What Is The Downside To Paying People What They Are Worth?

In business, as in life, we get what we pay for

Of all business decisions, establishing workers' wages is the most difficult. Businesses understand the costs associated with raw products and overhead as they generally remain fixed and attached to inanimate objects like a pound of hamburger or a building lease. But labor doesn't quite follow that "fixed" model. Labor, in most industries, is a variable expense. It is variable in that the wages for two individuals doing similar work may be different due to factors like seniority or educational background. Also, regarding productivity, the amount of labor it takes to produce a product or service is rarely finitely fixed either.

Businesses, such as in my restaurant industry, generally look at retail markup as a factor of raw costs. We will take the raw cost of that hamburger with French fries at $4.00 and multiply it by a markup factor to reach a retail price that we hope will cover the additional cost of labor and overhead thus producing a desired profit. (For the proper method for performing this task, see my book, Restaurant Management, the Myth, the Magic, the Math.) Labor in this scenario becomes a mitigating factor. Squeeze more productivity per hour out of the workforce and profits increase. Same goes for controlling wages. If a company can control wages and benefits, the mitigated labor expenses increase profitability without adjusting retail markup.

Because of this, most companies have a "catch and contain" labor strategy. Meaning they invest in multiple areas to attract potential workers. This "catch" may include signing bonuses, enhanced benefit offerings and even investing in attractive work culture amenities. Prospective employees, especially in low unemployment times such as now, are attracted by businesses that offer ample amounts of those three things. However, once a company snags a new employee, they immediately place them into the "contain" system. What that means is, once an employee is hired, the company has a very rigid set of policies and procedural steps that an existing employee must navigate to increase his or her wages moving forward. This is certainly true in service industries like law firms and CPA companies. Young Associates are wooed by slightly higher wages than they are typically worth as a raw recruit. But once hired, the young associate will be required to put in years of service and jump through multiple hoops in order to advance their income in any significant manner. This is because companies isolate recruitment and cultural costs as necessary business expenses, but look to existing wages as something that must be managed and if possible mitigated, so to drive profit. To this end, large companies simply set very narrow wage ranges for typical levels of employment. Then they set policies that control the speed of advancement from one level to the next in an effort to once again slow the speed of wage growth. Once an employee is "in the company system," their accumulated skill and knowledge becomes a wage increase liability instead of bankable asset.

A recent example of such a “catch and contain" policy was revealed to me in a conversation with one of my adult children's contemporaries. Daniel, a recent engineer graduate, applied for an entry-level position with a local medical device company. This would have been a "level I" wage position. He did not receive a job offer from that company but accepted a "level I" engineering position with a competing medical manufacturing company. After putting in less than two years of work with his number two choice company, he applied for "level IV" opening at his first-choice company and was hired. Had this young man been accepted by his first-choice company at the entry level I wages, he would have needed to labor at least four years to reach level IV status and wages. However, since companies place a premium on attraction, the "catch" if you will, Daniel was able to advance his wage prospects faster by working for a competitor for only two years.

For all the talk that companies make about building better cultures, they mostly focus on the culture of containment. That is, once they have employees into their system, policies are designed to slowly and methodically wring as much labor from their workforce while limiting the expenses of advancement within the company. For workers, because of the "catch and contain" mentality, there is little value in longevity with any one company. In fact, as Daniel proved, 'tis better to jump ship to take advantage of generous "catch" employment packages of competing firms than to suffer the snail-like "contain" level up policies at an existing company.

The only real deviation from this "catch and contain" employment system is found in startup companies, especially rapidly expanding startup companies. In these companies, the growth requires massive influxes of employees and individuals already working within the organization are premium as they can more quickly adapt to a level up position because of the familiarity with the company versus an outside hired individual. In these circumstances, companies willingly pay higher wages and ignore typical advancement requirements because the nature of the growth requires knowledgeable workers now. Time is of the essence for start-ups thus the worker that helps mitigate time is able to demand a premium wage.

In all these wage scenarios I discuss, none of them are associated with what a worker is worth. All wage values revolve around company formulas for wage to revenue ratios. Simply put, companies determine what percent of its revenues it can dedicate towards wages to produce a product with a desired profit and then go to work with on the arduous task of figuring out how they fulfill their labor requirements while staying within a defined labor percent to revenue cost ratio.

Don't get me wrong, this is a difficult and necessary part of running a business. Most businesses do not have the luxury of operating like the NFL. They don't get the opportunity to hire first and then meet their salary requirements by upping the price of tickets, negotiating a better TV deal, or raising the price on a watered-down glass of beer at the concession stand. Most businesses, like my restaurants, are in highly competitive environments and do not have the ability to "draft" top yet untested talent.

But because of the containment method of managing employees, companies often overlook their bench in favor of outside recruits because of wage mitigation policies. It is far better, in the eyes of most managers, to keep current employees placated within a controllable wage restraint than to upset that equilibrium by creating rapid wage growth opportunities within the company.

This unfortunate worker wage rates versus company wage management scenario have a negative impact on company labor ecosystems. In these businesses, an existing employee that is knowledgeable of the company, its policies and procedures and has adapted to company culture, holds a lesser status, and draws lower wages, than the recruit coming from a competitive firm. This creates an endless cycle of high performers, not advancing through one company, but constantly, and more rapidly, leveling up by moving to competing companies. This is because companies place a premium value of new employee recruitment and much lower value on current employee retainment.

I read lots of open job descriptions. These read like a wish list of all the extraordinary attributes in applying candidate needs to qualify for the job. All these open jobs cut sheets are designed to attract "Division I" applicants. In some cases, the company is even willing to pay D1 wages to land their superstar new employee. Far too often, companies are ignoring the D2 players already within the ranks. Those competent employees are overlooked because the company wage containment system keeps them mostly on the bench. Most people perform to the level of their compensation. Thus, a company wage ecosystem designed to slow grow wages is also designed to slow growth employees’ perceived competencies.

So, what would happen if companies paid employees what they are worth? More specifically, what if companies paid employees wages equal to what the position is worth? Over my career, I have witnessed more times than I can count, existing employees being elevated to higher positions because of an opening but not paid the typical wage of that position, the wage and outside recruit would be offered for that same position. The reason for that wage discrepancy is because company policy does not allow for an internal employee's wage to jump that fast. In most of the scenarios, the employee that was elevated to the new position but not receiving new position level wages, underperforms. As management, this underperformance is validation that existing employees are not competent enough for advancement, thus justifying higher recruitment expenses for bringing in new talent.

But the reality is, workers rarely rise above their compensation. If the company is going to elevate a player from their bench to a new level up role, they must also pay that employee the going wage for that position despite company policies that forbid rapid wage acceleration.

Wages paid, just like every other business expense, are not costs but investments, investments intended to make profits. Investing in workers, especially investing in reasons for workers to continue to advance their careers within the company will only enhance future profits. If companies focused half of their recruitment expenses on simply better compensation for their existing employees, their investment would pay higher future dividends. Paying employees their worth versus what they will accept is the first place to start. I highly encourage businesses to start making this notion part of their business culture.