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. Jeff Yablon says:

    Stephen, this is one of those amazing “think different” issues that we can debate forever. For the record, I’m on the “pro” side.

    I’ll try to give you my experience without going on for too long, or giving away any secrets.

    PC-VIP (http://pc-vip.com), our fixed-cost business computer support service for the SMB space, was conceived from day one with exactly this thought in mind. We hire (contractors, but the point is the same regardless) technicians at a rate that’s about 2.5 times what the typical independent computer geek makes.

    Those folks are loyal. We don’t lose them to competitors, and they don’t try to steal the clients we assign them to. ‘Nuff said.

    This idea is very much like the becoming-more-common “unlimited vacation” policies that companies are starting to adopt. Old-school thinkers will believe that this is a recipe for the benefits payer to be abused. Smart business people will see the truth; people with unlimited vacataion work to get their jobs done, not to satisfy a clock, AND (sad but true) tend to take less vacation in protection of their jobs. Oh, and there’s no legal/financial issue over unused vacation time.

    My company does outsourcing and various types of management consulting, and I can tell you from many years of experience that good management of issues like this are where business change and growth come from. It’s nice to see you talking about it out loud.

    Jeff Yablon
    President & CEO
    Virtual VIP Group.

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  2. KendellD says:

    I have seen this strategy in action, sort of. I worked for a major railroad and the pay was fantastic(like it said, make it costly for an employee to get fired or leave) but at a certain point if the management within the company is so terrible it becomes worth the penalty to get a different job. Poor management of employees can become such a drain on morale that you don’t even want to go to your very good paying job. I had the misfortune of working for one such manager, and the only way he could make it look(to his superiors) like he was competent was to dicipline employees for actions that were in fact minor. The only effect that this had on our shift was to make us hurry to get our work done so you could be somewhere else when he came in the morning. After 5 years of putting up with this guy it wasnt worth it any more.

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  3. mfw13 says:

    Three points:

    1) well-paid employees are usually happy and productive employees
    2) good word-of-mouth from satisfied customers is the best advertising
    3) businesses which view customer service as a cost, rather than an opportunity, are generally not long for this world

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  4. Bill Ogorodny says:

    This is a great article. I worked in retai management for organiztions that did not pay their sales help more than minimum wage. These employees did not care if they were fired because they could find other jobs that would pay the same. By paying the employees a decent wage an organization will reduce turnover. So much money is spent hiring new employees and training them

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  5. cjc says:

    This is an example of the “efficiency wage” concept (http://en.wikipedia.org/wiki/Efficiency_wage) mixed in with some Coasian theory-of-the-firm ideas.

    I wonder if more pervasive unemployment insurance undermines this notion.

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  6. Frank Pizza says:

    This letter does not prove the point really. A service several hundreds of times faster is going to be popular! Paying the staff well was probably more about the responsibility level being higher in managing such a new business and the need to attract highly capable and business-savy people to work there.

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  7. Fitty Stim says:

    Hidden due to low comment rating. Click here to see.

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  8. Ryan says:

    LIke a previous person said, i believe that if a business can do well, and make a decent living for the owner the owner should share the wealth with his employees. Yes, i do imagine that you could use the money to expand but in my mind the money you could use to expand could be used to make the places you have better. With that said, no matter how much money you pay your employees they still will leave if you can’t manage well. I believe that it is a mix of the two that lead to a healthy company and happy employees and customers.

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