more-arw search

The Changing Economics of Employment

This year will be remembered as the year the economics of employment changed greatly; and the following year will be the year the impact of these changes will be absorbed by businesses.  New regulations cover areas such as minimum wage, employment practices, overtime, background checks, and employee classification, i.e. independent contractor vs. employee.

With any regulation change there are three separate cost levels – cost of review – every entity assumes the cost of reviewing the requirements to understand if they apply to their situation; cost of planning - If the regulation applies, costs include developing an approach to implement, communicating the approach, and if required, training; and finally, cost of implementation - the actual financial impact of the change, which varies based on your organization.  New regulations are expensive.

To add to the complexity, labor laws are predominantly established at the state level.  If your entity transacts business in three states, three sets of rules will need to be considered.

For most organizations, employment costs are the greatest component of total expenses.  Unlike other inputs in the production process – salaries increase annually, but never decrease; when prices rise you cannot quickly reduce use of the resource or purchase the resource from an alternate provider; you pay for the resource, even if you do not fully utilize it; and unlike other inputs, emotion can play a part, i.e.  morale can be a great motivator or great hindrance to the entity.

Focusing specifically on the minimum wage.  A great number of states have increased the minimum wage, but not just for this year.  Several states have a schedule of increases, over time.  To put numbers around it, a $1 increase per hour equates to approximately $2,000 per year in increased employment costs per employee, i.e. $1 * (35 hours * 52 weeks) = $1,820.  The balance will come from employer paid taxes.  For a business that is people intensive, the added costs can be great.

“…the company’s program to raise hourly wages accounted for 75% of the lowered earnings target. He said the company expected to spend an additional $1.2 billion on wages this fiscal year and another $1.5 billion in fiscal 2017.”  (Wall Street Journal, 10.14.2015, Wal-Mart Lowers Sales, Earnings Outlook)

In the long-run, these additional employee expenses should benefit the entity through increased productivity.  A well-paid and well-trained employee works more efficiently, stays on the job longer, and provides better customer service, i.e. is more productive.  At the company level, when productivity improves, fewer resources are being used to produce the output.  Fewer resources equates to lower production costs, which translates to excess funds in the form of profits, for reinvestment into the business or distribution to investors.

However, in the short-run costs will be incurred prior to experiencing the benefits.

So when you raise wage, where does the money come from?  Options to pay the increased wage to your employees are as follows –

  1. Increase the price of your product/service and maintain your profit margin – if your industry is highly competitive, clients may not wish to pay the increased price and leave you to go to a cheaper alternative;
  2. Reduce the reward to investors, partners, owners through reduced dividends; or,
  3. Decrease the average annual raise to higher paid employees – this approach may work in the short-run, but until you can correct the issue, every employee that did not receive a fair increase that is representative of their contribution is a flight risk.

More than likely the increased expense will be absorbed through a combination of the strategies.

Now may be the time to examine your staffing to ensure that it is at the proper level –

Do you have more staff than you need to achieve your business goals?  More importantly, are you receiving the value from these employees that match or exceed the compensation you pay?   Do you still need the contract, temporary or part-time employees (if applicable)?

When costs increase, we are forced to address issues that may have been overlooked previously.

Finally, if your entity does not have any employees that are paid minimum wage, you may not be directly impacted by this change.  However, you will be impacted indirectly.  If your vendor’s costs increase due to these changes, they will attempt to pass the additional expense to your entity.

As such, once you complete your employee review, you may wish to also review your vendor spend.

Editor’s Note: Regis Quirin is a financial executive and author with 23 years of corporate experience.