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					                                                Managing the Workplace
                                                      Canice Prendergast
                                              Problem Set #1

                I pledge my honor that I have not violated the Honor Code
                during this examination or case write-up.

Philip Larson
Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

       1(a). General reasons a firm may choose to pay its employees more than the market wage.
       Generally, firms will continue to hire additional workers as long as the value those workers add to the firm
   exceed their cost to the firm. At some point, an additional worker costs more to employ than the benefit he or
   she provides to the firm’s profits and hiring stops. For many people, inherent in this basic system is the idea
   that workers performing similar tasks (e.g. providing the same level of productivity) should be paid similar
   wages. It would be unfair to pay some workers more and some workers less for the same productivity.
   Workers should be paid an efficient market wage determined by supply and demand. However, in real life
   firms deviate from this logic. In many situations, they choose to pay more than the market wage for certain
   workers. In other situations, firms choose to pay more than the market wage for all their workers. To many,
   this seems absurd. Are the firms exhibiting this behavior making irrational decisions or are there legitimate
   reasons a firm might be willing to “overpay” their workers? Research from the University of Chicago Booth
   School of Business suggests there are a number of reasons a firm may rationally choose to pay more than the
   market wage for their employees. For example, firms may overpay employees when 1) the cost of training
   workers is non-trivial, 2) the employees of the firm prefer stability in their income to the market’s natural
   fluctuations, 3) the information on quality of workers is imperfect, 4) the work to be done is difficult to
   monitor, and 5) the workers prefer certain benefits to their cash equivalents.
       First, firms may overpay employees when the cost of training workers is non-trivial. If the firm trains the
   employee and the employee receives a skill that other firms value, the firm may have difficulty retaining the
   employee later. Employees would flock to that firm for training and then flee to others willing to pay a
   premium for their general skills. To solve this problem, some firms will underpay an employee while they
   develop these general skills (essentially making the employee pay for the training him or herself) and then
   overpay the employee after the skill has been attained to prevent the employee from leaving for a competitor.
   This helps employee retention while still encouraging employees to develop new skills. Similarly, firms often
   want to induce employees to invest in skills specific to their firm. However, workers are unlikely to oblige if
   they feel like they could get fired. Therefore, firms may overpay employees to induce them to invest in firm-
   specific skills that are not easily transferred to other job opportunities.
       Second, firms may overpay their employees if the employees value the security of consistent wages. Many
   employees fear unemployment. Security in income enables workers to plan their finances and save without the
   threat of major disruption. Just as investors demand a higher return for risky stocks, employees require higher
   wages from firms if there is a risk of getting laid off in a down market. If the firm makes a credible promise
   not to lay off workers in a downturn, workers will be willing to work for a lower wage. When times are good,
   the firm is happy. It is paying less in wages for high productivity and profits are good. When things go bad,
   however, the firm may find itself paying more to its employees than their productivity would warrant. If the
   expected profits under the “no layoff” policy exceed the expected profits with layoffs in bad times, the firm has
   made a good, rational choice.

Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

       Third, firms often choose to overpay employees when there is imperfect information on the quality of
   workers. Consider a law firm, for instance. Law firms know that some lawyers will be more productive than
   others. However, their ability to predict which lawyers will be high producers and which will be slackers is
   very poor. To encourage only high producing lawyers to the firm, the firm may choose to underpay its
   associates and overpay its partners. The high quality lawyers most capable of making partner will be willing to
   take less money now knowing they will more than make up for it when they make partner. The lower quality
   lawyers, knowing their shot at making partner at the firm is low, will choose to go elsewhere where current
   wages are higher because employees aren’t subsidizing the partners’ inflated salaries. Moreover, if all other
   law firms are using this compensation model then a firm that simply chose to pay market wages would be
   unable to get the good lawyers and would end up with all bad lawyers. Therefore, firms may choose to
   overpay employees under certain circumstances to create good incentives for their employees over the long-
   term and to recruit the right type of worker to the firm.
       Fourth, firms may overpay workers when monitoring the workers productivity is difficult or costly. In the
   case of sales organizations for instance, it is often difficult to keep track of the productivity of individual sales
   reps. By compensating its employees on a commission basis based on the amount the sales rep has sold, the
   firm is able to align the incentives of the sales person with those of the organization. It underpays for
   underperformers and overpays for top performers. While it pays more than the market wage for the best reps,
   the firm is happy because the overall size of the pie is getting larger and they are taking their share.
       Fifth, firms may overpay when wages are interpreted as a combination of cash and benefits received. If
   workers prefer a benefit (say 401k matching or maternity leave) to its cash equivalent, a firm may choose to
   offer that benefit instead of increased salary. In certain circumstances, the worker will value the combined
   salary and benefits more or less than the market wage despite the fact that it costs the firm less than the market
   wage to implement. This does create certain selection challenges - the firm offering maternity leave must
   make sure that it attracts more candidates than just pregnant females – but sometimes the government will step
   in to mandate these types of benefits.

       1(b). Applying the reasons identified above to the Caterpillar case reveals that there are no
       compelling reasons for Caterpillar to be paying more than market wages for its employees.
       Caterpillar is paying $18 per hour when the going wage in the area is about $12 per hour and foreign labor
   wages are even lower. Therefore, Caterpillar is paying its workers more than the market wage for their
   services. Above we discussed five reasons a firm might want to do this. In this section, we apply the
   Caterpillar situation to determine whether these five reasons are at play in this example.
       First, it does not appear as though Caterpillar is overpaying its employees in an effort to encourage them to
   acquire firm specific skills or to prevent them from leaving for the competition after they acquired general
   skills. The majority of the labor involved in the Caterpillar strike are low-skilled blue collar workers. They do
   not have sufficient generic skills to warrant a premium for Caterpillar to keep them on. By contrast,
Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

   Caterpillar in many situations has options of outsourcing the work or doing the work in a foreign plant with
   cheaper labor. Therefore, the global supply of labor appears to be large and puts downward pressure on labor
   wages. Therefore, while Caterpillar has been unsuccessful at getting the UAW to agree to wages lower than
   $18/hour, this has not prevented Caterpillar from reducing their overall wage rates. Rather, they have simply
   cut the number of hourly workers in the US (from 60,845 to 29,479 from 1979 to 1992), increased their
   reliance on cheaper foreign plants, and outsourced many jobs to non-union suppliers. These trends have “cut
   deeply into the number of jobs open to Americans” even though the hourly wage has remained high.
       Second, firms that have frequent disruptions in work due to layoffs or strikes, for instance, often must
   overpay their employees to compensate for the riskiness of the job. However, this does not appear to be the
   case with Caterpillar. Many non-union workers are happy to work for less than the $18/hour. Additionally,
   both the outsourcing companies and the labor force in foreign plants consider a much lower risk premium to be
   appropriate than American workers who have perhaps gotten too used to high pay and great benefits.
         Third, firms often choose to overpay employees when there is imperfect information on the quality of
   workers. However, here the quality and productivity appears to increase when Caterpillar outsources portions
   of its manufacturing to non-union suppliers. Therefore, despite paying their union workers high wages,
   Caterpillar does not appear to get high quality output compared to global alternatives. Additionally, the rise of
   technology and robotics has enabled machines to replace many human jobs further reducing the value of low-
   skilled human labor.
       Fourth, firms may overpay workers when monitoring the workers productivity is difficult or costly.
   However, monitoring costs in a manufacturing plant are much lower than monitoring a global, distributed sales
   organization. Moreover, most of the time firms will overpay employees with commission based plans when
   monitoring is difficult to better align the incentives of the worker. They will not simply raise salary or hourly
   rates as this may not encourage workers to be more productive. Therefore, Caterpillar does not appear to
   overpay their employees because of high monitoring costs.
       Fifth, Caterpillar is not overpaying their employees by providing benefits to the employees that they prefer
   more than their cash equivalent. Caterpillar is overpaying in the salary itself because $18/hour exceeds the
   global market rate.
       Therefore, an analysis of Caterpillar’s high wages suggests that its workers do not warrant the additional
   pay. Even when times got better after Caterpillar invested $2B in capital upgrades and significantly increased
   profitability, these high wages are not warranted. The increased profitability was largely due to efficiencies
   based on better use of technology and robotics. These improvements are critical for Caterpillar to continue to
   fend off threats from foreign competitors where labor rates are cheaper and plants have access to the latest
   technologies. Rather, Caterpillar appears to be overpaying union workers simply because the costs of
   negotiating lower rates with the UAW are high. Therefore, rather than fight this battle head on, Caterpillar has
   been fighting it indirectly through reducing American workers, increasing reliance on foreign plants with
   cheaper labor and outsourcing manufacturing of some components to non-union suppliers.
Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

       2(a) Promoting from Within vs. Hiring Externally
       Businesses face difficult decisions regarding whether to promote from within or hire externally. On the
   one hand, promoting from within has a number of advantages. First, it is easier to assess the candidates since
   there is more information (e.g. past work history, relationships with coworkers, etc.) available for making the
   decision. Second, it is less costly and faster than trying to find someone externally. Third, employees
   promoted from within the organization are already familiar with the firm’s policies and overall culture which
   make them better positioned to work seamlessly in their new role. Fourth, promoting from within can create
   good incentives for other workers who see that career opportunities exist if they stay at the firm and work hard.
   On the other hand, promoting from within does not come without cost. Disadvantages to this policy are
   prevalent and difficult to manage. First, promoting from within creates an inbreeding problem in which
   employees are clouded by their environment making innovative ideas harder to come by. Second, in a firm
   experiencing rapid growth promoting from within is frequently not an option because there is insufficient time
   to properly train and prepare the employees for their new role. Third, training the internal employees itself can
   be cost prohibitive if the new skills required are difficult or expensive to attain. Fourth, relationships between
   employees can become problematic as one peer may become another’s boss. This can lead to discontent
   among those candidates who were not promoted as well as insubordination when employees question their
   new boss’ knowledge.
       Hiring externally can solve some of the problems associated with promoting from within. Hiring
   externally can help get new ideas and fresh perspectives into the organization. By increasing the diversity of
   thinking, this process can help cross-polinate ideas throughout the organization. Moreover, hiring externally
   can help enable rapid growth because it is not limited by the existing human capital within the organization
   and does not require expensive training. Furthermore, in some circumstances hiring an external experienced
   employee can be less upsetting to the existing organizational hierarchy because one peer is not promoted while
   others are rejected. However, the benefits of external hiring do not come without its disadvantages as well. In
   addition to taking longer and costing more, very little information about the candidate’s ability to fit into the
   rest of the organization is known compared with comparable internal candidates. Additionally, a culture of
   hiring external for strategic positions destroys the incentive of current employees to strive for promotion. And
   finally, even though hiring externally can reduce training requirements, there is still time and money that must
   be spent getting the outsider familiar with the firm’s current systems and ongoing operations.
       Therefore, like most things in life the decision of whether to hire externally or to promote from within
   requires carefully balancing the pros and cons within the context of the specific situation.

       2(b) Despite the issues to its culture, UPS has no choice but to hire external personnel with
       specialized IT skills.

Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

       In this case, UPS faces a decision about whether to staff its Information Services department by promoting
   from within or hiring outsiders. While UPS’ consultants, bankers and auditors have all been saying that UPS
   should hire new talent externally, there are a number of features of the firm that make this option less
       First, the company has relied on a compensation policy with substantial deferred compensation. The
   company provides a long-term bonus plan based on annual stock grants to each of its 15,000 managers. While
   UPS is a relatively flat organization (only six levels of management), pay differences were slight with the bulk
   of wealth of senior managers coming from accumulation of stock appreciation and dividends over their long
   careers with UPS. Moreover, this profit-sharing plan included a Thrift Plan for all regular employees who had
   completed at least a year of service, a Management Incentive Plan for full time managers, and a Stock Option
   Plan for the 1,200 or so top level executives. UPS’ unique profit-sharing and stock ownership plan has caused
   many employees to consider UPS “a lifelong commitment.” This unique profit-sharing plan helps attract
   better workers who are willing to work upfront for lower wages given the possibility of building a career,
   making manager, and eventually participating in the substantial upside of annual stock grants and bonuses.
   Employees are willing to work for less up front for the prospect of deferred compensation down the road.
   Hiring externally might disrupt this process. If current and prospective employees view management’s hiring
   of specialized external IT staff as a threat to their future opportunities for growth, they will no longer value the
   future opportunities with the firm as highly. UPS will have greater difficulty attracting the same caliber
   worker with the same long-term career goals with the firm.
       Second, UPS has emphasized decentralization in which the operating organization was divided into
   regions, districts, and divisions. While company-wide policies and procedures existed, regional management
   had a large degree of discretion (even down to the individual truck driver) for how to achieve results within
   their particular job functions. The IT function within UPS has the capacity to drastically disrupt this
   decentralized culture. For example, once the IT function completed their plans for an automated customer
   service telephone center, an electronic call tag system, an on-line billing and invoicing system, and a system
   for managing plant engineering and maintenance, it is likely that regional managers would have less control
   over their operations. Given potential of the IT function to disrupt this decentralized organizational structure,
   UPS has a particularly high need to ensure the IT systems are designed by individuals who understand UPS’
   core business. Hiring externally for IT positions has the potential to put individuals who do not understand the
   firm’s policies or the overall culture in charge of defining future policies and culture for the entire
   organization. Therefore, hiring externally poses a threat in this regard as well.
       Third, UPS’ strong historical preference for promoting from within has likely created a culture that is
   skeptical of outside hires. The firm already has good, substantial information on the strengths and weaknesses
   of current employees. Therefore, it would be less costly and faster to identify current employees with the
   capacity to pick up the engineering and computer science skills needed for the IT function than it would be to
   hire externally.
Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

       On balance, however, these organizational features of UPS that argue in favor of promoting from within do
   not outweigh the benefits of hiring externally to fill these key IT management positions. There is a reason
   analysts, consultants and bankers are all telling UPS to hire some external talent. UPS was asleep at the wheel
   when it came to overnight air delivery after the industry deregulated. Additionally, UPS has been slow to
   adopt the technology necessary to drive organizational efficiencies and improve operations. One could argue
   that these failures are a direct result of UPS not having enough diversity of ideas and opinions. External hires
   would help ensure a steadier flow of ideas through the organization and prevent these mishaps in the future.
       Additionally, UPS is growing rapidly and it simply does not have the personnel internally with the
   appropriate qualifications to run the IT organization. Putting off its plans for two years while it trains current
   employees is a waste of time and money and would likely lead UPS to continuously lose marketshare to its
   competitors. Moreover, it isn’t clear that even spending the time and money would solve the problem. UPS’
   current employees do not have the specialized skills in engineering and computer science to adequately
   perform the duties and responsibilities required in the IT function. It is unlikely that its employees will be
   capable of developing these skills during a short 10-week training program. Given the lack of human capital
   capable of developing these required skills, combined with the massive cost of delaying its IT plans, UPS does
   not have much choice about whether or not to hire external talent. Hiring IT managers externally will help
   UPS grow rapidly without being constrained by the need to find and train internal employees with the
   necessary computer skills. Hiring externally will help UPS save money by not requiring an upfront expense
   for this training but rather being able to spread the cost of this training in the form of higher salaries for these
   external hires with specialized skills. Additionally, as technology innovation continues, the IS organization at
   UPS will play an increasing role in the firm’s ability to stay competitive at an operational level. Therefore,
   external hires with the requisite expertise combined with new, fresh ideas are precisely what UPS needs to
   ensure they don’t fall behind in this critical area. Moreover, the negative aspects of hiring externally are
   somewhat limited within the IS organization given that this group more than any other is relatively isolated
   from the rest of the operation. Therefore, the compensation structures within the IS group need not drastically
   disrupt the culture of the rest of the organization.
       Therefore, while UPS has certain organizational features such as its decentralized structure and its deferred
   compensation policies which make promoting from within more desirable, in the case of the IS organization it
   must hire the specialized talent it needs externally or else it risks losing its competitive edge in a way that it
   might be incapable of recovering from.

Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

       3(a) Is Portman Hotel employing its employees the right way? Propose an alternative.
       Portman Hotel’s current practice of human resource management of its personal valets does not fit into its
   overall strategy. Portman’s goal was to achieve a new level of service among American luxury hotels. The
   hotel intended to carve out a new niche at the high end of the market setting new standards for quality of
   service and hospitality. The personal valets (“PVs”) were to act like butlers, providing comprehensive
   personal services for guests. In order for the business plan to work, the PVs would have to perform more
   responsibilities than typical hotel employees as well as be willing to perform tasks outside their official
   responsibilities, particularly when those tasks were requested by a guest. Portman Hotel failed to structure the
   incentives of the PVs to be properly aligned with these business objectives. In particular, Portman Hotel 1)
   recruited the wrong types of people for employment as PVs, 2) underpaid the PV’s in both base salary and in
   tips, 3) failed to create adequate feedback loops to enable disciplining poor performers and rewarding top
   performers, 4) missed an opportunity to clearly define a career path for PVs that would help reduce turnover,
   and 5) used a “floater” system that was ill-suited for its business.
       Recruiting: The recruiting process for the PV position does not fit well with Portman’s strategy. Portman
   tended to hire young people (under 35) who viewed the job as a way to support their true interest in life, such
   as painting, writing and entrepreneurship. The PVs, for the most part, did not intend to stay in the business and
   therefore had less incentive to go the extra mile to provide exceptional, high quality service. As a result,
   turnover was relatively high leading to disruption in team dynamics and larger training costs. While Portman
   was smart to employ SRI, the leading recruiting firm in selecting successful performers in the “hospitality”
   industry, they should have looked for more people interested in making careers in hospitality who the hotel
   could groom and promote.
       Compensation: Portman Hotel also failed to create an effective compensation package for the PVs. The
   base pay of the PVs was only about the level of a maid in a comparable hotel despite significantly more
   responsibility. Furthermore, the hotel had led the PVs to expect around $200/week in tips when the actual
   amont ended up being more like $40. Remarkably, the total monthly budget for PV salaries and benefits for
   90 PVs was about $91k. This compensation is way too low to properly incentivize the PVs to “do everything
   in their power to fulfill” their guests requests. Furthermore, while all associates received long-term disability
   and retirement benefits, these were probably not the benefits the PVs cared about most given that the people
   they employed generally had plans for other careers. An alternative compensation plan that would likely have
   been more effective would be to raise the base salary to about 20% above that of a maid in other comparable
   hotels. Additionally, they should employ a pooled sharing of tips within the 5-star team to help create a team
   atmosphere and providing adequate incentive for PVs to cover for someone else when the necessity arose.
   Perhaps even creating a system in which the PVs rated each other’s contribution and their bonuses were based

Managing the Workplace, Canice Prendergast – Philip Larson – Problem Set #1

   on these ratings. This would encourage teams to work well together and would encourage individuals not to
   shirk responsibilities.
       Feedback Loops: Portman Hotel further failed to structure the roles and responsibilities adequately by
   failing to provide a feedback loop to enforce accountability and improve employee discipline. As one
   employee noted, “I have to cover for people a lot…There’s no system to work out the problems”. In
   particular, Portman did not believe in “disciplining” poor performers. For a luxury hotel providing a new level
   of high end service, it is critical to have a formal system to provide a continual feedback loop to inform
   management of failures in this service level. Portman should have created a formal process for PVs to rate
   each others efforts within the team, discuss which other PVs they would prefer to work with, and provide
   feedback forms for complaints when certain PVs were not pulling their weight. Additionally, Portman Hotel’s
   should have been much faster to get rid of “bad apples” because these poor performers are a drag on morale
   and lead to an increase in guests’ complaints. Portman should have created an environment in which errors
   were not tolerated and attention to detail was heavily rewarded.
       Career Path: Portman Hotel failed to create clear, identifiable career paths for its PVs. There was plenty
   of potential career paths available but these paths were poorly articulated. For example, a PV could be
   promoted to a supervising PV. Supervising PV’s could be promoted to managers. Managers could be
   promoted to senior managers and the senior managers could eventually be promoted to directors. Defining this
   progression in greater detail, as well as clearly identifying the benefits of these new roles in terms of increased
   salaries and benefits would encourage higher quality of service from their PVs and would provide the PV’s
   with a reason to stay. The hotel has been concerned with the PV’s 50% turnover rate. Portman Hotel could
   reduce this rate by hiring people interested in building a career in the hospitality industry and by clearly
   articulating the career path to its new hires as part of its two week training curriculum.
       “Floaters”: Additionally, Portman Hotel’s use of “floaters”, or PVs who worked on different floors with
   different groups on an as needed basis, should be scrapped entirely. Floaters created problems because it
   became more difficult to pool tips (floaters weren’t part of the main team), they failed to develop long-term
   relationships with the guests because they constantly moved around, and they were less efficient because they
   had to learn new rooms and supply offices for each floor. Floaters had a reputation for caring less because
   they were not part of the larger team. As a result, there was general agreement that the use of floaters led to
   wasted time and lowered responsiveness to the guests. Therefore, Portman Hotel should scrap the floater
   system. While it is understandable that it sought to meet short-term increases in occupancy and guest requests
   by providing an adjustable, flexible supply of PVs, the benefits of the floater system simply do not outweigh
   the negatives described above. Rather, Portman should keep the teams as a single cohesive unit even if it
   means having a slightly higher labor expense.
       Therefore, Portman Hotel could have adjusted many aspects of its HRM practice to better align the
   incentives of its PVs with the operational goals of the business at hand.


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