How Businesses Can Profit From Raising Compensation At The Bottom

“Attention must be paid,” wrote the great American playwright, Arthur Miller. If only companies did pay attention to workers on the bottom rungs of the organizational ladder – like those on the top rungs — what would happen? As the authors discovered in their research, the company will benefit as much as the employees themselves.

It has long been assumed that companies stand to increase profits by cutting wages and benefits for employees at the bottom of the corporate ladder. While companies use diverse incentives such as high wages, performance rewards, and stock options to recruit, retain and motivate highly skilled professionals, they assume that employees at the bottom of the corporate ladder can be replaced easily — and don’t need incentives.

We conducted a six-year study of companies around the world that had tried investing in their employees at the bottom of the ladder. We sought to answer: 1) How successful were these companies in improving conditions at the bottom of the ladder and 2) What impact did the improvements have on the firms’ productivity, financial costs, and economic returns. We discuss our findings in this article.

Background
During the course of our research in 9 countries, we studied companies ranging in size from 27 to 126,000 employees. Companies included those in the automobile, financial services, personal goods, technology hardware and equipment, pharmaceutical, food production, construction materials, and industrial metals industries. We included public and private companies and chose them for their diverse geography, size and sectors. We interviewed employees at all levels, from the lowest‐paid to those in top management positions including CEOs, CFOs, and COOs. We also compiled information on companies from publicly available data, financial reports from publicly traded companies, and academic, professional, and media reports on the companies’ performance. Our findings very clearly demonstrate that investing in employees at the bottom can be an advantage both in times of economic growth and during a recession.

Different approaches to investment at the bottom of the ladder
Many of the companies we studied offered the kind of incentives at every level that were more commonly offered only to highly skilled professionals. These included higher wages, profit sharing, training and career tracks.  The ways in which they set up these incentives differed, with each firm devising a strategy that made sense for its particular business model. Two examples follow, a large publicly traded firm and a smaller privately owned company.

1. Costco: Paying higher wages and providing career tracks
Costco’s business model consists of selling a range of low- and higher-end goods at a very low markup. The low markup means that in order to be successful the company needs high volume. It increases profits by having customers who return repeatedly and are willing to pay membership fees. Providing a high-quality shopping experience is essential to ensuring the customer satisfaction and loyalty that a membership model requires. Costco’s CEO Jim Sinegal believes that the quality of employees the company was able to attract and retain was the foundation of the company’s success because it was essential to ensuring high volume and returning customers.

Costco attracted high-quality employees by offering better-than-average wages. It retained the best employees by providing rapid wage growth and career advancement opportunities. When we first visited the company in 2005, starting wages at Costco in the United States were $10 an hour for a full-time entry-level cashier, $11 an hour for meat cutters, and $15 an hour for truck drivers. At the time, the federal minimum wage was $5.15. It was only in 2009, four years later, that national wages for these positions had caught up. By then, average hourly wages in the United States across all levels of experience were $9.15 for cashiers, $11.01 for meat cutters, and $14.96 for truck drivers. Costco was able to choose the best possible applicants for a position, and it regularly received many more applications than job openings available. Even when unemployment was low it received about 800,000 applications a year for 400 locations in which approximately 14,000 people were hired. Senior managers explained that they did not spend any money on recruiting, since Costco was an employer of choice. Its ability to attract quality employees helped Costco enjoy other benefits.  For example, it had extremely low employee shrinkage. While the industry average was somewhere between 2 and 4 percent, Costco’s was less than 0.02 percent. Managers believed that their good wages and benefits were the reason that employee theft was so low.

Costco was aware that turnover was costly, both because of the costs of training new employees and because of their lower efficiency during their first months on the job.  Policies encouraged retention of warehouse employees by combining the strong salary progressions during employees’ first four years with real advancement opportunities. After four years of employment, the salary for a cashier could go up to $43,000. This was more than twice as high as the mean annual wage for grocery or department store cashiers.

Leaders at Costco believed that providing advancement opportunities for entry-level workers was necessary for the company’s continuing success. Given the company’s continuing growth, senior managers explained that preparing workers for management positions was the only way to guarantee that they would have managers who knew and understood the company’s operations. Costco executives believed that experience on the warehouse floor made for better leaders. Managers with warehouse experience understood how the warehouses functioned, how to improve operations, and how to best support their staff. The company’s commitment to promoting from within was evident in the fact that it promoted from within 98 percent of the time. Sixty-eight percent of warehouse managers had started with the company as hourly employees.

For Costco, treating workers well has led to increased motivation, higher quality service, greater productivity and lower turnover. After the first year of employment, turnover was less than 6 percent, one of the lowest rates in the industry. The combination of good wages and the knowledge that there were opportunities for advancement was an important incentive for employees to work hard and build a career with the firm. The high quality of service provided by motivated, engaged employees at Costco, combined with the low prices, meant that customers returned and were willing to pay the membership fees. Costco’s high-quality service also attracted a clientele that shopped not only for basic goods but also luxury items, which were still more profitable, even with the low markup. As a result, Costco had higher annual sales per square foot than its most direct competitor, Wal-Mart’s Sam’s Club,  ($795 versus $516), and higher annual profits per employee ($13,647 versus $11,039) even though Costco’s average wage was 42 percent higher. Over 16 years, Costco grew from 206 warehouses and $16 billion in sales to 554 warehouses and $69.9 billion in sales.

2. Great Little Box Company: Profit-sharing and financial incentives
A packing-supplies manufacturer in British Columbia, the Great Little Box Company employed an open-book management strategy, holding monthly meetings where executives discussed the firm’s finances, production, and sales performance in detail with staff at every level.   Leadership believed that in order to be effective, the open-book management strategy had to be combined with profit sharing. The company set a program in place in 1991, following VP of Human Resources Margaret Meggy’s belief that employees would work harder if they felt “they matter and that their work matters.”

The program provided immediate rewards for improved company performance; employees would learn of the company’s profits at the monthly meeting and receive a bonus on their paychecks. Great Little Box’s commitment to sharing profits extended to all employees. Every month, 15 percent of the company’s pre-tax profits were split equally amongst everyone from managers to workers on the factory floor. As a result, workers at every level were aware of how the firm was performing and were motivated to find ways to improve productivity and reduce costs. In addition to profit sharing, the company launched several programs that provided financial incentives for employees to reduce costs and improve quality. The Idea Recognition Program provided rewards for ideas that led to cost savings. The financial rewards employees received were based on how much the company saved from their idea, and ranged from $50.00 to $2,500.00 The company also set up financial incentives for quality control. Employees received small financial rewards for spotting flaws before orders were sent out.

The combination of open-book management with profit sharing and incentives gave workers a personal stake in the company’s success. Workers were motivated to increase the company’s profits, since this meant that their own incomes would increase at the same time. At the same time, they understood how the company was doing and how their actions could result in improvements. The resulting increased sense of ownership meant that employees worked harder and watched co-workers, since a drop in productivity and product quality would lead to reduced profits for the company — and reduced earnings for employees. Providing incentives for workers to come up with cost-saving ideas had a strong impact on performance. Factory-floor workers were constantly looking for ways to reduce costs and increase productivity. The company benefited from employee suggestions on improvements in the use of machinery. For instance, as a result of one employee suggestion on cross-departmental use, equipment that had been used solely in the label division began to be used to print folding cartons. This reduced costs by 12 percent on tasks that would otherwise be outsourced to specialized printing companies. Another suggestion from a production worker allowed the company to automate production that was previously performed manually, and consequently, to sell affected products at a lower price. Employees also discovered ways for the company to save on materials. A recommendation by a maintenance worker led the company to minimize cardboard scraps and thus save thousands of dollars a month.

Great Little Box has reaped substantial gains from the policies that fueled employee input. Over the past decade, sales have doubled from $17M to $35M.  During the past seven years the company’s success has enabled it to purchase the assets of six companies. Two more acquisitions are pending.

Lessons for leaders
Costco and Great Little Box benefited significantly by providing incentives for employees at every level of the firm. Both companies found ways to profit by offering better compensation to employees at the bottom of the ladder. The experiences of these two companies, as well as those of other companies we studied around the world, suggest lessons that corporate leaders can apply to enable all levels of a company to profit.

1. Understand who performs the majority of the essential work. At professional services firms, this may be lawyers or paralegals; in surgical clinics, this could include surgeons, nurses, technicians, paramedics, and individuals preparing the operating room; and in manufacturing, those working on the factory floor clearly carry out most of the essential work.

2. Realize that the firms’ success depends on the quality of the work performed by the majority of workers. Remarkably, few firms currently design their organizations to optimize the efforts of employees at the bottom of the corporate ladder—even when these employees are central to the firms’ ability to add value. At Costco, the sales staff was instrumental in ensuring the high-quality shopping experience that would draw customers to return. At Great Little Box, the company beat competitors because of its ability to respond rapidly to customized orders.

3. Recognize that the quality and productivity of employees at the bottom of the ladder depend on whether these employees are motivated, healthy, adequately rested, and well-prepared to carry out the tasks they are asked to perform. Employees at Costco were motivated to work harder and perform better by a combination of higher wages and opportunities for promotions. Great Little Box employees had a direct financial stake in the company’s performance.

4. Realize that line workers are often the ones who know best how to increase efficiency. Great Little Box benefited from suggestions from line workers that led to cost savings and greater flexibility in production. Managers at Costco had a better understanding of how to improve production because most had served as hourly workers.

Reprint from Ivey Business Journal
[© Reprinted and used by permission of the Ivey Business School]