The previous chapter examined organizations that let others do the investing in human capital, this one looks at those that invest only the minimum in human capital. A few organizations adopt this strategy by choice; others do it out of economic necessity. Either way, this is a viable option for many organizations. This chapter explores the issues involved in selecting and using the strategy of minimum human capital investment and examines its challenges, consequences, and advantages. This strategy has several hidden land mines that can be detrimental to some organizations in the long term if not recognized.
This strategy invests the very minimum in employees in every aspect of employee expenses: it sets salaries near the minimum-wage level or very low in the industry, provides benefits at a level just beyond what is legally required, invests in training only at the job skills level with almost no development and preparation for future jobs, and offers little in the way of employee-support services. Organizations adopting this philosophy operate in a culture that is sometimes reflective of the industry and the competitive forces in it. These organizations experience high turnover and usually adjust processes and systems to take into account the constant churning of employees.
This strategy should not be confused with efficient resource allocation. Obviously, efficiency is gained by keeping costs at a minimum. The strategy presented here is a deliberate effort to dispense only the minimum investment in human capital. This strategy is about facing the inevitable in some situations, or making a deliberate attempt to invest as little as possible in employees.
The landscape is littered with examples of companies that make the minimum investment in their employees. While this strategy is common in many small businesses, it is also a deliberate choice in many large businesses. For example, Wal-Mart, the world’s largest company, is noted for its low wages and a sparse benefits package. Wages are low enough to make other companies’ workers go on strike. The employee relations’ climate at Wal-Mart has been under scrutiny and examination for many years. Wal-Mart’s violation of the Fair Labor Standards Act concerning overtime, discriminatory treatment of employees, and other related issues dominates the headlines. Wal-Mart has carved out a strategy to invest the very minimum in its employees but still try to make itself an attractive place to work. It is a model that has paid off quite well, as the company is very profitable and its growth is incomparable.
Wal-Mart casts their jobs in almost missionary terms—“to lower the world’s cost of living”—and in this, they have succeeded spectacularly. One consultancy estimates that Wal-Mart saves consumers $20 billion a year. Its constant push for low prices, meanwhile, puts the heat on suppliers and competitors to offer better deals.
If a company achieves its lower prices by finding better and smarter ways of doing business, then yes, everybody wins. But if it cuts costs by cutting pay and benefits, then not everybody wins. Just as its “Everyday Low Prices” benefit shoppers who have never come near a Wal-Mart, there are mounting signs that its Everyday Low Pay (Wal-Mart’s full-time hourly employees average $9.76 an hour) is hurting some workers who have never worked there. For example, unionized supermarkets in California, faced with studies showing a 13 to 16 percent drop in grocery prices after Wal-Mart enters a market, have been trying to slash labor costs to compete, and thus they triggered a protracted strike. Where you stand on Wal-Mart, then, seems to depend on where you sit. From the consumer’s standpoint, Wal-Mart is good; from a wage-earner’s standpoint—maybe not so good.[1]
Other organizations have not been as fortunate as Wal-Mart. A case in point clearly exemplifies the problems that can be created when there is minimal investment in human capital. Service Merchandise Company, founded in the early 1900s, provided a range of household products, personal items, and gifts. Service Merchandise’s business model made it possible for customers to select items for purchase with little or no input from the sales staff and then their purchases were delivered on a conveyer belt as they left the store. Part of the Service Merchandise strategy was to invest the very minimum in employees by offering low wages and few benefits, resulting in an employee turnover rate exceeding 100 percent for full-time, permanent employees.
After years of dismal results with mounting debt, Service Merchandise changed the executive team. The goal of the new president was to change the business model to make the firm more responsive to the customer, provide products that attracted more interest, and provide a more efficient system to guide customer purchases.
As the company attempted to change its business model, they made a deliberate attempt to address the turnover problem. The actual cost of turnover was undervalued and underappreciated by the senior management team. A study was conducted to develop the annual cost of turnover for the permanent staff in an effort to get management attention. The results were staggering. When the study began, the human resources staff had estimated the annual cost of turnover to be in the $10–12 million range. When the study was completed, the total figure came in at $180 million! Neither the HR staff nor the management team had any idea of the extent to which turnover was devastating the business and influencing the business model as well as hurting customer satisfaction.
Unfortunately, Service Merchandise went into bankruptcy before they could completely change their business model. As one Wall Street analyst stated, “With another $100 million they could have survived long enough to make the transition.”
This story highlights the tremendous cost of turnover that is almost always inherent in organizations investing the minimum in its human capital. The signs of under-investing are obvious: the company offers the lowest wages in its industry and a benefits package offering little beyond the legal requirements. There are literally no frills with this type of organization. Consequently, there is usually high turnover. Under-investing is inherent in some industries, particularly restaurants (for example, the fast food industry) and retail stores. Competition is fierce and prices are constrained to the point that executives are forced—at least in their thinking—to invest as little as possible in their people.
The primary forces driving this strategy can be put into three words—cost, cost, and cost! Some organizations work in such a low-cost, low-margin environment that a minimal human capital investment appears to be the only option. These low margin businesses, such as Wal-Mart, operate on volume to make significant profits. Competition forces this issue in many cases. Competing organizations in a particular business, such as the restaurant industry or retail store chains, might not be able to offer significant differences in pay and benefits. The range from the lowest to the highest is narrow in these industries and the benefits package may vary only slightly.
Minimum-wage employees are a fact of life in the business world. In the United States, 2.1 million employees earn wages at or below the federal minimum wage level. Table 2-1 presents a profile of these minimum-wage workers.
Table 2-1. Profile of minimum-wage workers in the United States.
Demographic Profile of Minimum-Wage Workers |
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Source: Current Population Survey Bureau of Labor Statistics, 2003. |
In some cases the minimum investment strategy is adopted out of the need to survive—the organization must invest as little as possible to survive, particularly in the short term. These organizations are often managed by executives who see little value in their employees and view them only as a necessary cost to deliver the service. They consider employees to be dispensable, easily recruited, and quickly discharged if they are not performing appropriately.
Organizations investing only the minimum amount in human capital usually do not understand the true cost of turnover. They see the direct cost of recruiting, selection, and initial training, but do not take the time to understand the other impacts. Both the direct and indirect cost of turnover must be taken into consideration.
As illustrated in the Service Merchandise case study, the impact of turnover is both undervalued and underappreciated. Rarely is the total cost of turnover calculated in organizations investing minimally in their human capital. When the cost is estimated, it is often underestimated. More importantly, estimations of the total cost are not communicated throughout the organization, leaving the management team unaware of the potential costs. If turnover is a problem, the costs are always significant. In some cases, the actual impact can be devastating and can result in the organization’s demise.
The total cost of turnover involves both the direct and indirect costs. Figure 2-1 lists the costs in the sequence in which they occur. This figure suggests that there are many different costs, some of which are never known with certainty but can be estimated if enough attention is directed to the issue. When the total costs are calculated, it is often expressed as a percent of annual pay for a particular job group.
Table 2-2 shows the cost of turnover expressed as a percentage of annual pay for selected job groups. As this table shows, these costs, arranged in a hierarchy of jobs, are significant. The data for this table were obtained from a variety of research studies, journals, and academic publications where professors and consultants report the cost of turnover from their work. Also represented are data from publications for industries where turnover has become an issue and organizations in these industries have taken the time to calculate the fully loaded cost of turnover. The data also come from private databases of organizations working with this important issue as well as from professional organizations where turnover is an issue in the profession, such as nurses, truck drivers, or software designers. Collectively, these external studies provide a basis for understanding the total cost of this important issue and understanding the impact of turnover is the first step toward tackling it.
Table 2-2. Turnover costs for selected job groups.
Job Type/Category | Turnover Cost Ranges (Percentage of Annual Wage/Salary)[*] |
|---|---|
Entry level—hourly, unskilled (fast food worker) | 30–50 |
Service/production workers—hourly (courier) | 40–70 |
Skilled hourly—(machinist) | 75–100 |
Clerical/administrative (scheduler) | 50–80 |
Professional (sales representative, nurse, accountant) | 75–125 |
Technical (computer technician) | 100–150 |
Engineers (chemical engineer) | 200–300 |
Specialists (computer software designer) | 200–400 |
Supervisors/team leaders (section supervisor) | 100–150 |
Middle managers (department manager) | 125–200 |
[*] Percentages are rounded to reflect the general range of costs from studies. Costs are fully loaded to include all of the costs of replacing an employee and bringing him/her to the level of productivity and efficiency of the former employee. | |
When the phrase fully loaded cost is used, it is important to consider what goes into those costs. The turnover costs in Table 2-2 contain the direct cost categories as well as those that are indirect. A complete list of cost categories is included in Table 2-3. This table contains a list of cost items that can be derived directly from cost statements and others that have to be estimated. Essentially, those on the left side of the table can easily be derived while those on the right side typically have to be estimated. When considered in total, excessive turnover is expensive and very disruptive.
Setting a minimum investment strategy requires the same thought and rationale as that required for setting other investment levels. Obviously, if paying the legal minimum wage becomes the strategy, little thought goes into the process. However, most organizations attempt to pay above the legal minimum wage, while still limiting wages to a level they can afford. The wage must be high enough to attract reasonably qualified candidates for the job; otherwise, the job goes unfilled.
When offering a benefits package, it is helpful to include as many of the low-cost items as possible so the package is complete. This often includes benefits such as accidental death and dismemberment and term life insurance, which can be inexpensive, but is important to many potential employees. Medical and retirement plans are sometimes made available for employees to purchase. The company may contribute little, if any, of the costs. Also, supplemental benefits plans with a wide variety of options can be offered at discounts to employees, resulting in no cost to the employer. When presented in total, the benefits package appears to be a costly investment in the employee. In reality, the investment is minimal.
At a low investment level, with intense focus on cost control, it is difficult to provide resources to build an adequate employee support system. However, in an attempt to avoid turnover, there must be some basic levels of support, such as nonunion grievance procedures, employee assistance plans, and HR staff members who can provide assistance and basic counseling. With a support system, employees perceive a sincere investment in employee concerns on the part of the executives. Without a support network, employees perceive an organization that has no concern about the individuals who contribute to its success. Consequently, they may leave.
The tactics involved in implementing this strategy are straightforward. Recruiting is the key challenge, particularly when offering low wages and benefits. Innovative recruiting efforts must be employed, highlighting the many positive attributes of the company. If the company has a positive image (such as Starbucks), recruiting can build on the image of the organization and actually be included as a part of the in-store policies and practices. The strengths of the organization must be highlighted in the recruiting efforts. If possible, security and stability must be emphasized. For a fast-growing chain such as Starbucks, stability and security are important issues that can be underscored. This is particularly helpful where jobs come and go in other organizations.
Employing the disabled is another potential tactic. Pizza Hut has employed thousands of individuals with disabilities over the last decade and a half, and turnover among them is dramatically less than turnover among other new hires. Pizza Hut saves millions of dollars from this low turnover. On top of that, it receives millions of dollars in Federal tax credits for hiring job candidates with disabilities. There are about 54 million Americans with disabilities. Most do not have jobs; most want jobs; most deserve them; most can do them. This opens up a big opportunity for organizations that can make only minimum investment in human capital.
Clothing retailer Eddie Bauer employs 6,200 hourly wage earners at 439 stores nationwide. Most employees are young—between twenty-five and forty years old, and like other retail cashiers and clerks throughout the country, make less than ten dollars an hour. They often occupy the vast economic category known as the working poor. At Eddie Bauer, these frontline employees make up the overwhelming majority of the company’s 7,200-member workforce. They are the first and primary people customers come in contact with.[2]
The store recognizes the benefits of rewarding lower-wage employees with something extra in their paychecks. In an effort to energize its legions of hourly wage earners and maintain a committed workforce, the store launched a financial-reward program in 1998 that gives workers an additional 6.5 percent of their base pay if store goals are met. That amounts to $74.41 extra a month, or $18.61 per week, for a worker earning the minimum wage. An employee earning $10 an hour can pocket an extra $104 a month. That kind of financial incentive might make an employee think twice about leaving Eddie Bauer.
Such an incentive plan is one way of rewarding often-overlooked low-wage employees. Other large companies offer programs that help pay for child care, assist with education, or provide some other form of extra financial support. These programs not only help low-wage workers but also benefit the employer through increased loyalty and savings on hiring and retention. Maintaining a stable workforce is a business imperative. In the United States today, one in four workers earns $18,800 a year, or $360 a week. These people have jobs, but inadequate salaries and few if any benefits.
Clothing manufacturer Levi Strauss & Co. has a program that provides emergency financial assistance to all of its employees and retirees. The Red Tab Foundation, named for the familiar tag found on the rear pocket of the company’s blue jeans, offers money to employees who need immediate help to pay for things like funeral costs, emergency car or home repairs, or shelter from a violent spouse. Executive director Ann Ure says the foundation is a public charity cofunded by contributions from Levi employees, executives, and board members. Unexpected financial need is a primary criterion for eligibility, so the majority of grant recipients are hourly wage earners and retirees living on fixed incomes. By its existence, the foundation gives Levi employees a sense that there is a financial safety net, Ure says. “Employees see it as a bridge between paychecks when an emergency occurs.” From 300 to 900 Levi employees and retirees apply each year for grants, which average $1,000. Eighty percent of the requests are approved.[3]
Another important tactic for employers is to focus only on job-related skills, which provide workers with almost no preparation for future jobs or developmental opportunities for advancement. This is essential to maintain the minimum cost. With this approach, there are no elective training programs; skills are developed only when necessary. While some companies may not provide elective training and advancement, others, like Marriott International and Bank of America Corporation, which employ platoons of low-wage workers, are initiating benefits programs that include English-language instruction and free or subsidized child care. These programs differ widely in specific benefits, but each one addresses a low-wage employee’s work/life situation. Leon Litchfield, one of the authors of a 2004 study entitled Increasing the Visibility of the Invisible Workforce: Model Programs and Policies for Hourly and Lower Wage Employees by the Boston College Center for Work and Family, says these programs are helping companies gain productivity and loyalty while saving on recruiting and new-hire costs.
Investing the minimum in human resources can result in negative consequences for organizations. First, a minimum human capital investment strategy should be considered only in the context of simple, lower-level jobs. Automation is desired if the jobs can be eliminated. If not, they must be broken down into simple steps.
Second, organizations using this strategy must be able to adjust to high turnover. With low wages and sparse benefits, employees will jump to another organization which offers just a slight increase in pay. Some organizations adjust quite well. Executives can ensure that hiring costs are minimal and initial training costs are extremely low. For example, McDonald’s keeps the jobs simple and the training efficient, resulting in a low cost to build job capabilities. McDonald’s executives expect high turnover and are willing to live with and adjust for it.
Third, this approach can have a long-term negative impact as the turnover costs deteriorate the efficiency of the organization, the quality of service, and the ultimate impact on indirect costs. This is not a major issue in a fast-food chain where jobs can be broken down into small parts and administered efficiently. However, for a manufacturing organization or a large customer call center, it may be difficult to deal with the high turnover inherent with this strategy on a long-term basis. Also, high turnover and low pay often conjures up negative images of an organization taking advantage of employees. McDonald’s and Wal-Mart are two examples of low-paying organizations that are often criticized for their pay and benefits structure.
Surprisingly, there are many advantages to this strategy. The first and most obvious is low direct costs. Executives taking this approach strive to be the low-cost provider of goods or services. In doing so, they must invest in human capital at minimum levels. Southwest Airlines strives to be the low-cost airline operator. Consequently, they have lower wage and benefit structures than many other airlines. However, the executives work hard to keep turnover low, by selecting the right people, creating a supportive culture, and establishing a motivational climate. These practices provide the stability in customer service and support needed to be profitable. They are the world’s most profitable airline.
Another advantage is that this strategy usually applies to jobs, tasks, and processes. These job elements make recruiting, training, and compensation relatively easy.
Finally, this may be the best strategy for survival, particularly on a short-term basis. By the nature of the business, some organizations must operate with minimum commitment to employees in terms of investment levels.
This chapter provides a simple and basic strategy used by many organizations: invest in human capital at minimum levels. Sometimes this strategy is necessary due to the type of business, the challenge of low-margin survival, or the competitive nature of the industry. Organizations adopting this strategy will face challenges. The most significant challenges are in maintaining adequate levels of job satisfaction and low levels of turnover, as well as recruiting motivated and committed employees. The strategy to invest the minimum is challenging, but can be accomplished if the potentially negative consequences are addressed with the appropriate resources and focus.