Question

Define the concepts of internal and external equity, describing two basic models a company may use, and explain how the objectives of internal and external equity can conflict.

Answer 1

Organizations should choose a pay structure that depends on their needs and performance of the employees. It should keep in mind that internal equity is mainly focused on the internal organizational structure, whereas the external equity depends on the current situation in the industry and labor market, which is focused on the external environment to the industry.

The internal equity method aims to keep a balance in the compensation provided to a particular job profile in comparison to the compensation provided to its senior and junior level in the hierarchy. With the help of such a pay structure, the organizations attempt to balance the position of employees within organizations and to motivate and stimulate them to work better.

In case of external equity, the organizations set the compensation packages of their employees in alignment with the prevailing compensation packages in the market in other companies. This is considered as a fair treatment to the employees by many companies.

Where organizations use internal equity to create healthy organizational culture, harmonious working environment, equal conditions and opportunities for employees within the organization, external equity is the most appropriate for organizations operating in the highly competitive market. The aim of companies using external equity is when they try hard to retain their employees within the company and to decrease the risk of the high personnel turnover and attrition. Organizations do not pay attention to pay structures in other organizations or the industry, but they offer their specific pay structure, which employees have to accept in case of internal equity.

External equity allows organizations to make use of the competitive pay structure and the employees working in such an organization can compare the wages which are proportional to average wages in the industry for the same job profile. At the same time, the main aim of organizations following an internal equity policy is to pay employees respectively to their performance and contribution in the organizational performance.  In case of internal equity, the fairness is ensured with the help of techniques like job ranking, job classification, level of management, level of status and factor comparisons.

With internal equity there is a benchmark that is set for similar positions and then a possible range of performance is set according to that. There is no outside interaction when it comes to internal equity and there is no scope for comparison. The firm is setting their own cost to company packages for an employee based on job analysis within the company. With external equity, the philosophy is affected by the way the whole industry rewards its employees at given positions. The degree of fairness of the pay is determined by what the industry says and what’s determined from the researches done in the market.