Wednesday, March 8, 2017

Is it ethical to lay off employees in need?

Jorge Pine is a restauranteur who attributes success to three elements:  great food, great operations, and enough capital to support them.  However, after opening up a new restaurant, "Taco Love," he noticed a problem with operations.  The profit margin (net income divided by revenue) was only 5%, well below the 20% required to cover the cost of capital.

After looking at the books, Jorge noticed that labor costs were unusually high.  He spoke to his manager and discovered that she was reluctant to send workers home when demand was low, as on rainy days.  "They need the money," the manager explained, pointing out several workers who supported young families, or sent money back to struggling parents in Mexico.

Jorge sat his manager down and said, "look, if you do not hold costs down, this restaurant won't earn a profit, and my investors will not fund our next one."  Jorge had plans to open three more "boxes" under the same brand name.

Jorge continued, "Think about the families of the workers that I am not going to be able to hire, and what is going to happen to them if you don't earn a profit." The manager responded positively to Jorge's talk, and now Taco Love is so successful, that Jorge plans to expand to other cities.

The moral of this story is still one of incentive alignment--successful businesses will find ways to give workers enough information to make good decisions and the incentive to do so--but incentives include more than just money.  Great managers learn what motivates employees, and use that knowledge to get them to do the right thing.

This story also illustrates: (i) the zero-sum fallacy (when the restaurant makes more, the proverbial pie gets bigger), (ii) the consequentialist morality of earning profit, and (iii) the hidden cost fallacy--the manager should have considered the hidden cost of her decision, on the workers who were not going to be hired.

5 comments:

  1. I can see both sides in this post. I see Jorge's side because he wants the business to succeed. Especially in small businesses like this, it is hard when you are doing as much as you can but the profits are still not there therefore you are not making as much money as the money you need to keep the business running and pay the employees. Being able to cut costs whenever possible is a huge deal for companies like this. I worked at a small frozen yogurt store, yes it was a chain frozen yogurt store but it was still the owners first store. It was slow during the day so we were able to send a worker home. Yes, it sucked for that worker but if only one person could handle the store, there was no need for 2 or even 3. This was for the best interest of the company and that is what employees should realize. They are working to make this company successful, if they do not like the low hours then they can find a job somewhere else that will be able to give more hours.

    I also see the managers side though. These people have families to provide for and if you cut their hours down, it is taking away food from their family or the cost of a bill or any necessity to live. That is hard. But the manager also has to realize they are running a business and the success of the business should come first.

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  2. Replies
    1. The problem is the same. Workers are hired to be productive, to add value. If a worker at a not-for-profit enterprise doesn't produce enough value to pay his own wage, then a donor has to give the difference. That's no different from the difference having to be made up by those who contribute capital to the for-profit business. If they don't make a return equal to what they can get elsewhere, they are effectively donating that capital.

      The basic economic insight that most people miss is that a worker's wage cannot permanently be either more or less than the value the worker adds to the product. If that wage is too low, other companies can and will offer a higher wage; if it is too high, the business will not ultimately survive. Whether the company is run for profit or not, the trade-off is the same.

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    2. The non-profit organizations have more gray area to examine than do for-profits regarding the value of wages and employees. Specifically in healthcare or in an NPO in which humans are primary resources. Let's say an agency that serves the office of child and family services is running in the red due to inflated wages. That agency may not be able to fire at will because even though the performance of the employee may be underwhelming the employee themselves hold value in the fact that they are relied on to provide direct care services. In this respect - many NPOs would tolerate unjustified wages in order to continue serving their respective community. To indifferently fire entry level direct care workers would cause unsafe living conditions and oversight for vulnerable and at risk populations. In this regard, the opportunity cost of firing under performing employees would be more costly than to keep them.


      The NPO is different in that it's board of directors usually consists of prominent and affluent local citizens who as stakeholders will often utilize a utilitarian approach (it is human services after all); which more times than not will cater to enduring under performing staff vs firing staff in a sector that already has close to 50% turnover/vacancy rates.

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  3. This example shows a tricky decision where either side of the decision was not necessarily the most favorable. When a company like ‘Taco Love’ must decide on whether they shut down their business or fire/cut hours to retain the profit margin. Sometimes there could have been other ways, but when looking at what’s mostly eating at the business, the labor costs were very high. Any other cuts to be made to save the staff would have probably been too insignificant to improve business. The post brought up a good point that granted they may have to let go people now, but once the business picks up, they can create new jobs for people. If ‘Taco Love’ continued with just operating their business as normal, knowingly that there are issues, what happens is that the restaurant will close and everyone will be out of a job permanently. The text highlights, “demand and supply shocks change price in one industry, region, or profession, assets move in and out of industries, regions, and professions, until a new equilibrium is reached,” (p.117). The text furthermore explains that competition is forced to allocate resources to where they are most highly valued. In this topic, the resource that is talked about is the workers. The workers are assets, but they are also considered mobile assets (p.116). Depending on profit levels, assets will move in and out of industries until a long-run equilibrium is reached. This topic speaks on profits, ethics, and the denial of what labor costs actually reflects on the business profitability. Once making a harsh cut, the business can expand (hopefully). The point is to cut where needed and eventually gain back what you lost.

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