In an interesting Freakonomics podcast, authors Levitt and Levine discuss whether expensive wines are worth the price. Their conclusion: They are not.
Here's an example of an interesting experiment. Participants were asked to rate two different wines. All they knew was that one was a $10 bottle and one was a $50 bottle of wine, when in fact it was the same $20 bottle. The participants overwhelmingly chose the $50 bottle as having the better taste. Interestingly, some participants asked the testers if it could, in fact, be the same bottle of wine. When told that they'd have to decide for themselves, most of them reached the logical conclusion that they had to be different wines because of their different pricing — so they rated the more expensive wine as better.
Here's the point: We often value things more simply because we pay more for them. If this holds true for wine and cars and dates, then why wouldn't it be true for employees? Employers have tried to tweak compensation systems from Day 1. What's the right mix of compensation to help generate the greatest return on investment of an employee or workforce? Because it's a mistake to underpay or overpay employees, how do we decide just how much to pay?
A three-part solution
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1. Identify the market rate. What does the average employer pay for a certain level of employee? You can learn this from government labor statistics, state labor agencies, salary survey sites, or your local employers' group. In my experience and opinion, to pay anything more than about 25% above grade is essentially throwing away money.
For example, in the fast food industry if $8.50 is the norm, it might make sense to pay $10.50, as some employers do, or the premium that other large employers pay. However, it doesn't make sense to pay even 1% above grade if it's not going to buy you a more productive employee. Perhaps there are other ways to attract productive employees, such as offering a more flexible schedule or a distinctive workplace culture.
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2. Think team bonuses. When I perform employee surveys at companies, I always ask whether employees prefer incentives based on individual performance, on that of a team, or of the entire company. Over the years, I've found that where there's a great deal of trust, people prefer team-based incentives. If trust is low, they prefer individual incentives.
As an owner, if I wanted to help generate trust, I would offer team-based incentives. As the saying goes, "A rising tide floats all boats." I would recommend a bonus (for example, a percentage of net profits) and then distribute it based on employees' gross compensation. For example, if one employee makes $50,000 per year and another makes $25,000, the higher-paid employee gets twice the bonus. This simple formula avoids wasted time trying to finagle small percentage differences. If an employee displays outstanding performance, the chances are that they're in line for a raise or promotion; this is how you manage going forward.
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3. Award people immediately on an individual basis when they go the extra mile. According to Barber's 1001 Proverbs, "The greatest benefit is the one last remembered." Don't underestimate the power of rewarding what you want to reinforce and doing it immediately.
These rewards need not be expensive; they're as much about acknowledgment as they are about money. Of course, a little bit of cash helps too.
Frequently Asked Questions
How do I find the correct market rate for a role?
Use a mix of sources: government labor statistics, state reports, industry salary surveys, and local employer groups to estimate the typical pay for the role and location.
When are team bonuses better than individual bonuses?
Team bonuses work best when trust and collaboration are high and when contributions are interdependent; individual bonuses suit roles with clear, independent performance measures.
What are low-cost but effective ways to reward employees immediately?
Public recognition, small spot bonuses, extra time off, or meaningful written appreciation can reinforce desired behaviors without large expense.
How should I handle pay for top performers?
Consider promotions, meaningful raises, or targeted incentives that align pay with sustained higher performance rather than one-off premium salaries.