The second consideration in creating a base pay system is external equity. External equity refers to the relationship between one company’s pay levels in comparison to what other employers pay. Some employers set their pay levels higher than their competition, hoping to attract the best applicants. This is called “leading the market”. The risk in leading the market is that a company’s costs will generally be higher than its competitors’ costs. Other employers set their pay levels lower than their competition, hoping to save labor costs. This is called “lagging the market”. The risk in lagging the market is that the company will be unable to attract the best applicants. Most employers set their pay levels the same as their competition. This is called “matching the market”. Matching the market maximizes the quality of talent while minimizing labor costs.
An important question in external equity is how you define your market. Traditionally, markets can be defined in one of three ways. One way to define your market is by identifying companies who hire employees with the same occupations or skills. For example, if a company hires electrical engineers, it may define its market as all companies that hire electrical engineers. Another way to define a market is by identifying companies who operate in the same geographic area. For example, if the company is in Denver, Colorado, the market would be defined as all companies in Denver, Colorado. A third way to define a company’s market is by identifying direct competitors, that is, those companies who produce the same products and services. For example, Shady Acres Veterinary Clinic may define its market as all other veterinary clinics. Notice that these three characterizations can interact, that is, Shady Acres might define its market as all veterinary clinics in Denver, Colorado that employ veterinary technicians.
Once you have defined your market, the next step is to survey the compensation paid by employers in your market. Surveys can be done in a variety of ways. First, there are publicly available data through the Bureau of Labor Statistics in the United States. Second, there are publicly available data through the Internet, from sites such as www.salary.com or www.haypaynet.com. Third, salary information can be obtained from a third party source, such as an industry group or employer organization, which has collected general information for a geographic region or industry. Fourth, the company can hire a consulting organization to custom design a survey. Finally, one can conduct a survey one’s self. See http://www.hr-guide.com/data/G474.htm for more information about salary surveys.