Excerpt: Although offering minimal wages and benefits is the most common way companies try to lower their costs, our recent study of American management practices reveals that such bottom feeding may not be the most effective strategy. In fact, low wages paradoxically generate a variety of negative employee behaviors that add to the overall cost of doing business.

Low Costs Versus High Wages?
By James O'Toole and Edward E. Lawler III
Forbes, 4/25/07

In a radical cost-cutting move, Circuit City announced recently that it was dismissing 3,400 of its most experienced employees. While Circuit City's offer to hire many of those salespeople back at lower wages puts a surreal twist to the tale, in fact, the company is just one of many trying to gain competitive advantage by lowering labor costs.

In the last few years, Detroit automakers have laid off more than 70,000 workers, and most of the nation's grocery, discount, fast food and mall chain stores have undertaken "innovative" approaches to reducing employee wages and benefits to lower their costs. Wal-Mart Stores' CEO argues that he has "no choice" but to pay low wages to meet his customers' demand for low prices.

Although offering minimal wages and benefits is the most common way companies try to lower their costs, our recent study of American management practices reveals that such bottom feeding may not be the most effective strategy. In fact, low wages paradoxically generate a variety of negative employee behaviors that add to the overall cost of doing business.

Although managers rarely calculate these costs, they often turn out to be substantial. For example, employees at low-wage companies have significantly higher turnover rates than those at well-paying companies: Wal-Mart has nearly a 50% turnover rate, and at many fast food, retail and service companies, the rates are even higher. Researchers have computed the total costs of such turnover as the equivalent of one month's salary for unskilled workers and more than a year's salary for skilled ones.

In almost all industries, research shows that the most profitable companies are those with the lowest overall operating costs, and not those that pay the least. For example, pilots at "low-cost" Southwest Airlines actually are paid more on average than their counterparts at "high-cost" United Airlines.

The difference between these two unionized airlines--the first highly profitable, the second not--is found in their pay rates and the way they manage their people. Southwest managers do a better job recruiting the right employees, and Southwest employees at all levels are able to make managerial decisions and to work with a minimal amount of supervision.

In almost all industries, productive, higher-paid workers can more than cover the costs of their salaries and benefits, if they are managed appropriately. For example, Costco Wholesale pays its workers $17 an hour on average, while its competitor, Wal-Mart's Sam's Club, pays only $10 an hour on average; 85% of Costco employees enjoy company-provided health insurance, compared with less than half of the workers at Sam's Club. Significantly, these high wages and benefits do not come out of the pockets of Costco's shareholders. In fact, Costco has outperformed Wal-Mart on the stock market over the last five years. The real reason for the difference in compensation and benefits is that Costco employees have much lower turnover, better interaction with customers and are more productive than Wal-Mart's workers.

Because Sam's Club employees require layers of close supervision, they are much less productive than Costco's largely self-managing workers. The results speak for themselves: Costco generates slightly more sales than Sam's with 38% fewer employees. Moreover, Costco's engaged and motivated workers are organized in ways that encourage, and reward, them for adding value to their enterprise by way of their ideas and extra effort. Also, at Costco, there is a deep managerial understanding that the correct metric to be used with regard to labor productivity is "total overall labor costs" and not "unit labor costs."

Costco exemplifies a small but growing number of businesses whose labor practices are predicated on the understanding that competitive advantage increasingly is realized through the effective mobilization of an engaged and committed workforce.

These "high-involvement companies" offer workers challenging and enriching jobs and a say in the management of their own tasks. They also make commitments to low turnover and few layoffs. Found in manufacturing as well as services, these companies are relatively egalitarian, with few class distinctions between managers and workers and relatively small ratios between the salaries of the CEO and the average worker.

Typically, their workers are organized into self-managing teams; all employees are made to feel they are members of a supportive community; and all receive extensive, on-going training and education. Importantly, workers in these companies tend to be paid salaries, as opposed to hourly wages, and all participate in company stock ownership and share in company profits.

In our recent review of the performance of high-involvement companies, we found that the productivity of their workers more than justifies the high pay and good benefits they receive. In fact, when managed correctly, highly paid American workers are far more productive than even low-wage overseas workers. That's because managers at high-involvement companies organize work processes and systems in ways that allow employees to contribute significant amounts of "added value" to the products and services they make and provide.

When U.S. managers give their employees the organizational structure, resources and authority needed for them to contribute their ideas and efforts, they routinely outproduce their counterparts in less-developed countries, as witnessed by the ingenuity, initiative and efforts of the Americans who productively and efficiently make steel at Nucor, motorcycles at Harley-Davidson, consumer goods at Proctor & Gamble and high-tech products at W.L. Gore and Associates.

Waterloo, Wisc.-based Trek Bicycle is able to export bikes to the world because its American workers are empowered, and rewarded, to make continual improvements to their products and work processes. Trek's workplace system creates a constant stream of new products that forces the poorly paid, under-educated, and micromanaged workers making copy-cat bikes in South Asian factories to continually play catch up. Our research shows that the comparative advantage of having trained, motivated and committed workers enjoyed by Trek can be realized by a wide variety of businesses, both low-tech and high-tech.

Evidence of the positive potential of employee involvement doesn't rest on a few company examples. Analysis of the results of the 2002 U.S. Census of a cross-section of American workers shows that in all industries and among all demographic groups, the greater the extent to which employees participate in profit sharing, stock ownership and other forms of financial gains that derive from their efforts, and the greater the extent to which they also participate in organizational decision making, the more they are committed to, engaged in and satisfied with their jobs.

The existence of such data gives rise to an important question: Given the manifest benefits to shareholders, employees and society alike, why aren't there more High-Involvement Companies?

The High-Involvement model has not spread further largely because managers believe their companies have to be highly successful before they can offer good working conditions to their employees. As one CEO recently explained, "I would treat my employees as well as Starbucks treats theirs--if I could charge the equivalent for my product of $3 for a cup of latte!" But managers who assume that higher profits drive better working conditions have their logic backward.

Contrary to conventional wisdom, we have identified companies in virtually every industry that are profitable because they provide good jobs. As Starbucks CEO Howard Shultz explains, the high-quality customer service that makes it possible for his company to charge a premium for its coffee results from the investments it makes in employee welfare and training. This is true as well for the productive contributions of employees at such diverse high-involvement companies as package courier United Parcel Service, grocery chain Whole Foods Market and Circuit City's competitor in discount electronics, Costco.

In light of this evidence, we are left to wonder what might have happened at Circuit City had its executives appropriately rewarded individual, team and organization performance at all levels; invested heavily in the development of their human capital; and created conditions in which their workers could add large amounts of value?

Despite the evidence to the contrary, most American managers continue to believe they face a painful choice between offering high employee wages on the one hand or low customer prices on the other. In fact, their real alternative is between staying with conventional management or adopting high-involvement management practices.

James O'Toole and Edward E. Lawler III are professors at the University of Southern California's Marshall School of Business and authors of The New American Workplace (Palgrave-MacMillan, 2006).

http://www.forbes.com/2007/04/24/corporate-layoffs-costs-oped-cx_jot_04…