External equity involves employee perception of the fairness of their compensation relative to those outside the organization. Obviously, employee would not be thrilled to discover that those who do similar work in other organizations receive greater compensation. Employers need to be aware of salary structures of competitors and understand that this can impact motivation, and productivity.
Assessing external equity is relatively a straightforward process. Organizations should first collect wage and salary information to determine market wage rates. This information, Which can be collected in-house or through sources external to the organization, is usually readily available relative to the industry and geographic area through professional association, HR consulting firms, or though the organization’s own primary research. When making assessment of external equity, it is important to consider not only salaries but also other forms of compensation, such as bonus and incentive plans and benefits packages. Information pertaining to these additional forms of compensation may be more difficult to obtain, but it must be incorporated into the analysis, especially for higher-level managerial and executive positions that may have a significant portion of the overall compensation based on incentive pay.
After an investigation of the market has been completed, the organization then determines its own pay strategy relative to the market. The three strategies an employer can choose are a lead, lag, or market policy. A lead involves paying higher wages than compensations to ensure that the organization becomes the employer of choice .In other words ,this strategy assumes that pay is a critical factor in an applicant’s decision in choosing an employer and attempts to attract and help retain the highest-quality employees. In short, the employer desires to be the first-choice employer, that is, the organization wants first selection from available talent. However, any organization that offers higher compensation than its competitors needs to ensure that it has a means of remaining competitive relative to its cost structure and market prices. This requires the organization to have operational efficiencies that its competitors lack, a higher rate of employee productivity than its competitors, and or a product or service for which consumers are willing to pay a premium price.
With a lag policy, the organization compensates employees below the rates of competitors. An organization employing this strategy attempts to compensate employees through some other means, such as opportunity for advancement, incentive plans, good location, good working conditions, or employment security. The organization believes that work-related outcomes are multifaceted and more important, that employees consider more than just salary in weighing their employment options. An organization employing a lag policy needs strong insights into the personal and lifestyle choices of the employees it recruits to allow it to tailor compensation options for these individuals that will allow them to accept a lower base salary than that offered by the competition.
With a market policy, the organization sets its salary levels equal to those of competitors. An employer following this strategy attempts to neutralize pay as a factor in applicant decisions, assuming that it can compete in the labor market in attracting employees by other means such as those listed in the discussion of lag policy. It should come as no surprise that the majority of employers set their salary levels or very near market levels. Such a strategy assumes that employees are less likely to leave if their salaries would remain the same with a new employer.