The document discusses factors that influence external competitiveness in determining pay levels, including labor market factors, product market factors, and organizational factors. It outlines different pay policy alternatives for setting pay levels and pay mixes relative to competitors, and the potential consequences of those policies for controlling costs, attracting employees, and other objectives. The purpose is to help managers make conscious decisions about pay levels and mixes based on their competitive environment and objectives.

1. 7-1
External Competitiveness: Determining
Part the Pay Level
II
Chapter 7 Defining Competitiveness
Chapter 8 Designing Pay Levels, Mix,
and Pay Structures
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 7-2
STRATEGIC STRATEGIC
TECHNIQUES
POLICIES OBJECTIVES
Work Descriptions Evaluation/ INTERNAL
ALIGNMENT Analysis Certification STRUCTURE
EFFICIENCY
• Performance
COMPETITIVENESS Market Surveys Policy PAY • Quality
Definitions Lines STRUCTURE
• Customers
• Stockholders
Seniority Performance Merit INCENTIVE
• Costs
CONTRIBUTORS Based Based Guidelines PROGRAMS
FAIRNESS
COMPLIANCE
ADMINISTRATION Planning Budgeting Communication EVALUATION
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3. 7-3
Chap r
te
7
Defining Competitiveness
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

4. 7-4
Learning Objectives
After studying Chapter 7, students should be able to:
1. Explain the importance of external
competitiveness to the pay model.
2. Discuss the factors that influence external
competitiveness.
3. Discuss the difference between labor market,
product market, and organizational factors in
determining external competitiveness.
4. Explain the different pay policy decisions and
the consequences of using each.
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

5. 7-5
External competitiveness
refers to the pay relationships
among organizations - the
organization’s pay relative to its
competitors.
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

6. 7-6
External competitiveness is expressed in
practice by:
1. setting a pay level that is above,
below, or equal to competitors, and
2. by considering the mix of pay forms
relative to those of competitors.
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

7. 7-7
Pay level refers to the average of the array of
rates paid by an employer.
Σ Base + Bonuses + Benefits + Options / Σ Employees
Pay forms refer to the mix of the various types of
payments that make up total compensation.
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

8. 7-8
Pay level and mix focus attention
on two objectives:
Control Labor Costs
Attract and Retain
Employees
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

9. 7-9
Pay Level Decisions Impact Labor Costs
Number of
Labor Costs = x Pay Level
Employees
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

10. 7 - 10
What Shapes External Competitiveness?
LABOR MARKET FACTORS
LABOR MARKET FACTORS
Nature of Demand
Nature of Demand
Nature of Supply
Nature of Supply
PRODUCT MARKET FACTORS
PRODUCT MARKET FACTORS
Degree of Competition
Degree of Competition EXTERNAL
EXTERNAL
Level of Product Demand COMPETITIVENESS
COMPETITIVENESS
Level of Product Demand
ORGANIZATION FACTORS
ORGANIZATION FACTORS
Industry, Strategy, Size
Industry, Strategy, Size
Individual Manager
Individual Manager
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

11. 7 - 11
Labor Demand
! The marginal product of labor is the additional
output associated with the employment of one
additional human resource unit, with other
production factors held constant.
! The marginal revenue of labor is the additional
revenue generated when the firm employs one
additional unit of human resources, with other
production factors held constant.
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

12. 7 - 12
Supply and Demand at the Market and Individual
Employer Level
Market level Employer level
Ma
$100,000 $100,000 rg
De in
ma pr al r
nd od ev
uc en
t ue
Pay for business graduates
Pay for business graduates
$50,000 $50,000
Supply to
ly individual
pp
Su employer
$25,000 $25,000
0 5 10 15 20 25
Number of business graduates available Number of business graduates available
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

13. 7 - 13
Labor Demand Theories and Implications
Theory Prediction So What?
Compensating Work with negative Job evaluation must collect
differentials characteristics requires higher and compensable factors
pay to attract workers. most capture these negative
characteristics.
Above-market wages will improve Staffing programs must have
Efficiency wage
efficiency by attracting workers the capability of selecting the
who will perform better and be best employees. Work must
less willing to leave. be structured to take
advantage of employees’
greater efforts.
Pay policies signal the kinds of Pay practices must recognize
Signaling
behavior the employer seeks. these behaviors by better pay,
larger bonuses, and other
forms of compensation.
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

14. 7 - 14
Labor Supply Theories and Implications
Theory Prediction So What?
Reservation wage Job seekers won’t accept jobs Pay level will affect ability to
whose pay is below a certain recruit.
wage, no matter how attractive
other job aspects.
Human capital The value of an individual’s skills Higher pay is required to
and abilities is a function of the induce people to train for
time and expense required to more difficult jobs.
acquire them.
Job competition Workers compete through As hiring difficulties increase,
qualifications for jobs with employers should expect to
established wages. spend more to train new hires.
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

15. 7 - 15
Competitive Pay Policy Alternatives
Pay with Competition
Lead Policy
(Match)
Lag Policy
Flexible Policies
Employer of Choice
Shared Choice
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

16. 7 - 16
Pay Mix Policy Alternatives
Performance - Driven Market Match
Benefits Benefits
17% 20%
Options 4%
Options Base 50% Base 70%
16% Bonus 6%
Bonus
17%
Work - Life Balance Security (Commitment)
Benefits
20%
Benefits
30%
Base 50%
Base 80%
Options
10%
Bonus
10%
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17. 7 - 17
Some Consequences of Pay Levels
Contain operating
Increase pool of
expenses (labor costs)
qualified applicants
Increase quality and
experience
Competitiveness of total
compensation Reduce voluntary
turnover
Increase probability of
Reduce pay-related union-free status
work stoppages
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

18. 7 - 18
Summary
! There is no “going rate,” thus managers make conscious
pay level and mix decisions influenced by several
factors.
! There are both product market and labor market factors
that impact the pay level and mix decisions.
! Alternative pay level and mix decisions have different
consequences.
! Pay policies need to be designed to achieve specific pay
objectives.
! To achieve the objectives stipulated for the pay system,
both the pay level and mix must be properly positioned
relative to competitors.
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

19. 7 - 19
Review Questions
1. Distinguish policies on external competitiveness
from policies on internal alignment. Why is
external competitiveness so important?
2. What factors shape an organization’s external
competitiveness?
3. What does marginal revenue product have to do
with pay?
4. What pay level does the efficiency wage theory
predict? Does the theory accurately predict
organization behavior? Why or why not?
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

20. 7 - 20
Review Questions (continued)
5. What is a relevant market? What difference does it
make when determining people’s pay?
6. Can you think of any companies that follow a lag
and/or lead policy? Why do they believe it pays to
pay differently? Can you think of any companies
that follow performance-driven and/or work-life
balance policies?
McGraw-Hill/Irwin © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.