By now you've likely heard of Dan Price, the founder and CEO of a Seattle-based credit-card-payment processing firm Gravity Payments, who announced earlier this year that he was raising the company's minimum salary to $70,000 a year.
That move was met with overwhelming enthusiasm by many both inside his firm and out. Perhaps you've also read that things aren't working out so well for Gravity or Mr. Price. Two key people have left the firm--disenchanted by the idea that many employees got their salaries doubled while they experienced little if any increase. The CEO took his salary down to $70,000 as well (from a reported $1 million per year) and is now apparently struggling to make ends meet. Pundits and critics are all weighing in on the wisdom (or lack thereof) of the approach.
There is much to learn from the $70,000 salary story, so let's examine what happened.
The motivations and rationale driving this CEO to make the changes he did in compensation were rooted in some popular premises. The idea is that pay is not a motivator--and that leveling salaries puts everyone on an equal playing field. It's a bit of utopian approach that seems good in theory but doesn't play itself out so well in real life. There are essentially four reasons why the Seattle company's approach is failing:
- A Flawed Philosophy. For Gravity's pay approach to work, two things have to be assumed: 1) All employees contribute equally to creating value for the company, and: 2) People are not concerned about the relationship between what they contribute and what they earn. There are few if any instances where either of these assumptions are valid (maybe in a non-profit, charitable organization). Instead, companies need to be able to define what value creation means to the business and how and with whom it will be shared. If increases in compensation aren't linked to value creation, they're unsustainable.
- An Inherent Unfairness. I'm sure if you're making $35,000 per year and you suddenly hear your salary is being raised to $70,000, you're pretty stoked. But what if you're making $70,000 at the time of the change--and your salary isn't doubled--or even modestly increased? Further assume you're the type of employee who works more effectively, stays longer hours, manages more people or otherwise makes a greater contribution than others earning the same amount you do. What are you feeling? As you look around and see people slacking (compared to you) but still earning the same salary as you, are you not just a little peeved? Unfairness is felt at a visceral level and becomes very toxic very quickly.
- A Mediocrity Bias. An equalized pay system appeals to sub-standard talent and encourages mediocre performance. The evidence? Two key people are leaving the firm because they perceive their value to be greater than their pay reflects. Compensation is a tool that is used, in part, to communicate what kind of partnership you want to have with your employees. Catalysts, those who can make a difference in pushing you towards your growth goals, are looking for a relationship between the value they create and how they are paid. If that relationship isn't aligned, catalysts will leave. They know they can find it elsewhere--even if it means they need to start something on their own. So they go--or perhaps never join the firm in the first place.
- An Assault on Profits. When compensation instead of profitability drives decision making, the latter will suffer. You can't divorce the pay discussion from the production and allocation of profits, because margins matter and pay increases impact margins. Instead, there needs to a proper evaluation of the level of profitablity that has to be achieved for certain pay standards to be maintained or improved. Modeling that tests various scenarios before pay levels are altered is an essential part of the compensation engineering process.
Compensation is strategic issue for an organization. It communicates such things as what's important to shareholders, what an employee's role is in the business model, why profits matter and how the business grows. It should elicit an ownership mindset, one where employees become stewards of the shareholders' vision and growth goals. An egalitarian approach such as the one Gravity has attempted--noble as it is--cannot achieve any of those outcomes. It may make some feel good for a short period, but then cracks in the culture emerge.
Ultimately, pay needs to strike the right balance between guaranteed and variable pay as well as between short and long-term value sharing. Value can only effectively be shared if a business has clearly defined value creation thresholds for owners and articulated a compensation philosophy--one that clearly delineates what the company is willing to "pay for." Instead of trying to solve income inequality by equalizing salaries, organizations should be learning how they can multiply wealth for all stake holders. A rising tide lifts all ships.
In the meantime, we wish Dan Price and Gravity well. If they need help restructuring their pay approach...well, we'll certainly take their call.