Looking to Benchmark Pay?
Employer Ability to Pay
Ability to pay influences the salary levels of organizations, largely by setting top and bottom boundaries on pay levels.
| Ability to pay | The ability of a firm to meet employee salary demands while remaining profitable. |
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Ability to pay is often an issue in collective bargaining and may be used by either side to prove its point.
The major constraint on an organization's ability to pay is the product market in which it operates. A company must be able to either absorb a salary increase and still remain solvent, or it must be able to pass the increase on to the customer. In this way, companies appear to establish salary levels somewhere between the upward demands of employees on the one hand and the downward pressures from the product market.
Productivity
Salaries are labor costs to employers, and these costs are high or low depending on what the employer gets for the salary – the results of effort. What the employer actually pays is labor cost per unit of output.
Productivity is the salary cost divided by these results.
PRODUCTIVITY = SALARY COSTS/RESULTS
Increased productivity can lead to higher profits AND high salaries.
More profitable firms tend to pay higher salaries, no matter what type of productivity their profitability is based on. Some factors that can affect productivity are:
- the product market
- worker efficiency
- management ability
- investment in technology
- organization size
A salary increase may or may not increase labor cost per unit, depending on changes in productivity:
| Doesn't increase labor costs | Increases labor costs |
|---|---|
| A salary increase that would be offset by increases in productivity does NOT increase labor costs. It meets the requirement of ability to pay. | A salary increase that increases labor costs, however, requires determining whether the increase can be passed on to customers or offset by a reduction in other costs. Success in either effort meets the requirements of ability to pay. |
How is ability to pay used?
Salary determination by the organization is an assessment of its own ability to pay. Union accepted pay cuts in bad economic times illustrates the significance of inability to pay. Good economic times usually signal a rising salary level, but this doesn't always occur. In the late 1990s, profits rose rapidly but salaries rose modestly at best. Most workers lost ground in terms of real salaries during this time period.
Memory Jogger
Ability to pay is the ability of a firm to meet an employee's salary demand while remaining: