Pay for performance is perhaps the most obvious way, but the way that we reward people shapes their performance. But it's not the only way. In fact, it turns out that how much we pay people also helps to shape their alignment with the organization. How should we set wages? Let's step back a minute and think, as we're trying to pay people, what's the right level to set that pay at? If we take economics, we start fiddling around with our demand curves and supply curves and thinking about where they cross. Basically to say that we want to think every dollar that we put on pay, that's a dollar straight out of our pocket. In higher wage bills, we want to think about what the benefits are. From supply and demand perspective, the benefit is if the pay goes up, I'm going to attract better people, I'm going to attract more applicants, so I need to offer a certain amount of pay in order to fill the job, and they're probably going to stick around slightly longer. I might set my pay in that way thinking what's the market wage, the wage at which I'm paying just enough to be able to get people and hang on to people. In principle, I might think that's the profit maximizing wage, that's how much I want to pay. But there is some evidence that actually I might get benefits from increasing pay beyond that level. That there are other ways in which higher pay benefits me because of the way it increases the motivation of my people. What are the reasons for that? There are two reasons why higher pay might increase people's motivation. One of them is what economists sometimes describe as efficiency wages. This idea that wage doesn't just shape who comes to work at my organization, but the efficiency with which they work there. Obviously, an important source of motivation in any job is the fear of getting fired. Unless we do the things that our employer wants us to do, they might decide they'd be better off with somebody else. We'll show up on time, follow instructions and so on. I need to want to hang on to my job. Well, if my employer is paying me just enough to keep me in the job, then the value of keeping my job might not be that high. If they're paying the market wage and lots of other employers are, if I lose my job here, I'm going to walk across the street tomorrow, and chances are I'm going to get a job that pays the same wage. If I don't pay very much, then the value of hanging on to my job is low. In that case, how hard am I really going to work in order to try and retain that job? Suppose though that my employer increases my wage. Suppose now my wage is substantially more than I could expect to get if I went out and looked for a different job tomorrow. Well, now my calculation is quite different. If I lose my job, I'm not going to do nearly as well somewhere else that I might go. I want to hang on to that job. If that means showing up on time, I'm going to do it. If that means following all the procedures carefully, I'm going to do it. If I have to be nice to customers, okay, I'll even do that. The more that I pay, the more I can expect my people to do in order to hang on to their job. Let's go to the economic rational version of that. There's a more psychological version as well as idea of social exchange. When we think about pretty much any interaction between two peoples in exchange, you've a conversation. I praise you, you praise me, I give you information, you give me information. Certainly, work is an exchange. I provide services for you, you provide me money. Well, one of the key ideas of exchange is we expect balance. In fact, anthropologists claim that when they look at all of the different cultures that have been studied around the world, there are only two norms, two basic beliefs that are common to all of them. One of those norms is importance of reciprocity. That I expect other people to treat me the way that I treat them. This applies to pay as well. If my employer is paying me the bare minimum to persuade me to come to work, then that's transactional. What my employer is saying is, I'll pay you as little as I can get away with, just as much as you require. My response then in order to remain balanced is, great, and I will do just enough work to hang onto my job and just as much as you require and no more. If on the other hand I feel that my employer is being generous, if my employer is paying me substantially more than they need to, then I feel I need to reciprocate that generosity. Then I in turn feel like you're helping me, I want to help you. I don't just want to do my job, but I want to make sure this works out for the employer as well. That pressure of social exchange, that reciprocity also means that as pay goes up, we expect employees to care more about the organization and be more aligned to it. You see a lot of employers trying to offer more generous wages, more generous rewards on the basis that doing so also creates a workforce that's much more willing to do what it takes to make the organization successful. Thinking about levels of compensation, I've suggested that it's not just about setting pay as low as you can get away with, but how generous employees perceive your pay to be is going to have a big effect on their motivation. The extent to which they're trying to meet your goals and how they do their job. In thinking about how they assess generosity though, it's important to understand there are many different factors that go into that assessment. Some of the most important of those are not just the rewards that they're receiving but also the rewards that other people are receiving. When I think about my relationship with my employer, are they treating me well? Well, partly how they treat me relative to what I would expect other employers to give me. But a big thing I care about as well is, how are they treating me relative to the way that they treat other people? Any of you who have small children will be pretty familiar with this idea that they could have more than one small child endlessly hearing, it isn't fair. Why is James got this and I've only got that? We're used to hearing that. It's hard-baked, hard-wired, definitely baked into the way that we see the world. Turns out it's not just us. If you have a spare moment, I strongly encourage you to Google the words macaque, it's a kind of monkey, M-A-C-A-Q-U-E, and the word cucumber. Look at any YouTube videos on that. I promise you, you won't be disappointed. May get some strange ad served to you by Google, I suspect after those two words, but there are some great videos looking at fairness among monkeys and how important it is to them. For all of us, these questions of equity are important. It means that as you've said pay, one thing you want to bear in mind is, does this seem generous relative to what employees think they could get from other employers? But also, do they feel that they are being paid adequately relative to what other people are getting? Now, that doesn't mean you need to pay everybody the same. We tend to think about it in terms of these balanced relationships. I care about balanced framework I'm giving you as an organization and what you're giving me, and I expect to see a similar balance for other people. If somebody else is clearly much more valuable to the organization than I am, I'm happy for them to get paid more. But if I feel I'm providing similar value to the organization, I expect to get paid similarly. If I think I'm more valuable than somebody else, well then, in order to be fair, I think I should get higher rewards. The importance of maintaining the sense of equity, the sense of fairness, can really come back and buy organizations. A nice example of this comes from Walmart. I mentioned before in these videos, Walmart, I think historically had this reputation for not being a particularly generous employer. For a while, they had a strategy really very much based on cost minimization. Over the years, that has shifted. I think as they saw some of the costs to their customer service, to their logistics, to their brand of that cost minimization, they shifted to taking investing in their workforce much more seriously. I think also among senior management, there's been the sense that as more stuff moves online, it becomes more important to persuade people to enter stores, and actually having better customer service matters. There's a big part of that has been actually invested in raising wages. The way they frame this initially was raising the minimum wage. There's also a lot of political pressure on large stores who often don't pay that well, you need to be doing better for people. Around 2015, they put in a program to raise wages for the lowest paid people in their stores to ensure that everybody was being paid above a certain minimum. Sounds crazy. Everybody should be happy, you're getting a pay raise. Very nice. Turns out some people were unhappy. Even though nobody lost money under this, those people who were being paid just above the minimum started to feel that was unfair. As far as they were concerned, they'd worked a number of years at Walmart, they'd accrued seniority. Because of that seniority, they had certain rewards that have gone into their pay. These new people are coming in. They didn't have the seniority, they were being paid less. Then some in these new people, their pay goes up to very close to the more senior people. They didn't put in those hours, they didn't earn those rewards. The more senior people thinking, "Well, what's in this for me? How come I'm not really getting rewarded for the fact that I have all of this additional seniority?" People care about those differentials. It really didn't lead some serious unhappiness amongst some of the more experienced workers. You see other employers trying to avoid this. Starbucks, very similar set of dynamics. Starbucks, big coffee shop in the US, very large workforce, worried about pay rates, and wants to make sure they're increasing the pay. They framed this as making sure that everybody is paid above $15 an hour, getting everybody above some minimum wage. But they haven't done this by just saying, "We're setting a floor." Because doing so creates these problems of not having sufficient differentials across jobs. Instead, the way they've gone about it is by giving everybody a pay raise. Increasing the rate of pay for everybody in their stores 10 percent, 11 percent a year. Even slightly more for people who've been there for more than three years on the basis that doing so eventually brings everybody up above this $15 an hour minimum they think is important, but continues to maintain these differentials so that people also think there's fairness in pay. Those people who've contributed more, who are more valuable to the organization are being paid more. Pay setting is somewhat complex. It's not as simple as just paying whatever wage it takes in order to bring in enough people. Instead, you want to think about the effects of pay. Also on, are people going to want to stay in the job? Is this job valuable enough that people feel is worth their while to work hard to stay in it? You want to think about the effect on social exchange. Do people feel that you're generous enough and treating them well enough, that they feel in return, they want to work hard for you? You want to think about these differentials. People are going to compare their pay to the pay of those around them. If they feel they're contributing more, they will expect to be rewarded more. They certainly don't want to feel they're being rewarded less than other people who are making comparable contributions. I'm not saying managing any of this is easy. There are a lot of different pieces there, each of which needs to be managed carefully. But if you don't pay attention to these different factors, chances are, you're likely to run into trouble. Paying careful attention to getting those pay levels right is important to maintaining a motivated workforce.