Efficiency Wages Not So Efficient Anymore

The March 28th online edition of Business Week reports that electronics retailer Circuit City is planning to lower employee wages across the board as a way to reduce costs and boost profits. Faced with fierce competition from long-time rivals such as Best Buy, Circuit City is hoping the wage cuts, along with other structural changes, will allow them to stay ahead of other electronics retailers. (Business Week, 2007)

Previously employees at Circuit City were paid above market, or efficiency, wages. Voluntarily paying higher than average wages has its benefits. First, higher wages attract a better pool of employee candidates. Second, it reduces employee turnover because less people leave for other equitable-position jobs at competing companies. Less turnover leads to a well-trained and experienced sales staff, and eventually more sales. Finally, higher wages gives employees the impression that the company cares about them, which fosters company loyalty and a greater willingness to perform to the best of their abilities while on the job.

In fact, these benefits were taken into account during Circuit City’s decision making process. The retailer realized that the general composition of its sales force would change due to the pay cuts. One major drawback is that the competency of its sales staff will decrease as its best employees leave for higher paying jobs. Also, the time and effort needed to train new employees will undoubtedly have a negative impact on sales in the near future. Because of these changes, “Circuit City is expecting to have consolidated net sales growth of 8% during fiscal 2007, down from the 9% to 10% originally forecast.” (Business Week, 2007) This means that the estimated effect of efficiency wages is between 1-2% of Circuit City’s net sales.

Interestingly, Circuit City does not intend to hire more employees at lesser wages. Instead they will be rehiring the same amount of workers as before. Normally companies that pay above market wages hire fewer employees to keep costs at reasonable levels, leading to less demand but greater supply in the labor force since more people want the higher-paying jobs. Now that Circuit City is lowering its wages to the market equilibrium but keeping the number of employees constant, the demand is not changing, but the supply should decrease because less people will want to work at Circuit City under the new wage structure.

Source:

“Circuit City Cuts Wages to Juice Profits.” Business Week Online. March 28, 2007.
Reference URL: http://www.businessweek.com/investor/content/mar2007/pi20070328_712708.htm?
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