7-1
Chapter
7
McGraw-Hill/Irwin
Defining
Competitiveness
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7-2
What Is External Competitiveness?
External competitiveness
refers to pay relationships
among organizations - an
organization’s pay relative to
its competitors.
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7-3
How Is External Competitiveness Expressed?
Setting
a pay level
 Above,
 Below,
 Equal
or
to competitors, and
Determining
mix of pay
forms relative to those
of competitors
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7-4
What Is Pay Level? Pay Forms?
Pay level refers to the average of the
array of rates paid by an employer
Pay forms refer to the mix of the
various types of payments that make
up total compensation.
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7-5
Pay Level and Pay Mix: Two Objectives
Control Labor Costs
Attract and Retain
Employees
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7-6
Pay Level Decisions Impact Labor Cost
Labor Costs
=
Number of
Employees
x
Average Pay
Level
Base Pay
+
Increases
+
Benefits
+
Allowances
+
Perquisites
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Pay Level Decisions Affect Ability
to Attract and Retain Employees
7-7
Exhibit
7.1: One Company’s Market
Comparison: Base vs. Total Compensation
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Pay Level Decisions Affect Ability
to Attract and Retain Employees
7-8
Exhibit
7.2: Two
Companies: Same
Total Compensation,
Different Mixes
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Exhibit 7.3: What Shapes
External Competitiveness?
7-9
LABOR MARKET FACTORS
Nature of Demand
Nature of Supply
PRODUCT MARKET FACTORS
Degree of Competition
Level of Product Demand
EXTERNAL
COMPETITIVENESS
ORGANIZATION FACTORS
Industry, Strategy, Size
Individual Manager
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7-10
How Labor Markets Work
Theories
of labor markets begin with four
assumptions
 Employers
always seek to maximize profits
 People are homogeneous and therefore
interchangeable
 Pay rates reflect all costs associated with
employment
 Markets faced by employers are competitive
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Pay for business graduates
Exhibit 7.4: Supply and Demand for Business
School Graduates in the Short Run
7-11
$100,000
$50,000
$25,000
100
McGraw-Hill/Irwin
Number of business graduates available
1000
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7-12
Labor Demand
 Analysis
of labor demand indicates how many employees
will be hired by an employer
 In the short run, an employer cannot change any factor of
production except human resources
 An employer’s level of production can change only if it
changes the level of human resources
 An employer’s demand for labor coincides with the marginal
product of labor
 Marginal product of labor
 Additional output associated with employment of one
additional human resources unit, with other production
factors held constant
 Marginal revenue of labor
 Additional revenue generated when firm employs one
additional unit of human resources, with other production
factors held constant
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Exhibit 7.5: Supply and Demand at the Market
and Individual Employer Level
Market level
Employer level
$100,000
Pay for business graduates
$100,000
Pay for business graduates
7-13
$50,000
$25,000
$50,000
$25,000
Number of business graduates available
McGraw-Hill/Irwin
Supply to
individual
employer
0
5
10
15
20
25
Number of business graduates available
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7-14
Labor Supply
Assumptions
employees
about behavior of potential
 Many
people are seeking jobs
 They possess accurate information about all job
openings
 No barriers to mobility among jobs exist
Upward
sloping supply curve assumes
that as pay increases, more people are
willing to take a job
However, if unemployment rates are low,
offers of higher pay may not increase
supply
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Exhibit 7.6: Labor Demand
Theories and Implications
Theory
Compensating
differentials
Efficiency wage
Signaling
McGraw-Hill/Irwin
Prediction
So What?
Work with negative
characteristics requires higher
pay to attract workers.
Job evaluation must collect
and compensable factors
must capture these negative
characteristics.
Above-market wages will improve
efficiency by attracting workers
who will perform better and be
less willing to leave.
Staffing programs must have
the capability of selecting the
best employees. Work must
be structured to take
advantage of employees’
greater efforts.
Pay policies signal the kinds of
behavior the employer seeks.
7-15
Pay practices must recognize
these behaviors by better pay,
larger bonuses, and other
forms of compensation.
© 2005 The McGraw-Hill Companies, Inc. All rights reserved.
Exhibit 7.7: Supply Side
Theories and Implications
Theory
Prediction
So What?
Reservation wage
Job seekers won’t accept jobs
whose pay is below a certain
wage, no matter how attractive
other job aspects.
Pay level will affect ability to
recruit.
Human capital
The value of an individual’s skills
and abilities is a function of the
time and expense required to
acquire them.
Higher pay is required to
induce people to train for
more difficult jobs.
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7-17
Product Market Factors and Ability to Pay
Two
key product market factors affect
ability of a firm to change price of its
products or services
 Level
of product demand – Puts a lid on
maximum pay level an employer can set
 Degree
of competition – In highly
competitive markets, employers are less able
to raise prices without loss of revenue
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7-18
Relevant Markets
 Three
factors determine relevant labor
markets

Occupation

Geography

Competitors
 Issues
related to defining the relevant
market

Competitors – Products, location, and size

Jobs – Skills and knowledge required and their
importance to organizational success
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Exhibit 7.8: Probable Relationships Between
External Pay Policies and Objectives
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7-19
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7-20
Pay Policy Options: Match the Competition
Attempts
to ensure an organization’s
 Wage
costs are approximately equal to those of its
product competitors
 Ability
to attract potential employees will be
approximately equal to its labor market
competitors
Avoids
placing an employer at a
disadvantage in pricing products or in
maintaining a qualified work force
May
not provide an employer with a
competitive advantage in its labor markets
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7-21
Pay Policy Options: Lead Policy
Maximizes
ability to attract and retain
quality employees and minimizes
employee dissatisfaction with pay
May
offset less attractive features of work
If
used only to hire new employees, may
lead to dissatisfaction of current
employees
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7-22
Pay Policy Options: Lag Policy
May
hinder a firm’s ability to attract
potential employees
If
pay level is lagged in return for promise
of higher future returns
 May
increase employee commitment
 Foster
 May
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teamwork
possibly increase productivity
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7-23
Pay Policy Options: Flexible Policies
Employers
have more than one pay
policy
Policy may vary for different occupational
families
 Above
market for critical skill groups
 Below or at market for others
Policy
may vary for different pay elements
 Above
market in total compensation
 Below market in base pay
 Above market in incentives and rewards
 At or above market in benefits
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7-24
Exhibit 7.9: Pay-Mix Policy Alternatives
Performance - Driven
Benefits 17%
Options 16%
Market Match
Benefits 20%
Base 50%
Options 4%
Bonus 6%
Base 70%
Bonus 17%
Work - Life Balance
Security (Commitment)
Benefits 20%
Benefits 30%
Base 50%
Options
10% Bonus
Base 80%
10%
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7-25
Pay Policy Options: Employer of Choice
 Companies
compete based on their
overall reputation as a place to work
 Defines
compensation more broadly to
focus on all returns from employment

Organization’s position based on total
returns of working for it
 Approach
corresponds to brand or image
a company projects as an employer
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Pay Policy Options: Shared Choice
 Begins
with traditional options of lead,
meet, or lag
 Adds
a second part -- offer employees
choices (within limits) in the pay mix
 Similar
to employer of choice in
recognizing importance of both pay level
and mix

Employees have more say in forms of pay
received
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Exhibit 7.10: Volatility of Stock Value
Changes in Total Pay Mix
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Exhibit 7.11: Dashboard: Total Pay
Mix Breakdown vs. Competitors’
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7-29
Exhibit 7.12: Pay Mix Varies Within the Structure
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Exhibit 7.13: Some Consequences of Pay Levels
Contain operating
expenses (labor costs)
Competitiveness of
total compensation
Reduce pay-related
work stoppages
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Increase pool of
qualified applicants
Increase quality and
experience
Reduce voluntary
turnover
Increase probability of
union-free status
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Which Pay Policy Achieves
Competitive Advantage?
7-31
Involves
assessing consequences of
different pay policy options
Evidence ???
 Pay
level affects costs
 Effects on productivity
 Effects on ability to attract
and retain employees
Possibility
of achieving competitive
advantage
 Message
that pay level and mix signal to
people
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