Compensation Management the Minimum Wage

Compensation Management

The minimum wage should not be increased, for several reasons. These include the increased flexibility that a lower minimum wage gives to employers, the economic impacts of lower minimum wages, the reasoning that the minimum wage is ineffective at defending against poverty and the fact that states often set their own minimum wages. This paper will outline these different arguments in making the case against a rise in the minimum wage.

For businesses, a minimum wage is a constraint. With a lower minimum wage, businesses have greater flexibility in a number of areas. The first of these is the ability to adjust wages to local conditions. A human resources department can set wages in line with local costs. This may lead the firm to locate in low-cost areas, increasing competitiveness of the firm. With a national minimum wage, the ability and willingness of firms to move around the country to maintain competitive advantage is restricted, making firms vulnerable to foreign competition.

From a human resources perspective, wages are one element of the compensation package that can help to attract specific types of workers. Michael Porter tells us that the ability of a firm to succeed is dependent on the ability of a firm to adopt its chosen business strategy. A firm that intends to compete on the basis of cost leadership, for example, may have very simple labor needs and therefore seek to find the cheapest possible source of this labor. The minimum wage makes it more difficult to bring this investment to the United States, as the firm would face diminished competitiveness as the result of wages higher than the natural equilibrium level. If the firm is adopting a different strategy, it can pay higher than the minimum wage to attract better employees. The higher the minimum wage, the less flexible a firm faced with a global competitive environment can be with respect to using higher wages as a recruitment tool. It is worth remembering that so some extent, prices are dictated by the supply and demand dynamics of the market, not the firm's cost structure. The firm may have some pricing control, the impact of which will be discussed shortly, but for firms in industries where the market sets the price, a higher minimum wage directly reduces the ability to control costs and remain competitive.

The economic impacts of the minimum wage are negligible at best, negative at worst. Proponents of higher minimum wages argue that they raise the living standards among the poor. Yet companies faced with higher cost structures will seek to maintain their profit margins, which means increased prices. The inflation sparked by an increase to the minimum wage will mean that real wage gains are minimal. From the company's perspective, these cost increases also make the firm less competitive against foreign competition not subject to the same cost increases. If firms are less competitive, they will ultimately be forced to reduce the size of their workforces, so the minimum wage will cost the economy jobs (Saxton, 1996). Some would argue that the jobs lost were not good jobs anyway (Landsburg, 2004), but this argument disguises the fact that job losses are a symptom of a decline in the nation's economic performance.

Political decisions are not always made strictly on economic criteria, as governments seek to achieve social goals in addition to economic ones. The case made for a higher minimum wage is that it reduces poverty. Yet, higher minimum wages are ineffective at fighting poverty for a number of reasons. The first was mentioned above -- firms adjust prices for cost increases, causing inflation that negates the wage increase, such that the real wage remains flat even after a rise in the minimum wage. In addition, the purpose of the minimum wage is not to provide a long-term comfortable standard of living, but to provide a minimal standard of living for workers in transition. Workers on minimum wage are not intended to stay there, but to move forward into better positions over time. The key to alleviating poverty is to increase the number of good jobs available and to provide the education and training needed to put Americans in those jobs, not to artificially interfere with market wages at the low end.

Indeed, the minimum wage is a relatively punitive means of transferring wealth. It targets the owners of businesses that employ a higher percentage of minimum wage workers for direct wealth transfer to those workers. This wealth transfer does not hold over the long run as a result of the inflation in induces, and this wealth transfer is not spread over the broader section of the public. Other poor -- both working and not -- are not affected, neither are other business owners. While there is an ethical case to be made for the transfer of wealth to the poor, the minimum wage is an inefficient means by which to accomplish this task (Landsburg, 2004).

Combining the business argument for greater flexibility with the political concept of states' rights, it is also worth noting that individual states are free to set their own minimum wages. States are in competition with each other, as well as with foreign jurisdictions, for investment capital and jobs. Different states can have vastly different resource sets and different views on how they wish their societies to use. States' rights advocates have reason to be wary of a one-size-fits-all approach from the federal government -- what may be good for Oregon may not make any sense in Oklahoma. Just as the imposition of a minimum wage makes it difficult for firms to invest as they see fit, it also makes it difficult for states to compete.

The minimum wage is a contentious issue, because it often is viewed as a conflict between economic interests and human interests. Yet, the minimum wage is a poor means by which to enforce a social agenda. From a compensation manager's perspective, the minimum wage reduces the effectiveness of wages as a competitive tool, either in the ability to minimize costs or in the ability to offer higher wages to attract better people. There is no business case for a higher minimum wage, and there is little political case either, save for perhaps winning votes from the handful of career minimum-wage earners who will directly benefit from this inefficient form of wealth transfer.

2. Reducing expat costs can be done by attacking the largest sources of expat costs. These most significant costs are assignment allowances, which can be up to 35% of costs, property costs (35%) and relocation costs (15%) (Friedman, 2010). These costs are impacted by a number of different factors including the number of expats, the nations to whom the expats are sent, the package offered, using deductibles and changing the relocation agent. This paper will outline some of these strategies in terms of how they work to reduce total expat costs.

The first solution is the simplest and most obvious -- reduce the number of expats. On the surface, this seems difficult because the firm's business interests drive the number of expats it has and the number of placements it has. However, not all placements require expats and in many cases the number of expats in a placement can be reduced. Some nations will be more able to supply local talent than others, so this evaluation should be undertaken by the company to ensure that no superfluous expats are utilized.

Another strategy is to ensure that there is competition for expat slots. If a candidate knows or believes that he/she is the only viable candidate, he/she will have a stronger negotiating position and be able to improve his/her package. The human resources department should focus on building a strong pool of candidates in order to reduce this cost. With more candidates, the company is in a stronger position with respect to negotiating the expat package.

Expats with families come home early more often than expats that do not have families, primarily because of family influence. Therefore, a human resources department committed to reducing expat costs should consider focusing expat recruitment efforts on employees without families. Another factor affecting early returns is local language skills (Selmer, 1995). By identifying the factors that lead to early returns and taking steps to mitigating them, companies can reduce the costs associated with expat programs. This often means providing support to spouses and families. While it is typical that the employee receives significant work support, the family often does not. As a result, many assignments fail because of pressure from dissatisfied spouses or children. The company needs to be attentive to the needs of the total family, especially in more challenging nations, or simply select expats that do not have families (where it is possible to do so without compromising the assignment).

It is also worth examining the countries to which expats are sent. Many nations have stronger workforces that may be immediately obvious. Increased local hiring can reduce the need for expats, as can improvements in local training programs. By bringing more locals into the overseas operation, the use of expats can be reduced. In addition, the cost of expats should be factored into the decision to enter a market. Major markets will still be profitable even with the presence of expats, but there are many marginal markets that may not be viable once expat costs are included (for example, where Malaysia may be profitable, adjacent Brunei may not be).

The human resources department can also reduce the value of the package offered to expats. If assignment allowances and property costs are 70% of the expat costs, then these costs should be the focus of efforts to reduce total expat costs. For example, one solution is to introduce funding at a blanket level, and then allow the expat to determine how those funds should be dispersed. This strategy fixes the amount of money that is spent on the assignment, rather than have the costs subject to market fluctuations. For example, the price of a trip home can vary significantly depending on when and how the trip is booked. An employee with a finite budget will choose the lowest price option, whereas one with an undefined budget may choose a more expensive option.

Housing costs in particular can be controlled through the use of a fixed total budget (Friedman, 2010). The housing needs of different expats will vary. Any given expat may prefer to have the choice between luxury accommodations with few trips or spartan accommodations with many trips. The expat should appreciate having the choice while the company benefits from having greater cost certainty.

Another financial means of saving money on expat is through the use of deductibles (Friedman, 2010). Deductibles account for the fact that the employee saves money in some areas. For example, if a long-term assignment allows the employee to rent his/her domestic residence, this can be deducted from the housing allowance paid by the company. Other deductibles can be made for education, maid service, medical costs and other areas where the assignment may deliver savings. Similar to deductibles is gain-sharing. In a system where the employee has a set housing allowance, but gets to keep half of what is not spent, the incentive is to take more modest accommodation. The result in a win-win situation where housing costs to the company are lowered and the employee receives extra cash after choosing acceptable accommodations (Friedman, 2010).

Given that housing costs are one of the most important costs associated with expats, the company should consider evaluating the different housing options. Typically, the shorter term the rental, the more expensive it will be, with hotels being the most expensive. Lowering expat housing costs can be accomplished through the use of rentals that are well-matched to the length of the assignment. Hotels are unnecessary, for example, for any assignment over one week in most parts of the world. Short-term rental rents should not be paid for assignments over a few months in length. A human resources department can save a significant amount of money if it takes the time to investigate the local housing market. Indeed, the use of a flat benefit that the employee is free to spend as he/she sees fit will typically result in a better study of the housing market and lower housing costs for the employee.

Relocation costs can be upwards of 15% of total expat costs. As mentioned above, one way to reduce relocation costs is to relocate less often, by keeping expats satisfied. Beyond this, the actual cost of performing a relocation can also be reduced. Last minute shipping is always more expensive, and therefore should be avoided. Better planning of expat moves can reduce shipping costs dramatically. In addition, furniture should be rented locally rather than shipped, to reduce total shipping costs considerably in both directions. For popular assignment regions, shipments can be shared among expats in order to reduce total shipping costs by shipping full loads. Volume limits can be utilized to reduce shipping costs. The limit can be strictly enforced or can be the result of incentives such as deals on storage that compel employees to leave more at home (Friedman, 2010).

It is also worth considering that the human resource department should reduce its own infrastructure for dealing with expat assignments. Part of this can be accomplished through streamlining the expat cost process. For example, the use of multiple cost centers is likely to increase total costs, so the cost center structure should be simplified (Friedman, 2010). Having a simplified formula for calculating expat costs will also reduce the total administrative costs associated with expat management (Friedman, 2010).

Allowances being one of the major expenses, the company's understanding of cost structures in the nations in which it operates should be kept current. In China, for example, the cost of food is much lower than in the West, but at the same quality. Transportation costs in gulf countries with subsidized gasoline or in nations with strong public transport systems (Singapore, Hong Kong) can be much lower than at home. Firms based in expensive cities such as New York, San Francisco or London may find that housing costs are much lower abroad. Currency fluctuations can dramatically affect cost structures. There should be some attempt on the part of the human resources department to understand the changes to the cost structures of overseas assignments over time and make adjustments to allowances accordingly.

Expat assignments are expensive, especially given that they often result in failure. It is the role of human resources departments to minimize the costs associated with expat assignments, as these costs can impact the overall profitability of the project. There are a number of different sources of costs, and the company seeking to minimize these costs should focus its efforts on the most significant costs first. These include costs associated with allowances, housing and relocation. Other costs can be targeted, but the impact will be less effective.

Most of the best ways to reduce expat costs are structural in nature. The manner in which costs are calculated, in which money is allocated and in which costs are controlled by the company all have an impact on the bottom line with respect to expat assignments. The more that costs are streamlined with respect to assignments, the lower the costs will be. In addition, if the employee is given a strict allowance to spend as he/she sees fit, the company can control costs. There are also ways that incentives can be built in to the expat compensation system that can create incentives for the employee to minimize costs. With some creativity, a human resources department can alter the firm's cost structure with respect to expat assignments, lowering costs associated with expat assignments in the process.

3. I agree that merit pay grids do have the potential to undermine employee motivation. The merit pay grid is designed to encourage greater levels of efficiency and effectiveness from employees, with merit increases tied to reaching specific performance objectives. However, there are many pitfalls that can result in merit pay undermining employee motivation.

The first pitfall is that many employers only reward extreme performance. This leaves the vast majority of employees unable to hit the targets required for merit increases. For merit pay to succeed, the targets must be achievable. When an employee is faced with an unachievable target, this removes all extrinsic motivation for the employee. It also sends a message to the employee that his or her best will never be good enough, removing most if not all of the intrinsic motivation from the employee as well. This pitfall can be alleviated with better goal-setting on the part of the management. When all workers are treated as average by the compensation system, they will only strive for average results (Zenger, 1992).

Another pitfall, which can manifest in reduced motivation, is that the merit structure does not recognize the constraints faced by the employees. Employees may be willing and under ideal conditions able to perform at a merit-triggering level, but when faced with limited resources, poor training, or ineffective team members, they may be unable to achieve their potential. The employee's motivation will be undermined specifically because the employee will feel undermined. Employees must be given the tools required to achieve their potential if they are to be motivated by merit increases on a merit scale set at the high end of their potential.

A merit system in and of itself is insufficient to improve employee motivation. The nature and structure of the system is of critical concern for compensation managers. Merit-based systems, to be effective, must include achievable goals, and even then will only work if the employees are given the tools they need to succeed. If not, motivation can actually decrease as the result of the merit-based system.

4. Employers are faced with rapidly escalating health care costs and their ability to control these costs is central to their ability to maintain competitiveness in a global business environment. In order to control these costs, employers must first understand the nature of these costs. The most obvious solutions -- to not offer health care -- is a non-starter, since almost every company over 200 people offers health care benefits (Christianson & Trude, 2003). No company can attract good employees without offering health care. So the issue must be addressed in different ways. This paper will examine some of the ways in which companies can control their health care costs.

The first issue is largely structural in nature, and revolves around the employer-employee relationship. Employers believe that one of the keys to containing health care costs is in to change employee health care usage patterns -- in other words to reduce demand created by employees for health care that is paid for by the employers. One of the major obstacles to changing usage patterns is that employees typically feel that they are "effective healthcare consumers" and that addressing the issue of rising health care costs is the responsibility of the company (Davis, 2003).

In order for employers to address this gap in understanding, they must increase and improve their communications with employees. One way in which this would manifest is for employers to provide more information to employees that will make them better health care consumers (Davis, 2003). Employees are genuinely doing well with the information they have -- they simply do not have enough current information with which to work. There are also gaps in willingness to absorb information. For example, younger employees are less likely to improve their health care consumption patterns because they are less inclined to consider health care issues entirely. Older or ill workers are more likely to be educated on health care consumption issues and are therefore more receptive to further communication on the subject. Programs to better educate employees will over the long run allow the employees to make better decisions, lowering the overall demand for health care services, and even lowering the cost of services provided, for example through the use of generic drugs rather than brand names.

Improved consumer education can also be part of a broader strategy to bring the company into a more consumer-oriented approach to health care. The consumer-oriented approach involves introducing market incentives to health care. This typically requires a move beyond managed health care plans. For example, the company can allow the consumer a budget with which to receive a procedure or medication, and allow the consumer to shop around, perhaps keeping 50% of the difference between the price they find and the allowance. This allowance can be delivered to the consumer in the form of a health spending account (HSA) or a health reimbursement account (HRA). This type of system moves the employer away from a fixed health care benefit to one that is more driven by competitive market principles. These systems also compel the consumer to increase his/her level of health care consumption knowledge, as this will help him/her to reduce his/her spending level. HSAa and HRAs can be offered in conjunction with a modified insurance plan that covers more extreme circumstances. Such a plan can be low-premium and high-deductible in nature (Zirkelbach, 2007).

Beyond this, employers also have a few other options, many of which relate to improving the state of their employees' health. Chronic illnesses drive up drug costs, as do unfit employees with poor health habits. There are many negative outcomes for companies of having unfit and unhealthy employees, most relating to major long-term illnesses that could have been prevented and the attendant drug, treatment and surgery costs. Wellness programs are typically multi-faceted. They often include an education component, where the employees learn about ways to help stay fit. A dietary component is often critical, as many employees do not eat well. In addition, many employers either offer fitness facilities on-site or they offer discounted fitness club memberships to their employees in order to encourage greater fitness. Despite the effectiveness of wellness programs, few employers offer them -- just 10% of employers nationwide in 2008 (Atlanta Business Chronicle, 2008).

What the move towards consumer-drive health care represents is a more efficient way to deliver health care services to employees. Health care plans are a key recruiting and retention tool, especially given the reality that employees view rapidly rising health care costs as a threat to their financial well-being (Christianson & Trude, 2003). It is important, therefore, that employers reduce health care costs in ways that do not materially impact on employees' own ability to manage these costs. Increasing education and market incentives are key elements to this strategy, since much of the increase in health care spending in recent years owes to a low level of health care consumer knowledge on the part of employees and the overreliance on managed health care plans on the part of employees.

The other side of the equation is prevention, which is where wellness programs become useful. America is facing an obesity epidemic and an aging population. While the latter cannot be addressed directly by employers, the former can. Employers can arm their employees not only with knowledge about health care decisions after illness strikes, but before, so that fewer trips to the hospital are required, fewer drugs are required and so that employees can take their health into their own hands. By doing this, employers will be able to offer the same level of comprehensive health care while being better equipped to manage the costs associated with providing that care.

5. Introduction

Merit pay and seniority-based pay are two different systems of employee compensation. Each system has advantages and disadvantages, and as a result the ideal system should be determined within the context of both the organization's objectives and the position itself. As such, the question of whether or not the employer is getting the desired value from the programs is case-specific and not subject to blanket judgment. A more intelligent approach to the issue is to analyze the ways in which the two systems match up to specific corporate objectives. Once these matches are understood, employers can have a better sense of which type of compensation system is more appropriate for their company.

Seniority-Based Pay

To most people today, seniority-based pay probably seems anachronistic, such is the influence of merit-based pay on modern compensation systems. Seniority-based pay was in vogue for much of the 20th century. It is a simple system, where one's tenure with the company dictates their pay scale and the raises that he or she receives. From an economic perspective, seniority-based pay creates only one primary economic incentive -- to increase one's tenure with the company. Thus, seniority-based pay engenders loyalty on the part of employees, and creates disincentive for employees to seek work elsewhere. Bayo-Moriones et al. (2004) showed that companies that utilize seniority-based pay are "more likely to engage in other human resources management policies that result in long employment relationships." Thus, firms that remain tied to this old compensation believe that they have valid reasons for doing so, and make seniority-based pay a core element of their total HR system. These companies also are less likely to offer explicit performance incentives and are less likely to monitor performance (Ibid).

The first question worth asking is whether or not these firms stick by this view simply because they are using dated human resources management policies or whether the incentives created are the ones that the company desires most. A high level of seniority in a workforce can be expected to have a number of positive outcomes. Workforces with a long average tenure tend to have higher productivity, better congruence with organizational values and culture, a shorter learning curve, fewer accidents and higher overall quality (Auer, Berg & Coulibaly, 2005). Of these, higher productivity stands out because of its direct economic benefits to the firm. Higher rates of productivity are related directly to lower production costs and higher profit margins. Higher total quality can be related to the company's reputation, which if sufficiently strong can be a means by which the company can gain sustainable competitive advantage; the name can be leveraged to charge premium prices for the product.

Whether or not these outcomes occur, of course, is dependent on the type of output being generated. Firms producing standard goods and services -- everything from textiles to public transport to hairdressers -- benefit from workers with many years' of experience in producing the same good or service. For some other firms, the nature of the firm's business and the sources of competitive advantage can change over time, meaning that there is no advantage to having a high-tenure workforce. Indeed, depending on the rate and intensity of these changes, a high-tenure workforce may be a detriment. Aspects of a high-tenure workforce that can be positives can also be negatives -- adherence to corporate norms can be a detriment for example when survival of the company depends on creative thinking. Radical changes in production methods could leave a manufacturing company with a highly-paid high-tenure workforce that is greater than it needs, yet cutting that workforce would remove any incentive value associated with seniority pay.

In addition to the incentives created by seniority-based pay, it is worth considering the disincentives that it creates as well. Highly productive younger employees may feel that they are not receiving adequate compensation, so the company may well lose such workers. Other workers may not be sufficiently motivated to be productive -- while their skills and experience may make them inherently productive they lack incentive to maximize their output. Indeed, it could be argued that the retention affects of seniority pay only truly work with the least productive workers. Workers with a high skill level and a high level of intrinsic motivation can increase their pay either by building tenure or by seeking a change of company, no matter what age they are. The only workers who are compelled to remain with the company in order to build their compensation by virtue of increased tenure are specifically those without marketable skills that could gain them a higher compensation package elsewhere. Under such a scenario, compensation-based pay's tenure incentives are ineffective with the best workers and only truly effective with the least productive and least desirable members of the workforce.

Also, seniority-based pay has the macroeconomic effect of reducing flexibility in times of change in an industry (Bejaoui & Montmarquette, 2008). The primary incentive created for workers -- to increase tenure -- can leave a company with a large workforce at a time when it would prefer reducing its workforce. Yet should it choose to cut high-tenure workers to alleviate the situation, other workers will take this as a sign that the company's commitment to high-tenure workers has undergone a radical shift, and they may lose incentive to remain with the company. The company then must undermine its primary compensation system in order to adjust to the market. Under other compensation systems not based on seniority, the company would not be faced with a decision to undermine the heart of its compensation system during times of workforce reduction.

Beyond the incentives it creates, one of the most obvious benefits of seniority-based pay is that it is easy to implement. When only one output is truly measured (tenure), the implementation of the compensation system is easy. Managers need not make decisions -- indeed, the raises can be determined through a pre-set formula or through collective bargaining. The costs associated with the system are low, making it an attractive, simple option, especially for firms whose business may not be understood to benefit significantly from the creation of other incentives.

Merit-Based Pay

Merit-based pay emerged as an alternate form of compensation plan to seniority-based pay in order to address many of the issues of seniority-based pay. Merit-based pay functions in roughly the same manner -- in principle -- as seniority-based pay. It is a system where the employee is rewarded on the basis of the quantity and quality of output. Under seniority-based pay, the only measure that matters is tenure. Under merit-based pay systems, any output can be measured, including tenure if the company so desires. Merit-based systems are at their most effective when the output measures used by the organization in the system are congruent with the outputs that are the drivers of profit at the company. The success of any merit-based system therefore is firm-dependent, based on how well the company understands its key success drivers and the degree to which the merit-based compensation system promotes activities that improve those key success drivers.

This is not to say that merit-based compensations systems are straightforward. Indeed, they can be difficult to design and to administer. Employees may perceive the system as unfair, where co-workers are given different raises even when they have the same job title and responsibilities. Such a system can especially be perceived as unfair by older employees, who grew up in an era when seniority-based systems were the norm and may even have started their career under such a system and see the present day as their payoff for years of working hard for little pay when they were younger. There is also a greater risk of perceived unfairness in merit-based systems when a significant component of the employees' performance evaluation is based on qualitative outputs, which tend to be evaluated at the discretion of the manager (Heneman & Werner, 2005). There are a number of pitfalls inherent in a merit-based system that HR managers should be aware of and account for. Indeed, a merit-based pay system may not even properly address some of the issues inherent in seniority-driven systems. Eskew (2009) showed that merit pay can be scarce during difficult economic times yet executives receiving merit pay have come to see it almost as an entitlement. This means that merit pay is not that much more effective at helping firms moderate the impacts of the business cycle than is seniority-based pay.

A prime example of a poorly-designed merit-based pay system comes in discussions of executive pay. Executive compensation is a relevant way to articulate some of the issues associated with merit pay because so-called "exempt" employees are the most common recipients of merit-based pay (Petty, 2002). The theory behind executive bonuses is that if the bonuses are tied to firm performance, the executive will be oriented towards improving the firm's performance. There are a number of flaws in this system that are not immediately evident. For one, such a system is not properly oriented in terms of time frame. The executive may receive cash, shares or options, but in all cases the incentive created is short-term in nature. The executive is oriented to generating short-term results to receive the bonus, but the firm's business cycle may be longer-term in nature. Quarterly and annual results may be relatively important when compared with long-term growth. Incentives that encourage a short-term orientation will by their nature encourage greater risk-taking behavior, the executive knowing the significant short-term gains will be made. So the first lesson with respect to building a strong merit-based pay system is to ensure that the incentives created are temporally congruent with the firm's objectives.

That executives may engage in a greater amount of risk-taking behavior as a result of their merit-based system highlights the ways in which a merit-based system impacts employee behavior. Each incentive created will impact on employee behavior in some way. Merit-based systems often falter when they created unintended incentives or when the company fails to anticipate some of the incentives they create. A simple example would be a system that pays employees per piece of output, without placing any restrictions of the quality of the output. The result would be a higher level of unit outputs, but also a higher level of defects. When cost savings are incentived strongly, it is reasonable to expect that customer service levels may decline, which could be counter to the company's objectives.