Foundations of Internal Labor Market Analysis


Obviously, a necessary step toward managing the dynamic process in the internal labor market is to understand it. At a minimum, that means describing it accurately. Better still, understanding means knowing why the internal labor market operates as it does and what the consequences are for an organization.

The dynamic process we have described is complex but not inscrutable. New analytic tools and the wealth of data in modern human resources (HR) information systems make it possible to measure and model these labor flows and rewards, decipher their patterns, identify the forces that drive them, and gauge their consequences. That knowledge can be used to forecast what the future workforce will look like in response to changes in external conditions or management practices. The knowledge gained also provides the basis for implementing the right measures to track progress toward achieving the most desired internal labor market dynamics.

The analytic tool we’ve devised for these purposes is the Internal Labor Market (ILM) analysis. The concept of an internal labor market dates back to the 1950s, although the idea was developed most fully in the early 1970s in the work of Peter B. Doeringer and Michael J. Piore. Their seminal book, Internal Labor Markets and Manpower Analysis, was concerned with labor transactions within organizations, which those authors tried to characterize and understand.[1]

Doeringer and Piore actually used the term internal labor market to describe institutional practices that supplant the external market. Those practices reflect and encourage long-term commitments between the employer and the employee and include, for example, reliance on formal career paths, a tendency to hire only at lower levels within each career path, and the convention of linking pay to jobs within a rigid hierarchy of jobs rather than to the attributes of individual employees. The effect of those practices is largely to insulate an organization from the influences of outside labor markets.

Our use of the term is not limited to a particular organizational form or set of employment practices. Instead, we use it to encompass the entire range of management practices that govern transactions between employer and employee inside the organization. To us, the most important and practical implication of Doeringer and Piore’s work is that every organization is running a form of labor market, usually without realizing it. Decisions made by executives affect the efficiency with which that market operates and the results it produces. By managing their internal labor market astutely, executives can shape the workforce to the specifications of the business and leverage human capital investments far more effectively.

In the years since Doeringer and Piore’s book was published researchers in economics and organizational psychology have tended to focus on particular aspects of internal labor markets, such as the drivers of turnover and compensation and patterns of response to vacancies created by employees leaving an organization. A vast research literature has emerged that provides valuable information and insights that can be used to interpret findings about one’s own internal labor market dynamics.[2] (See Appendix B.) However, until now no one has provided a holistic view of the way internal labor markets operate or characterized the dynamics of this system through the use of a set of integrated statistical models. That is what ILM analysis is all about. It can be used to understand what makes a company’s internal labor market tick, the processes by which it creates the company’s human capital and applies it to business objectives. That understanding can help leaders manage the microeconomy of their organizations to deliver the workforce and practices their business strategies require.

The three principles of human capital management—system, facts, and value—come together in an ILM analysis. That analysis views an organization and its environment as an interconnected system. It uncovers facts relevant to decision making and determines where value is being created and lost. ILM analysis is systematic in the sense that it looks at the different pieces of the human capital puzzle and the ways they interact. Rather than relying only on employees’ and managers’ opinions or what company policy manuals state, ILM analysis establishes the facts by observing and measuring critical workforce events and behaviors over extended periods and identifying what drives them. Finally, it concentrates on value creation by forecasting how human capital will grow and where value is created.

What Internal Labor Market Analysis Does

ILM analysis provides a fact-based platform for making many essential decisions about human capital. At the most basic level it examines the flow of people into, through, and out of an organization by using HR data and answers fundamental questions about a firm’s workforce, including the following:

  • Who gets hired?

  • Who stays?

  • Who advances?

  • Who performs well?

  • What actually gets rewarded?

  • How are rewards distributed?

  • How is talent developed?

At a higher level ILM analysis provides critical insights into the operation of the human capital system, reflecting actual practices and their consequences. It focuses on causal links between critical workforce events and behaviors over time; thus, it can be used to forecast the effects of specific changes in management practices and market conditions. ILM analysis combines simple descriptive counts and sophisticated statistical modeling techniques that we and our associates have been perfecting through research and work with companies since 1994. It draws on an organization’s HR and payroll databases and other relevant sources, including external labor market data. It can be applied to the entire workforce or to particular occupational groups and business segments.

Mapping Human Capital

The point of departure for an ILM analysis is the creation of an internal labor market map, a graphic, quantitative picture that describes key dynamics related to the flow of people into, through, and out of an organization over time. The map is a flexible, highly detailed description of the way an organization’s internal labor is operating currently. To best understand the current state, of course, it is useful to understand the recent changes that have brought it about; thus, ILM analyses typically capture facts from the preceding three to five years.

The map tallies and displays things such as the average annual number of people entering and leaving an organization at various career levels. It quantifies the movement of people within and between career levels. The map also is used to display where various attributes of human capital—experience, selected skill sets, and so on—are concentrated. An ILM map can do this for the entire organization, for each of its business units or functions, and for different segments of the employee population. In summary, an ILM map provides a concise picture of an organization’s human capital.

Every organization has a unique ILM map. Figure 5-1 shows the ILM map for TechCo, the chip-making company whose business problems were introduced in Chapter 2. How does one read such a map? Let’s begin with the horizontal bars in the center of the figure. Each bar represents a different career level. Each level clusters a number of jobs and titles and shows the relative proportions of employees at that point in the hierarchy. Those levels are not just markers of salary grades; they represent major points of career advancement at which the level of responsibility, authority, scope of job, and pay change fundamentally. The numbers in the horizontal bars represent the number of people in the level.

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Figure 5-1: TechCo’s Internal Labor Market Map 2003, Mercer Human Resource Consulting LLC

Now note the arrows between the boxes. Upward-pointing arrows indicate the average annual number of people promoted to the next higher level during the period, with fast-track promotions shown by arrows that skip a level. The numbers next to each upward arrow show the associated probability of promotion. Downward-pointing arrows indicate the rare instances of demotions. For example, on average 15 people were demoted from level 4 to 3. Some of the demotions are performance-related, and some are the product of negotiated arrangements between employer and employee, such as helping employees make the transition to retirement or deal with pressing issues of work-family balance.

The left-hand column of arrows in the map indicates the number of people entering at each level per year. Those average numbers also are expressed as a percentage of the total employees in their respective career levels. The number of individuals (and percentages) leaving the company from each level per year are shown in the right-hand column of arrows and numbers.

All calculations for an ILM map must be based on a consistent unit of time, such as a year, to be meaningful. Maps, however, can be constructed for shorter or longer periods, depending on the organization’s needs. The map in Figure 5-1 is only one example of the kinds of facts that can be displayed. Other maps might highlight the number and rates of lateral moves within a career level. Still others might represent the proportions of employees at each level by employee segment, such as gender or high-potential standing. Maps like the one in Figure 5-1 are flexible and accommodating to each organization’s circumstances and needs.

ILM maps come in a number of different shapes (see the sidebar following). Obviously, the shape reveals how hierarchical an organization is and how employees are spread throughout the organization. It also indicates something about the likely role of career advancement in the overall reward structure of the organization. By looking at patterns of entry and promotion throughout the hierarchy, one can tell whether an organization is prone to buy or build its talent. Build-from-within organizations tend to limit hiring at the middle and upper levels in order to concentrate on the development of homegrown talent and keep promotion opportunities for incumbents strong. A proportionately large number of middle-level hires is inimical to both objectives.

Finally, the pattern of entry and exit can indicate something about the organization’s sensitivity to changes in outside labor market conditions. Doeringer and Piore note that in some organizations inflows and outflows of employees are concentrated at certain levels only, what they call “ports” of entry and exit. These are touch points with the marketplace where the company has the greatest exposure to outside influences.

Organizations that build talent from within might have the most entry points at certain lower levels and exit patterns that are more diffuse. Organizations that tend to buy talent have many touch points with the market, as evidenced by diffuse patterns of entry and exit. In a build-from-within organization, reward systems may be hierarchical as well, strongly linked to job level and/or length of service. Hence, employees are locked quickly into the organization as the cost of leaving becomes prohibitive. This creates a degree of insulation from the outside labor market. Indeed, changes in labor market conditions have little or no impact on turnover for a build-from-within firm. The advantage is more stability in the workforce and greater opportunities to invest in people and build firm-specific human capital. The disadvantage is loss of flexibility and a distancing from market realities. This can be especially hazardous at times of fundamental change in competitive conditions.

[1]Peter B. Doeringer and M. J. Piore, Internal Labor Markets and Manpower Analysis. Lexington, MA: Heath, 1971.

[2]This research has spawned a new field within labor economics called the new economics of personnel. The hallmark of this work is the application of classic optimization and modern game theory perspectives to the analysis of labor transactions inside a firm. This research has probed areas such as the determinants of pay; the provision of work incentives; human capital development; supervision; and organization structure. A landmark publication in this field is E. P. Lazear, Personnel Economics. Cambridge, MA: MIT Press, 1995. Other seminal works directly relevant for understanding internal labor markets include the following:
• G. P. Baker, M. Gibbs, and B. Holmstrom, “The Internal Economics of the Firm: Evidence from Personnel Data,” Quarterly Journal of Economics, 1994, no. 109, 881–919.
• G. P. Baker, M. Gibbs, and B. Holmstrom, “The Wage Policy of the Firm,” Quarterly Journal of Economics, 1994, no. 109, 881–919.
• B. Holmstrom, “Moral Hazard in Teams,” Bell Journal of Economics, 1982, no. 13, 324–341.
• E. P. Lazear, “Agency, Earnings Profiles, Productivity and Hours Restrictions,” American Economic Review, 1981, no. 71, 606–620.
• E. P. Lazear and S. Rosen, “Rank Order Tournaments as Optimum Labor Contracts,” Journal of Political Economy, 1981, no. 89, 841–864.
• G. C. Calvo and S. Wellisz, “Supervision, Loss of Control and the Optimum Size of the Firm,” Journal of Political Economy, 1978, no. 86, 943–952.
Similar developments have taken place in other disciplines. Sociologists have studied differences between firms in employment systems and their implications for occupations and mobility (for example, see R. P. Althauser, “Internal Labor Markets,” Annual Review of Sociology, 1989, vol. 15, 143–161). Others in the organizational sciences have looked at differences in the operation of internal labor markets within an organization (for example, see Jeffrey Pfeffer and Y. Cohen, “Determinants of Internal Labor Markets in Organizations,” Administrative Science Quarterly, 1984, vol. 29, 550–572). Lawrence Pinfield’s The Operation of Internal Labor Markets (New York: Plenum Press, 1995) describes the range of disciplines offering research-based insights into the concept of internal labor markets and notes the preeminent contributions from the disciplines of economics, organizational psychology, and human resource management.




Play to Your Strengths(c) Managing Your Internal Labor Markets for Lasting Compe[.  .. ]ntage
Play to Your Strengths(c) Managing Your Internal Labor Markets for Lasting Compe[. .. ]ntage
ISBN: N/A
EAN: N/A
Year: 2003
Pages: 134

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