Thinking of Salaries as Pricing

Tuesday, November 4, 2014

What's the one item that almost everyone sells but no one understands how to price? Their time.

I was talking to a recent graduate a few days ago. He was salaried and working at a new job. As it turns out, he received straight salary, but was awarded no paid time off. Any hour he missed led to deductions from his paycheck.

Immediately I started pushing him to look around. After all, there were better jobs out there. Wouldn't it make sense to find a job that paid him better?

The average person would probably agree that this recent graduate was being taken advantage of, but a classically-trained economist would probably disagree. The classical economist would state that I have no basis for making any assumptions about this person's salary. For all I knew, his job paid an enormous salary that more than made up for his lack of benefits.

In this case, a little knowledge can be a very dangerous thing. The classical economist would be right that I have little evidence, if we were dealing with a question from a textbook.

We are not dealing with a question from a textbook.

It's true that I'd jump if offered a job that paid $1,000,000 per year but included zero benefits. In fact, I'd prefer to have a higher salary and then take days off whenever I wished.

That being said, even without knowing his salary, I feel safe in assuming that his price (his total compensation) is probably well below market rates, due to two factors:

The price anchoring is somewhat clear in this case. When applying for a job, the only portion of compensation that is discussed early on is salary (exclusive of benefits). Because industry analysts and workers typically evaluate offers based upon this singular number, the cheapest (and often most effective) way for a company to improve the appearance of its payment structure is to move money away from benefits and into salary. For example, an offer from a company that paid $60,000 in salary and $2,000 in benefits would appear far superior to one that paid $40,000 in salary and $40,000 in benefits - despite the fact that the first offers significantly less in total compensation.

There is also the matter of signaling. When a male peacock grows large and fancy tail feathers, it signals to potential mates that it is able to gather so many resources that it can afford to "waste" energy on looking pretty. While the peacock uses "postive" signaling, "negative" signaling can occur too. Just as poor skin, missing feathers or lack of muscle may cause potential mates to look elsewhere, companies will often signal lack of quality quite explicitly. A company that pays little in benefits will likely shortchange their employees in other ways as well.

Intrigued? Want to learn more about how to price software? You'll certainly want to check out my guide to pricing software applications.