It depends on the market.....

A recent survey among the HBS Graduating class brought some interesting findings. Around 80% of the graduating class voted that they are happy with a salary of $100,000 if their peers are getting a salary of $80,000. But they are not happy with a salary of $120,000, if their counterparts are getting $140,000. This implies , it is not the absolute value of the salary that alone is sufficient but what matters more is how it is compared , vis a vis others. And this brings in “Market Competitive Pay".
Take the example of a homogenous set of employers; say Big-4 consulting firms or top-5 Indian IT Companies. These organisations are similar to a great extent, in terms of work environment, organisational structure, line of business and the skills they look for in an employee. Here market competitive pay becomes paramount importance if the organisation wants to retain its key employees. The other thing that works for employees here is the liquidity of their skills in the job market. An employee can demand a competitive pay package as other organisations need the skill set he possess and might pay him. This can be best described as a free market scenario for both employees and employers and Market competitive Pay is most prevalent here. If an employer cannot pay the industry bench mark levels, he won’t be able to retain its key employees. He cannot also pay significantly ahead of its peers as the line of business and the bottom lines are more or less same for them. No employee can also demand a pay package, comparably higher than his counter parts, because, the employer can find a substitute of his skill sets in a lesser price. The whole system leads to equilibrium in compensation which may be described as Market Competitive pay.
But things are not quite similar for the programmer of an out dated programming language. If there are not too many players in the market to recruit him for his skills, he cannot really demand a competitive package. Here the employer has the freedom to decide the salary. Now consider the case of a top notch neurosurgeon or country’s best criminal lawyer. There are not too many substitutes for his skills. So the employer may have to pay him significantly higher than the market to recruit & retain him as he is the critical success factor to his business and a very specific asset to the organisation with no immediate substitutes. What we can conclude here is market competitive pay does not work, in an oligopositic or monopolistic market. This can be vindicated if we take the case of IT Product companies like Google and Microsoft who thrives on innovation. They tend to pay significantly ahead of the market as they need the best of the talent pool and the bottom line of the business supports it.
To sum the above discussion, Market competitive Pay package works in a Free Job where there are immediate substitutes avaialble for both employers and employees available. But it is not seen incase of a monopolistic / oligopolistic market, where the substitutes are scarce.

( the author of this post is an employee of a leading IT Consultancy firm in India)