How is that $70,000 Minimum Wage Working Out? Not So Well
Acton Institute Powerblog

How is that $70,000 Minimum Wage Working Out? Not So Well

dan-price-gravityThey say the road to hell is paved with good intentions. What they don’t often mention is that, like a parade route, both sides of that road are crowded with well-wishers cheering you on.

In a country where we give children “participation trophies” for merely showing up and “doing their best,” it’s not surprising that we applaud business leaders simply for “trying to make a difference.” As long as their intentions are good, why should we criticism their efforts?

I was reminded of that pervasive attitude after writing about Dan Price and Gravity Payments. My article in April on “Why the $70,000 Minimum Wage is Doomed to Fail” was the most criticized piece I’ve ever written for this blog. As one commenter wrote, “We just witnessed a CEO become a humanitarian and I’ve never seen so many people wish for his failure.”

This was a typical reaction to the article, and an all-too-common response to any criticism of good intentions, especially in the business world. Merely pointing out that a policy is likely to conflict with the norms of economics and human behavior is enough to get you labeled a cold-hearted pessimistic scrooge. Why focus on the negatives, people say, when someone is merely trying to do good?

The reason, as the old proverb implies, is that when divorced from prudence good intentions can lead us to be worse off than we were before. That was the reason I was critical of Price’s decision to pay every one of his 120 employees a minimum of $70,000 a year. I thought then—and believe still—that is could lead to unemployment for the company’s workers.

However, in my article there was one thing I was clarly wrong about. I assumed the policy would lead to the company’s bankruptcy within 5 years. A new article in the New York Times shows that the company many not last even that long.

The fall of Gravity would be a shame, not only for the jobs that would be lost, but because Dan Price seems to be a charming and humble guy. His reaction to both the praise and criticism his policy has received is refreshing. He even admits that he needs to heed the warnings of those who say he has set himself up for failure.

While it is too soon to say the pay policy has been a complete disaster, there are signs that after only three months it is having a detrimental affect on both Price and Gravity. Price says that he is even renting out his own house to “make ends meet.”

Here are a few of the ways the policy has affected his business:

An increase in new customers — The most common pushback I received to my article was the claim that the positive PR and media attention would lead to an increase in customers for Gravity. And they were right! Before the announcement of the pay increase, the company had been adding 200 clients a month. In June, 350 signed up.

That may sound like an obvious win, but there are many bankrupt business owners (e.g., some who have relied on Groupon) who will tell you that adding new customers quickly can kill a business. Too often, new customers immediately drive up a company’s revenues while the profits follow a long time afterward.

That seems to be the case with Gravity since Price says the new business won’t start paying off for 12 to 18 months. “To handle the flood, he has already had to hire a dozen additional employees — now at a significantly higher cost — and is struggling to figure out whether more are needed without knowing for certain how long the bonanza will last,” notes the Times. The new employees add at least an additional $1,000,000 to the payroll—money that is quickly going out and may never come back in if his new clients drop him after the PR effect wears off.

Employee backlash — The most predictable outcome from the pay change was the inevitable resentment of employees who had heavily invested in their own productivity (e.g., taking out student loans to get a college degree) make the same salary as less invested, less productive workers (e.g., the manager’s assistant who dropped out of high school). So far, at least two of Gravity’s most valuable employees have quit, including a financial manager who helped create the new policy:

Maisey McMaster was also one of the believers. Now 26, she joined the company five years ago and worked her way up to financial manager, putting in long hours that left little time for her husband and extended family. “There’s a special culture,” where people “work hard and play hard,” she said. “I love everyone there.”

She helped calculate whether the firm could afford to gradually raise everyone’s salary to $70,000 over a three-year period, and was initially swept up in the excitement. But the more she thought about it, the more the details gnawed at her.

“He gave raises to people who have the least skills and are the least equipped to do the job, and the ones who were taking on the most didn’t get much of a bump,” she said. To her, a fairer proposal would have been to give smaller increases with the opportunity to earn a future raise with more experience.

A couple of days after the announcement, she decided to talk to Mr. Price.

“He treated me as if I was being selfish and only thinking about myself,” she said. “That really hurt me. I was talking about not only me, but about everyone in my position.”

Already approaching burnout from the relentless pace, she decided to quit.

Even those who received a bump in pay aren’t thrilled by some of the ramifications of the new pay:

The new pay scale also helped push Grant Moran, 29, Gravity’s web developer, to leave. “I had a lot of mixed emotions,” he said. His own salary was bumped up to $50,000 from $41,000 (the first stage of the raise), but the policy was nevertheless disconcerting. “Now the people who were just clocking in and out were making the same as me,” he complained. “It shackles high performers to less motivated team members.”

Mr. Moran also fretted that the extra money could over time become too enticing to give up, keeping him from his primary goal of further developing his web skills and moving to a digital company.

And the attention was vexing. “I was kind of uncomfortable and didn’t like having my wage advertised so publicly and so blatantly,” he said, echoing a sentiment of several Gravity staff members. “It changed perspectives and expectations of you, whether it’s the amount you tip on a cup of coffee that day or family and friends now calling you for a loan.”

Several employees who stayed, while exhilarated by the raises, say they now feel a lot of pressure. “Am I doing my job well enough to deserve this?” said Stephanie Brooks, 23, who joined Gravity as an administrative assistant two months before the wage increase. “I didn’t earn it.”

Inability to pay shareholders and prepare for threats to the business — Whatever the other reasons, a for-profit business exists to make money for its shareholders. Most people (including me) assumed that as a small, family-owned company there was no concern about taking money from Gravity’s shareholders and giving it to the employees. It turns out that assumption was wrong. Dan is being sued by his brother Lucas, who owns 30 percent of the company:

“Dan has taken millions of dollars out of the company for himself while denying me the benefits of the ownership of my shares, and otherwise favoring his own interests as the majority shareholder over my interests.” He said his complaints predated the pay raises.

Even so, they clearly are critical to the outcome. With profits, at least in the short term, shifted to salaries, there is little left over to buy out his brother, let alone pay the legal bills or make longer-term capital improvements in the company, Dan said.

These problems and other that Gravity faces  may not be insurmountable. In fact, Price is likely to implement a policy in the next year that fixes all the problems caused by the pay raise: change the pay policy back to what it was before.

The spotlight is still on Price so he can’t do it right away. But eventually business pressures will likely force him to choose between closing down and rolling back his $70,000 a year minimum wage. When he does I recommend a strategy he should have adopted in the first place: give the employees a cut of the profits.

If you give employees a bonus from the profits, then if there are no profits there is no problem. But if you promise employees higher compensation based on profits, they’ll still expect the higher wages even when the profits dry up. So it’s the compensation structure, not the charity, that makes Price’s policy imprudent.

Employee profit-sharing isn’t sexy, and adopting it as a policy isn’t going to get you mentioned in the New York Times. But it provides incentives for everyone in the company to contribute their labors in way that ensures the company’s survival. In the long run that is a much better strategy than giving employees a steep raise before sending them to the unemployment office.

Joe Carter

Joe Carter is a Senior Editor at the Acton Institute. Joe also serves as an editor at the The Gospel Coalition, a communications specialist for the Ethics and Religious Liberty Commission of the Southern Baptist Convention, and as an adjunct professor of journalism at Patrick Henry College. He is the editor of the NIV Lifehacks Bible and co-author of How to Argue like Jesus: Learning Persuasion from History's Greatest Communicator (Crossway).