The contentious debate over President Obama's proposal to raise the federal minimum wage from $7.25 to $9 looks like it will only get more heated in the coming weeks. While some polls report more than 70 percent of the general public favors the raise, the issue has split opinions and spurred business opposition from small business owners to retailers to national restaurant associations.
Proponents of the measure emphasize that while millions of Americans struggle to live on $14,500 or less - the annualized rate for a full-time minimum wage earner - corporate bosses, such as Wal-Mart's CEO, Mike Duke, reportedly makes $11,000 an hour. Meanwhile, opponents cry foul over further government intervention, raising concerns that higher labor costs will lead to fewer jobs and reduced hours.
We're neither politicians nor economists so we'll leave the fairness debate over the" living wage" to others. While labor costs seem to be weighing so heavily on business leaders' minds, however, we'd like to highlight an issue that has been mostly ignored so far: most companies don't fully understand their true labor costs.
Most of the industries that pay minimum wage suffer from tremendous employee turnover ranging from 50 to 200 percent. To put it simply, if a company has 100 percent annual turnover in a position, it's essentially hiring two people over the course of the year to fill one job. Now, many conscientious human resources leaders will cite studies showing that replacement costs for workers can be anywhere from 30 to 150 percent of yearly pay. Everybody knows it's a big, expensive problem - they just don't know exactly how big.
We've worked with several major retailers, each with over 50,000 employees, and found that all of them grossly underestimated their labor costs directly resulting from turnover. For one of the companies, a 107 percent churn rate among its part-time labor accounted for more than $150 million in annual expenses once all the costs were fully loaded (hiring, training, on-boarding, separation, etc.). Another company discovered that nearly 50 percent of its turnover happened within the first two months of employment, meaning workers tended to quit just as they gained enough experience to actually be productive. Not only did the company incur big expense as employees came and went, but customer service and sales also suffered.
In industries where minimum- or low-wages tend to be prevalent, labor costs are usually one of the top two or three expenses. We find it mind-bending that business leaders often aren't deeply informed about their actual costs incurred due to high turnover, relying instead on generalized industry figures and focusing predominantly on hourly pay. It's a bit like basing a decision on which car to buy by looking at the sticker price versus calculating the real costs of ownership once gas, insurance and the many other expenses are factored into the equation.
Many retailers can tell you, however, the bottom line impact of increasing wages or adding staff to their labor model. One analysis of Wal-Mart, for example, conducted by Bloomberg demonstrated that adding five employees to each of the company's superstores would increase its selling, general and administrative expenses (SG&A) by 0.5% and reduce the corporate giant's profit by $448 million annually.
Not every company views labor costs so narrowly. Costco, for example, provides a starting pay of $11.50 per hour and offers benefits. Aldi, the German discounter whose parent company owns Trader Joe's, offers cashiers a starting pay of $10.50 per hour. And Zappos, the online apparel company owned by Amazon, pays up to $16 per hour for its call center representatives. Guess what all three have in common? Much lower employee turnover.
These companies have learned the simple lesson that wage increases can be partially offset by lowering employee attrition, leading to a happier, more productive and more knowledgeable work force. Proving this inside a company requires rolling up sleeves and doing some time-consuming analysis, but evaluating the statistical relationship between turnover and financial outcomes doesn't require a PhD. More challenging, once the data is understood, acting on it requires alignment among a company's leaders in operations, finance and human resources. Finally, keeping ongoing focus on improvement goals necessitates metrics that go beyond the outcome (annual turnover) and highlight underlying expenses and productivity measures so leaders can see what's really working.
We're not minimizing the potential impact that raising the minimum wage will have on many companies' profitability, particularly at a time when health care and tax reform may take bigger bites out of earnings. But we'd encourage business leaders to look a little harder at their labor costs to see where they can trim great waste and improve productivity before making a final judgment on what their companies can really afford.
This article was co-authored by Noel Tichy and first appeared on Forbes.com.