Efficiency Wage

| 2 Comments | 3 TrackBacks

Here is some anecdotal evidence of the efficiency wage. This is, for those not familiar, when a company pays a higher than market clearing in return for a greater effort from its employees. From this article in LZ-NET.de:

One analyst at Deutsche Bank in the USA is quoted as having said that "it's better to be an employee at Costco, than a shareholder." But if one takes a closer look at the economic indicators for both companies it becomes clear that the analysts are actually wearing blinkers. Despite paying higher wage costs, Costco is much higher on productivity. Sam's Club turnover of USD 35 billion is achieved by 102,000 employees, whilst Costco's USD 34 billion is achieved by only a fraction of that number, 68,000 employees. Costco's productivity per square meter is 54 per cent higher than that of Sam's Club, its productivity per employee is 45 per cent higher, while its profits are almost 24 per cent higher.

Before you start saying "we're all Keynesians now", a couple of things need to be pointed out. First, Costco formerly went after a higher end clientele, not everybody could join. The result of this discrimantion is that the company has a substantial higher per check out ticket than its competitors. Second, Costco may pay a higher wage, but their workers may be higher skilled as well. In reality, each companies workers may be receiving the same pay rate for the amount of skill they have. This is different from saying that you could pay the the Sam's Club employee the same as Costco and get the same level of productivity. Costco, by paying more, attracts and retains better employees. The article tries to point this out:

Wages and fluctuation

Employees like Costco not only for its good wages but also for its generous healthcare benefits. They are not only highly motivated and productive, they are also loyal. The fluctuation rate is only 6 per cent, compared to Sam's 21 per cent. Even Wal-Mart knows that a change of staff costs 2,500 dollars per person, and this then adds up to USD 50 million each year.

The reaction of the Wall Street analysts to the figures published by Costco's were not primarily aimed at penalising a company for stepping outside of the ranks of wage cutters, it was all about the interests of the Costco shareholders.

Their numbers don't seem right. 21% turnover of 1.4 million workers at $2,500 per employee would mean that this costs them $735 million a year. If they had a 6% turnover, it would be $210 million a year for a savings of $525 million. As this PDF points out, Costco does achieve a higher level of profit per employee. For Wal-Mart to achieve the same level of profit, they would need to cut the number of employee and raise the remaining one's pruductivity. Is that possible with their current workforce? I don't know and it is beyond the scope of this post. However, as I write this, Bloomberg is flashing across the bottom of the screen that the company is planning to raise the starting wage.

3 TrackBacks

Costco vs. Sam's Club Wages from Always Low Prices -- Always. on June 4, 2004 8:37 AM

Just wanted to point out Bob Arne's excellent post comparing CostCo and Sam's Club wages (and resulting profits) on my other blog Truck and Barter.... Read More

Costco Proves That the Wal-Mart Model Isn't the Only Path to Success from Wal-Mart Beat - The Joe Hill Dispatch journal of Walmart news and activism on June 8, 2004 12:14 AM

Business Week: James Sinegal is the CEO of Costco Wholesale Corp., which compensates its workers far better than rival Wal-Mart Stores does. A recent study by BusinessWeek found that by paying its employees more, Costco gets lower turnover and higher... Read More

Costco Vs. Sams Club from Wal-Mart Beat - The Joe Hill Dispatch journal of Walmart news and activism on June 8, 2004 12:14 AM

Truck and Barter has an interesting post looking at a study by Deutsche Bank on the differences in wages, productivity and profits at Costco and Sam's Club.... Read More



The conventional description of efficiency wages for effort monitoring being an explanation for premium wages being paid for similar jobs by different employers is improbable, at best.

Imagine that all of the potential employees are equally qualified for the job under consideration.
Also imagine that each potential hire comes attached with a 5 year bank CD payable to their employer, but varying in rate of return from 1% to 20%, paid on the amount of the wage premium paid. To the extent that the interviewer can determine the rate of return for a given applicant, he would be willing to pay a premium wage IF the company is profitable enough to do so. The result is that hidden in the employee's paycheck is an allocation of part of company profit in a tax advantaged investment.

Of course, no such bank CD exists, but if the interviewer can rank the applicants in order of possible future value to the company, he should be willing to bid up the wage to ensure that the company is actually able to hire the highest ranked applicant, even if the current job would be satisfactorily filled by all the applicants.

In modern complex companies, variations in productivity are largely the result of differences in the products and the organization of the company itself, and are little affected by the simple productivity of the employees themselves.

Regards, Don

A very interesting way to look at it, never thought of it like that. I was somewhat trying to explain the difference in wages as a result of the business models, but was never able to.


Powered by Movable Type 5.02

About this Entry

This page contains a single entry by Bob published on June 4, 2004 5:58 AM.

Enron Traders and Me was the previous entry in this blog.

Google IPO is the next entry in this blog.

Find recent content on the main index or look in the archives to find all content.