When does a role holder become more expensive than the value s/he generates, and what can be done about it?

Transaction cost theory, developed by Ronald Coase and expanded by Oliver Williamson, offers valuable insights into minimizing costs associated with economic exchanges and organizational structures.?

A simplified illustration:?

Let us consider any role for which we hire someone from outside. There are certain associated costs:

• Search costs: cost incurred in finding and onboarding the candidate.
• Bargaining Costs: Negotiating new terms or roles within the organization. Will include salary costs?
• Adaptation Costs: The cost incurred in learning & development of the employee to adapt to job requirements.
• Monitoring Costs: Ensuring the employee's performance remains satisfactory. Usually in the form of the time and energy invested in supervising staff as well as the price of additional performance monitoring instruments.

The first-year investment in search, salary, training, and supervision results in higher overall costs. The experience curve also leads to a significant increase in role-holder productivity.

The overall cost of growth decreases in the second and third years, but salary costs rise as a result of pay increases. The role holder's interest and productivity may start to decline as there is little new to learn in their current roles, which is similar to the experience curve in that performance improvement becomes slower over time.

After the third year, costs continue to rise due to salary increases, but gains in productivity begin to decline as employee engagement declines. According to Cyert and March's behavioral theory of the firm, people begin to satisfy rather than maximize performance. This is interesting yet true. We tested this in our organization and found it to be true. At this juncture, the transaction costs become higher than the value of the job.?

If we don’t do anything, we are simply running a loss-making operation with an experienced but expensive role-holder.

The same situation with a different outcome occurs when human resources professionals and managers take action to avoid satisficing and promote maximizing:

Let us say we change the role of the role holder after the third year, as soon as transaction costs overtake productivity value.?

Bargaining costs, monitoring costs, and adaptation costs go up because:

• The new role with a higher level of productivity expectations will have a higher salary.
• Since the role holder will be new to the role, there will be training and supervision costs.?
• Productivity will come down because the role holder is learning new skills and the job.?
• But because of the experience curve, productivity increases again the following year, and it keeps going up for the next two to three years.

In the second scenario, where there is a role change, it is evident that the transaction is profitable overall and the role holder receives a higher salary. A computation illustration for someone hired at a salary of INR 6 lakh is given below:

Therefore, using transaction costs, the experience curve, and the behavioral theory of the firm, HR professionals can find answers to the following questions:

• When does employee loyalty start to hurt the organization?
• Does it make sense to have a person perform the same job over a long period of time??
• Do we keep giving increments to this person?
• When should we consider making some change in the role of a role holder to the role of a higher value??
• How can we build a solid business case for internal job postings with those line managers who are not willing to release their team members?
• How can we convince line managers that a longer tenure in the same role does not always translate into increased profit?