Compensation 11th Edition by George Milkovich,Jerry Newman,Barry Gerhart

Exercise 6

Let's get started with trying to assess the degree to which compensation is an important cause of company success (or lack of success) in two different competitive environments.
First, let's consider the case of consumer electronics and the experiences of Circuit City and Best Buy. Circuit City had traditionally used a commission pay plan that paid off big for experienced, high-performing salespeople. Top salespeople knew the products and kept up to date and customers knew that they could get expert advice at Circuit City. The strategy differentiated Circuit City from archrival Best Buy, which featured self-service stores with huge inventories, but less expert salespeople. Best Buy hired young, less-experienced people and offered lower wages and smaller bonuses. However, Best Buy's sales and total shareholder returns soared past those of Circuit City. Subsequently, Circuit City laid off 3,900 top-earning salespeople in 2003 and replaced them with 2,100 less-experienced people who received lower wages and smaller bonuses. Circuit City said it could no longer afford to pay big commissions to its sales staff while its rivals paid less. 71
In 2007, Circuit City fired 3,400 of its highest-paid store employees and began to replace them with lower-paid workers in hopes of reducing labor costs. In the following quarter, Circuit City reported that the company lost money. Some commentators attributed the loss to the fact that Circuit City had gotten rid of many of its most experienced and highly trained employees, which they believed translated into a poorer customer experience and, in turn, lower revenues and profits.
For example, according to BusinessWeek , "In the world of pricey consumer electronics, where customer service is arguably as important as quality products, Circuit City Stores is missing the mark and further eroding its profits." However, a company spokesman said that only a few sales-people per store were affected by the workforce reductions and that many of the employees affected worked as customer service representatives or in the warehouses. As such, he questioned whether the cuts had significantly affected the in-store customer experience and thus whether the cuts had caused the decline in the company's performance. Eventually, the bottom fell out of Circuit City's profits and stock price and it had to liquidate, closing its over 500 stores (resulting in over 30,000 employees losing their jobs). 72
Now consider the next part of the story. Best Buy itself subsequently sought to further cut its own labor costs by essentially demoting 8,000 senior sales associates to positions that could pay half as much. A question being asked is whether the Best Buy pay-level cuts will have the same consequences as what one person described as the "disastrous personnel moves" made at Circuit City just a few years ago.73 Apparently, Best Buy does not see it that way. More recently, Best Buy announced that it would close 50 stores. It will also cut 400 corporate jobs and aim to cut $800 million in costs. Best Buy also plans to open 100 smaller, more profitable Best Buy Mobile stores. Why is Best Buy aggressively cutting costs and changing its stores USA Today stated that Best Buy "is trying to avoid the fate of Circuit City, which went out of business in 2009. It faces slower sales of expensive items like TVs, plus increased competition from Amazon.com and discount stores" such as Walmart and Target. 74
Here are data on stock prices and customer satisfaction for Circuit City, Best Buy, and two other competitors, Amazon and Walmart.

Now, consider a different product market: the airline industry. American Airlines is currently going through bankruptcy, something that other "legacy" airlines (e.g., USAir, Delta, United) have already done. American states that its goal is to reduce labor costs by $1.25 billion per year. 75 In the airline industry, costs are typically expressed as cost per available seat mile (ASM). As we will see later in the book, prior to bankruptcy, USAIR had a labor cost/ASM of.055. After bankruptcy, labor cost/ASM was.031. At American, in contrast, the labor cost/ASM is.046, or.046/(.046 -.031) = 33% higher than USAir. The two airlines have similar customer satisfaction scores from the American Customer Satisfaction Index (ACSI TM ).
Do you believe that the compensation changes at Best Buy are a major reason for its current difficulties