Today we are going to discuss the issue of “why don’t greedy companies pay their employees higher salaries?” I have been hearing this a lot lately, both in my personal interactions and in the media. So, bear with me why I try to explain this issue in the simplest terms possible. I am struck that surprisingly few people understand the basics of how businesses work, so I will be trying to do a little educatin’.
I have started several small businesses. I have also worked in a corporation where I had to hire and fire people. So, I have first-hand knowledge of how small businesses work and how large corporations work.
Again, bear with me, but I think we need to first define what a job is. A job involves one person renting out his time and experience to another person or group of people. It is a voluntary transaction that is mutually beneficial. So, if you have a job where you work 40 hours a week and make $40k per year, you have made a voluntary decision that it is worth trading your time, which is valuable, for money, which is also valuable.
Let me emphasize the voluntary nature of this transaction. Unless you are a slave (in which case send me an email so I can find a way to help you), you have voluntarily decided that at the time you took the job it was the best thing available. You have free will. When you took the job, you could have decided to take another job, start your own business or not work at all. Nobody forced you to take that job (again, unless you are a slave).
The same principle applies to the poor people working at McDonald’s making $7.25/hour. At the time they took the job, that was the best thing they had available. Of all of their possible life-choices, that minimum wage job at McDonald’s was the best one.
So, why does McDonald’s pay such a low wage? People can’t live on $7.25/hour, right?
Well, the first point is that many people at McDonald’s are in high school or college or are just starting out their careers. So, relatively few of them are actually “living on” $7.25/hour. Many of them probably still live at home or in dorms rooms. They are doing what all employees are doing. They are renting their time (which is valuable but less valuable because they have relatively few skills) for money, which is also valuable.
But let’s say that there is an employee at McDonald’s who is trying to maintain a family on his own. How is it “fair” that he or she is making so little money?
The first point to understand is that most McDonald’s are franchises. This means they are actually not owned by the huge corporation McDonald’s but instead are owned by small business people. What they do is they pay McDonalds a franchise fee and either buy an existing McDonalds or build a new one. The McDonalds corporation charges a monthly fee to these franchise owners.
Starting a McDonald’s franchise is expensive. A good rule of thumb is that you probably want to have at least $100k cash to start the business, and perhaps a lot more if you are building a new McDonalds. And there is no guarantee you will be successful. As anybody who has driven around town knows, there are all kinds of fast-food competitors. As anybody who has started a business knows, you could spend money opening the restaurant and not be successful and lose all of your money.
So, the franchise owners expect a return on their investment. They didn’t invest $100k so they could spend the rest of their lives making $20k/year. They invested the money (and took the risk) so they could make a good living.
Each McDonalds employs dozens of people. Labor cost is your biggest expense. You pay what the market will bear. If you can’t hire good people at $7.25/hour, you may need to pay $9/hour or more.
True story: during the 1980s economic boom I spent a summer in Massachusetts working for the Boston Globe as a business reporter. This was the summer of 1984, and Massachusetts was going through a golden period. There was virtually no unemployment, and McDonalds franchise owners were having problems hiring people. They used to advertise starting salaries to get employees. When I got to Boston in June, they were advertising $6/hour, but by the time I left in August the pay was up to $7 or $8/hour. This is probably the equivalent of $16/hour or more today. The owners were desperate for employees and were in a bidding war to get people to work. But note: a hamburger in Boston in 1984 cost a lot more than a hamburger someplace where the labor market was not so tight. All fast food restaurants had to raise their prices to make up for the higher pay for the employees.
So, why do people work at $7.25/hour at McDonalds today? Because the economy stinks. It may be the only job available.
Point number one: if you want McDonalds to pay more money, you need to favor policies that will cause unemployment to go down so franchise owners will be forced to pay more.
Point number two: franchise owners are simply business people trying to run the business the best they can. They might bring in $1 million per year for their restaurant, but again they have to pay some of their monthly profits to McDonald’s, they they have to pay for maintenance of the building, then they have to pay for the products, etc. And of course they must pay for their employees. They have a manager and several assistant managers. They are constantly worried about their property being stolen by unscrupulous employees. Most franchise owners work in their restaurants, often 12 hours/day.
These hard-working franchise owners are not millionaires (for the most part). They constantly fear competition. They are worried that people will prefer Burger King or Wendy’s or In N Out (my personal favorite).
Could these franchise owners pay their employees more? Sometimes yes, but again you need to consider the fact that many of them took out loans to come up with the $100k franchise fee. If they don’t pay their loans, they will lose their business. In addition, franchise owners have their own families and their own bills to pay.
So, let’s say a kind-hearted franchise owner pays his employees $15/hour because he believes nobody can live on $7.25/hour. There are probably some franchise owners who do this, but most of them don’t. He may think it is a wise business decision: perhaps you get better, more productive employees who don’t steal as much.
But let’s say all of the other fast food restaurants in town keep wages low. What happens when the economy goes south? What happens when people stop eating at McDonald’s and start eating at In N Out? The franchise owner must either 1)fire people 2)cut wages or 3)go out of business.
The reality is that small business people who stay in business are always worried about such eventualities. It simply does not make sense to pay people much more than what the market will bear. You are taking a risk that you may lose your business and all of the money and time that you have invested.
Point number three: paying what the market will bear is a prudent move for business owners if they want to stay in business long-term. It may seem “mean” to pay such low wages, but the reality is that in a competitive marketplace it may be the only way you can stay in business.
And lastly, point number four as a reminder: the employee agreed to take the job because it was the best thing available at the time. If the employee does not like the job or the conditions, he has two choices: 1)ask for more money or better working conditions or 2)find another job. Remember, this employee is part of a voluntary transaction where he is renting his or her time and skills for money. Note the word “voluntary.” Nobody owes you a job.
One last point: in this environment, it is easy to see why minimum wage laws are extremely foolish. The franchise owners are working with very small margins. They have XX amount to spend on salaries, and they will not spend more. So, if you can employ 50 people at 7.25 /hour and the government says you must pay $10/hour, what do businesspeople do? They fire people. Minimum wage laws cause higher unemployment, hurting the people they are intended to help.