A Cheap Employee Is … a Cheap Employee (Ep. 79)

(Photo: Alan Cleaver)

Our latest Freakonomics Radio on Marketplace podcast is called “A Cheap Employee Is … a Cheap Employee.”

(You can download/subscribe at iTunes, get the RSS feed, listen via the media player above, or read the transcript here.)

It’s about the question of whether low-paid employees are indeed a good deal for a retailer’s bottom line as the conventional wisdom states.

The piece begins with a couple of stories from blog readers, Eric M. Jones and Jamie Crouthamel, which were solicited earlier here. (One of the true pleasures of operating this blog is having a channel by which to turn readers into radio guests — thanks!)

We then hear from Zeynep Ton, who teaches management at MIT’s Sloan School. Ton did a study (related blog post here) which looked at successful low-cost retailers including Costco, Trader Joe’s and the QuikTrip convenience stores. She found that while these companies spent more on labor than their competitors – higher wages and more training – they were in fact more profitable:

“When a retailer doesn’t invest in his people then execution at the stores suffers.  You often find products in the wrong locations, sometimes in the back rooms as opposed to the selling floor. promotions not carried out on time, or at all, or mistakes at the checkout. So these operational problems — what was surprising to me was how frequent these problems and how expensive these problems were.”

We also touch on another retailing study which found that customers don’t really care about all those in-your-face niceties that some retailers seem to think are important. As co-author Nicholas Toman tells us:

“It was not the pleases, the thank yous, the flowery language … that didn’t matter so much. Making things simply easier for customers, getting a question answered, returning an item, making the burden as low as we can on the customer results in the greatest initial economic benefit for the company itself.”

In the podcast, you’ll also hear Kai Ryssdal deal with some pretty bad Freakonomics Radio customer service.

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So it sounds like paying more makes it possible to attract and retain good workers (obvious enough), but simply paying more won't turn a mediocre employee into a good one. Your goal, therefore, must be to have the good employee work for you and the weak employee work for your direct competitor. That suggests that you don't actually need to pay "well", so long as it's just enough more than your competitor's that the job applicants notice.


This logic only works on a few assumptions. First, that you have an essential service with no easy substitutes. Might work for say, a grocer or a cable company, but probably wouldn't work for a clothing retailer or jeweler. If people can just stop buying your product altogether, then the relative quality between you and your competitor will be less important. If both you and your competitor provide poor service, people can just skip both, making both companies suffer.

The other assumption is that simply paying slightly more will be enough to attract more skilled / attentive employees. If you aren't in a particularly skilled labor market, it doesn't really matter if you pay more than your competitor. For example, if you are a grocer that pays 10% more than your competing grocer, your employees can still leave you to work at a clothing retailer. In the labor market, your "direct" competitor becomes everyone who employs the same skill level of labor.


Joe Dokes


You're right an employee might leave and go work for another retailer that requires similar skills but in a different industry and higher wages.

But June is largely correct. For example, In-n-Out Burger (West Coast Burger Chain) pays nearly two dollars an hour above minimum wage. Jobs are highly coveted by high school students for their higher pay and the "cool factor" lacking at say McDonalds. As a result the service is excellent, the stores are clean, and the food is good, (Debate: In-n-Out Burger vs. Five Guys, discuss) some argue they have the best fast food burger. In-n-Out is able to demand the best teenagers because they offer the best wages.

That being said, the workers at In-n-Out being largely teens, means they eventually leave the job. Is it for higher wages in other retail establishment? Perhaps? It could also be that the skills they acquire like a good work ethic and customer service oriented attitude that make them attractive employees for a number of firms besides retail.

Thus, In-n-Out is building human capital and harvesting the reward. Although privately held it is arguably highly profitable in spite, though quite clearly, as a result of paying a 20% premium for its workers.

Finally consider this, would you rather higher a twenty-year-old with two years of experience at Walmart or In-n-Out Burger?


Joe Dokes


Joe Dokes

They needed a study to show this?

The irony is that today's American corporate structure is focussed on driving down employee wages and benefits while disinvesting in employee training and then the same companies are surprised by the poor skills and low morale of their employees.

All segments of society need to take ownership of human capital, and human development.


Joe Dokes


Well this is a microeconomics theory called "No Shirking constraint" and talks about a wage equilibrium called efficiency wage. Example (from an economics text book) In 1913 turnover at Ford was 380% only to reach 1000% the next year. In 1914 Henry Ford increased the wages to $5 a day (the industry average was between $2 and 3). Productivity increased by 51% and profitability rose 100% in 2 years...


Again, long term stability is always sacrificed for short term profits in this quarterly reporting driven marketplace.

Haven't there been recent studies done regarding the current employment crisis, there are plenty of jobs "out there" but people are simply not willing to do the types of labor / work or relocate for the pay and instability being offered by the company.

But it seems like the fact that unemployment is so high makes companies feel justified in offering minimal wages, while on the other hand potential employees don't think of the general labor market as what their skills are worth, they think of one thing primarily: their former job. People are notoriously unwilling to accept employment for significantly less than their former position. (I believe there is a chapter about this in Thinking, Fast and Slow). Combine that with the availability of unemployment insurance, and you end up with the current mess we're in now. Underemployment on the human capital side, and suffering companies due to lack of quality employees.



If that is true, how is WallMart so profitable? WallMart plays much less than Costco but still very profitable. Or is it possible that WallMart profitability isn't 'real' profitability, but profitability b/c WallMart has such low labor cost. That is, WallMart profitability comes from cut costing and not from the retailing side of WallMart. Just curious!


Not all truths are universal - there are always other ways to succeed. While they have changed some practices in recent years, Wal-Mart has traditionally thrived on being the absolute cheapest place to buy things. So, customers don't expect good service or a clean store or anything else, just low prices.

Additionally, I believe Wal-Mart is at the cutting edge of eliminating employees from the retail process. Almost everything is automated. I haven't shopped at Wal-Mart in a while, but I certainly don't remember having much interaction with employees beyond the checkout counter.


Does this only apply to businesses? Many public services jobs pay well, have good benefits, and are secure--yet how many people find that DMVs offer good service? I remember commuting on BART where wages were very good (and they were always threatening to strike for even better pay) and the service was abysmal.


This kind of thing makes me nervous that people will hear it and use it as a reason to claim that all companies should pay their workers more, and all service everywhere will be better. Instead of the more nuanced idea that companies that offer higher wages will have more people wanting to work there, so can select higher quality workers.

It's important to emphasize that paying a bad/unproductive worker more than they merit won't turn them into a more a productive worker.

Christoph Micklon

At the end of this particular show it asked listeners to vote for Freakonomics Radio podcast on the iTunes Facebook page. I spent go good half hour trying to find where to vote.

Any way of providing a link so I can vote?

Rishi B

Banana Republic, at the least two I've worked at Metro Detroit, could learn a lesson from this. The Sommerset Mall location allows workers to take a 15 minute break on top of their lunch break, they pay a different company to clean the bathrooms, and they take employees out for drinks after work. Almost everyone I used to work with there is still there a year later. The Partridge Creek mall location does none of those things and no one I used to work with there is still there, minus the general manager.


It is fashionable these days for high paid business consultants to sing the virtues of the many employee incentives that are allegedly way more important than pay.

To that end I laughably respond:

"Brains Cost Money, How Smart Do You Want Me To Be?"


I think demographic relationships affect this data.

An upper-class neighborhood's mall probably has more transactions and bigger transactions. So it seems like companies could offer more money to employees.

A lower-class neighborhood's mall would have the opposite situation. You'd only be able to afford cheaper labor.

Maybe I'm wrong?