Self-Selection

It has come up a couple of times recently, and enough times over the years since I got my MBA, that I think it’s worth addressing the issue of why low pay is really such a bad idea – from the company’s point of view. For the employees, of course, the idea of being paid less is understandably bad, but what exactly does the company have to lose? Even granted that morale will suffer if the employees’ first-level (survival) needs are not being met, doesn’t the savings in salary make up for whatever loss in productivity is incurred?

To understand the answer, you need to look at all of the costs associated with low pay, not just the obvious worker dissatisfaction. First, keep in mind that people who feel they are underpaid, particularly if they are underpaid by industry standards, are going to be likely to leave as soon as a higher-paying position becomes available. Therefore, we have all of the costs associated with turnover: recruiting replacements, hiring new personnel, training the new employees, and the loss of productivity incurred while these new people fight their way up the learning curve to become fully proficient in their new jobs.

Second, the employees who are most likely to leave the company are those with the best skills, the most experience, and the greatest initiative – in other words, the best employees present. This is actually harmful for two independent reasons: not only will the company continuously lose its best people, but also those people will migrate to jobs that offer better pay elsewhere in the industry. Not only are you constantly losing your best people, you are effectively providing free recruiting services for your competitors, and increasing their competitive advantage over you.

Third, the remaining personnel (e.g. those who remain working for you despite the low wages) will most likely resent the situation, including both the low pay and the fact that their traitorous former colleagues are being rewarded for leaving the company. Performance WILL suffer as a result – it can not fail to, since you are deliberately equipping your company with the worst available workforce and then motivating them with the worst possible morale. If the company is also skimping on benefits (e.g. poor quality health benefits, no pension or retirement plan) and perks (e.g. low vacation days or vacations cancelled to increase production, no free parking or transportation allowance), or worse yet attempting to make up the loss in productivity at the expense of working conditions (e.g. mandatory unpaid overtime, no air conditioning in the summer, no heat in the winter), the company can expect an additional fall-off in production.

Considering all of these effects, the benefit to the company hardly seems worthwhile. It may be possible to save a few dollars (or a few thousand) on each position each year, but the benefits are unlikely to outweigh the potential hazard. And who’s even mentioned the idea of organized labor, strikes, sabotage, or government regulations yet? Remember, the employees are the tools by which management does the job at hand, and it ALWAYS pays to buy the best tools – and then keep them sharp and well maintained.