Why It Pays to Pay Employees More

(Photo: Peter)

We blogged a while back about how some retail firms succeed by hiring more, not fewer, floor employees, and by treating them particularly well. Among the examples: Trader Joe’s and Whole Foods; among the counterexamples: Michael’s.

This prompted an e-mail from Hal Varian, Google’s chief economist. (If you don’t know of Hal you should, as he’s an impressive and fascinating guy — check out the Q&A he did here a few years back.) His e-mail reads:

Saw your piece about Trader Joe’s et al.  Here’s one reason to pay people more than their market wage (from my textbook):

Gabor Varszegi has made millions by providing high-quality service in his photo developing shops in Budapest. (See Steven Greenhouse, “A New Formula in Hungary: Speed Service and Grow Rich,” New York Times, June 5, 1990, A1.)

Varszegi says that he got his start as a businessman in the mid-sixties by playing bass guitar and managing a rock group. “Back then,” he says, “the only private businessmen in Eastern Europe were rock musicians.” He introduced one-hour film developing to Hungary in 1985; the next best alternative to his one-hour developing shops was the state-run agency that took one month.

Varszegi follows two rules in labor relations: he never hires anyone who worked under Communism, and he pays his workers four times the market wage.  This makes perfect sense in light of the above remarks about monitoring costs: there are very few employees per store and monitoring their behavior is very costly.  If there were only a small penalty to being fired, there would be great temptation to slack off. By paying the workers much more than they could get elsewhere, Varszegi makes it very costly for them to be fired — and reduces his monitoring costs significantly.

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  1. jonathan says:

    Costco pays its people more and offers better benefits. Wegmans has more people and pays better. Market Basket (a NE chain) also has floors crowded with employees. These are highly profitable companies.

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  2. Mike B says:

    Paying employees the lowest price the market will bare and not offering benefits that keep them attached to the organization (ie pensions or career tracks with wage and responsibility increases) has accelerated the proliferation of both the disposable worker and the disposable job. This isn’t your grandfather’s disposable worker where some evil boss uses up the worker’s mental and physical health before discarding them to be replaced by some new worker who has no other choice. Instead the relationship is mutual. Employers don’t care about the employees and employees don’t care about the job. A disposable job is where compensation is so low and the long term prospects so absent that its barely worth the employees time to bother even showing up. The real loser actually turns out to be the consumer who, in their effort to minimize costs, winds up with exactly the service they are paying for, ie bad.

    Employers who go after disposable employees aren’t necessarily being stupid. If training and replacement costs are low (which they certainly are in this economy) churning through a long string of employees isn’t going to erode the bottom line. However, if so much additional success can be had with the higher cost, non-disposable model, why do so few employers embrace it? First of all it requires more management skill. With disposable employees the solution to every problem is to fire the worker and get a new one. With employees that represent an involvement you suddenly have to manage them to protect that investment and get the highest return from it. Second, disposable employees represent less risk to managers living in a Cover Your Ass environment. If they hire a bad apple, under the disposable model they’re out the door and the cost is minimal. Under the higher value model not only will the employee have been invested in to a greater extent in terms of training, but also have taken home 4 times the pay.

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  3. J1 says:

    If the competition really took a month to do the same job, any service at all would have made him rich. Does this example really support your point?

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  4. Speed says:

    Are these people paid more than the market wage or are they paid the market wage for superior workers?

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    • Erik Dallas says:

      The ultimate case of superior wages is the CEO job, however this seems to be the nepotism of good old boy network and not the use the fear of firing to invoke superior more dedicated performance.
      For everyone else and their real earth bound job structure where lack of performance has real consequences: this is the age old problem of Paying for superior quality service or cutting cost to produce the cheapest possible disposable low quality product/service. If you pay nothing and don’t like what you got you can always sample another source to see if another cheap product is any more desirable. What gets interesting is when superior wages invoke superior volume or increase client / customer base such that superior wages incent higher return on investment – i.e. it increases output profit per wage dollar. As noted by others skilled jobs, jobs with a lot of specific job training, or client service jobs where relationship matter, are probably more likely to invoke high replacement cost and thus warrant above market pay as a retention and performance method.

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  5. Julie says:

    Same goes for In-N-Out Burgers. For fastfood, they pay very well and offer benefits. Their restaurants are always very clean and their employees really friendly :)

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  6. Jessica Epp says:

    Does the opposite hold true? Does this mean that in environments where it is extremely difficult to fire employees (unions, situations where you have to prove just cause, etc.) there are few rational reasons to pay an above market wage?
    I imagine that in Hungary in the 80’s there would be little to no liability risk in firing an employee. The more difficult it becomes to get rid of an unsatisfactory employee, the less this strategy would seem to work.

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    • Fitty Stim says:

      @Jessica Epp: There was no such thing as firing an employee in Hungary (or anywhere in Eastern/Central Europe) in the 80’s. We’re talking the pinnacle of Rambo Communism here.

      Factory workers making vases, trucks loading said vases and driving them to another factory that crushes the ceramic vases into powder, workers loading powder into bags and loading them onto a truck to take to the vase making factory.

      But at least the trains ran on time…

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  7. Dill says:

    A mentor of mine always used to tout: “If you pay’em peanuts, you’ll get monkeys”

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  8. Travis says:

    This seems kind of obvious to me. You get a dual benefit from paying more: Employees have increased risk of losing a job, but also you get your “pick of the litter” so to speak which presumably means more competent and higher performing employees.

    Customer service tends to be a big factor in patronage.

    When I was younger I had a friend who worked at a support center, where call in to fix a problem with some hardware or software or computer they just bought. His description of the place was great, it sounded like a great place to work and people actually wanted to work there. He worked there for a few years before starting his own landscaping company. They handled support for some companies that had a reputation which hinged on the support provided. A few years later (about 8) I was hard up for a job and saw they were hiring. It had completely changed.

    The place had an average employee retention of something like 2 months. I worked there for 3 months before I was completely spent by the job, and when I quit there was literally only 9 or 10 other people who were hired at the same time I was. I started in a pool of over 30 people in training, and training wasn’t cheap. At least I assume it wasn’t, because we got paid and it was a week long.

    I don’t know if they changed because they were facing increasing competition with centers in India (which this company had some recently opened there) or if it was some other motivation. But the change was for the worse, and the products they supported no longer had a reputation for great support. And the most ironic thing, they had this huge presentation about how we were supposed to bend over backwards for the customer, yet the company wasn’t even willing to go half as far for the employees.

    This, to me, seems to all stem from the modern corporate culture of the short term profits over long term business cultivation. Cutting workforce, QA and employee benefits is great for the next few quarters’ reports, but the long term effect often seems disregarded.

    It would be great to see a study of long term performance (2 to 5 years) of several companies following sharp layoffs and employee benefit cuts.

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