s competencies and performance determine placement within the band.

This type of structure fits organizations that see themselves constantly evolving and in a state of change. It allows them to respond to changing markets without being tied to those markets and able to reward outstanding performance easily. Employees are focused upon improving their work skills and performance, not working toward promotions.

Person-Based Structures

A number of new types of wage structures are being developed based upon the person and not the job. These go by a number of terms such as competency pay, skill-based pay, pay for knowledge and multi-skilled pay. What these approaches have in common is that the pay is based upon what the person brings to the organization and not what he/she does while there. The rationale is that in these times the value of an employee lies in what he/she can do. This enables the organization to move the person around into what currently needs to be done.24

Skill-Based Pay. These systems are ordinarily used in production or service jobs. The organization examines a production unit and identifies what the skills are that are used in producing the product or service. These skills are placed into blocks, and workers get paid according to their knowledge and ability to apply the skills. Each time the employee passes a test for the block, his/her pay rate is increased. This provides the organization with flexibility to assign employees to any set of tasks that use the skills of the employee. It also provides motivation to the employee to learn new skills on the job.25

Competency-Based Pay. At higher levels of the organization person-based pay structures are called competency models. They start at a different point than skill-based pay. Here the starting point is to identify the core competencies of the organization, those that give it its competitive advantage. From there competencies of employees are developed that create and support the organization's core competencies. These competencies are then defined in behavioral terms to enable the organization to measure them for a full range of Human Resource functions. These competencies are broader than those in skill-based pay to include not only skills but knowledge and personal characteristics necessary for successful performance. Finally, these competencies need to be ordered in a hierarchy for setting pay.26

Variable Pay

Variable pay is pay for the outcomes of work and effort. It is pay for performance in its best and broadest sense. This performance measure may be the individual employee, the work group, the organizational unit or the total organization. We include this in the discussion at this time not because it represents a different type of wage structure but because it is a factor that has become more important in recent years in compensation practice.

The result of a wage structure is a range of base pay that is possible for the employee to earn. More and more, the determinant of where in this range the employee is paid is the performance of the employee. The idea of a pay being variable is that some proportion of what the employee is paid is related to how the employee performed during this time period. This part of the pay does not carry over into the next time period. The extreme of this is incentive plans in which all pay is variable, such a commissioned sales.

In addition, pay beyond base pay in the form of some sort of bonus is being used at lower levels of organizations more than ever before. The result of all this is that more of an employee's pay is related to performance today and less upon job worth.

SUMMARY

The discussion in this chapter showed that the development of a wage structure is the result of a number of influences. These factors vary from ones over which management has a great deal of control to ones in which management must simply be responsive. Given the variety of influences, it is also not likely that organizations will always be able to develop optimum structures and that current structures will need adapting in the future.

While the economics of the labor market is a major consideration, it is not the only determinant to influence the design of wage structures. Most organizations also must consider labor-cost ratios, product market competition, and union demands, when determining their wage structure. Furthermore, many labor markets are abstractions that do not provide a close fit for an organization's jobs or wage-paying ability.

Wage structures have to do with the internal alignment of jobs in a wage hierarchy. To do this, there must be a hierarchy or structure of jobs within the organization. Determining this internal job structure in the past has been the task of job evaluation. This process compares jobs, not people, in terms of a set of criteria, called compensable factors, to establish the job hierarchy. Job evaluation has been the major tool that organizations have used to make job comparisons when determining the relative equity of jobs within the organization. This is changing. Recently, market pricing has taken the place of job evaluation as the major method for determining relative wages. In addition, person-based pay plans have also found a place in the changing organizational climate.

Footnotes

1 T. A. Mahoney, "Compensating for Work," in Personnel Management, ed. K. M. Rowland and G. R. Ferris (Boston: Allyn & Bacon, 1982), p. 227-61.

2 See the discussion of Adam Smith in chapter 3.

3 G. H. Hildebrand, "External Influence and the Determination of the Internal Wage Structure," in Internal Wage Structure, ed. J. L. Meij (Amsterdam: North-Holland Publishing Company, 1963), pp. 260-99.

4 E. H. Phelps-Brown, The Economics of Labor (New Haven: Yale University Press, 1962), ch. 5.

5 See Hildebrand, "External Influences." op. cit.

6 D. W. Belcher, "Pay Equity or Pay Fairness?" Compensation Review, second quarter 1979, pp. 31-37.

7 Heneman, H.G. III & Schwab, D. P. (1985). Pay Satisfaction Its multidimensional nature and measurement. International Journal of Psychology, 20, 129-142.

8 Groshen, E and Levine, D. "The rise and Decline (?) of U.S. Internal Labor Markets," Research Paper 9819, Federal Reserve Bank of New York, 1998.

9 L. Iacocca, Iacocca (New York: Bantam, 1984).

10 Freidman, T. The World is Flat, New York, Farrar, Strauss, and Giroux, 2005.

11 Friedman, T., Ibid.

12 Galbraith, J. Created Unequal, New York, The Free Press, 1998.

13 Katz.L. "Technological Change, computerization, and the Wage Structure" Paper given at conference Understanding the Digital Economy: Data, Tools, and Research, Washington, D.C., May 25-26, 1999.

14 Heneman, R., Ledford, G. and Gresham, M., "The Changing Nature of Work and its Effects on Compensation Design and Delivery" in Rynes, S. and Gerhart, B. Eds. Compensation in Organizations, San Francisco, Jossey-Bass, 2000.

15 Neilsen, N., "Job Content Evaluation Techniques Based on Marxian Economics," WorldatWork Journal, Vol. 11 #3, Third quarter 2002, pp. 52-62.

16 Ashkenas, R, Ulrich, D., Jick, T., and Kerr, S., The Boundaryless Organization, San Francisco, Jossey-Bass, 2002.

17 Friedman, T., Op Cit..

18 Friedman, T., Op Cit.

19 Cappelli, P. "Market-Mediated Employment: The Historical Context," in Blair, M. and Kochan, T. The New Relationship: Human Capital in the American Corporation, Washington, The Brookings Institute, 2000.

20 Market Pricing: Method to the Madness, Scottsdale, AZ. WorldatWork, 2003.

21 Grigson, D, Delaney, J. and Jones, R., "Market Pricing 101- The Science and the Art," Workspan, Scottsdale, Az. WorldatWork, Oct. 2004, pp.46-53.

22 Hinchcliff, B., "Juggling Act: Internal Equity and Market Pricing," Workspan, Scottsdale, AZ. WorldatWork, Feb 2003, pp. 47-48.

23 "Broadbanding" a White Paper of the WorldatWork, Scottsdale, AZ. 2000

24 "Skill-based Pay" A white paper of the WorldatWork, Scottsdale, Az. May 2000

25 Ghorpade. J. and Edge, J., Understanding Skill-Based Pay: An Approach to Designing and Implementation, WorldatWork, 1997.

26 Lucia, A. and Lepsinger, R., The Art and Science of Competency Models, San Francisco, Jossey-Bass, 1999.

Internet Based Benefits & Compensation Administration

Thomas J. Atchison
David W. Belcher
David J. Thomsen

ERI Economic Research Institute

Copyright © 2000 - 2013

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