Variable Costs

Henry Ford was famously known for paying his employees very well. In fact working at Ford meant your starting wage was $5/day, a figure well above the $2.25 market rate during this time.

The question people usually think about is – why would you pay someone above market rate if you could reduce costs by paying them less?

There is a stigma in the working world that employers should minimize hiring costs and hire just enough people to meet demand, using something like capacity to gauge how productive their work force is. But what’s productive for an employee isn’t always what’s best for your business. Inventory, holding costs, and service bottlenecks need to be considered for your entire business flow.¬†Henry Ford’s key insight was that the signal from the market on the value of an employee is different than what that employee is worth to you. As the business owner, you should be looking at the “shadow price,” or the marginal revenue contribution of each additional employee to your company’s net income.

By paying his employees more, Ford was able to reduce employee turnover, attract better talent, and ultimately use profit maximization as the driver of his business rather than some arbitrary productivity metric.

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