CHAPTER 3

DEFINING INTERNAL ALIGNMENT

LECTURE NOTES

SLIDE 1: COMPENSATION STRATEGY: INTERNAL ALIGNMENT

Setting objectives is our first issue in a strategic approach to pay. Our second issue,
internal alignment, addresses relationships inside the organization. Matthew doesn’t tell
us how the work in the vineyard was organized. Perhaps laborers worked in teams: Some
trimmed while others tied the vines. Does trimming require more judgment than tying?
How do the responsibilities and pay of the trimmer relate to the responsibilities? and pay
of the tier, the householder’s cook, or the steward? Internal alignment addresses the
logic underlying these relationships. The relationships form a pay structure that should
support the organization strategy, support the work flow, and motivate behavior toward
organization objectives.

An internally consistent pay structure is one that supports the organization’s internal
structure and is perceived as equitable when pay rates for different jobs within the
organization are compared, i.e., the array of wage rates for different jobs in the
organization is deemed to be fair or equitable.

SLIDE 2: LEARNING OBJECTIVES

After studying Chapter 3, you should be able to:

 Define what is meant by internal alignment and pay structure.

 Describe the three factors that define how internal pay structures are designed.
 Describe the factors that shape internal structure.
 Explain the two strategic choices involved in designing internal pay structures.
 Explain four theoretical approaches to determining which pay structure is best
for an organization.
 Describe three consequences of an internally aligned pay structure.

SLIDE 3: INTERNAL ALIGNMENT

often called internal equity, refers to the relationship between the pay structure and the
design of the organization and the work. Internal alignment, often called internal
equity, refers to the pay relationships among different jobs/skills/competencies within a
single organization.

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 It focuses attention on the importance of designing a pay structure that supports the
workflow, is fair to employees, and directs their behaviours toward organizational
objectives.

SLIDE 4: EXHIBIT 3.1

shows a structure for engineering work at a division of Lockheed Martin, the world’s
largest defense contractor. Lockheed also builds rockets, shuttles, and Martian rovers for
NASA. Lockheed has the contract to build the next shuttle that will take manned flights
back to the moon and on to Mars. The six levels in Lockheed’s structure range from entry
to consultant. You can see the relationships in the descriptions of each level. Decisions
on how to pay each level create a pay structure.

SLIDE 5: PAY STRUCTURE

refers to the array of pay rates for different work or skills within a single organization.
The number of levels, the differentials in pay between the levels, and the criteria used to
determine those differences describe the structure.

SLIDE 6-7: COMPENSATION STRATEGY: INTERNAL ALIGNMENT

The relationships form a pay structure that should support the organization strategy,
support the work flow, and motivate behavior toward organization objectives.

Supports Organization Strategy

The organization’s strategy tells us how it plans to achieve its purpose. Internal
structures that are aligned with a strategy help achieve it.

For example, on Lockheed Engineering Structure, Lockheed decided that six levels of
engineering work would support the company’s strategy of researching, designing, and
developing advanced technology systems.

Supports Work Flow

Workflow refers to the process by which goods and services are delivered to the
customer. The challenge is to design a pay structure that supports the efficient flow of
that work.

The pay structure ought to support the efficient flow of that work and the design of the
organization. For example, financial service firms in the United States traditionally offer
investment advice and products through client centers. At Merrill Lynch, customer
associates used to take all calls from clients or new prospects and route them to financial
advisors (FAs). If the caller wanted a specific transaction, such as purchasing a stock,
mutual fund, or certificate of deposit, the customer associate passed the information on to

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an FA who was legally certified to make the purchase. No one at Merrill Lynch “owned”
a client. Personal long-term relationships were not emphasized.

But Merrill Lynch recognized that its clients’ investment needs varied, depending on
their net worth, among other factors. They wanted advice specific to their circumstances
from someone they knew and trusted. And rather than waiting for calls from these people,
the FAs should initiate calls to them. That would help build the long-term relationship
around adding value to clients’ investments. Merrill Lynch also noticed that meeting the
needs of these high-net-worth clients was very profitable, So Merrill Lynch redesigned
the flow of work to better reflect its clients’ needs—and increase its profits.

Motivates Behaviour

Internal pay structures influence employees’ behaviour. The challenge is to design the
structures so they direct people’s efforts toward organization objectives.

Internal pay structures are part of the network of returns discussed in Chapter 1: pay
increases for promotions, more challenging work, and greater responsibility as employees
move up in the structure. The challenge is to design structures that will engage people to
help achieve organization objectives. Merrill Lynch financial advisors work to meet the
specific needs of their clients by building long-term relationships. Lockheed engineers
work together to share knowledge with each other and with their customers. It will in a
well-designed pay structure. The structure ought to make clear the relationship between
each job and the organization’s objectives. This is an example of “line-of-sight.”
Employees should be able to “see” the links between their work, the work of others, and
the organization’s objectives. And the structure ought to be fair to employees.

SLIDE 8: STRUCTURES VARY BETWEEN ORGANIZATIONS

SLIDE 9: LEVELS

Reflect the overall hierarchy of the flow of work in the organization- the number of levels
and reporting relationships.

One feature of any pay structure is its hierarchical nature: the number of levels and
reporting relationships. Some are more hierarchical, with multiple levels; others are
compressed, with few levels.

SLIDE 10:

The stated goal of GE Healthcare is to provide “transformational medical technologies

and services that are shaping a new age of patient care.” One of their many product lines
is magnetic resonance imaging (MRI). In comparison to Lockheed’s six levels for
engineering alone (Exhibit 3.1), GE Healthcare uses five broad levels, described in

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Exhibit 3.2, to cover all professional and executive work, including engineering. GE
Healthcare would probably fit the Lockheed Martin structure into two or three levels.

SLIDE 11: DIFFERENTIALS

Pay differences between the levels are called differentials. Differentials should be based
on some measure of the differences in the value of the work to the organization.

The pay differences among levels are referred to as differentials. If we assume that an
organization has a compensation budget of a set amount to distribute among its
employees, there are a number of ways it can do so. It can divide the budget by the
number of employees to give everyone the same amount. In most, pay varies among
employees. Work that requires more knowledge or skills, is performed under unpleasant
working conditions, or adds more value is usually paid more.

SLIDE 12:

Exhibit 3.3 shows the percent differentials traditionally attached to Lockheed Martin’s
engineering structure. (Actual pay levels are now somewhat higher for the entire
structure.) One intention of these differentials is to motivate people to strive for
promotion to a higher-paying level. As Exhibit 3.3 shows, the same basic structure, in
terms of percent differentials, can be paired with different pay level policies. For
example, although a lead engineer gets paid more in the structure on the right, the percent
differential between the lead engineer and systems engineer is the same in both (28
percent).

SLIDE 13: CRITERIA

Work content and its value are the most common bases for determining internal
structures. Content refers to the work performed in a job and how it gets done (tasks,
behaviors, knowledge required, etc.). Value refers to the worth of the work: its relative
contribution to the organization objectives. A structure based on content typically ranks
jobs on skills required, complexity of tasks, problem solving, and/or responsibility. In
contrast, a structure based on the value of the work focuses on the relative contribution of
these skills, tasks, and responsibilities to the organization’s goals.

Job-and Person-Based Structures- A job-based structure looks at work content- tasks,

behaviours, responsibilities. A person-based structure shifts the focus to the employee:
the skills, knowledge, or competencies the employee possesses.

Keep in mind, though, that the choice is rarely either/or. Rather, the differences are a
matter of degree: Levels can range from many too few, differentials can be large or small,
and the criteria can be based on the job, the person, or some combination of the two.

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SLIDE 14: USE VALUE AND EXCHANGE VALUE

Use value reflects the value of goods or services an employee produces in a job.
Exchange value is whatever wage the employer and employee agree on for a job. Think
about IBM software engineers living in Bangalore, Kiev, and Purchase, New York. Their
work content is very similar across all locations. Now think about them working together
on the same project—same company, same job content, same internal job. They have the
same use value. Wage rates in Bangalore and Kiev are a lot less than in Purchase, New
York. The jobs’ exchange value varies. For promotions, IBM treats these jobs as being at
the same level in the structure. The difference between exchange value and use value also
surfaces when one firm acquires another. IBM’s acquisition of PricewaterhouseCoopers
(PWC), where consultants were the lifeblood of the company, is a case in point. At the
time, IBM was moving from being a computer company to a provider of information
technology solutions whose applications were broader than the IT department. PWC
consultants could help IBM’s marketing teams engage with clients at a higher
organization level. The use value of the PWC consultants within IBM differed from their
use value within PWC (how they contributed to IBM or PWC objectives). So, similar
marketing jobs in two different companies may be valued differently based on how they
contribute to organization objectives. Alternatively, the same work content in the same
company (IBM’s software engineers) may have different exchange value based on
different geographies.

SLIDE 15: JOB- AND PERSON-BASED STRUCTURES

A job-based structure relies on the work content—tasks, behaviors, responsibilities. A

person-based structure shifts the focus to the employee: the skills, knowledge, or
competencies the employee possesses, whether or not they are used in the employee’s
particular job. The engineering structure at Lockheed Martin (Exhibit 3.1) uses the work
performed as the criterion. GE Healthcare (Exhibit 3.2) uses the individual employees’
competencies/knowledge required at each level of work. In the real workplace, it is often
hard to describe a job without reference to the jobholder’s knowledge and skills.
Conversely, it is hard to define a person’s job-related knowledge or competencies without
referring to work content. So rather than a job- or person-based structure, reality includes
both job and person.

SLIDE 16: FACTORS INFLUENCING INTERNAL PAY STRUCTURES

1. Societal Factors, Just wage doctrine claims that societal norms, customs and
tradition justify pay structures. Present-day manifestation of then just wage
doctrine can be seen in debates over minimum wage legislation and comparable
worth, which also argue against economic forces as the sole determinant of pay
structures.
2. Economic Factors, Globalization of economic competition is having a major
impact on pay structures. In essence, pay structures are being redesigned to face

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 the new economic realities. The supply and demand for specific skills also
influence pay structures.
3. Organizational Factors, The technology employed is a critical organizational
factor influencing the design of pay structures. The organization’s human
resource policies are another influence on pay structures. Most organizations use
promotions as an incentive to induce employees to apply for higher level
positions.

SLIDE 17: EXHIBIT 3.5

Internal Labor Market refers to the rules and procedure that:

-Determine the pay for the different jobs within the single organization, and
-Allocate employees among those different jobs.

In the organization depicted in Exhibit 3.5, individuals are recruited only for entry-level
jobs (an engineer would be hired right out of college; a senior engineer would have a few
years’ experience). They are later promoted or transferred to other jobs inside the
organization. Because the employer competes in the external market for people to fill
these entry jobs, their pay must be high enough to attract a pool of qualified applicants.
In contrast, pay for jobs filled via transfer and promotions is connected to external market
forces, but the connection is less direct. External factors are dominant influences on pay
for entry jobs, but the differences for nonentry jobs tend to reflect internal factors.

SLIDE 18: STRATEGIC CHOICES IN DESIGNING INTERNAL STRUCTURES

Aligned pay structures support the way the work gets done, fit the organization’s business
strategy, and are fair to employees. Greater internal alignment—fit—is more likely to
lead to success. Misaligned structures become obstacles. They may still motivate
employee behavior, but it may be undesirable behavior. Two strategic choices are
involved: (1) how specifically tailored to the organization’s design and work flow to
make the structure and (2) how to distribute pay throughout the levels in the structure.

SLIDE 19: TAILORED VERSUS LOOSELY COUPLED

A low-cost, customer-focused business strategy such as that followed by McDonald’s or

Walmart may be supported by a closely tailored structure. Jobs are well defined with
detailed tasks or steps to follow. You can go into a McDonald’s in Cleveland or Shanghai
and find they all are very similar. Their pay structures are, too. There are seven jobs in
each McDonald’s (under supervisors and managers). All are very well defined in order to
eliminate variance in how they are performed. Cooking french-fries takes nine steps. It
seems hard to make a mistake in these jobs. It is also hard to be the very best French-
fryer in the whole company. Differences in pay among jobs are very small.

In contrast to McDonald’s, 3M’s business strategy requires constant product innovation

and short product-design-to-market cycle times. The 3M competitive environment is
turbulent and unpredictable. No steps at all are laid out. 3M engineers may work on

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several teams developing several products at the same time. 3M’s pay structures are more
loosely linked to the organization in order to provide flexibility.

SLIDE 20: EGALITARIAN VERSUS HIERARCHICAL

Egalitarian structures operate on the belief that all employees should be treated equally
in their pay. This means that there are few levels; less hierarchy and small pay
differentials between levels. A hierarchical pay structure would form the other extreme,
with large pay differentials between levels.

Still, it is hard to be against anything called “egalitarian.” If we instead use the word
“averagism,” as for example a Chinese worker do when describing the pay system under
socialism’s state-owned enterprises. Equal treatment can mean that the more
knowledgeable and high-performing employees—the stars—feel underpaid. They may
quit to go to an employer that better recognizes their contributions with higher pay or
simply refuse to do anything that is not specifically required of them. Their change in
behavior will lower overall performance. So, a case can be made for both egalitarian and
hierarchical structures.

SLIDE 21:

Pay structures can range from hierarchical to egalitarian. Exhibit 3.6 clarifies the
differences. Egalitarian structures have fewer levels and/or smaller differentials between
adjacent levels and between the highest- and lowest-paid workers.

SLIDE 22:

Structures can also be said to vary from layered to delayered. In Exhibit 3.7, the layered
structure has eight different levels, with relatively small between-level differentials in
comparison to the delayered structure, which has only three levels.

The layered structure is more hierarchical than the delayered structure and less egalitarian
in terms of number of levels; the multiple levels would include detailed descriptions of
work done at each level and outline who is responsible for what. Hierarchies send the
message that the organization values the differences in work content, individual skills,
and contributions to the organization.

In the delayered structure, several levels of job titles are removed so that all employees at
all levels become responsible for a broader range of tasks but also have greater freedom
(with less close supervision) to determine how best to accomplish what is expected of
them. The delayered structure is more egalitarian in that it sends the message that all
employees are valued equally. Employees are less closely supervised and they are given
more autonomy (less close supervision), in hopes of allowing them to exercise
independent thought, initiative, and action. The assumption is that more equal treatment

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will improve employee satisfaction, support cooperation, and therefore affect workers’
performance.

SLIDE 23: Exhibit 3.10 summarizes the potential outcomes or effects attributed to
internally aligned structures. The impact of internal structures depends on the context in
which they operate.

Here are the potential outcomes attributed to internally aligned structures,

Read the slide

SLIDE 24: CONSEQUENCES OF STRUCTURES

Importance of Internal Alignment

1. EFFICIENCY - Research shows that an aligned structure can lead to better

organization performance. If the structure does not motivate employees to help achieve
the organization’s objectives, then it is a candidate for redesign. Internal pay structures
imply future returns. The size of the differentials between the entry level in the structure
and the highest level can encourage employees to remain with the organization, increase
their experience and training, cooperate with co-workers, and seek greater responsibility.

2. FAIRNESS - Writers have long agreed that departures from an acceptable wage
structure will occasion turnover, grievances, and diminished motivation.61 But that is
where the agreement ends. One group argues that if fair (i.e., sizable) differentials among
jobs are not paid, individuals may harbor ill will toward the employer, resist change,
change
employment if possible, become depressed, and “lack that zest and enthusiasm which
makes for high efficiency and personal satisfaction in work.”62 Others, including labor
unions, argue for only small differentials within pay levels and for similar work, in the
belief that more egalitarian structures support cooperation and commitment and improve
performance

3. COMPLIANCE - As with any pay decision, internal pay structures must comply with
the regulations of the countries in which the organization operates. While the research on
internal alignment is very informative, there is still a lot we do not know. What about the
appropriate number of levels, the size of the differentials, lie in understanding the factors
discussed in this chapter: the organization’s strategic intent, its design and work flow,
human capital, and the external conditions, regulations, and customs it faces. We also
believe that aligning the pay structure to fit the organization’s conditions is more likely to
lead to competitive advantage for the organization and a sense of fair treatment for
employees.

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Career Path Differentials

We need to understand how differentials within the career path support work flow. The
next several chapters discuss how these internal structures (the levels, differentials, and
criteria) are designed and managed.

WHAT THE THEORY TELLS US

Equity Theory

Employees judge the equity of their pay by comparing the work, qualifications, and pay
for jobs similar to theirs. However, very little research addresses the question of which
specific factors influence employees’ perceptions of the equity or fairness of the pay
structure, as opposed to the equity or fairness of the pay.

Expectancy Theory

Employees make cognitive estimates of how much effort will be required to perform at a
certain level and what that performance level will mean in terms of person outcomes.
Then based on how appealing the outcomes are for the employee, a decision is made
about how much effort to expend.

Tournament Theory

Structures with greater differentials at the top have a more positive effect on
performance than smaller differentials for people at all levels in the structure, according
to tournament theory. The main thing affected by individuals’ performance is whether or
not they get promoted to the next level. Pay has little motivational effect on people
already in a job. Instead, the pay offered for a higher position motivates those at lower
levels in the organization to come to work and do their best in order to stay in contention
for promotion. So pay should be set with its motivational effects on people at lower
levels in mind.

It then follows that, within limits, the bigger the prize for getting to the next level, the
greater the motivational impact the structure will have.

Institutional Theory

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Institutional theory says that practices of other firms influence an organization’s pay
structure decisions- simply copy what others are doing.

WHICH STRUCTURE FITS BEST?

In practice, the decision about which structures best fits a particular business strategy
probably lies in our original definition of internal alignment: An internally aligned
structure supports the work flow, is fair to employees, and directs their behaviour toward
organization objectives.

CONSEQUENCES OF STRUCTURES

There are two practical reasons for paying attention to internal structures. The first is
that there are unique jobs that reflect organization idiosyncrasies. The second reason
for paying attention to internal alignment is that some jobs are valued by a specific
organization more or less than the rates for that job in the market.

What to consider: Competitive Advantage, Fairness, Legal Compliance

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REVIEW QUESTIONS

1. Why is internal alignment an important compensation policy? What happens

when a compensation policy is not internally aligned?

Internal alignment recognizes the relative values of various jobs within an organization.
It can affect employees’ decisions to pursue training, join, or remain with the
organization. Internal consistency forms the basis of the pay structure by providing
differentials for jobs of unequal worth. It recognizes differential value of jobs’ outcomes,
qualifications to perform different jobs, and/or conditions under which jobs are
performed.

2. Based on your own experience, which factors shaped the internal pay structure
at your most recent employer? Provide examples that support your choice.

The factors that influence internal equity include: ( 1) societal norms or customs
regarding fair wage differentials;( 2) economic factors, including a) productivity
differences attributable to differences in the employee, the job, and the match between
the employee qualification and job requirements, b) the abundance or shortage of skills
and c) the value of the output of each job. (3) organizational factors including a) the
organizational “culture” or “values”, b) congruence with career paths, c) union
contract requirements, d) technology-dictated skills and e) human resource management
policies; (4) employee acceptance- workers’ perceptions of what constitutes an equitable
system.

The second part of this question is designed to elicit classroom discussion. Students
should be able to defend their choices.

3. Explain the consequences of internal alignment for competitive advantage,

fairness to employees and legal compliance.

The first is that there are unique jobs that reflect organization idiosyncrasies. The
second reason for paying attention to internal alignment is that some jobs are valued
by a specific organization more or less than the rates for that job in the market.
Internal pay structures imply future rewards. The size of the pay differential between
the entry level and the highest level in the structure may induce employees to remain
with the organization, increase their experience and training, co-operate with co-
workers and seek greater responsibility. Employees’ attitudes toward the fairness of
the pay structure affect their work behaviours. As with any pay decision, the design
and management of internal pay structures must comply with the regulations of the
countries in which the organization operates.

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EXPERIENTIAL EXERCISES

1. Look into any organization- your university/college, workplace, or the grocery

store where you shop. Describe the flow of work. How is the job structure
aligned with the organization’s business, the workflow, and the organization
objectives? How do you think it influences employee behaviours?

Internal alignment addresses the relationships inside the organization. The relationship
among different jobs inside an organization makes up its internal structure. Internal
alignment, often called internal equity refers to the pay relationships between the
jobs/skills/competencies within a single organization. The relationships form a pay
structure that can support the workflow, is fair to employees and direct their behaviour
toward organization objectives. Pay structure refers to the array of pay rates for
different work or skills within a single organization. The number of levels, differentials
in pay between the levels, and the criteria used to determine those differences create the
structure. The last part of the question will elicit classroom discussion.

2. Prepare a list of a least five Canadian laws at various levels of government that
impact pay rates.

Canadian laws include Pay Equity, Employment Equity, Employment Standards, Human
Rights Legislation, Sexual Harassment

3. Illustrate the internal labour market for faculty at your university/college, using
Exhibit 3.5 as a guide.

Professor, Co-ordinator, Chair, Dean, Academic Vice President, President

CASE

The Orchestra

Summary of Case

An actual salary structure for a regional orchestra permits discussion of reasons for the
differences.

Learning Outcome

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All organizations, no matter their size, have compensation issues. Decisions on internal
consistency frequently are the most contentious.

Questions

1. Describe the orchestra’s pay structure in terms of levels, differentials, and job- or
person based.

Structure appears job-based. Job accounts for the differences among instruments, very
hierarchical. Principal instruments get much more than others playing the same
instrument. So a very elaborate system with lots of levels and differences.

2. Discuss what factors may explain the structure. Why does violinist receive more
than the oboist and trombonist? Why does the principal trumpet earn more than
the principal cellist, clarinetist but less than principal viola and flute players do?
What explains these differences? Does the relative supply versus the demand for
violinist compare to the supply versus the demand for trombonists? Is it that
violins play more notes?

Because this chapter discusses a number of economic and psychological theories, it is

useful to ask what each theory would predict, and compare those predictions to the
actual salary structure.

Students most commonly appeal to the “market” as the justification for salary
differentials. So ask them, “is there a greater demand for violin players compared to
their supply than the demand and supply of trombone players?

The pay differences can be explained by strategic importance: the quality of the violins
is deemed more important in the repertoire of most orchestras than the quality of the
trombones.

Another explanation for the differences may be the amount of work: violinists generally
have more notes to play than the trombones.

Students generally enjoy this discussion because most of them are familiar with the
various musical instruments; have heard orchestras play (or may have played in them);
yet probably never wondered about how the musicians were paid. This exercise will
sensitize them to the reality of compensation decisions all around them.

3. How well do equity and tournament models apply?

Tournament model- seems to apply in that going to the principal positions increases pay
substantially. Greater differentials than moving from violin II to violin I. Size of
differential increases at the top. However, the case could be made that these are all
separate structures within instruments, i.e., no one is going to move from flute to
principal cello.

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Equity model- the elaborate structure would seem to contradict Drucker’s depiction of
the orchestra as the cooperative work unit for the future where all members are working
in harmony toward a single goal.

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