Q. I own a business that has about $5 million per year in revenue. I have just heard that the minimum annual compensation for employees who are exempt from overtime is being raised from $23,700 to $50,400. In my small business, I have about 15 exempt employees that are making an average of $35,000 per year. They are each working about 50 hours per week. If I have to pay overtime, I don’t think I’ll be able to pay myself. Do I have any options?
A. You are correct, this change is coming and small businesses will have to comply. One thing politicians seem to forget is that when they change the rules to try to force higher pay, the money has to come from somewhere. There are only three places from which it can come: (1) the profits of the business (or perhaps in this case, your compensation), (2) your customers, or (3) the employees themselves. We’ll explore each.
The profits of the business – One approach is to divide your employee’s salary by the standard number of straight time work hours in a year (2,080 hours) and make this their new hourly compensation. For your employees that make an average of $35,000 per year, this would be $16.83 per hour.
If your employees are working an average of 50 hours per week, you would have to pay 10 hours per week of overtime. Given that you have 15 employees making this amount and assuming that you will pay overtime 46 weeks out of the year (we are assuming that because of vacations and holidays, you won’t pay overtime for six weeks out of the year), your costs will increase by $174,191 per year ($16.83/hour X 10 hours/week X 1.5 X 46 weeks with OT X 15 employees). In effect, each employee will get an $11,613 per year raise ($174,191 / 15 employees). This will represent a 33% pay increase for your employees ($11,613 / $35,000). If you don’t do anything else, you will have to survive with $174 thousand per year less in profit. We’re not sure about your situation, but many small businesses couldn’t survive this. We don’t think many small businesses will choose this option.
Your customers – You could try to pass this cost increase on to your customers in the form of a price increase. In your case, that would be about a 3.5% increase ($174,191 / $5,000,000). This may work if all of your competitors increase their prices as well. If not, it is likely that the price increase will result in a loss of sales volume. This would, of course reduce your profit, so you would still be funding, at least a portion, of the cost increase out of your own pocket. By the way, depending on the amount of volume you lose, you may find that you need to reduce your costs by laying off some of the very employees the new rules were intended to help—another example of the law of unintended consequences.
The employees – Finally, the employees themselves may be called on to fund the changes. One way this could happen is to set an hourly pay rate that will mean that they work about the same number of hours per year they are currently working and make about the same total compensation they are currently making.
For example, let’s assume that your employees will be paid straight time for 2,080 hours each year (40 hours/week X 52 weeks/year). You will also pay each employee 460 hours of overtime (46 weeks/year X 10 hours/week). Because overtime is paid at time and a half, the 460 hours of overtime would be the equivalent of 690 straight time hours (1.5 X 460). This means that your employees will be paid the equivalent of 2,770 straight time hours per year (2,080 + 690). If the employees were paid $12.64 per hour, they would make approximately the same thing they are currently making. $35,013 = ($12.64/hour X 40 hours/week X 52 weeks/year) + (10 OT hours/week X 46 weeks with OT X $12.64 X 1.5). This keeps you whole and has the advantage of leaving your employees whole—they work the same number of hours and make the same thing as before the change.
A second way that employees might be called on to fund the change is through increased productivity. Many employers allow salaried employees considerably flexibility. For example, they might be able to take a longer lunch break to run errands. Watercooler chat with colleagues is accepted. Checking Facebook or personal email is allowed. All of these things are fine because the salary is fixed and the job has to get done. Time spent on other activities during the day simply means working later to get the job done. Once employees become hourly, employers would be reasonable to demand an end to these types of activities.
Another option would be to hire additional employees to do the work on straight time and keep yourself whole. In this case, you would determine the straight time hourly wage by dividing current compensation by the total number of hours worked. In your case $35,000 / (2,080 + 460) = $13.78 per hour. Employees would then be limited to working 40 hours per week. To make up the slack you would hire three additional people at the same rate ((460 formerly OT hours X 15 people) / 2,080 hours per year per person). You would still be a third of a person short, but you could make this up with increased productivity or by hiring a part time person. Your costs would remain unchanged. Your employees would work fewer hours, but would actually see their compensation decline to $28,662 (an 18% pay reduction)—another example of the law of unintended consequences.