Internal Equity versus External Equity

by | Mar 22, 2022 | Article, Job Evaluation, Pay Equity | 0 comments

Internal equity and external equity are important, but not the only factors, in determining job evaluation in your organization. What are the benefits of a hybrid approach in comparable worth of jobs?

Experienced compensation practitioners may consider these words of wisdom ‘old hat’. For those struggling to understand the concepts and interdependencies of internal equity, external equity, market pricing and job evaluation, please read on.

External equity versus internal equity is not a binary decision. Most compensation systems are a hybrid of internal and external equity. Let me explain by first considering external equity.

External equity simply means that an organization uses market prices to administer employees’ salaries or wages i.e., the market price determines the pay opportunity of the job.

How is market pricing important in the compensation process?

A word about market pricing. Market prices are established by salary surveys. However, ‘market price’ is a misnomer. There is no single market price. Salaries for a specific job will fall in a range best illustrated by the quartile salary/wage data found in most credible salary surveys. Organizations typically adopt a specific statistic, such as median, to represent the market price. The trouble is that the median, like all the statistics, move around year over year, both up and down.

There are many reasons for this, for example:

  • The companies participating in the survey are likely to change year to year;
  • The benchmark survey descriptions may be too subjective leading to various interpretations of the match year over year; and
  • The compensation analysts (and his/her familiarity of the job matches) are likely to change year over year.

It is difficult to administer employees’ salaries relative to a moving reference point; therefore, organizations try to stabilize these reference points year to year.

Internal Equity versus External Equity by Encompassing VisionsIs there value in a hybrid model of relative comparable worth of jobs?

Now back to internal versus external equity. Market pricing organizations seldom find reliable salary survey data for all the jobs in the organization. Consequently, those jobs for which there is no data are aligned for salary purposes with jobs that are market priced. So, someone has made a decision about the relative comparable worth of the jobs. This is internal equity i.e., relative comparable worth of jobs has been considered and a pecking order is determined.

This approach to compensation has now become a hybrid system consisting of market pricing and assessments of the comparable worth of jobs. But who makes the decision and what are the criteria? For example, should the Global Logistics Coordinator be aligned with an Engineer C, with a market price of $70,000 or a Systems Analyst D, with a market price of $76,000.

The organization can avoid such fine distinctions by creating a pay band and administering the salaries of all three jobs based on a common reference point, say $76,000.

The reference point of $76,000 is close enough to the market prices that the organization can still attract and retain employees. Pay bands can be created to account for all jobs in the organization. Jobs can be assigned to pay bands based on a subjective assessment of comparable worth. This approach to compensation administration relies on internal equity as jobs are assigned pay bands based on their comparative worth; and, the market reference points approximate the market prices for those jobs.

Validating and justifying the assignment of jobs to pay bands

Organizations often need to validate and justify the assignment of jobs to pay bands i.e., adopt criteria and a process for determining the comparative worth of jobs; i.e., job evaluation. Typically, job information is documented (the job description) and the job is evaluated base on the job’s required skill, effort, responsibility and working conditions. This results in evaluation points; and, the points then determine the pay band assignment.

There are a number of reasons that an organization may need this increased rigor in determining comparable worth:

  • Managers and employees may be discontent with the subjective assignment of jobs to pay bands;
  • Organized labour may demand a rigorous process to decide comparative worth;
  • An organization may need a rigorous process to manage the cost of salaries, as subjective processes may lead to ‘pay band creep’; and
  • Legislation may require a rigorous analysis of comparable worth to assess pay gaps for specific classes of employees (gender, race, colour, region, etc.)

Organizations that adopt the rigor of job evaluation will occasionally encounter situations where internal equity (the pay opportunity of the pay band) doesn’t coincide with external equity (market price of the job or the market value of the incumbent). In special circumstances, external equity will override internal equity and the organization will adopt policies that lead to a hybrid compensation system.

For example, a specific job skill may be in short supply in the market and may command a salary higher than afforded by the assigned pay band. The organization may choose to extend a temporary premium to those jobs to enable competitive compensation. The premium may be retracted once the market normalizes. Or, an organization may choose to hire a person who is overqualified for the role in order to import expertise to build organizational capability. For instance, a 20-year veteran may be hired to reorganize global logistics. The individual is already earning competitive compensation. To attract the candidate, the individual may be assigned an ‘administered’ pay band, higher than the evaluated pay band to create a higher pay opportunity.

Encompassing Visions has simplified the traditional complex job evaluation process

Job evaluation will validate and justify the assignment of jobs to pay bands; however, traditional job evaluation systems are viewed as complex, time consuming, bureaucratic and costly. The typical complains are that:

  • Huge investments in time and effort are needed to create a job description;
  • Developing the job description is an exercise in creative writing; ‘inflate the description get the points’;
  • The evaluations are subject; the written narrative needs to be interpreted in light of the obtuse evaluation criteria; and
  • Evaluations are not credible as the process is a black box to both the manager and the employee.

Encompassing Visions has overcome these issues through innovative tools, processes and technology. Encompassing Visions has:

  • Invented a better way to collect Job Data; an on-line, multiple-choice Job Analysis Questionnaire collects job information, which only takes about one hour to complete;
  • The multiple-choice questionnaire eliminates the need for creative writing (no open- ended questions);
  • The questionnaire probes Job Data across 27 clearly defined job factors; the granularity of the Job Data captures every compensable aspect of every job;
  • The Job Evaluations are objective – system generated evaluations based on the responses to the questionnaire (no subjective interpretation of evaluation criteria);
  • Technology enables storage, as well as, easy and efficient management of the Job Data to produce system generated job descriptions and job evaluations (as well as, recruiting tools).
  • The Job Descriptions incorporate the actual response to the questionnaire; there is no question as to what constitutes the evaluation criteria; the system is transparent.

Encompassing Visions – Job Evaluation Reimagined!

If you’re searching for solutions to job evaluation within your organization, we’d love to be of service. Our industry-leading job evaluation software at Encompassing Visions provides critical tools to help understand and engage the important process of job evaluation. If you would like to request a free demo of our industry-leading  job evaluation software, we’d love to chat with you to discuss how we can help your organization.