Explain the internal and external considerations of compensation package development

Explain the internal and external considerations of compensation package development

Determining the “right” compensation can be tricky. Not only is money a touchy subject, but so many factors play into determining compensation rates that are both fair and competitive. Here, we discuss the factors that influence compensation rates the most:

1. Years of experience and education level
It probably goes without saying, but the more experience and education a candidate has, the higher their expected compensation. So, if you’re hoping to attract job seekers with master’s degrees or more than 5 years’ experience, you need be ready and willing to compensate accordingly.

2. Industry
Workers with similar, or even the same job title can expect vastly different wages depending on what industry they’re in. There are many reasons for this discrepancy – in some cases their job function may be critical to a particular industry, or it may simply be a matter of one industry being considerably larger than the others.

3. Location
Cost of living, a major factor to consider when determining compensation, is largely dependent on location and, more specifically, the cost of housing. This is at least partially why salaries in large urban areas are generally higher than salaries for similar positions in more rural locations.  However, with the surge in remote work, many employers have shifted to role-based compensation, rather than location-based. Do some research to see what the trend is in your field.

4. In-demand skill sets
When it comes to determining compensation, key skills may be an even more reliable metric to compare against than job title. After all, different companies may have very different definitions of the same job title. On top of that, many skill sets can apply to a wide variety of roles – all of which are effectively competing for the same talent. That’s why it’s important for employers to consider the value of key skills when determining compensation.

5. Supply and demand
It’s crucial to be aware of the availability of relevant talent in the geographic region where you’re recruiting. If you’re recruiting in an area where the demand for a certain skill sets and experience outweighs the supply, you should expect to pay more in order to attract talent.

The cost of not offering competitive pay
You may think you’re saving money by keeping compensation rates low; however, it’s important to consider what it’s costing you in other areas. For instance, many employers overlook the costs associated with having unfilled positions for extended periods of time. Similarly, keep in mind the burden an unfilled position can put on your current employees, who may be taking on extra work to fill the gaps – not to mention what that can do to morale.

What happens if you can’t pay market value?
Luckily, it is possible to attract top talent even if you can’t offer the most competitive salary. Supplementing your compensation package with low- or no-cost perks, such as development opportunities, remote work, more vacation time and flexible hours can go a long way in retaining your current workforce. Another option is to recruit from areas where compensation rates are lower, and let employees work remotely from home or from another office closer to where the employee lives.

Take the guesswork out of determining compensation
Unless you’re an amazing guesser, it’s important to do a little recon when it comes to determining competitive pay rates. Competitive intelligence is your best friend when it comes to determining compensation. CareerBuilder’s Supply & Demand Portal provides up-to-date and relevant compensation rates for even the most specific of positions. You should also be able to see where compensation rates may be lower or higher (if you’re considering recruiting in other location), and – perhaps even more intriguingly – get a peek at what your competitors are paying.

Compensation is far from the only factor candidates consider when applying to jobs. To attract more talent, check out what candidates want in today’s job market.

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.

What are the external and internal factors considered in deciding the compensation?

It is helpful to understand external factors such as unemployment rates and market competition, and internal factors such as job analyses, influx of new talent and business conditions, in order to determine the appropriate levels of compensation.

What are the different internal and external factors influencing the compensation structure of an organization?

These factors are as follows: (i) Labor Market- The demand for and supply of labor also influences the employee compensation. The low wage is given, in case, the demand is less than the supply of labor. On the other hand, high pay is fixed, in case, the demand is more than the supply of labor.

What considerations should you make when developing a compensation plan?

A number of factors should be taken into consideration during the development phase of the compensation plan , including the company's size, financial position, industry and objectives. Also important are market salary data and the level of complexity involved in finding the right talent.

What are the external factors while deciding compensation?

5 essential factors for determining compensation.
Years of experience and education level. ... .
Industry. ... .
Location. ... .
In-demand skill sets. ... .
Supply and demand. ... .
The cost of not offering competitive pay. ... .
What happens if you can't pay market value? ... .
Take the guesswork out of determining compensation..