Exam Number: s163025

Word Count: 1514……

CRANFIELD SCHOOL OF MANAGEMENT

Full Time MBA Programme 2011/12

Term: 1

Part: 1

Economics of Organisations & Strategy

(EOS)

WAC

This assessment/report is all my own work and conforms to the University’s

regulations on plagiarism 
 EOS WAC – Memphis Blues

An identical copy of this document has been submitted to the Turnitin system


EXECUTIVE SUMMARY

The essence of this report is to identify the incentives problems faced by EuroCover,
analyse these problems and recommend actions to motivate the back-office staff in
order to improve the firm’s economic performance.

EuroCover’s underwriting profit and investment income fell considerably from 2006
figures and by the end of 2007, fourteen employees had resigned from the firm with a
few others likely to follow.

The issues plaguing EuroCover all appear to be interrelated and are summarised as
follows:
1. Lack of financial incentives
2. Inadequate human capital development
3. Unfit organisational structure
4. Unutilised internal labour market
5. Un-empowered employees

Having analysed the identified issues and their effects on the economic implications to
EuroCover, the following action points are recommended to reverse their dismal
economic and HR performance:
1. Implement a remuneration and reward system based on the payment of
effeciency wages in order to attract, motivate and retain back-office employees.
2. Invest in human capital development in the back-office via trainings, seminars
and possibly degree level education to improve productivity.
3. Modify the organisational structure of the company to a multi-divisional form to
allow for the proper management and comparison of performance of the back-
office.
4. Promote the development of the internal labour market at EuroCover to build
long term relationships between employees and employers which will encourage
congruence of goals.
 EOS WAC – Memphis Blues

5. Empower employees to participate in the decision making process in order to

motivate employees and to speed up the decision making process.
TABLE OF CONTENTS

1.0 INTRODUCTION 1

1.1 Background 1

1.2 Aims and Objectives 1

2.0 INCENTIVES ISSUES 2

3.0 ANALYSES 3

3.1 Lack of Financial Incentives 3

3.2 Inadequate Human Capital Development 4

3.3 Unfit Organisational Structure 4

3.4 Unutilised Internal Labour Market 4

3.5 Unempowered Employees 5

4.0 CONCLUSION 6

5.0 RECOMMENDATIONS 7

REFERENCES 8

BIBLIOGRAPHY 9

APPENDICES 10
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1.0 INTRODUCTION

1.1 Background

EuroCover’s underwriting profit and investment income have fallen considerably from
2006 figures and by the end of 2007, fourteen employees had resigned from the firm
with a few others likely to follow. The ability of an organisation to attract, motivate and
retain its human capital ultimately impacts its productivity. In order to achieve high
levels of efficiency, the organisation must foster the belief amongst the employees that
its rewards and incentives programs are reasonable and fair (Rickard, 2006).

1.2 Aims and Objectives

Although EuroCover has requested a focus on salary, a full understanding of the process
of motivation involves behavioural as well as economic theories. Therefore the essence
of this report is to identify all the incentives problems faced by EuroCover, analyse
these problems and recommend actions to motivate the back-office staff in order to
improve the firm’s economic performance.

This report comprises of five parts. The first section is the introduction which highlights
the background, aims and objectives of the report. An identification of the incentives
problems facing EuroCover is presented in Section 2 while the analyses and
interpretations of these problems are presented in Section 3. The conclusions and
recommendations are presented in sections 4 and 5.

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2.0 INCENTIVES ISSUES

The problems plaguing EuroCover all appear to be related to motivation issues and have
contributed to the increased rate of employee turnover, reduction in profitability and the
imposition of additional capital reserves by Lloyd’s. These issues can be categorised
under the following headings:

1. Lack of Financial Incentives

EuroCover commenced operations with a view on remunerating employees at
the “going rate” scrapping previously existing fringe benefits and cutting
salaries. This has seen back-office staff move to alternate employment and
increased annual turnover to 1.2 employees per year.
2. Inadequate Capital Development
The high rate of employee turnover has channelled the focus of HR towards
recruitment thereby neglecting training and development of back-office staff.
3. Unfit Organisational Structure
EuroCover operates a flat unitary form of organisational structure with inherent
loss of control and scope for opportunistic behaviour.
4. Unutilised Internal Labour Market
Vacant positions are filled by external applicants and back-office staff have little
prospects of being promoted to the more highly rewarding position of
underwriter.
5. Un-empowered Employees
Employees are expected to follow instructions and be courteous and helpful to
clients rather than utilise their knowledge and experience. Decision making is
highly centralised and most tasks are routine and mundane.

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3.0 ANALYSES

This section analyses the issues identified in Section 2.0 and relates them to specific
theories relating to wages, incentives, human resources and productivity.

3.1 Lack of Financial Incentives

The decision of EuroCover to pay the “going rate” of wages which according to them
represents the realities of the market is in line with the neo-classical approach
(Appendix I) to the demand of labour which assumes a perfect competition, profit
maximisation, and homogeneity of workers. As the price of labour is determined solely
by the forces of demand and supply, neither the buyers of labour nor labour itself has
any discretion over the price of labour (Rickard, 2011).

However, contrary to the neo-classical model, differences do exist in the wages of

individuals and markets are imperfect giving employees and employers some degree of
market power. In practice, many forces will influence the employee’s decision to seek
new employment. As information is readily available, employees will have perfect
information regarding the going rate wage in other industries and will react rapidly to
relative changes in wage rate. Therefore, paying the going rate will increase shirking,
employee turnover and the transaction costs involved in replacing employees.

In order to improve effeciency, a remunation incentive system which minimises moral

hazard and encourages effort such as the effeciency wage, should be implemented. The
efficiency Wage theory (Appendix II) sets wage rates above market going rates with the
intention to discourage shirking, reduce turnover, and to attract superior employees.
Shirking is discouraged because it results in lost worker productivity as a result of poor
effort and hence and increased opportunity cost of losing work becomes higher,
decreasing the probability of shirking and increasing productivity.

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3.2 Inadequate Human Capital Development

Education and training can increase the value of the employees of an organisation. The
higher the investment in human capital, the higher is the productivity of the firm’s
workforce, ceteris paribus (Rickard, 2011). Human capital theory explains the
difference in wage rate based on the difference in human capital stocks that determine
an individual’s marginal productivity. The theory addresses the heterogeneous nature of
the labour market, relaxing the basic neo-classical model assumption of homogeneity.

3.3 Unfit Organisational Structure

A flat unitary organisational structure leads to inherent loss in control and opportunistic
behaviour (Rickard, 2006). It has become increasingly impossible to measure the
performance of the back-office back-office performance. Hence the current unitary
organisational structure should be replaced with the multi-divisional form which allows
for proper measurement and comparison of the performance of business units. This will
help monitor and control the contributions of the business unit to the bottom line and
allow intervention at the right time (Rickard, 2006).

3.4 Unutilised Internal Labour Market

Job positions within the organisation should be filled with internal applicants where
necessary before inviting outside applicants. Recruiting from within and having
properly defined career paths are key features of the internal labour market which build
long-term relationships between employers and employees. These long-term
relationships are likely to converge the goals of the employees and employers and in the
long run the nature of an employee’s skills, attitudes and commitment will be shown
(Rickard, 2006).

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3.5 Unempowered Employees

A highly centralised decision making process is not always beneficial. Decision making
should be pushed to lower levels to speed up the decision making process and improve
coordination. However, this should be accommodated with clearly understood
boundaries.

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4.0 CONCLUSION

The essence of this report was to identify the incentives problems faced by EuroCover,
analyse these problems and recommend actions to motivate the back-office staff in
order to improve the firm’s economic performance.

The foregoing has shown the relationship between the rewards system and human
resource productivity. As well as motivating and rewarding individuals, retaining and
developing productive employees are also very essential. The skills, efforts,
accumulated knowledge and commitment of a firm’s employees are a major source of
competitive advantage hence the importance of managerial skill in devising and
implementing efficient human resource policies, an area of specialisation that falls
under the heading of human resources management (Rickard, 2006).

Figure 1 is based on the expectancy theory which attempts to summarize the

interrelationships of behaviours which affect the bottom line of an organisation.
According to Rickard (2006), expectancy theory predicts that an employee will exert a
high level of effort if a strong relationship between effort, performance, rewards and the
satisfaction of achieving personal goals is perceived.

Figure 1: Effeciency motovation and performance

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5.0 RECOMMENDATIONS

In order to improve the economic and HR performance of EuroCover, the following

actions are recommended:

1. Implement a remuneration and reward system based on the payment of

effeciency wages in order to attract, motivate and retain back-office employees.
2. Invest in human capital development in the back-office via trainings, seminars
and possibly degree level education to improve productivity.
3. Modify the organisational structure of the company to a multi-divisional form to
allow for the proper management and comparison of performance of the back-
office.
4. Promote the development of the internal labour market at EuroCover to build
long term relationships between employees and employers which will encourage
congruence of goals.
5. Empower employees to participate in the decision making process in order to
motivate employees and to speed up the decision making process.

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REFERENCES

Rickard, Sean (2011). The Economics of Organisation and Strategy, from Cranfield
School of Management.
Rickard, Sean (2006) The Economics of Organization and Strategy (1st ed), McGraw-

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BIBLIOGRAPHY

Rickard, Sean (2011). The Economics of Organisation and Strategy, from Cranfield
School of Management.
Rickard, Sean (2006) The Economics of Organization and Strategy (1st ed), McGraw-

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APPENDICES (TEAM APPENDICES)

APPENDIX I: THE NEO-CLASSICAL DEMAND FOR LABOUR

WorldCover was resolute that EuroCover pay only the going wage rates in order to
maximise profits in the global competitive market. They had assumed that they were
operating in a perfectly competitive market where labour units are viewed as
homogeneous and that each firm’s demand for labour was relatively small. This is in
line with the neo-classical approach to the demand of labour which assumes that human
beings are essentially the same type of resource.

According to the neo-classical school of thought, labour is assumed to be sold in

perfectly competitive markets where neither the buyers of labour nor labour itself has
any discretion or influence over the wage paid per unit of labour. Therefore, employers
are required to pay the going wage rate which is determined exclusively by the
coincidence of demand and supply in the labour market for each time period. Therefore,
the firm’s managers will only hire an extra unit of labour as long as it is profitable.

The figure below illustrates the neo-classical model for a firm’s decision to employ
labour. The horizontal line represents an infinite supply of labour at the wage going rate
and the down-ward sloping curve represents the individual firm’s demand curve for
labour reflecting the law of diminishing returns and its associated marginal product of
labour, MPL. Therefore, the more labour the firm hires, ceteris paribus, the lower will be
the marginal revenue product (MRPL = MPL.P).

(Source: EOS Lecture Notes)

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The cost of hiring an extra unit of labour is w and if the firm only hires N0 units of
labour the MRPL generated (point A) is greater than the cost w. The profit maximising
employer will therefore want to employ labour up to the point where w = MRPL. Hence,
the quantity of labour hired will be N1 units at a going wage rate of w (Rickard, 2006).

In reality, however, the neo-classical approach to labour demand is flawed because the
assumptions of homogeneity of labour, perfectly competitive labour market, perfect
information, and the derived demand of labour are not valid.

APPENDIX 2: “GOING RATE” & EFFICIENCY WAGES

Figure 2:- “Going Rate” Figure 3:- Efficiency Wage

Theory

Figure 2 illustrates the “going rate” concept whilst Figure 3 defines Efficiency Wage
theory to allow the understanding of incentivising and the benefit of retaining workers
to establish long term sustainability.

It represents the insurance industry determining the “going rate” (wages) as a whole
which individual firms have to adopt to be competitive in the labour market. EuroCover
currently assumes the “going rate” for individuals within the industry is at W1, which
we are assuming to be below the market clearing rate of W*. This has occurred due to
the Non-Executive Chairman having asymmetry information of the labour market. This
has resulted in the company offering a less competitive package in comparison to other
firms in the industry, thus leaving them to struggling in competing for the skilled and
experienced labour they require as they are operating at S1 rather than S*.

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Figure 3 offers a solution to their current problem, demonstrating if EuroCover were to

offer a “going rate” Wₑ above the market clearing rate of W*, it would incentivise their
workers as they would be paying a higher wage in respect to the market. The cost for
workers losing their job would be far greater as they would experience a significant
reduction in wages if they were to go elsewhere within the industry. This incentive
should encourage workers to reduce shirking and increase productivity. If workers
increase productivity from MRP₁ to MRP₂ this productivity increase should offset
increases made in wage rates, resulting in the company not needing to reduce labour
units from N₀ to N₁. The increase in productivity (from point A to B) will be dependent
upon a risk factor (represented by the normal distribution curve) however if managed
correctly it should be possible as workers will feel a greater loyalty to the company
whilst increasing their length of employment and experiencing learning curve benefits
and knowledge. These factors combined will lead to a greater retention of labour whilst
establishing improved long term sustainability for the organisation.

APPENDIX 3 - HUMAN CAPITAL AND WAGES

Figure 4: Relation between human capital and wages

Human capital consists of the knowledge and competencies of the entire workforce of
the firm. A firm’s productivity is directly proportional to the human capital it possesses
and thus it is very important for an organisation to invest in raising their human capital.
In the case of EuroCover, the attrition of firm-specific human capital should be

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prevented instead the resources should be nurtured to improve the organisation’s overall
productivity.

Training the organisation’s workforce (N₀ in number) to develop firm-specific skills

and knowledge will raise the marginal revenue of product from MRP₀ to MRP₁. For the
firm’s employees with the firm specific knowledge, the supply curve becomes vertical
at N₀ and thus it becomes justifiable to pay them at wage W₁. The dashed line reflects
that any potential external resource, at a wage above W₀, likely to be recruited by
EuroCover will have little or no interest to the firm.

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