Some economics of zero hours contracts – part 2: the fixed costs of employment and minimum hours constraints

A good way to start the second part of my discussion of zero hours contracts is to focus on the economic rationale as to why they should not exist because of the fixed costs of employment. Under zero-hours contracts, employees agree to be available for work as and when it is required.

The fact that zero hours contracts do exist, and are growing in popularity, and many workers freely choose to sign onto these contracts, suggest they are an important labour market innovation with the gains of the shared between employers in terms of temporary above normal profits and higher wages.

The fixed costs of employment

Employers incur fixed costs of employment when they recruit and train new employees. These recruits must be expected to stay long enough to work sufficient hours for the firm to expect to recover these investments.[Oi (1962, 1983a, 1990), Idson and Oi (1999), Hutchens (2010), Hutchens and Grace-Martin (2006)]

These costs are fixed costs because they do not vary with how many hours the employee works or with how long an employee stays with their employer. On-going supervision, office space and other overheads can increase with the number of employees, not the hours they work per week. These fixed employment costs must be recouped over the expected job tenure of the employee with the firm.

Employers will not hire an additional worker unless they anticipate recovering the costs of doing do including fixed employment costs and other overheads. Hiring one more worker for 40 hours per week is cheaper than hiring two workers to work 20 hours per week each. These two part-timers would about double the recruitment and training costs to secure the same total additional supply of hours worked per week. Profits are a small share of the revenue earned on selling the output of each worker.

A small change in non-wage labour costs can have a large effect on profit margins. One full-time employee is cheaper than two part-timers because of fixed employment costs unless hourly wages paid to the two part-times adjust to offset the additional overheads of recruiting them both.

Fixed employment costs are higher when filling higher skilled vacancies because more time and resources are spent on recruiting more skilled workers (Oi 1983a; Idson and Oi 1999). Employers interview for longer and interview more applicants to find the best possible match. The applicants for more skilled vacancies have more diverse backgrounds and their jobs are more important to the success of the firm. Employers will invest more in training recruits to more skilled vacancies (Oi 1983a, 1983b, 1988, 1990; Hutchens and Grace-Martin 2004, 2006).

Useful estimates of the fixed costs of employment are rare. An illustration of the size of the fixed costs of employment is provided by Parsons (1987). He found that the investments of an employer he studied per employee increases rapidly with skill levels. The U.S. dollar investments by the manufacturing employer he studied were $911 for a least skilled worker, $5,715 semi-skilled workers, $13,353 for first-line managers, $53,413 for middle line managers, and $113,503 for top level managers (Parsons 1987).

Recouping overheads with minimum hours constraints

Fixed employment costs can explain minimum hours constraints and many other labour market puzzles. Examples are occupational differences in the stability of earnings, the uneven incidence of unemployment by skill levels in recessions, higher wages in large firms, the persistence of differential job turnover rates, overtime, joint investments in specific human capital, seniority pay and seemly discriminatory hiring and firing policies (Oi 1962, 1983a, Idson and Oi 1999).

The puzzle we are attempting to explain here is despite the fixed cost of recruiting and training an employee, the employer makes no commitment to employee this new recruitment for a minimum number of hours per week.

When a zero hours contract is in place, how is the employer to recover the costs of recruiting the employee, and the cost of initial training and orientation to the job where productivity is low?

Wages and the fixed costs of employment sum to the labour costs that their employers seeks to recoup from sale of their outputs. The higher are the fixed costs of employment, the longer are the hours that the employer will prefer the employee to work to generate enough revenue to recoup investments in recruitment and training (Oi 1962, 1983a, 1987; Hutchens and Grace-Martin 2004, 2006).

An employer often welcomes longer hours for employees with high fixed employment costs. The added output net of overtime paid contributes towards the recovery of investments in their recruitment and training (Oi 1962, 1988).

The more hours worked, the more hours over which can be spread the fixed costs of employment. When fixed employment costs are high, paying existing employees for longer hours is less expensive relative to hiring and training additional workers.

This cost differential can lead to a minimum hours constraint and the preference of employers for overtime over recruitment of more workers (Oi 1962, 1983a, 1990; Hutchens and Grace-Martin 2004, 2006).

Part-time jobs usually pay disproportionately less per hour than many full-time jobs (Hirsch 2000, 2005). Part-time workers can be more costly per hour than equally productive and qualified full-timers because their fixed costs of employment are spread over fewer total hours.

Early empirical studies of part-time work, after accounting for skill, occupation, age and other differences, found a part-time wage penalty of about 10 per cent, but more recent studies were unable to find a large part-time wage penalty (Hirsch 2000, 2005).

The more recent studies have found a small part-time wage gap for men but no gap for women after accounting for skill, occupational, age and other differences, and no much of a wage penalty for switches to or from part-time to full-time jobs in the same occupation or industry. [Rogers (2004), Booth and Wood (2006), Hirsch (2000, 2005, 2008), Manning and Petrongolong (2008) and Mumford and Smith (2009).

A major empirical finding about part-time jobs is that there are significant occupational and skills differences between full-time and part-time jobs (Hirsch 2000, 2005). These differences explain most of what are otherwise large raw gaps in hourly wages. Part-time jobs pay less because they usually require less human capital (Hirsch 2005).

Workers who have invested more extensively in human capital usually seek full-time jobs to work sufficient hours over their careers to recoup their investments in education and training.

There are part-time jobs that pay wage premiums (Hirsch 2005). These are limited to industries with seasonal and other short spikes in labour demand.

When product demand is fluctuating, full-times can be more costly because they are frequently idle. Shops, supermarkets and food outlets are examples of firms with within day highs and lows in sales and who profit from hiring part-timers. The cost savings induce these employers to pay a premium to find part-time workers.

Another reason for the lower hourly wages in part-time jobs is daily labour productivity of every workers is linked to the length of their working day. There are starting-up, planning, co-ordination and self-organisation tasks at the beginning of every working day before anything can be produced (Barzel 1973). Part-timers will produce relatively less per working day because an equally as long a part of their day is lost in starting-up costs. These fixed costs of starting the work day must be recouped over a shorter working day.

One conclusion that can be drawn here, in terms of zero hours contracts, is they should be confined to industries and jobs where the fixed cost of recruiting and training employees is low.

The firms that offer of zero hours contracts are likely to be employers subject to peaks and surges in product demand. Not surprisingly, zero hours contracts were pioneered by the retail sector, and in particular the food sector.

What can be said with some confidence is zero hours contracts are unlikely in jobs where workers must be provided with a dedicated workspace and other dedicated work tools. These dedicated resources would not be in use if the particular employee is not called in to work.

Workers on zero hours contracts must be interchangeable in terms of skills and experience and have no need to debrief each other as they change shifts. Starting-up, planning, co-ordination and self-organisation tasks at the beginning of each working day must be relatively low.

Fixed costs of employment increase with recruitment efforts and specialised training and the time spent supervising, co-ordinating and monitoring employees. Employers that hire lower skilled workers, offer less training, and which assign simple and easy to monitor tasks will incur lower fixed costs of employment (Hutchens and Grace-Martin 2004, 2006; Oi 1983a, 1983b).

Minimum hours of work constraints are more likely for skilled recruits and for those employees who have benefited from employer funded training [Oi (1962, 1983a, 1983b, 1988, 1990) and Hutchens and Grace-Martin (2004, 2006)]. Employers will invested more in finding the more skilled recruits because these workers have more specialised and they have varied backgrounds (Oi 1983, 1990, 1992; Idson and Oi 1999).

The more that is invested in training specialised to the firm, the more in fixed costs of employment that the employer must later recoup as additional employee output (Oi 1982, 1983a, 1987, 1988; Hutchens and Grace-Martin 2006). Employers are less likely to agree to requests for reduced from these types of trained employees unless their hourly pay reduction is large enough to keep recovering the fixed costs of their employment.

Employers will profit from structuring their recruiting choices and retention incentives in their employee compensation packages so that average job tenures at least break-even on investments in recruitment, training and supervision.

Longer staying employees will balance out the losses on those that quit early. Employers recoup investments in training by sharing some but not all of the added returns from the specialised training with the employee (Oi 1962, 1983a; Becker 1975). This wage premium over what the worker could earn elsewhere is a staff retention incentive that facilitates a long-term employment relationship. The longer is this employment relationship, the better are the chances for the employer of recovering fixed employment costs (Oi 1962, 1987; Becker 1964).

An employer with major upfront investments in recruitment and specialised training and from overheads from the co-ordination and management of staff has a good incentive to recruit and retain employees on the condition that they work a minimum number of hours per week. The fixed costs of employment increase with the number of workers employed rather than the number of hours they work. The fixed costs of employment for a part-timer and a full-timer will be similar.

The foregoing discussion suggests that zero hours contracts will be confined to jobs where recruitment costs are low, and training specialised to the job and firm are low. The recruit will be expected to come job ready with generalised training mobile across many jobs within their occupation and sector.

Spans of control and the cost of entrepreneurial time

One constraint on the growth of any firm is entrepreneurs have a limited span of control (Coase 1937; Williamson 1967, Lucas 1978; Oi 1983a, 1983b). A span of control is the number of subordinates that an individual supervisor has to control and lead either directly or through a hierarchical managerial chain (Fox 2009).

There are only so many tasks that even the most able entrepreneurs can carry out in one day. Over-stretched spans of control motivate entrepreneurs to hire professional managers and delegate to them a wide range of decision-making rights over the firms they own (Williamson 1975; Foss, Foss and Klein 2008).

Entrepreneurs and the professional managers they hired to assist them must divide their respective time between monitoring employees, identifying new business opportunities, forecasting buyer demand and running the other aspects of their business (Lucas, 1978; Oi 1983, 1983b, 1988; Foss, Foss, and Klein 2008). The larger is the firm, the more employees there are for the entrepreneur to direct, monitor and reward. These costs of directing and monitoring employees will increase with the size of the firm and larger firms will encounter information problems not present in smaller firms (Alchian and Demsetz 1972; Stigler 1962).

The cost of entrepreneurial time spent monitoring employees will increase with the size of the firm (Lucas 1978; Oi 1983b). The time of the more talented entrepreneurs is more valuable because they had the superior managerial skills and entrepreneurial alertness to make their firms large in the first place and remain deft enough to survive in competition. Time spent on the supervision of employees is time that is spent away from other uses of the talents that got these more able entrepreneurs to the top and keeps them there (Williamson 1967; Lucas 1978; Oi 1983b, 1988, 1990; Idson and Oi 1999; Black et al 1999).

Firms in the same industry tend to exhibit systematic differences in their organization of production and the structure of their workforces because entrepreneurial ability is the specific and scarce production input that limits the size of a firm (Lucas, 1978; Oi 1983b). The less able entrepreneurs tend to run the smaller firms while the more able entrepreneurs tend to lead both the currently large firms and the smaller firms that are growing at the expense of market rivals (Lucas 1978, Oi 1983b; Stigler 1958; Alchian 1950).

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