Breaking the Grip of High Labor Costs

From heavy industry to the retail sector, companies are using two-tier compensation systems to permanently reset wages.

New hires at Caterpillar Inc. sign on at $10 to $15 per hour and work alongside employees who were hired only a few months ago at $20 to $22 an hour. They also receive less extensive health-care benefits than veteran workers do. This two-tier arrangement, the result of an agreement ratified by the United Auto Workers (UAW) on January 9, will enable the Peoria, Ill.-based engine and equipment manufacturer to phase out the high wages it has traditionally paid and cut its labor costs in half. The UAW agreed to the two-tier system and other wage concessions after the company threatened to expand outsourcing and offshore production.

The Caterpillar arrangement is one of many two-tier compensation systems that have appeared over the past few years. These structures closely resemble the plans that many organizations installed 20 years ago when they gained the upper hand in contract negotiations after two back-to-back recessions. However, today's two-tier systems are marked by a pair of new developments: They are appearing in industries far beyond the hard-hit manufacturing sector, and in addition to providing lower wages for new employees, they offer significantly reduced benefits.

Unions generally oppose two-tier compensation systems because they trap new members in lower-paying positions and destroy member unity. And employers tend to avoid them because they can create morale problems in the workplace. But as competitive conditions intensify, businesses are taking another look at this compensation strategy, which can radically reduce their labor costs. "By creating a wage and benefits structure more in line with that of our market and industry, we are better able to compete from our traditional manufacturing and logistics locations," reports Benjamin S. Cordani, spokesperson for Caterpillar.

The largest unionized supermarkets in Southern California proposed a two-tier system in their 2003-2004 contract negotiations in an attempt to pull their costs into line with those of nonunion competitor stores, including Wal-Mart. "When you consider that we are competing with stores that offer little in the way of health benefits -- or none at all -- the problem becomes very serious very quickly," says Larree Renda, executive vice president of Pleasanton, Calif.-based Safeway Inc. Although the proposal touched off a five-month work stoppage that severe-ly damaged earnings, the companies refused to back off and eventually prevailed. In Safeway's Southern California stores, new hires now top out at $2.80 an hour less than their veteran co-workers, and they also pay a higher share of their health-benefit costs.

Grocery workers across the Western states are now under pressure to accept various forms of two-tier pay and higher benefit copayments. Two-tier plans have also been implemented by hotel companies in Nevada, day-care center operators in New York and auto parts manufacturers in Michigan.