For the employer-employee relationship to be sustainable for the long-term, it needs to be in the best interest of each side. Wages are a big part of that but frequently are not looked at correctly. Here are the 3 rules that determine wages:
- The teammate needs to provide more value than they cost, otherwise it doesn’t make sense for the company.
- The company needs to pay the teammate more than they can get somewhere else or it doesn’t make sense for the teammate.
- The teammate needs to provide more value than the company could get elsewhere for the same cost or it doesn’t make sense for the company.
Let me give you an example to illustrate what I’m talking about. Let’s say there’s a paper salesman named Dwight. Dwight is providing 1000 Schrutebucks of value per hour. Because of Rule #1, this means the company can afford to pay Dwight somewhere between 0 and 1000 Schrutebucks/hr.
If Dwight were to go looking for a job, let’s say he could find another job that pays him 400 SB/hr. Because of Rule #2, this means that the company needs to pay Dwight at least 400 SB/hr or he should take the other job. Combining Rules 1 & 2, this means Dwight’s salary should be somewhere between 400 – 1000 SB/hr
If the company could find a comparable paper salesman that could generate 1000 SB/hr and pay them 600 SB/hr, then adding Rule #3 means Dwight’s salary should be somewhere between 400 – 600 SB/hr.
Digging a little deeper to explain why this is the optimum range for Dwight’s salary:
- If the company were to pay any amount less than 400 SB/hr it’s a bad deal for Dwight because he could make 400 elsewhere.
- If the company were to pay any amount more than 600 SB/hr it’s a bad deal for the company because they could get someone else to do that for a cheaper cost.
- Anywhere in the 400-600 SB/hr range is the sweet spot where it is the best deal for both sides. In this case, I would want to split it right down the middle at 500 SB/hr.
At 500 SB/hr, the company is getting 1000 SB/hr of value but is only paying 500 so that’s a big win. At 500 SB/hr, Dwight is making more money than he could anywhere else. At 500 SB/hr the company can’t find anyone else that can do his job for less. This is the optimum salary for Dwight and is sustainable for the long term.
What would have to change for this wage to no longer work for both sides? Some potential ideas:
- Dwight got a lot better and now provided 10,000 SB/hr. Because he was so much better, it might take two people that cost 800 SB/hr each (1600 total) to combine to replace his productivity. This boost in productivity would change the equation so that the sweet spot was now between 400-1600. Splitting that down the middle would put the fair value at 1000 SB/hr.
- If the market changes and the company can now find other comparable paper salesman for only 500 SB/hr, now the sweet spot is 400-500 and the fair price is 450.
- If the other company that could hire Dwight at 400 is a terrible place to work, then that number doesn’t really count. If removing them the next best offer is more like 200, then the range is like 200-600, so the fair value is down to 400.