Friday, February 7, 2014

What determines the salary of employees

Have you wonder what determines the salary of employees?

In my point of view, the lower limit of the salary is the price offered by employer so that the employee will stay put with the company, and the upper limit is the cost of the company to remain competitive in the business.

If the salary is on the low side compared with market rate, the employee will have a lot of options, including:

  • to join another employer who offer a better package
  • to self-employ
  • to stay at home
If the employer is paying a high salary, the cost of maintaining the company will be high, and that need to be compensated with either one or more of the following:
  • to charge higher price for goods/services provided to customers
  • to tolerate a lower profit margin
  • to cut cost from existing operations
  • to get more customers and/or sell more goods/services to existing customers
If the company charge higher price to customers, the customers might have options to buy from another company, or just not to buy.

If the company tolerate a lower profit margin, that will bring down the net profit, and in turn, lower down the dividend to shareholders/investors.

If the company try to cut cost from existing operations, it might need to sacrifice the quality and/or quantity of goods/services produced, which in turn reduce the customers satisfaction level, and the customers might have options to buy from another company, or just not to buy.

So, it is a rule of thumb that salary cannot be too low, or else the employees will part away. At the same time, it cannot be too high until the business is unsustainable.

The salary is indeed directly related to the productivity of the employee. A productive employee will be able to help the company generates more quantity and quality of goods/services that is saleable to customers, which can realized into sales and profit.

So, its seems that the only feasible option for sustainability is "to get more customers and/or sell more goods/services to existing customers" which needs to be backed up by the productivity of the employees. If the employees are not productive enough, the employer will need to hire more employees, which will then share out the HR salary budget of the company.

The more productive employees deserve higher salary, because competitors are willing to pay for that to bring over the employees to work with them. The supply and demand in job market will naturally drive the salary of productive employees.

In the investment world, there is a common indicator called Price/Earning (P/E) ratio to evaluate the worthiness for investor to buy and hold a share. Perhaps in the mind of the employers, there is also a Salary/Productivity ratio to evaluate the worthiness for the company to employ and maintain the employee.

As an employee, if you want to have high salary, then you need to:
  • be productive
  • join a highly productive company that is very profitable (driven by its productivity)
If you are not very productive and get a high salary, the good time might not be for long. If your company is very profitable but not supported by productivity, the good time might also not be for long.

During the 80's when Dr. Mahathir just became the prime minister, Malaysia is on the right track by emphasizing on productivity to boost the nation's economy, particularly the GDP. It seems that the current government has completely lost track by intervening the pricing of certain goods/services (instead of letting the free competition supply-demand factor to drive the price), intervening the salary with minimum wage, intervening the supply-demand by imposing restrictions that is non-productivity related, etc. Is there any hope that we will be on the right track again, and who will be the long waited hero to put back the right track in place?


Peter Yew said... Reply To This Comment

The only hope lies with a change of government, fast.

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