Better Pay for Better Profits

How increased wages and operational improvements can help your bottom line

Back Longreads Jul 28, 2015 By Steven Yoder

Among the counterintuitive gems economists have excavated in recent years is this curious insight: When the economy is humming along and unemployment is low, the U.S. death rate rises. Many in the field have tried to fathom why. And now, UC Davis Graduate School of Management interim dean Ann Huff Stevens and three of her colleagues think they know. (They published their findings in a paper released last May.)

Most of the additional deaths that occur in economic good times happen among older people living in nursing homes, Stevens and company found. It’s because nursing homes can’t retain low-wage staff when unemployment rates are low. Certified nursing aides make as little as $9 an hour, and the work is both physically and emotionally grueling. Taking another job — even one that doesn’t pay more — is often a step up.

So as turnover rises in these homes, the ratio of patients to staff rises. Infections don’t get the attention they need. New workers make mistakes in administering medications. And more patients die.

Companies that strengthen their operations and training and motivate employees with better pay, decent benefits and predictable schedules are out-competing their rivals.

High turnover drags down profits in any business, but in nursing homes it can kill people. Recent state court cases make that clear. Rosewood Post-Acute Rehab, a privately run home in Carmichael, was hit with several lawsuits over the years because of quality-of-care problems related to inadequate staffing. In 2013, the state fined Rosewood $100,000 after a patient was given a lethal overdose of a blood thinner, according to a New York Times report. In February, Rosewood’s parent company filed for bankruptcy to escape potentially catastrophic legal verdicts. That’s the second time in two years a California nursing-home chain has liquidated to avoid lawsuits related to inadequate staffing.

As minimum wage debates gain momentum regionally and nationwide, the business community has continued to argue that increasing employee pay drives up overhead and jeopardizes job growth. But a number of companies in thin-margin industries are proving that they don’t have to compete by treating staff like cheap, disposable cogs. Companies that do the opposite — by strengthening their operations and training and motivating employees with better pay, decent benefits and predictable schedules — are out-competing their rivals.

An Alternative to Retail’s Race to the Bottom

Conventional wisdom among service industries mirrors that in sail racing: Light and lean wins. Successful companies undercut competitors on price by shedding excess employees and tamping down wages for those who stay. Employers target wages and benefits for a good reason — they’re often the biggest controllable expense these companies have.

For example, in the two biggest retail job categories (sales worker and cashier) median wages run between $9.17 and $10.29 an hour. That means a person working full time in one of these positions brings home between $18,000 and $20,500 a year, at least 15 percent lower than the poverty level for a family of four.

Those low wages and benefits come with long-term costs to a company, says Zeynep Ton, a professor at MIT’s Sloan School of Management and author of the 2014 book The Good Jobs Strategy. Ton hones in on the low-wage approach used by Walmart, the world’s largest private employer. A National Bureau of Economic Research paper last November showed that Walmart cashiers, for example, average just $8.48 an hour. Ton says the company’s size has forced the entire retail industry to follow suit by trimming pay scales.

But that race to the bottom may well be the herd thundering into a box canyon. At Walmart, low wages show up in unhappy customers — the company has consistently ranked as one of Consumer Reports’ lowest-rated grocers for customer satisfaction since 2005. Stevens points to “efficiency wage” studies done since the early 1980s that suggest profits actually can rise when wages go up because employees work harder, better workers are attracted to the jobs and turnover drops, all of which increase productivity. Among that research is a 2003 study of San Francisco airport contract employees after new policies in 2000 increased their wages. After the boost, almost half the contractors reported that workers were offering better customer service. Turnover rates fell from almost 50 percent yearly to 20 percent. Absenteeism dropped by almost a third.

Related: The 4 Commandments of a Good Jobs Strategy

But boosting performance normally demands more than just raising wages, according to Ton. Her research focuses on the performance of the jumbo retail chains Costco, Trader Joe’s, QuikTrip and Mercadona, the largest supermarket chain in Spain. All four provide wages and benefits considered high for their industries.

They also use four key operational strategies: First, they’ve winnowed down what they sell — they actually give their customers fewer choices by limiting products and promotions. That cuts cost and makes staff more knowledgeable about what the company does offer. Second, instead of cutting staff hours when business is slow, they heavily cross-train workers so staff can take on other roles in times of low demand, like having the fruit-and-vegetable specialist restock shelves in another department when foot traffic is slow. Third, they operate with slack: They have more employees than they need, giving staff breathing space to offer better customer service and suggest operational improvements. And finally, they standardize every employee task while also empowering staff to make decisions for which behavior is hard to prescribe, like how to respond to customer problems and complaints.

The results, Ton found, show up as both happier workers and higher profits. Costco’s store employees, for example, earn about 40 percent more than their counterparts at Walmart’s Sam’s Club. Costco’s turnover is less than 6 percent a year for workers who stay for more than a year, compared with overall turnover of about 60 percent in the industry. Its customer service is ranked as high as that of Nordstrom, which is known for treating shoppers well. Costco’s prices are as low as Sam’s Club’s and about 40 percent lower than those in a typical supermarket. And from 2003 to 2013, the company’s share price shot up 240 percent, compared with 50 percent at Walmart.

At least one ex-Costco employee thinks the company lives up to that hype. Wages and benefits at Costco are “golden handcuffs,” making it tough to leave, says former employee Phillip Hutchens, 53, of Eau Claire, Wisc. In his experience, staff feel the company invests in them, and he says his own decision to depart for a career in ministry was “incredibly difficult.”

Can It Be Scaled Down?

It’s easy to object that a good-jobs strategy successful in huge retail firms can’t work in small businesses, with their tiny profit margins and fewer company resources. But Ton points to The Container Store, which has been operating on the philosophy since launching in 1978 with a single Dallas store. The company has since grown to 63 locations in 22 states. “If anything, it’s much easier in a smaller company,” Ton says, because owners usually have more control and don’t have to remake a whole corporate culture.

Ginger Elizabeth Chocolates Head Pastry Chef Alison Clevenger and Owner Ginger Hahn.

(Photo: Kelly Barr)

Ginger Elizabeth Chocolates Head Pastry Chef Alison Clevenger and Owner Ginger Hahn.

(Photo: Kelly Barr)

Whether Ginger Elizabeth Chocolates in Sacramento will achieve growth on that scale has yet to be seen. But keeping happy and productive employees has been a meme of company culture since launching in 2008, says co-owner Tom Hahn.

Training staff to work in the company’s retail store takes a month, compared with the eight hours or so that workers get at some large retailers. Hahn says the company wants to empower employees to do what’s best for customers. That means “no one gets in trouble for doing what they think is best when a new situation arises,” he says. “If we want to do something different than the decision that the employee made, we’ll talk about it and write it into policy going forward.”

The company also sacrifices short-term profits for long-term staff loyalty; when business is slow, managers don’t send people home. Between 13 and 15 of the company’s 20 staff are full time, depending on the time of year. By the time a staffer has been there a year, they’re making about $11 an hour and getting full health benefits as long as they work 30 hours a week, he says. Among those who stay more than a year, turnover is “quite low,” Hahn says, though he doesn’t know a percentage.

Ginger Hahn, his wife and business partner, would like to someday start an employee daycare. “We want to ask a lot of people, so we need to give them something back,” Tom Hahn says.

Making the Transition

It’s easiest for businesses to launch a good-jobs strategy when they’re starting out. For existing companies, transitioning away from the bad-jobs approach is like remodeling a house, Ton says. But she has advice for companies that do want to overhaul.

The business owner or CEO has to fully commit to the change and get buy-in from investors, lenders or other shareholders. “They need to explain to them that this is a long-term play. Taking care of your customers and employees, creating operational efficiencies and operational excellence, it doesn’t happen overnight,” she says.

Costco’s store employees earn about 40 percent more than their counterparts at Walmart’s Sam’s Club. Costco’s turnover is less than 6 percent a year for workers who stay for more than a year, compared with overall turnover of about 60 percent in the industry. And from 2003 to 2013, the company’s share price shot up 240 percent.

They also need to set some milestones to measure progress. Raising wages without redesigning how employees work may just result in higher prices. “For everybody to win, you need to find a way to get more productivity from the employees in whom you have invested,” she says, such as through the four operational strategies that Costco and others have used.

Finally, she recommends implementing the new strategy in a small setting, in one store or section of a store, for example, to see what works and what doesn’t. The company then can adapt the strategy to the company’s circumstances and culture before rolling it out firm-wide.

With California’s minimum-wage debate looming large, the new evidence of a nexus between better pay and higher profits gives talking points to advocates on either side. Those in favor of a wage increase can argue that not only could businesses afford to raise pay — they can hardly afford not to. Those opposed can counter that new data proves that the free market pushes up wages on its own, higher minimum wage or no.

Whatever position a business takes on that issue, Stevens thinks there’s an additional reason for companies to get out ahead of a state requirement: “If you see the minimum wage increase coming and want to take advantage of raising wages to boost worker morale, you’re likely to get more of a boost if you do it before it’s mandated,” she says. Call that smart cynicism or just enlightened self-interest.