Category: compensation

Do This, Not That: Market Versus Social Norms

Dan Ariely makes a distinction between market norms and social norms in the fourth chapter of Predictably Irrational. He touches briefly upon the way that employers mix their messages, dangerously breaking social contracts and making things about money when they are attempting to lead a socially-driven organization.

As the book documents, operating on market norms (i.e., thinking about the money I’m getting in return for the activity I’m doing) can damage productivity even when compensation is considered adequate. But worst of all, it can damage relationships when we assumed we were operating on higher terms–social norms like trust, reciprocity, and friendship. And we can’t mix the two: once we perceive that our efforts are being valued according to market norms, that’s the mindset we use for the entire interaction.

The next era of commerce will not be kind to organizations that depend on market norms, except as perhaps a back end, business-to-business protocol. For the most part, those things that are driven by competition, price, and data can be outsourced to computers and become a secondary function of people-facing businesses, businesses that use humans for those things humans are uniquely capable of accomplishing.

If you’re still using market norms to run your business, it’s best to start weeding them out now, before they relieve you of all your self-motivated people and leave you with half-hearted key-punchers.

Here are a few “do this, not that” guidelines for common business practices:

  1. Pay healthy salaries, don’t track hours. Some businesses require hour tracking, but to the extent that it’s possible your people shouldn’t identify the time they put in with dollar amounts. Doing so puts them in a market mindset: Am I getting enough money to be worth what I’m doing? Paying healthy salaries instead removes market questions from their minds, and has the potential to make the rare transformation of money into a social contract: the business is a community that takes care of your needs, rather than an employer compensating you for your activity. This is the genius behind Netflix’s policy to pay employees as much as they would pay to keep them: there’s no need for employees to ever negotiate salary or think about how much their work is worth, so they operate on a basis of trust and social contract rather than constantly competing with the employer for a fair wage. Even better if employees have direct deposit, where the money simply appears in their accounts as if by magic.
  2. Appeal to social contract, don’t talk about money. It should go without saying that you should never bring up the fact that you’re paying an employee, or use money as a bargaining chip for a change in behavior. They’re already aware that a threat to their position in the community is a threat to their livelihood. Focus on the social contract rather than the monetary transaction. Are they letting down their co-workers? Are they hurting their ability to make a difference in the organization? Talk about those things. If you have to mention money, it’s already a lost cause. (If they’re the ones bringing money into it, you might as well address their concerns–they’re already thinking in market terms. Take it as a form of feedback on your ability to keep market norms out of your business, and consider whether the issues raised might affect other people as well.)
  3. Make your people financially secure, don’t cut costs at their expense. If your employees have to be worried about paying the rent, covering bills, and eating, then they are already thinking about their jobs in terms of market norms. If you’re going to employ someone, make sure you’re ready to pay enough that they don’t have to be concerned about the basics of life. That includes health care, child care, and retirement. Ariely and James Heyman report that people who perceived themselves as paid inadequately lost as much as a third of their productivity at a very simple mechanical task (forget creative problem solving), and that’s without factoring in any worries about feeding their children. And if Costco is any indication, paying a living wage is a clear path to sustainable business.
  4. Share successes, don’t pay bonuses. This is a tricky one: Traditionally, bonuses are the way you share successes. But paying bonuses can create a clear line between the actions of an employee and the money, turning the action into market-regulated action rather than social-regulated action. There are different ways of accomplishing essentially the same thing. One is to reframe the concept of compensation entirely, as with my post on taxation. If employees interpret the amount they earn not as a payment from you but as something they are accomplishing with you, it may be possible to avoid activating market norms. Another way is to award the bonus as an in-kind gift–but this is fraught with pitfalls. Having the employee choose the gift causes the employee to think about the monetary value; choosing the gift for the employee puts one in danger of choosing something the employee doesn’t want or need; and having co-workers choose may invite comparison and market-norm thinking among the co-workers.
  5. Show loyalty, don’t dig moats. There are already a lot of financial obstacles to leaving a job. Creating new ones causes your people to think about the job in terms of their financial need instead of thinking about the social contract. Instead, you should make it as easy as possible for them to leave–and challenge yourself to convince them they shouldn’t. To the extent your people feel that they are with you by choice and not by necessity, they will be more likely to act on social norms instead of market norms.

It can be difficult to manage the financial needs of the business while operating on social norms, but undermining the social norms can quickly undo all the effort you’ve placed into creating them. If you start by thinking of your organization as a community, a family, or a nation, you will be on more solid ground. And when in doubt, leave the money out of it.

Are Your Taxes Too High?

Many business owners and investors stand squarely on the side of tax cuts. Their belief is that taxes are too high and should be reduced to encourage economic activity. And yet many of them fail to apply the argument to their own nations.

“Wait–taxes?” you say. “I don’t levy taxes.”

With the invention of capitalism, economists re-branded feudal taxation as “harvesting excess value.” But wages can also be seen as a reverse tax on the value produced by workers: where a feudal lord might take a certain amount or percentage, the capitalist allows an employee to keep a certain amount.

This reverse tax was an important invention when capitalism was conceived. It allowed people who didn’t create revenue directly (in the form of crops, manufactured goods, etc.) to create new kinds of value, particularly value that could only be created in concert with other specialists. In turn, workers were given a stable wage and economic and seasonal fluctuations were (in theory) absorbed by the capitalist. So a business became a kind of micro-socialist system within the larger context of capitalism.

Employees are, by and large, grateful for this micro-socialism: generally speaking, employees prefer to have stable paychecks, benefits, and job security–and if they don’t, they can always start their own businesses. But trying to squeeze every cost-saving measure you can out of your employees can be counter-productive, in the same way that increasing taxes can be counter-productive when there aren’t meaningful benefits to match.

While many entrepreneurs face the problem of not paying themselves enough, there are some who pay themselves far too much. And as the size of the company slides upward, owners and executives tend more and more frequently to be out of touch with how much they are taxing their employees–and the cost to their businesses.

This brings up two relevant issues from the world of economics and policy:

  1. What is the appropriate level of taxation to maximize revenue?
  2. What social programs are meaningful enough to justify taxation?

The appropriate level of taxation to maximize revenue follows what is known as the Laffer Curve (although the idea goes back to Arthur Pigou). The basic idea is that tax revenues at 0% and tax revenues at 100% are both zero (which is not entirely accurate, but close enough to be useful). That means that somewhere in between 0% and 100%, there’s a point at which you would receive less revenue if you either increased or decreased taxes, because increasing taxes would discourage revenue-earning activity and decreasing taxes wouldn’t result in substantively more revenue-earning activity.

The second question belies the fact that the peak of the curve can be shifted by many variables–and in fact is always shifting. One of the ways you can create a positive shift–that is, justify increased taxes while also increasing tax revenue–is by implementing meaningful social programs. In the politics, these social programs can be controversial, but in the operation of a business, they are relatively standard: health benefits, flexible hours, etc. They generally fall under the HR umbrella, but can also fit into support departments like printing, IT, and so on.

By this point you may be thinking this over-complicates the issue. The conventional wisdom is that labor is labor, and you compensate people based on the work they do and how well they do it–a simple transaction of value for money.

However, conventional economics has this one wrong. The emerging field of behavioral economics recognizes that not just incentives and disincentives, but context, internal motivations, values, ethics, biases, and other factors affect behavior. When you hire someone, an hour isn’t always an hour. The amount their work is taxed, the context in which they operate, and their emotions toward their work and employer will affect their behavior.

Given this knowledge, you could go with a more libertarian approach–give as much back to your employees as possible–or you could choose to go full socialist.

Lately, many organizations are going full socialist, including The Container Store and Wegmans Food Markets. In addition to providing great benefits, they’ve absorbed nearly all possibility of layoffs, and almost exclusively promote from within rather than recruiting experienced hires.

Netflix employes a different model of socialism: They pay literally top dollar–as much as they would offer to keep you if you got a job offer somewhere else. Management helps you if you’re in a slump, and if your skills just don’t fit the needs of the organization anymore they offer a generous severance package, including placement assistance.

There are two interesting traits in these socialist models: they all experience an increase in revenue that more than makes up for the reduction in employee taxes, and none of them offers the outrageous benefits offered by Google or other Silicon Valley heavyweights.

Which brings us to the question: What makes a meaningful social program (a.k.a. benefit)? Google is famous for having extravagant campuses with free meals, on-site massages, and a host of other benefits. But these only provide minor incremental value because they are simply “free stuff.” The same is true if you give your employees gift cards or tickets to a sports game. These aren’t really fostering a better environment, they’re just “free stuff.”

Meaningful social programs remove obstacles and increase feelings of security and freedom. They promote stability and peace-of-mind, they remove distractions or red tape, and they let you know that if something happens–if you have a child or have to take care of an elderly parent, if you have a bad quarter or even a bad year, etc.–your organization has your back. Each program must have a specific intent behind it that removes worries and stigma, provides a safe environment, or better enables problem solving and innovation. Especially for those who are budgeting a start-up, let these criteria be your guide.

For a lot of people reading this, extravagant social programs won’t be within the realm of possibility anyway. You might already be paying your employees less than they could get somewhere else. But it’s not so much an issue of whether you’re paying them less–so long as they’re able to cover their cost of living–but whether you’re taxing them fairly and giving them the tools they need to close the gap with what they could earn elsewhere. Help them–or sometimes just free them–to create new value and bring in new business. Not every potential employee will be excited about the idea, but the good ones will see the opportunity and jump for it.

There’s a lot more to be learned from macroeconomics and tax theory if you have a large business or your business is growing, but I’d love to hear your thoughts and answer any questions in the comments.