Compensation Waste 101 – When Raising Your Minimum Wage Will Lower Your Costs

Increasing the minimum wage does not improve the skills and contributions of those who currently earn the minimum wage – but increasing an organization’s minimum wage may be essential to achieving needed levels of productivity and performance.   Organizations of all types need to understand, from a business perspective, why being cheap is rarely the right answer.

A company may find themselves able to hire employees at the minimum wage or just above, and justify this based on the need to keep costs low in order to better achieve their mission or maximize their profitability.  In reality, unrealistically low wages will have a negative impact on most aspects of operations:

  • The available labor pool will likely not possess the skills, or the work ethic, to effectively provide the services required of the job
  • High turnover resulting from employees leaving for as little as a few cents an hour interrupts the continuity of services and the relationships between staff and customers
  • The morale of employees who can’t afford a basic living shows up in performance and attitudes displayed toward customers and other employees.
  • The cost of turnover, both direct and indirect, will negatively impact the bottom line and reduce the productivity of employees who remain.

Organizations should consider raising their expectations and concurrently raising their compensation opportunities.  This will almost certainly result in improved productivity and lower overall cost.  Consider a simple scenario.  An organization has ten employees performing “front desk” service activities in a health center, such as check-in, insurance verification, bill payment, scheduling and retrieving medical records.  Traditionally performed by $8 to $9 an hour labor, the roles are very specifically defined to mesh with the skill set available at these wages.  The ten employees may fit into three or more different job descriptions — it is likely the organization will have simplified its jobs over time in reaction to the lower capacity of those it hires at or about the minimum wage.  Turnover is roughly 30% per year (about half again as high as the average voluntary turnover rate in health care), and service is not considered particularly effective.

A change in perspective might result by simply asking the question “if we hired better people, what would we really need to get the job done?”  In most situations, fewer people could do the work of those ten if the jobs were combined and performed by people with more skill.  Higher-skilled, better- motivated employees would require less direct supervision, allowing supervisors and managers more time to focus on other things.  The workforce will be more stable, and better positioned to adapt to change.   All of these would be considered significant improvements worth an investment – but what if these also resulted in reduced costs?

Turnover cost is real, and has both direct financial impacts and indirect productivity costs.  Even using the most conservative estimates of turnover costs, the department described in this article is incurring turnover cost of at least the annual cost of one full time employee.  Creating better paying and more interesting jobs, and staffing them with higher quality employees, is a real way to reduce turnover.  Some scholarly articles allege that higher wages alone do not yield lower turnover rates; however, many of these are focused on broad generalizations of the entire workforce, and ignore the fact that for low-wage positions, the need for increases in pay are paramount at a personal level.  The reality is that when wages are more realistic, turnover is almost certain to decrease, as there will be less pressure on employees to find better paid work.

The current department as described above has roughly $315,280 in employment-related costs:

  • Employee base pay (assuming $9/hour average) – 10 at $18,720 or 187,200
  • Benefits and payroll taxes (assume basic benefits and time off) – 10 at $10,000 or 100,000
  • Turnover related costs (direct and indirect – assume 50% of base pay) – 3 at $9,360 or 28,080

A reasonable organizational analysis could conclude that the work of the ten employees could actually be performed by seven, after duties are combined and higher productivity levels assumed.  Raise the performance expectations bar, and raise the average pay rate by 33% to $12/hour, assume turnover reverts to industry average (20%) and watch costs drop nearly 17%:

  • Employee base pay – 7 at $24,960 or 174,720
  • Benefits and payroll taxes – 7 at $10,000 or 70,000
  • Turnover related costs – 1.4 at 12,480 or 17,472

The new cost of the department is $262,192.  In addition to the lower employer costs, an approach like this makes a real difference in the lives of employees.  Because of the relatively high rates of turnover in these positions, an approach like this can be phased in over time.  Implementation of a new program is simply a matter of identifying the already higher performing individuals and making appropriate adjustments to their expectations and subsequently their compensation.  The remainder of the employees will either rise to the occasion or separate themselves over time and be replaced by higher skilled employees the organization will be able to attract with their new compensation opportunities.

To determine how this might work in an organization, start with a blank sheet of paper in a labor intensive operation.  Without reference to current job descriptions or staff, examine the most effective way to provide the services of that department or operation.  Develop outline or “bullet point” job descriptions, and then use the compensation system, or market surveys if the organization does not have a structured approach, to determine the costs of the employee in each job.  To keep things simple, measure base pay, the average cost of employee benefits, and make a reasonable allowance for turnover costs (half of a year’s base pay is a very conservative turnover cost for entry level positions).

Periodically analyzing departmental structures, without preconceived notions, is an essential element to proper management and compensation planning.  In today’s economy, it is a necessity, not a luxury.  For more information, visit our website at www.mercesconsulting.com, or contact the author at ebura@mercesconsulting.com.


Edmund ("Ed") B. Ura is the President and Senior Consultant at Merces Consulting Group, Inc.  With more than 25 years of experience in compensation consulting Ed works with Boards and Senior Management to identify their needs and develop programs that attract, retain and motivate employees.  Prior to forming Merces in 1991, Ed was a Consultant with TPF&C (now Towers Watson). 

For more information on performance and compensation management contact the author at ebura@mercesconsulting.com, or visit www.mercesconsulting.com.