How would companies respond to all employees being eligible for overtime compensation payment, as compared to only some employees being eligible?

Question

My world is set in present day to near future North America. The political and economic landscape is similar to what it is now.

Background

There are two primary models for paying employees, the first of which is on a pure hourly basis where the employee is paid only for as many hours as they work, no more, no less. If the employee works more than 40 hours a week, their hourly rate increases to their base pay per hour plus half their base pay (time and a half). In some circumstances, they make double their hourly rate (double time).

The second approach is to negotiate a yearly salary where as long as the employee comes to work they will make their salary. Often, sick time and vacation benefits are included in this salary.

From the company's perspective, a salaried employee is a known, invariate cost. This payment model works well where the workload from year to year, and day to day is stable. On the other hand, if there is a large swing in workload on an hourly basis, or seasonal basis, it doesn't make sense for a company to pay lots of employees to sit around doing nothing. Hourly employees give them the flexibility to meet their needs without spending too much during low demand. When demand is high, wage costs are higher because of overtime but income is higher too so it works out.

However, there is an exploit in this system. Companies, with an eye towards profit, will not hire new salaried employees to match growing demand unless absolutely necessary. However, the work still needs to be done but it is instead distributed over an insufficient number of employees. Salaried employees are pressured via a variety of means to work lots of unpaid overtime at the expense of their leisure time and their health. In short, they pay large costs to maintain their jobs while their employer makes profits on essentially free labor.

This pattern of unpaid salaried labor grows to be very pervasive and so exploitive that a national movement gets the labor laws changed to where salaried employees are also eligible for overtime. No other changes are made to the labor laws. (For the sake of simplicity, no other changes to labor law will be made for the next five years.) The law takes effect on January 1st of the year after next. (So if the law was enacted in July 2015, it comes into effect on 1 Jan 2017.)

Question

As the CEO and board of directors for a large, high skill, services company, how do you respond to this change? You have 10k salaried employees and 5k hourly employees. A recent survey indicated your average employee works 55 hours a week and takes only half of their allocated vacation time ever year. Annual earnings are 5 billion dollars and profits of 500 million dollars.

In the short term, your labor costs may skyrocket because previously externalized costs are reinternalized.

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Constaints

I'm primarily interested in how the Board and executive team respond to the change in terms of what policies they might implement and the effects of these policies on employees. Impacts on the broader economy are outside the scope of this question. Assume that earnings stay about the same for the next five years.

Answer 1

Is the board a bunch of heartless, money-grubbing exploiters of the working class? Given their treatment of the salaried employees, this would seem to be the case, and if the condition of the salaried has persisted for a long period they probably are invested (professionally and emotionally) in the status quo. Actually, it doesn't matter. The company is about to suffer catastrophe, and almost any strategy to get around the new laws needs to be considered.

Your numbers are incomplete. I assume you mean that the salaried work 55 hours a week, while the hourly only work 40. Let's assume that the effective base pay is the same for both groups. Then, using an example of 10 dollars/hr, and a 2:1 salaried/hourly ratio, weekly labor costs for the hourly class is 400, while the salaried are paid 800, and the average pay is 400 per employee. If the salaried are now paid overtime, the cost for the salaried jumps to 1400, and average wage becomes 600 per employee, a 50% increase.

Since this is a high-skill company, let's figure on labor at 50% of total costs. Doing 5 billion in business will now require 3.75 billion in labor costs rather than 2.5, and profit drops from 500 million to minus 750 million. Running -15% profit margins is not sustainable even in the medium run (short of the dotcom boom startup behaviors)

In this case, an obvious strategy is to coerce the salaried employees to ignore their legal rights. It should be made clear to the salaried employees that those who insist on being paid overtime will not have their contracts renewed at the end of the year. This is a fairly delicate operation, particularly in light of the fact that political opinion is apparently in favor of the salaried, as evidenced by passage of the new law. It will also be necessary to get rid of the hourly employees, since their differential treatment will be a constant source of friction, and will serve to remind the salaried how badly they are being treated. As a practical note, it seems unlikely that this strategy will succeed in a company this large unless there is severe economic pressure on the salaried to stay with the company (In Thucydides terms, it won't work if the labor force is mobile). There are simply too many individuals to expect that none of them will blow the whistle on the illegal practices.

New contracts will feature markedly lower hourly rates, and managers will be ruthlessly culled.

At the same time, every opportunity will be taken to cut costs and increase productivity. As has happened in the US with constantly rising health costs, medical benefits should be reduced as much as possible. Depending on the industry, a major effort to replace workers with robots and other forms of automation should be embarked on, wherever significant long-term cost savings can be realized, and the fact that labor costs are about to jump by about 50% suggests that there is ample opportunity. Note that China is doing exactly this, despite the existence of labor costs which are much lower than in the US. These efforts will be aided by the fact that the salaried do not, apparently, have an effective union presence, although this may change.

Answer 2

I think it shouldn't matter on the long run.

The question specified a company in a high-skill sector, so we can assume that all the employees can read a contract and do basic mathematics. Both salaried and hourly workers can look at their average annual pay and their average annual working hours and do the numbers. If they don't like them, they can negotiate a raise or take their valuable skills elsewhere.

The exploit you mention doesn't have anything to do with salaried vs. hourly contracts. It happens when the economic situation is so bad that the highly skilled workers you talked about can't find other, more equitable job offers. Or if they don't realize that they can do that.

Edit: I'm in a job where I make less money than the industry average for less stress and fewer hours than the industry average. I could find more money for more work, but I like it the way it is.

Answer 3

I assume that as a CEO, your first priority is the success of the company for the foreseeable future (as opposed to, say, a political agenda of enforcing some form of social justice amongst your employee, or maximizing the price of your stock options on the day they vest, etc.).

One obvious choice you need to make is whether to keep working hours as long as they are now and pay employees more accordingly, or pay no overtime and thus receive less hours of work from each employee, or something in between. If you get less work in total from the employees, you have a choice between doing with less work and recruiting more. In addition to the effects inside your company, you need to think about what other companies do: if they implement different policies, that may affect how attractive your company is for the best-performing employees.

A key factor is productivity. If your employees work less but equally productively, you get less work overall. But what if employees work more productively for less long? Does productivity depend on the number of hours worked?

The answer has been known for a long time: long hours reduce productivity. So much, in fact, that typically high-skill employees working 40 hours a week produce more per week than employees working 55 hours over a sustained period! For low-skill work, productivity tapers off at a lesser rate, so working extra hours isn't useless but spreading the hours between more workers pays off.

One famous study on the topic is one by Henry Ford. Henry Ford was keen to improve productivity of his factories, and is well-known for pushing the assembly line mode of production. But he also settled on a 40-hour week (at the same pay as the former 48-hour week!) and found that it increased productivity, with a side benefit of making his workers more likely to buy his products.

Ford was not the first to observe that longer hours hurt productivity. Pre-WWI German scientist and entrepreneur Ernst Abbe introduced a 8-hour work day, and found that production increased from the former 9-hour day. Other studies on the topic show similar effects, such as a recent study about productivity of munition workers during WWI. A 2013 OECD study studying hours worked yearly against GDP and in OECD countries found a steady decrease in GDP per hour worked, to the point that people working more hours per year are fairly consistently less productive per year, not just per hour.

The upshot is that it is in your best interest to stamp down on overtime. This is the case whether the law takes effect or not. Cut working hours, and you probably won't need to hire much if at all.

One thing you'll need to watch out for is company culture, especially among management. Since employees working longer are regarded positively, they're likely to keep working long hours, even if it actually kills their productivity. So make sure to enforce those working hours and vacation time. Having crunch periods can be useful; to ensure that they aren't abused, impose a total number of hours worked per year, so that the occasional crunch is compensated by more time off during slow times.

There's a risk that some of your employees will try to work around this policy, especially in middle management. In a high-skill industry, projects tend to be shared between many people, so it's difficult to quantify how much value each employee produces. Hours worked is a simple metric: if Bob wants a promotion, it's rare that they can easily make a good claim that “I earned the company X millions”, but “I worked X hours” is easily verifiable. With the new law, you should be rid of employees getting promoted solely on the basis of the hours they stay at their desk. You now have the opportunity to find and impose ways of evaluating how well employees actually work. Plan the way you're going to bring the company's management into that new culture.

All in all, that new law gives you the opportunity to do something that's beneficial to the company, but that may be difficult to impose otherwise.

Answer 4

We see this already in the form of contract employees; people who theoretically do not belong to the company at all, but are contracted to the company for a particular job or period of employment.

The most extreme form would be in the entertainment business, where gaffers, carpenters, cameramen, even the talent and the director are hired for the duration of the production and then let go.

This is also common practice in service industry (people who drive for Uber are contract employees, as are most of the staff at Canadian banks, to use two examples), so companies can simply contract more or less labour as the demand changes. This is often known as the "gig economy" and may represent the future of employment for millions of people around the world as the economy fragments and moves to smaller, more ephemeral "companies" which may resemble movie studios; forming production companies to do particular pieces of work, then releasing the contracted employees once the project is done.

An alternative is an employee shareholder corporation, where everyone is given a small base salary, and share in the profits of the company at fiscal year end when dividends are declared and paid out. Long term employees and people in management positions will tend to have more shares (and the principals most of all), so the share out of the profits will still be based on factors like skill, time in "rank" and position and what levels of authority you have within the corporation.

Labour and capital are quite mobile these days, so the passage of laws like the ones postulated in the question will simply drive away many companies and the workforce will attempt to follow the work, rather than stay and starve. One might note that attempts to impose "millionaire taxes" in some US States results in a dramatic drop in the number of millionaires in the jurisdiction (they either leave or game the system so they are no longer "millionaires" according to the tax code), while "Living wage" legislation results in smaller employers shutting down or downsizing as they are unable to meet the wage costs imposed by legislation. Even Obamacare is responsible for a massive downsizing in the US economy as business reduces headcount to escape the Obamacare mandates (the "49ers" as Obamacare applies to business with 50 or more employees, and the "29ers" as Obamacare covers people who work 30 hours or more a week).

So heavy handed attempts to manipulate the market forces of employment will generally have worse effects than simply leaving things be and letting the market clear (if you don't have enough workers to do the job, you either have to scale back or hire more workers. If there are a lot of people needing workers, the market price for labour (wages) will rise. Most of the time you find exceptions to the rule, you also find some sort of legislative or regulatory obstruction to the market clearing mechanism).

Answer 5

To complement the excellent answer by @Thucydides (e.g, the most realistic scenario for a knowledge based company would be to simply change primary employment jurisdiction to a country with different labour laws - as many of them have a lot of experience with from outsourcing and international campuses. Intel, Microsoft, Google etc... all have non-USA campuses galore, as do the likes of Goldman Sachs):

The company would try to rationalize resource allocation and labour division:

1. Attract top star talent (they would be salaried, and their salary would be a very good investment due to the share of IP and human capital they bring). Basically, Google model - note that they already pay pretty well for their top-flight talent (20% projects, perks on campus, high salaries).

2. Rebalance back towards heavier emphasis on performance bonuses and even equity awards (e.g. lower base salary, higher bonus).

   • Performance bonuses are awarded for contribution to bottom line, independent of hours. They are a pretty hard art/science to get right, but they are possible to get right with effort.

   • Equity awards got de-emphacised in 2000s, because of a series of accounting and tax scandals. It may very well get back in vogue as their economics improve in light of overtime costs of senior employees.

   • Truly high-performant employees - and those who put in meaningful overtime are a large chunk of them - would appreciate those bonuses more than overtime pay (say, you work 25% more hours than 40 hour week, for 50 total. If you have a realistic shot at 50% performance bonus at the cost of your annual base salary being slashed 25% to keep salary costs down, you may likely agree).

3. Also, as Google does, focus on less tangible benefits.

   Many will take less salary if I'm provided with a company swimming pool, or ping pong table, or subsidized bicycle parking, or other perks.

   Many more will take less salary if they are officially allowed to openly contribute to open source projects (for programmers) - it raises their own human capital value AND tickles their fancy.

4. Reallocate lower-skill tasks to lower-skill, lower-paid employees.

   Personally, 20-30% of my own workload last week was spent doing BAU, lights-on, red tape, and other similar tasks that could very likely have been done by a lower-level employee. I don't have such a resource right now, since the company would spend more money hiring an extra employee, and I put in that 20% overtime. BUT, if they had to pay that 20% extra overtime, you bet my senior management would higher junior employee to take those tasks off of me; AND/OR hire extra developer resource to automate some of those manual tasks. Hire an extra Administrative Assistant for our team to take admin load off of ALL team members, not just Director level ones.

5. As mentioned above, increase automation and productivity.

   It takes a lot of time to do things manually that could be automated - sometimes, because the team that could automate them has no resources to get to lower-impact automation requests. Automated voice transcription of meetings. Entering settings for 60 items I own piecemail, because the app for maintaining the settings has no functionality for bulk load from spreadsheet or applying identical setting to 15 things at once. Siri/Google-Now personal assistant that would do all the admin work for registering my vacation day automatically (enter into HR system + set out of office in Outlook + OOO on phone + entry in team calendar + entry in my own calendar + entry in project plan resource availability). Possibilities are endless, and today are largely not pursued because it's easier to have me stay 30-120 minutes late every day doing those tasks.

6. On the "tighten the screws" side, track ONLY your productive time.

   Track how long you spend in the toilet (think it's ridiculous? Bloomberg company reportedly did just that, at least around 2000s). Track how long employees spend on Facebook etc... and subtract that from billable hours.

7. Focus project management and resource allocation on only highest-payoff investments.

   I am currently responsible for 4 projects. 1 of them is a project that would likely not make all that much revenue/cost difference, even if it succeeds. Yet I still spent hours of billable time on it, because some manager or another liked the idea (THIS app should look THIS nice way. Literally. Just prettying things up, no big usability/productivity gains).

Answer 6

I think what you'd see is the hourly wage for salaried employees drop. Or at least, effectively drop by a decrease in the frequency and amount of raises. This would continue until the total amount spent on personnel was what the company was willing to spend on personnel originally.

So employees in a firm who work an average of 45 hours, for example, would find after a few years of being paid for 'all' 45 hours, that their income really hasn't increased. Some exceptional employees who put in ridiculous hours, like 60+, might make out better - assuming the employer allows them to work that many hours.

Basically, it would be a feel-good measure, but ultimately not change much.

One other thing to consider is this would likely mean all 'salaried' employees (who aren't really salaried any more) would need to track their hours. There would be compliance costs for doing this. Even if a only few minutes a week, multiplied by 90 million employees, it's a lot of lost productivity to the economy.