JUNE 2007: ECONOMIX, STATEWIDE ECONOMIC ANALYSIS
By Eric Fruits
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Pay me what I’m worth, or else
Many years ago, I was in my first management job as a senior
managing economist. The problem was that I was under 30, so I
wasn’t very senior, and I also didn’t manage anyone
(and I certainly didn’t manage any other economists). So
I asked my boss what sort of management activities I could take
on. Ten minutes later, I was managing a group of approximately
10 research analysts — mostly 20-somethings just out of
college.
It just so happened that my new duties coincided with the
beginning of the annual review process. The first thing I
learned was that every 20-something knows precisely how much
his or her peers are being paid. There are no secrets. The next
thing I learned was that everybody believes they deserve a
raise. The justifications are many:
“I had a 4.0 in college.”
“The other analyst is getting a raise.”
“Our competitor pays more.”
“I’m the only analyst who can do
statistics.”
After about two weeks of relentless badgering about raises, I
sought advice from my boss, an economist through and through:
“What do you say to an analyst who wants a
raise?”
His response: “I’d say ‘Hold me
hostage!’”
When he saw the confused look on my face he explained that if
someone has a hard-to-find skill or exceptional expertise, you
want to keep that person. That person adds the most value to
the business and should be first in line for a raise.
Economic logic dictates that those who add the most value to
the firm ultimately get paid more. In my field, it’s
tough to find someone who can do statistics. Someone with such
rare skills has a lot more leverage than someone merely with
good grades.
Economics tells us that sometimes it’s optimal to hold
your customers hostage or to be held hostage by your employees.
Unique skills benefit a business because the company’s
competitors can’t duplicate the products or services it
provides the market. Just as an employee with unique skills has
leverage over his employer, a firm with unique products or
services has leverage over the market. This leverage produces
more sales or lower costs. Either way, it improves the bottom
line.
Take a look at some of the better-performing Oregon companies.
What sets them apart? In most cases they provide unique or
highly specialized offerings that are in high demand. For
example, Portland’s Precision Castparts has seen its
stock price approximately double in the past year. It provides
complex metal components and products for the aerospace and
industrial gas turbine industries. The booming world economy
has, in turn, led to a boom in aerospace. The nation’s
search for more — and cleaner — sources of
electricity has led to a boom in the construction of gas-fired
generation plants. The complexity of Precision Castparts
products means that competitors cannot easily duplicate them.
This buffers the company from the intense competition faced by
those who produce dime-a-dozen products.
Seattle-based Starbucks, on the other hand, can’t buffer
itself from increasing competition. Consequently, it’s
seen its stock price drop by about 20% in the past year.
Starbucks has always faced competition from other specialty
coffee shops. Recently, though, everyone seems to be getting
into the good-strong-coffee game. McDonald’s is the most
recent high-profile entrant. It gave its test kitchen and
market research team the task of making the “best”
cup of coffee.
As a result, the company made headlines when Consumer Reports
announced McDonald’s won its taste test. Will people stop
going to Starbucks because McDonalds makes a better drip
coffee? No. But this battle showed that anyone could make a
good cup of coffee. And when anyone can make a good cup of
coffee, Starbucks’ leverage erodes. On the other hand,
Starbucks has a defensible brand — no one goes to
McDonald’s to take in the music and ambience.
Beaverton-based Nike is perhaps the quintessential Oregon
company that has used branding as a way to gain leverage over
the market. The Nike brand adds value to otherwise mundane
sportswear. This leverage has been translated into stock
returns. Since going public, Nike has vastly outperformed the
S&P 500.
Branding, however, is not the easiest path to outperforming
the market. Both Starbucks and Nike have spent decades building
their brands. The dot-com bust is littered with the corporate
carcasses of companies that thought they could build a brand in
weeks rather than years. (Exhibit A: Pets.com.)
Many business books are about team building. And many career
books are about self-esteem. But most of the books that
aren’t about team building or self-esteem are, in fact,
about hostage-taking. They tell businesses to produce the
product, develop the service and find the niche in which your
business has some leverage in the market. They tell individuals
to learn the skills and develop the network that give you
leverage in the workplace.
In an economic version of the Stockholm syndrome, customers
don’t mind being taken hostage if they are getting
something special. Similarly, employers don’t mind being
taken hostage if they are getting added value. There is no
king’s ransom with competition: You get what you pay for
and you pay for what you get.
Eric Fruits is a senior
economist at Portland consulting firm ECONorthwest and an
adjunct professor at Portland State University.
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