Because most philosophies that frown on reproduction don't survive.

Wednesday, August 12, 2015

Why Gravity is Having Trouble with its $70k Minimum Wage

Back in April I wrote about one of those stories which launched a thousand hot-takes: The CEO of Gravity, a small (120 person) credit card processing company in Seattle, had decided that he would establish a $70k minimum wage for his company, both as a blow against income inequality and because he's read some research that raises up to the $70k threshold have a much bigger impact on personal happiness than raises thereafter. This caused a massive media sensation, and a lot of people thought that it said something Very Important about where American business was heading and how much could be achieved if only CEOs were less selfish.

Gravity employees aren't all making $70k yet, although the news it all at once the company plan which was put in place phased the wage increases in over three years. However, some employees have already seen raises of around $10k/yr and the company is experiencing significant transition pains, and the NY Times has an interestingly detailed follow-up story describing them.

A number of pieces were written at the time criticizing Gravity Payments' move. One that I linked to and discussed was by Joe Carter writing at the Acton Institute, whose piece was descriptively titled: "Why the $70,000 Minimum Wage is Doomed to Fail" It presented two main arguments. First, that Gravity Payments would lose business to competition, since any company which had a lower average wage and offered the same service could easily take customers from that. Second, that those currently making less than $70k/yr in pay were probably providing the company with value below $70k, and so therefore these employees would become net losses to the company, and thus the most likely to be cut when the company ran into financial problems.

Since I deal with pricing analytics professionally, this kind of story fascinates me. However, I took a bit of issue with Carter's approach in that while at an Econ 101 level, his criticisms are accurate, it's a lot harder to know whether these specific problems will apply in any given real world situation.

Recently I did a pricing analysis on a fairly small company which sells consumer electronics. They have four main models of their product, and their product is fairly unique. There aren't direct competition for their products, although they do, of course, face what we call "share of wallet" competition, which is basically to say that consumers have to decide whether to spend money on their products or on some other thing that they might buy which isn't in any way a similar product in function, but is also a kind of cool household gadget which people buy when they have the money for discretionary spending of household electronics toys. The results that I came up with were that they should significantly reduce discounting (and thus in effect increase price, on average) on their most expensive models. The reason is that their most expensive models were selling more than their middle priced models with similar features. This suggested that a lot of consumers perceived the value of the top model as being significantly above it's price. If they increase the after-discount price on this top model, more consumers would trade down to the mid-range models. They would have a more even distribution of sales between their models and higher profits overall. Now, normally, if you increased the price of a product by 20-30%, you'd expect to lose a lot of sales to competition. Indeed, even a very small increase can cause a lot of people to buy less or to move to competition in a highly competitive area. This is why the editorials we read every so often explaining that all McDonald's or Walmart has to do in order to pay all their employees better is increase prices by 5% show a lack of understanding of what happens when retailers like that increase prices. (A few years back I did pricing for one of the big three fast food chains, and believe me, small price increases can cause big reductions in purchasing by consumers.)

While there are a few basic economic tendencies which are at play within most pricing questions, it takes a lot of familiarity with the specifics of a given company's situation to understand which ones will be at play and how. This made me hesitant to confidently assert that Gravity would run into problems because of its $70k minimum wage, because I didn't know the dynamics of the particular business in question and whether this unusual approach to compensation would work. (The answer to whether this could work for all companies is simple: No.) Reading about how things have worked out thus far, I think it's interesting that none of the problems are of the simple Econ 101 type which were being predicted. They're mostly far more human.

The first major impact was simply the onslaught of attention. CEO Dan Price admits that he partly made the move in the way he did in order to score some positive publicity, but it's hard for anyone to predict the kind of pressures which a news story going viral can produce:

The move drew attention from around the world — including from some outspoken skeptics and conservatives like Rush Limbaugh, who smelled a socialist agenda — but most were enthusiastic. Talk show hosts lined up to interview Mr. Price. Job seekers by the thousands sent in résumés. He was called a “thought leader.” Harvard business professors flew out to conduct a case study. Third graders wrote him thank-you notes. Single women wanted to date him.

What few outsiders realized, however, was how much turmoil all the hoopla was causing at the company itself. To begin with, Gravity was simply unprepared for the onslaught of emails, Facebook posts and phone calls. The attention was thrilling, but it was also exhausting and distracting. And with so many eyes focused on the firm, some hoping to witness failure, the pressure has been intense.
But any plan that has the potential, as Mr. Price has put it, to “set the world on fire,” is bound to make some people squirm. Leah Brajcich, who oversees sales at Gravity, fielded complaints from several customers who accused her boss of communist or socialist sympathies that would drive up their own employees’ wages and others who felt it was a public relations stunt. A few were worried that fees would rise or service would fall off. “What’s their incentive to hustle if you pay them so much?” Ms. Brajcich said they asked. Putting in 80-hour weeks after the announcement, she called the mistrustful clients, stopping by their offices or stores, and invited them to visit Gravity to see for themselves the employees’ dedication. She said she eventually lured most back.

Some customers didn't like the move, either because they saw it as endorsing politics they didn't like or because they saw it as embarrassing them by making them look greedy for not making a similar move. Others worried that despite promises to the contrary, Gravity would increase its fees to cover the expense. The attention got Gravity new clients (they nearly doubled their usual number of new customers in the month after the announcement broke) but because of the startup expenses of getting a new client launched those new customers won't actually be profitable for Gravity for about a year.

It sounds like one of the things which both led to the salary increase and also to the problems coming afterwards has been the personality of Mr. Price. He apparently got in arguments with some other business owners about the move:
Roger Reynolds, a co-owner of a wealth management company, said his discussion of the pay plan with Mr. Price got heated. “My wife and I got so frustrated with him at a cocktail party, we literally left,” said Mr. Reynolds, who complained that Mr. Price unfairly accused him of measuring his self-worth solely in terms of money and trying to hold somebody else down. Everyone may have equal rights, but not equal talent or motivation, Mr. Reynolds said. “I think he’s trying to bring in some political and aspirational beliefs into the compensation structure of the workplace.”

But he's also had problems in his relations with some employees:
Mr. Price’s drive to succeed, fierce commitment to help small businesses and exacting standards attracted other business-minded idealists. Some even took pay cuts to work at Gravity. Keeping an existing client is more important than getting a new one, he decreed. Never make a caller hear more than two rings before picking up.
Maisey McMaster was also one of the believers. Now 26, she joined the company five years ago and worked her way up to financial manager, putting in long hours that left little time for her husband and extended family. “There’s a special culture,” where people “work hard and play hard,” she said. “I love everyone there.”

She helped calculate whether the firm could afford to gradually raise everyone’s salary to $70,000 over a three-year period, and was initially swept up in the excitement. But the more she thought about it, the more the details gnawed at her.

“He gave raises to people who have the least skills and are the least equipped to do the job, and the ones who were taking on the most didn’t get much of a bump,” she said. To her, a fairer proposal would have been to give smaller increases with the opportunity to earn a future raise with more experience.

A couple of days after the announcement, she decided to talk to Mr. Price.

“He treated me as if I was being selfish and only thinking about myself,” she said. “That really hurt me. I was talking about not only me, but about everyone in my position.”

Already approaching burnout from the relentless pace, she decided to quit.

The problem here seems dual: On the one hand, as someone putting in a lot of time and effort she sees it as unfair that there will be very little money available to provide raises to her and other top performing employees as the company struggle to meet the new salary commitments for lower level employees. On the other hand, that might have been smoothed over had Dan Price (doubtless also under long hours and mental pressure himself) been able to better handle his discussion with her about her concerns.

Perhaps most cripplingly for the company's financial future, however, has been a falling out between CEO Dan Price and his brother Lucas Price who owns 30% of the company. There are apparently long been tensions between the two brothers, and the pay increase (which in the short term may take the company's profits to near zero, before building back to profitability, according to Dan Price's plan) was apparently the last straw. Lucas is suing his brother demanding to be bought out. Since Dan has just committed to take the company's profits down, and has cut his own salary in order to help finance the salary transition, he's short of money with which to buy his brother out.

Another interesting take on the wage increase comes from an employee who doesn't want to find himself trapped at Gravity by the high pay:
The new pay scale also helped push Grant Moran, 29, Gravity’s web developer, to leave. “I had a lot of mixed emotions,” he said. His own salary was bumped up to $50,000 from $41,000 (the first stage of the raise), but the policy was nevertheless disconcerting. “Now the people who were just clocking in and out were making the same as me,” he complained. “It shackles high performers to less motivated team members.”

Mr. Moran also fretted that the extra money could over time become too enticing to give up, keeping him from his primary goal of further developing his web skills and moving to a digital company.

And the attention was vexing. “I was kind of uncomfortable and didn’t like having my wage advertised so publicly and so blatantly,” he said, echoing a sentiment of several Gravity staff members. “It changed perspectives and expectations of you, whether it’s the amount you tip on a cup of coffee that day or family and friends now calling you for a loan.”

A company is built around relationships: relationships with customers and relationships with employees. And in this case, obviously relationships between owners as well. It's not surprising that such a major change has caused turbulence in these relationships, even granting (as so far appears to be the case) that the basic Econ 101 sources of concern are not at play here. If I were to guess what will be the biggest long-running program with the new $70k minimum wage, it will be satisfying the sense of fairness for the people in mid-level positions at Gravity, people who currently make more then $70k and thus don't stand to benefit from the new regime. Often, especially in a young startup company like this, those positions are held by people who voluntarily put in a lot of extra hours and effort, both because they take a lot of pride in doing good work, and out of a desire to "get ahead". If many of them end up like Ms. McMaster, feeling that they are not getting the raises they deserve because all the money is being spent on bringing low level employees up to the $70k mark, the company is going to have a hard time keeping good talent and thus maintaining its current level of service and growth. One hopes that Price took account for giving those people proportional boosts in salary as well when he was planning the cost of his initiative.

I hope the journalists continue to check in on how Gravity is doing, not because I think they represent a model for something most companies can do, but because it's always interesting to see how real people deal with unusual situations. It will be interesting to see if Price ends up having to change his plans on the new salary structure. While I don't agree with Dan Carter's analysis at Acton on the potential pitfalls of the move, I do agree with his parting thought, which is that if Price wanted to share the profits of his company more widely he would have been much wiser to set up a bonus program or employee ownership program which all his employees could have participated in proportionately. But then, that sort of plan would not have received the nationwide media coverage which the "$70k minimum wage" caused, and Price sounds like he is, like many company founders, something of a showoff.

1 comment:

Joseph Moore said...

This reminds me of my father: He grew up on a farm during the Depression, so 12 hour days of hard labor were nothing to him, in fact, expected. Once he got a regular job with regular hours, he was always taking night classes to add to his skills - he was ambitious. After WWII, he worked his way up to foreman at Kaiser Steel in SoCal - and hated it. Union Shop, so that a guy like him, who could crank out twice or more of the work of the typical worker was treated the same as them. He ended up eventually starting his own company, where he was very successful - and drove most of his employees crazy. (Exceptions: other farm boys and immigrants from Mexico - those guys worked like he did.)

So, yea, predictable problem. I know where I work now, a laid back office, the biggest source of disgruntlement is people getting paid big bucks for doing things with no describable connection to the bottom line. We DO have profit sharing, which makes it all the more painful. Years ago, when I was just starting out here, I put in the long hours and contributed mightily (measured in dollars). These days, watching people here getting as much or more than I do while making no measurable contribution to bottom line makes me very likely to head home right at 5 and count the days until I can retire.