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Why folks get paid by the hour instead of by the job

08 Jun 2011

A year back I had a good time reviewing the financial food chain and how it may affect one's value system. In that riff I covered a broad range of income levels from minimum wage all the way up to Warren Buffet+ money. This morning I'll explore why hourly pay dominates the job market, and review perceived limitations which shape today's earnings structures.

The macro trend is that service based businesses gravitate towards hourly pay (outside of sales), while product businesses allow for earnings based on other statistics, like number of products shipped, while penalizing defects or returns.

Let's start off with reasons why paying by the hour is a gold standard in the majority of todays businesses:

  1. It's easy to evaluate. An employee works 10 hours, their paycheck is 10 times their hourly rate
  2. It boils individuals down into a predictable resource. This way workers can be quantized into discrete bins, to assist in estimating project costs.

    This is common for service companies which provide and charge a fee on top of labor. Project managers aren't allowed to apply bundles of capital against individual tasks without having a body count behind it.

    Hourly rates aid in estimating cost for specific contracts and competitive bids. Potential clients can judge companies based on bids and their rates, which is the base plus overhead charged on man hours

  3. Related to the above rationale, specific clients and customers have their own constraints on acceptable hourly pay. Consider an extreme case:

    Certain customers gladly pay a senior manager egomaniacal blowhard (EB) with credentials 5-10x the rate of a hard working hacker out of school. This holds true even when the young tech will end up doing the lion's share of building a working product. In addition they'll do so while dealing with the regular interruption of pointless status meetings to assuage leaderships' egos. Even if the project is a smashing success the credit and earned value will go to the EB. I count myself fortunate for working with great hands on project leads, even if they are a little egomaniacal ;).

    I'd have no qualms paying the kid with the technical chops a lump sum, and skipping the middle management and coworker tier all together. But my line of thinking doesn't fit well into large bureaucratic enterprise systems.

The above are just a few of the reasons why hourly income is the most prevalent form of payment, and I'm confident you could tack on many more of your own forcing functions. Now that we've covered reasons for hourly pay, let's look at variations in earnings systems.

Alternative Income Systems

It's only by peeking outside the circus tent of enterprise America that we can begin to see more rational reward systems. Far beyond BigCo negotiated executive salary wonderland, the higher pay brackets are all based on investment returns and measured company growth.

Commission
If your effort results in X% revenue growth or profits, then your income is Y% of that increase. This works fantastic in finance, affiliate marketing, and is effective for motivating and retaining business leadership. There's limited space for the bullshit factor in this earnings systems, making it near and dear to my heart. I love bs'ing, I just don't believe in getting paid for it.

Even for strategic leaders, determining how much growth is based on their direct efforts is fuzzy. Was the growth product based? Was it marketing? Did the market itself grow drastically faster than your business? It's hard to judge what fraction of corporate growth is a function of individual contributions beyond the finance industry, limiting this model's adoption outside of sales positions.

Price fixed projects
Shrewd consultants and companies with strong customer relationships take on cost fixed contracts. They are hesitant to do so with new clients due to ill defined or open ended projects and expectations. For those conditions periodic negotiated rates fit the unknown task better.

The structure of cost fixed projects falls under a product based business umbrella. It's a single customized product, but client and company expectations are made clear before work commences. Profit margins are based on execution efficiency, a thing of beauty.

What other earning systems am I forgetting this morning (offline or I'd be stalking Wikipedia)? Consider yourself cordially invited to pitch in and elaborate in the comments below.