What’s the worst thing an employer can do to employees? Excluding things that are illegal, unethical, immoral or unsafe, the worst thing might be to pay them significantly more than a market-rate wage. We can see people’s hands going up volunteering to receive that type of harsh treatment, but the results can be devastating for the employee.
A market-rate wage is the amount of compensation that employees could reasonably expect to earn if they lost their current job and had to find work. It is what the market would pay someone with their education, experience and skill. A problem arises when employees are paid 50 percent or even 100 percent more than they could get elsewhere. If you think that doesn’t happen, guess again.
The Overpayment Trap
In most cases, people don’t recognize that they are overpaid. It’s human nature. Most of us believe that we are worth more than we are being paid. At most, we think that we are paid fairly. It is a very unusual person who recognizes that their compensation is well above what they could earn elsewhere.
Often, overcompensated employees, not recognizing the precariousness of their situation, build a lifestyle that cannot be sustained by less than their current income. Even if they know that they can’t replace their income, most behave as though they can. People stretch to buy the biggest house for which the bank will approve a loan. They buy new cars with debt, and they leverage themselves to the hilt. Spending on extras chews up cash, and savings are minimal. Often, it takes their current income just to service their debt.
Overpaid employees create a lifestyle based on
income they'd be unable to replace.
Then, the unthinkable happens. It could be a plant closing, a layoff or perhaps an employer who finally realized that they could replace overpaid employees at a substantial savings to the business.
Here's an example: A company that operated call centers wanted to be on Fortune magazine’s list of best places to work in the U.S. To achieve this, they offered above-market-rate compensation, extremely generous benefits, three to five weeks of vacation and numerous other perquisites such as “fun days.” The company made Fortune’s list. Then, the economy turned down and things got tight. A bright analyst figured out that the company could save millions by outsourcing its expensive call center operations; the party was over. Paying significantly above market rates to employees who cannot justify the premium through increased output is not only irresponsible, it’s an abrogation of a public company’s fiduciary responsibility to its shareholders.
Earnings Misperception Perils
Most people who find themselves out of work will try to replace the income they have lost. They believe that they can because they think they are worth what they were making. Refusal to accept lower-paying jobs lengthens unemployment and makes matters worse. They try to hang on to the lifestyle they built, not realizing that they will not be able to attain their former level of income.
Cars are repossessed, homes go into foreclosure and marriages have broken up under the stress. In one particularly sad case we know of, a person committed suicide.
Blue-collar employees are not the only ones subject to this phenomenon. Many white-collar professionals have met the same fate. Having worked very hard for years to make it, they proceed to build a lifestyle that requires their current level of income to sustain. Too often, when the ride is over, their world comes crashing down.
Doug and Polly White are principals at Whitestone Partners, a management consulting firm that helps small businesses build the infrastructure they need to grow profitably. Polly served as the head of HR at several midsize companies; her expertise is in people management and human systems. Doug began his career with McKinsey & Co. and then worked as the CEO or COO for a number of small and midsize businesses. His areas of focus are strategy, operations and finance. They are co-authors of the book Let Go to Grow (2011), which explores why some businesses thrive while others fail to reach their potential.
Effectively Managing Base Pay: Strategies for Success, SHM Research Articles, January 2010
Building a Market-Based Pay Structure from Scratch, SHM Research Articles, December 2008
Rewarding Employee Contributions, Not Job Titles: A Base Pay Strategy to Retain Peak Performers, SHRM Online Compensation Discipline, January 2007
Job Evaluation and Market Pricing, SHRM Research Articles, July 2004
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