The effective organizational performance is virtually impossible without the development of an effective pay structure. In this regard, it is possible to distinguish internal equity and external equity as two different pay structures. Organizations should choose either pay structureе depending on their needs and employees’ performance but they should remember that internal equity is mainly oriented on the internal organizational structure, needs and performance, whereas external equity depends on the current situation in the industry and labor market.
In actuality, the internal equity method undertakes the job position in the organizational hierarchy (Becker and Gerhart, 788). The process aims at balancing the compensation provided to a job profile in comparison to the compensation provided to its senior and junior level in the hierarchy (Becker and Gerhart, 789). In such a way, through the pay structure organizations attempt to balance the position of employees within organizations and to stimulate them to work better.
However, in case of internal equity, the fairness is ensured using job ranking, job classification, level of management, level of status and factor comparison (Delery and Doty, 811). What is meant here is the fact that organizations should pay attention to the extent to which the pay is fairly distributed within them. For instance, employees with equal qualifications and positions are supposed to receive equal wages but some organizations violate this principle. As a result, the fairness of such organizations is under a question and employees feel dissatisfied with their wages that naturally provokes internal conflicts and deterioration of the organizational performance.
At the same time, the main point of internal equity is to pay employees respectively to their performance and contribution to the organizational performance. Organizations use internal equity to create healthy organizational culture and equal conditions and opportunities for employees within the organization. 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 this regard, external equity is totally different from internal equity. In fact, in case of external equity, the market pricing analysis is done (Delery and Doty, 812). Organizations formulate their compensation strategies by assessing the competitors’ or industry standards. Organizations set the compensation packages of their employees aligned with the prevailing compensation packages in the market (Becker and Gerhart, 791). This entails for fair treatment to the employees. Unlike internal equity, which focuses on the internal balance in pay structure respectively to the organizational hierarchy, external equity focuses on the competitive environment anв pay structure in the industry. In fact, external equity is the most appropriate for organizations operating in the highly competitive environment, when they attempt to retain their employees and to decrease the risk of the high personnel turnover. External equity allows organizations to createу the competitive pay structure. As a result, employees working in an organization using external equity can count for wages proportional to average wages in the industry.
However, at times organizations offer higher compensation packages to attract and retain the best talent in their organizations (Delery and Doty, 813). In such situations, organizations can gain a competitive advantage over their rivals attracting well-qualified human resources by the higher wages compared to average in the industry.
At the same time, it is worth mentioning the fact that internal equity is often used by large organizations, which hold the leading position in the industry and which can offer its employees comfortable conditions of work. In fact, the advantage of internal equity compared to external equity is the offer of unique pay structure compared to other organizations, while external equity normally offers employees similar pay structure compared to average in the industry. On the other hand, internal equity may fail to meet general trends in the industry and employees can flow to other companies, if their organization offers them consistently lower wages compared to other organizations. In such a way, organizations using internal equity may offer employees exclusive pay structure but fail to match the average pay in the industry, whereas organizations using external equity use similar pay structure compared to their competitors but fail to offer unique pay structures. For instance, organizations using external equity may fail to offer its employees attractive compensation plans, following the lead of other organizations (Becker and Gerhart, 780). In contrast, organizations using internal equity can offer employees their attractive compensation plans and bonus system but fail to offer employees wages comparable to other organizations.
Thus, internal equity and external equity are different pay structures, which can be used by contemporary organizations. At the same time, organizations can use either pay structure but they have to take into consideration their needs and business environment. At this point, organizations can use internal equity, when they want to offer unique pay structure to its employees and to balance their internal organizational structure. In contrast, external equity helps organizations to meet average pay level in the industry.
Becker, B. and Gerhart, B. “The impact of human resource management on organizational performance.” Academy of Management Journal, 39(4), 1996, 779–801.
Delery, J. and Doty, H. “Modes of theorizing in SHRM.” Academy of Management Journal, 39(4), 1996, 802–835.