There are many ways to pay employees. The process of initially setting pay levels entails balancing internal equity—the worth of the job to the organization, and external equity—the competitiveness of an organization’s pay relative to pay in its industry. Obviously, the best pay system reflects what the job is worth and also stays competitive relative to the labor market. Some organizations prefer to pay above the market, while some may lag the market because they can’t afford to pay market rates or they are willing to bear the costs of paying below market.

Some companies that have realized impressive gains in income and profit margins have done so in part by holding down employee wages. Pay more, and you may get better-qualified, more highly motivated employees who will stay with the organization longer. A study covering 126 large organizations found employees who believed they were receiving a competitive pay level experienced higher morale and were more productive, and customers were more satisfied as well.

But pay is often the highest single operating cost for an organization, which means paying too much can make the organization’s products or services too expensive. It’s a strategic decision an organization must make, with clear trade-offs.