It’s been a long time since my last post. Perhaps too long. Things have been busy at Gridstone Research, the startup I work for and blogging had to take a back seat for a while.
So to make up for it, here’s a meaty subject. Why do people in different professions get paid what they get paid? It’s an interesting subject and I thought I would find some research on it on the internet, but I couldn’t. There’s a lot of data on what people get paid in different professions, but the question we are trying to answer is why.
Let’s first clarify the question at hand. We are not dealing with executive compensation here, although that is quite an interesting (and topical) subject in of itself. We also know that in any profession the higher you sit in the organization chart the more you get paid (generally). What we want to compare here is compensation in different professions – investment banking or software sales or retail bank front office – taking out the effect of position and years of experience. We will ignore stock option related windfalls, which are anyway becoming rare. And for this piece, we assume that we are comparing professions in the same city, so there is no cost of living impact on wages.
After all the assumptions in the last para, you are still left with a significant variation in compensation both at entry level (out of college or business school) or at any time marker after that. The question is why? What makes some jobs worth large amounts of money while others are so-so?
Here’s my hypothesis. If the person in a job can directly impact the company’s profit in a significant, measurable way that job will get paid more than someone in a job that doesn’t.
That sounds almost like a truism. But let’s examine more closely what it means. An example will make it clearer.
Take the job of a Portfolio Manager (PM) at a Mutual Fund. The PM decides which stocks to buy, hold or sell for the Fund. He almost entirely determines how the Mutual Fund performs. If the Fund performs well, its shareholders make higher returns than other comparable funds. The word spreads and more money pours into the Fund swelling the management fee that the Fund Management firm charges. The average mutual fund in the US had assets of $1.05B and expenses of 1.25% in 2005. A 25% increase in assets increases the firm’s fees by over $3 million which should largely drop to the bottom-line. As you can see, the correlation between the PM’s decisions and the business outcomes are very high. Also, and importantly, there are few if any other things that matter. Unlike in a manufacturing company where many people contribute to the value and quality of the product, the PM might depend upon the recommendations of the Fund’s Analysts who research companies, but he makes his own final decisions. Random events or luck play a minor role, especially if these events impact the benchmark as well.
The PM’s job therefore fits our criteria perfectly. He directly impacts the firm’s profits in a significant, measurable way. Not surprisingly, the Portfolio Manager for a Mutual Fund in the US is a highly paid job. Many of them take home over $ 1 million.
Sales people in most industries that sell to businesses tend to get paid more. What predictions can one make about compensation in the Sales profession using my hypothesis? A Sales professional will be paid more when Gross Profit (or Contribution) per Sales professional is higher (significant impact to profit). A salesman for Boeing should therefore be one of the highest paid salesmen in any industry. Also Revenue Producers will be paid more in the Professional Services industries where the Partner or the Banker is the product himself. The client often knows and trusts the Partner or Banker and will give him the deal because of him and not the company he works for (direct impact). Therefore, Management Consultants, Lawyers and Investment Bankers all get paid oodles of cash.
A school teacher’s job is a tough one. They mold young minds. A good teacher can be a glorious thing for a young student. What can be more important than this job to both individuals and society? Yet school teachers are paid very little in almost every country. I have often struggled with this paradox. Why wouldn’t we pay school teachers more and get the best we can for our children?
Let’s take a school teacher’s job and evaluate it against the criteria in our hypothesis. A school teacher definitely directly impacts the outcomes for particular students. This impact can be undoubtedly significant. You might decide to become a writer because of a superb English teacher, or totally lose interest in Biology because of lousy one. However, a school teacher in the US typically works for a public (government) school and not for a business. And the outcomes for students discussed above are not exactly measurable outcomes. So a school teacher’s job doesn’t fit the criteria in our hypothesis on a couple of counts. So school teacher salaries will predictably be low, attracting average talent and with lower incentives to excel.
On the other hand, consider the teachers in Delhi’s IIT coaching classes. Their outcomes are very measurable – the students’ JEE rank. The students’ JEE rank drives both the enrollment in the coaching classes and the fees per student. No wonder these teachers can take home as much as Rs. 15 lakhs a year, a salary that an ordinary school teacher in India can only dream of.
I think the hypothesis in general works. But like most things in the complex world of business, it’s hard to make rules stick. There are always eddy currents that produce exceptions. If you find any, let me know.
Maybe something that could be evaluated on the lines of risk?
Maybe like the likelihood of you getting fired/ shot down the ladder if your performance is under par. Or the extent to which your performance can be compared to your peer’s.
Ability to quantify/ monetize outcomes and results. Linked to incentives? Linked to future opportunity? Therefore, if monetary value is lower than usual – you risk losing an incentive.
Maybe the link between the role and company profits AND rewards for risk?
Some more parameters I can think of are closeness to the customer and criticality of the function to the entire organization.
First closeness. A sales person in, say a bank, closes a deal and the operations department executes it. A sales person, obviously gets paid more, in spite of the fact that execution is equally important.
Then, criticality. Consider a sys admin working for a large bank and the same job in a software company which develops enterprise software. Both involve managing a server farm. But, the function in the bank is more critical as it means the bank conducts its business or shuts down for the day. For the same job in software company, it means delay of a day or two in the deadline.
“If the person in a job can directly impact the company’s profit in a significant, measurable way that job will get paid more than someone in a job that doesn’t.”
I must say, I have been waiting for your next post and it makes a very interesting read..
In growing organizations, the impact that job roles(people) can make is tough to measure.. How do one handle it..?
Does the industry has a measurement mechanism in place to realize the value articulation that a person can bring in..?
I am not sure if this happens everywhere but in the era of global organizations where employee strength keeps an upward count daily, it is indeed a challenging task..
As far as comparing roles across industries, more or less we as human beings have pre concieved set of notions which drive us..
A car mechanic is as important as a doctor, its all about life.. Isn’t it..?
But for us doctor is god but a mechanic isn’t
Good one. Agree with you on the economics.
The hypothesis seems to be correct and logical but not exhaustive. It is quite clear that in meritocratic organization, salary is a function of value created. If the value is significant salary also becomes significant.
Now, my point is what happens when the value is significant but not measurable?
Measurability tends to decrease over a period of time. As time goes by, many initiatives and variables affect the outcome. So, if the value is not measurable (due to the outcome after a medium to long lag) will the initiative owner’s salary be low? I do not think so.
Typically roles whose impact will not be significant but with a lag (and hence not clearly measurable) are strategic in nature. Lets consider the roles of head of strategy & planning, head of research, head of product development and head of marketing (not sales). Strategy formulation, cutting edge research, product incubation and brand building can not be directly related to topline / bottomline figures. However, these roles are core of the organization and ensure long term success. Hence the compensation of people in these roles are also quite high (sometimes higher than the ones whose contribution can be clearly measured).
So measurable contribution is good-to-have and not must-to-have criterion for high compensation. Whereas significant contribution is a must-to-have criterion. Successful organizations have a tendency to understand the value of a role irrespective of the contributions being measurable. Hence these organizations compensate competitively the resources creating value in the long term compared to the ones creating measurable value in the short term.
Basab, the school teacher example is a good one. Another example is journalism in particular news media.
The guy who sells ads gets paid more plus, of course a cut of sales. The best journalists though don’t get paid that well because as most ppl know (though journos are still in denial) Dalal Street cares more about profits than path-breaking journalism.
The few journos who can rake in the moolah are those whose brand value is big enough to pull readers/viewers which indirectly translates into profits.
Tom Friedman (though I detest his overtly simplistic views) or Rajdeep Sardesai can command that I guess!
Lets go back to the fundamentals. The sole objective of any business is to make money. And you can broadly classify all jobs in that company as “Core” or “Context” (“Crossing the Chasm”: Geoffrey Moore). And typically an employee who is working in the areas classified as “Core” will obviously get paid more than someone who is working in the areas that are “Context” to that company. Core and Context, as you can imagine, change with every company. Cisco’s context is Infosys’ core…so on and so forth.
So in essence if you want to get paid more, you need to be working in a company where your core competency matches the company’s core competency. For example, If you are a SW engineer, you can work at a SW company (paid more) or work in a hospital (paid less) and that makes a huge difference in salary.
Now, coming to your second part about teachers – the fundamental statement (The sole purpose of a company is to make money…) is not true in the US. It is a service provided by the govt. Hence the low salary. And hence the big delta in pay between private (IIT coaching classes) and public educators…
I know I am oversimplifying..but just another point of view!
Here’s an interesting perspective on this from Forbes. The tournament theory explains why people up the ladder get paid more…
My hypothesis is that it depends on two factors:
1. How much people are willing to pay for the product/service to consume
2. The scarcity of people to do the same job in that industry
In Basab’s example, if the portfolio manager can be easily replaced by another, soon the price ( or compensation in this case)comes down.
For people to be paid enormous amounts of money, both conditions have to be satisfied. The product/service has to be valuable- That is why a cricketer gets paid many times more than, say a hockey player. And second, it should be hard to replace. Example- Pilots are paid much more than ground staff because pilots are harder to be replaced though both are within the same industry.
Coming back to Basab’s example, why teachers are paid less than portfolio managers- I think both factors at work. People value portfolio management more than teaching and portfolio managers are harder to be replaced than teachers.
Thanks for the interesting post!
This anamoly can be explained by a few factors :
(1)Supply and demand – We are in 1995,Internet suddenly explodes and everyone wants a web strategy or a webstrategist. If you can say HTML, you can make lots of money as an employee
(2)Oligopolies – Investment banks are oligopolies.Otherwise, there is no reason why they should get 7% for peddling IPOs.
(3)Being at the right time at the right place : Being an arms dealer during times of war pays a lot of money. Stock broking during bull runs are the same.Volumes go up dramatically and every broker makes money.Sometimes,people wrongly attribute their pay checks to ability or skill.But the truth remains.They were at the right time at the right place.
(4)Perception play : In many jobs, evaluating ppl objectively is difficult. How do u evaluate a HR guy? Can be done , but difficult. So the ppl who play the perception play well rise in ranks till they reah their level of incompetence. Wallstreet obsession notwithstanding, most professional CEOs add little value. BUt teh game goes on.