Chapter 7

Defining Competitiveness
McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Chapter Topics
Compensation Strategy: External
Competitiveness
What Shapes External
Competitiveness?
Labor Market Factors
Modifications to the Demand Side
Modifications to the Supply Side
Product Market Factors and Ability to
Pay
7-2

Chapter Topics (cont.)

Organization Factors
Relevant Markets
Competitive Pay Policy Alternatives
Consequences of Pay-Level and Mix
Decisions: Guidance from the
Research

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Compensation Strategy: External

Competitiveness
External competitiveness is expressed
by:
Setting a pay level that is above, below,
or equal to that of competitors
Determining the mix of pay forms
relative to those of competitors

External competitiveness refers to the

pay relationships among organizations
the organizations pay relative to its
competitors
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Compensation Strategy: External

Competitiveness (cont.)
Pay level refers to the average of the
array of rates paid by an employer:
(base + bonuses + benefits + value
of stock holdings) / number of
employees
Pay forms are the various types of
payments, or pay mix, that make up
total compensation

7-5

Compensation Strategy: External

Competitiveness (cont.)
Objectives:
Control costs and increase revenues
Attract and retain employees

7-6

Control Costs and Increase

Revenues
Labor costs = (pay level) times
(number of employees)
Higher the pay level, the higher the
labor costs
Higher the pay level relative to what
competitors pay, the greater the
relative costs to provide similar
products or services
7-7

Labor Market Factors

Two basic types of markets:
Quoted price
Example: Stores that label each items price

Bourse
Example: eBay allows haggling over the
terms and conditions

7-8

Labor Market Factors (cont.)

In both markets, employers are the
buyers and potential employees are
the sellers
If inducements offered by the
employer and skills offered by the
employee are mutually acceptable, a
deal is struck

7-9

How Labor Markets Work (cont.)

The market rate is where the lines for
labor demand and labor supply cross

7-10

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

7-11

Labor Demand (cont.)

An employers level of production can
change only if it changes the level of
human resources
An employers demand labor coincides
with the marginal product of labor

7-12

Marginal Product
Marginal product of labor is the
additional output associated with
employment of one additional person,
with other production factors held
constant
Diminishing marginal productivity
Each additional employee has a progressively
smaller share of the other factors of
production with which to work

7-13

Marginal Revenue
Marginal revenue of labor is the
additional revenue generated when
the firm employs one additional
person, with other production factors
held constant
A manager using the marginal revenue
product model must:
Determine pay level set by market forces
Determine marginal revenue generated by
each new hire
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Labor Supply
This model assumes:
Many people are seeking jobs
They possess accurate information about
all job openings
No barriers to mobility exist

These assumptions greatly simplify the

real world

7-15

Modifications to the Demand Side

Economic theories must frequently be
revised to account for reality
When focus changes from all the
employers in an economy to a particular
employer

Issue for economists:

Why would an employer pay more than
what theory states is the marketdetermined rate?
7-16

Compensating Differentials
According to Adam Smith, If a job has
negative characteristics then
employers must offer higher wages to
compensate for these negative
features
For instance, if:

Necessary training is very expensive

Job security is tenuous
Working conditions are disagreeable
Chances of success are low
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Efficiency Wage
According to efficiency-wage theory,
high wages may increase efficiency
and actually lower labor costs if they:

Attract higher-quality applicants

Lower turnover
Increase worker effort
Reduce shirking
Reduce the need to supervise employees

7-18

Efficiency Wage (cont.)

Firms with greater profits than
competitors are able to share success
with employees via:
Leading competitors pay levels
Bonuses that vary with profitability

7-19

Signaling
Employers deliberately design pay
levels and mix as part of a strategy
that signals to both prospective and
current employees kinds of behaviors
sought
On the supply side of the model:
Suppliers of labor signal to potential
employers
Characteristics of applicants and
organization decisions about pay level
and mix act as signals
7-20

Product Market Factors and Ability

to Pay
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 revenues
Single sellers are able to set whatever
price they choose
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Segmented Supplies of Labor and

(Different) Going Rates
People flow to the work
A segmented labor supply involves:
Multiple sources of employees
From multiple locations
With multiple employment relationships

Level and mix of cash and benefits paid

depends on the source

Work flows to the peopleon site, offsite, offshore

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Segmented Supplies of Labor and

(Different) Going Rates (cont.)
Reality is complex; theories abstracts
Segmented sources of labor means
that determining pay levels and mix
requires understanding market
conditions in different locations
Managers need to know:
Jobs required to do the work
Tasks to be performed
Knowledge and behaviors required to
perform them
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Organization Factors
Industry and technology
Labor-intensive industries tend to pay
lower than technology-intensive
industries;
New technology within an industry
influences pay levels
Employer size
Large organizations tend to pay more than
small ones
7-24

Relevant Markets
Three factors determine relevant labor
markets:
Occupation
Geography
Competitors

7-25

Relevant Markets (cont.)

Employers choose their relevant
markets based on:
Competitors Products, location, and
size
Jobs Skills and knowledge required and
their importance to organizational
success

7-26

Globalization of Relevant Labor Markets:

Offshoring and Outsourcing
Factors to consider in deciding where jobs
will be:
Countries with lower average labor costs
tend to have lower average productivity
Companies must devote resources to
systems that monitor worker effort or
output (Agency theory)

7-27

Globalization of Relevant Labor Markets:

Offshoring and Outsourcing (cont.)
Customers reactions must be considered
How long the labor cost advantage will
last
Whether qualified employees will continue to
be available as other companies tap into this
labor pool

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Pay with Competition (Match)

(cont.)
Attempts to ensure that an
organizations:
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

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Lead Pay-Level Policy

Maximizes the ability to attract and
retain quality employees and
minimizes employee dissatisfaction
with pay
May also offset less attractive features
of work
If used only to hire new employees,
may lead to dissatisfaction of current
employees
May mask negative job attributes that
contribute to high turnover later on
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Lag Pay-Level Policy

Paying below-market rates may hinder
a firms ability to attract potential
employees
Lag pay-level policy coupled with the
promise of higher future returns:
May increase employee commitment
Foster teamwork
May possibly increase productivity

7-31

Exhibit 7.16: Some Consequences

of Pay Levels

7-32

Consequences of Pay-Level and Mix

Decisions: Guidance from the Research (cont.)

Fairness
Satisfaction with pay is directly related to
pay level
Sense of fairness is related to how others
are paid

Compliance
Employers must pay at or above the legal
minimum wage
Prevailing wage laws and equal rights
legislation must be met
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Consequences of Pay-Level and Mix

Decisions: Guidance from the Research (cont.)
Pay forms are also regulated
Caution must be exercised when sharing
salary information to avoid antitrust
violations

7-34