Article 5.2


Most of us know about the excellent service/value offered by both Federal Express and UPS. Few people, however, know that they pay their operational people 150% of the going compensation package, benefits included. They have no clever incentive plans; they just pay the most to expect and get the most, and they make good profits with high wages. How does it economically work? We first need some information from the "bell-shaped curve" for wages in a marketplace.


Appreciate that all wages are set by the marketplace as employees and employers compare and negotiate constantly. Unattractive jobs, places, and hours attract fewer willing workers so demand pushes the wages higher. There is, conversely, plenty of supply for low-skill, low-stress jobs in nice offices with - no heavy lifting, normal hours, and no travel required, but the wage range is appropriately shifted lower. The entire range for a given job will shift from city to city depending upon factors such as the cost of living and the quality of life. Because few people want to live in Alaska, wages for warehouse workers are much higher there than in San Diego. Even within the Southwest, the average wage for a warehouse worker in Phoenix might be about $6 per hour; perhaps $7+ in San Diego; and $8+ in Los Angeles, but housing costs increase with the wage rates too.

Taking the Phoenix case further, if a firm there decided to pay all of their warehouse people 120% of the average which would be $7.20 that would put them in the 95th percentile for that city; only 5% would pay the same or more. And if a firm paid 150% of the average, that would be 99%+. Note that two-thirds of all firms will be paying within plus or minus 15% of the average which causes the bulge in the middle of the diagram.

Let us imagine further that we have a warehouse in Phoenix in which we have a number of employees, two of whom are Joe Average and Tony Tiger. Joe is average: he is pretty good at one of the routines, but weaker or uncertain at others; he is sporadically productive and punctual; he needs supervision and his work inspected or his performance deteriorates. He probably is worth $6 per hour.

Tony, however, arrives early, stays late, and works steadily to do 120% of what Joe does. He manages and inspects himself; he is a quick-study for multiple jobs; and he is generally eager to help. In theory we should be glad to pay Tony 120% of what we pay Joe, because he does 120% of what Joe does. But, if we had hired all "achievers" like Tony, we could pay them 150% to quickly get 160% output and eventually 200% - here is how:

1. Remove the warehouse manager and designate one of the rest to be a lead-person for occasional decisions, because they all manage themselves- save 15% on overhead cost.

2. Eliminate the inspector. With achievers, good training and systems pay off, and achievers check their own work - save 10% on inspecting costs and more if the inspector wasn't perfect.

3. Cross-train the team to do all functions interchangeably, so one isn't sitting while others may be making rush errors and clocking overtime. If there is a surge of orders, everyone pulls and packs so that all orders go out on time. If there is a surge of inbound shipments, the team allocates all slack time to receiving. This flexibility boosts team output 15% and improves service too.

These first three benefits, when added to a base output of 120%, total 160%, so if we paid them all 150% we would still be ahead. Some would suggest paying 130%, but then you wouldn't achieve the following benefits:

4. If you pay the most, you can expect the most. Post statistics for-output, error-rates, on-time shipments, cycle count rates and goals. For the pay, you can demand that they justify their wages or leave for lack of measurable results, because hundreds of qualified people would love to have the chance to make the same and attain the results. If customers get perfect service, you will retain them at a greater rate than the competitor whose errors will drive customers to you. Besides growing faster than the industry through retention, you will be able in time to charge 5-10% more than the mediocre competitors' margin rate; e.g., if they were selling at a 20% margin, you could charge 21-22% for your distinctive service. This assumes, however, that: you are successful at applying this pay-service policy for all value-added aspects of the business; and your salesforce can sell best total value for a higher price.

5. Your personnel turnover rate and costs will be a fraction of what other penny-wise warehouse operators will be suffering. It shouldn't be zero, because the best gardens grow people worth promoting and are also quickly weeded if someone slips irretrievably from high performance levels.

6. Managers and salespeople who are suppose to be the agents for change and growth can be proactively doing so instead of addressing damage control due to poor service and turnover.

7. And finally, suppliers will flock to you with extra initiatives, because you will be growing faster than the competition and discounting your bills due to your higher profitability cash-flow.

You can try to put percentage values on all of these benefits, but it might be better to track how much gross margin per employee per year the firm is doing in comparison to industry standards. In service businesses, people are a big resource input and margin dollars are what the customer pays for the firm's value-added. High performance firms will achieve 200%+ of industry standards. You will get there a bit quicker if you measure this ratio for the past 12 months trailing every month, and if you keep asking all employees what and how they can do things to get it there and beyond. Good leaders have high expectations of their followers, and big pay allows you to make big responsibility requests.

If you want to see an example of this pay-service strategy, talk with your UPS driver about: their wages and benefits; how difficult it is to get hired and earn a route; and what standards they must meet to keep their job. Some complain about the hard work and no-leeway standards, but given their pay, their pride, and being home every night, they work hard and don't quit. Other nationally known firms that pay a 150% package to achieve 200%+ output include L.L.Bean and Nordstrom's. Think about it - what other pay policy will earn you the seven benefits detailed above?

To go from a pay-less, expect-less, and get-less environment to a high-pay, high-performance one isn't easy. If you advertise high pay, plenty of applicants will show; how do you pick the true achievers? If you hire an achiever at a higher wage then what some of your experienced "coasters" are making, can you explain the difference to everyone's satisfaction? It would help if you could create a pay-for-knowledge certification program that allows everyone to cross-train their way to merit increases that have everyone peaking at 150% compensation regardless of starting wage. To cross-train, however, requires time, money and teaching talent. This forward-investing might depress profits today to make more in the future, but most people want to manage the past and the numbers, which are symptoms, instead of the future and the underlying profit-causers. Look for solutions to these issues and start experimenting, the risks of trying and failing are less than managing the status quo.


Merrifield Consulting Group, Inc. Article # 5.2