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.
Two-tier plans are particularly attractive to organizations in sectors where turnover is high. For companies with low turnover, the cost benefits accrue gradually. "Two-tier plans can generate substantial cost savings; however, the savings are generated over a number of years," notes Fred Crandall, Chicago-based senior consultant with Watson Wyatt Worldwide. "The cost savings are the result of adding employees to the new lower-cost structure and the attrition of employees in the older, higher-cost structure. An actuarial analysis can pinpoint the attrition rate as a basis for calculating cost savings." Some employers, including Safeway, offer buyouts to veteran employees to increase the rate at which new hires replace higher-paid workers.
The level of savings that two-tier plans generate hinges on how long the company takes to complete the transition. "A CFO should first evaluate the cost of labor -- wages plus benefits -- in the marketplace in which the employer competes for talent," says Tony Pilegge, Houston-based director of Alvarez and Marsal Business Consulting. "This will provide valuable information on the new, typically lower, wage rates and benefits package that should be established for newly hired employees." A two-tier plan that sets wages below market rates may reduce the company's ability to attract workers to new job openings.
Cost savings may contract if the two-tier system increases turnover among new hires, but the cost of higher turnover should be easy to track, notes Howard L. Bernstein, a partner with law firm Neal, Gerber & Eisenberg LLP in Chicago. He cautions, however, that some two-tier plans have not been as effective as anticipated. "Given the state of the economy, many companies are simply laying off employees at all levels and not replacing them. With little or no turnover or job growth, a two-tier system produces no economic gain."
Companies can structure a two-tier plan to meet their specific needs. Plan design considerations include the level of unionization and the degree of detail in the existing job classification and wage structure. "For example, a plan could separate new employees into salary schedules with reduced grade midpoints," Crandall says. "A more subtle approach would be to hire new employees in different, lower-paid classifications."
In nonunion settings, an employer is free to implement wage cuts across the board at any time. "Of course, employers are reticent to reduce wages or salaries of the current employee base under any circumstances because of the potential for reduced morale, dissatisfaction, sabotage and other consequences that often arise in takeaway situations," Crandall observes.
Many nonunion employers create two-tier systems with lower rates for new hires and a longer period for progression up to higher salary levels. "New hires are generally offered a lower wage rate than existing employees, even if they share the same level of experience, especially for more seasoned new hires," Pilegge says. "Additionally, many nonunion employers are moving to a more highly leveraged compensation system -- with the employee's total compensation more heavily weighted on the bonus or variable element of the wage -- as a means of controlling labor costs in leaner years."
Nonunion employers may decide to institute a two-tier system to realize savings in "soft" benefits. "For example, nonunion new hires typically are offered less vacation time than their longer-service counterparts, which creates lower costs for the new hires," Pilegge explains. "Also, they are typically not eligible to receive a matching 401(k) contribution for a period of time. The 'hard' benefits, such as retirement and medical benefits, are subject to ERISA guidelines, which include numerous discrimination tests. For deeper savings, however, both union and nonunion employers will have to focus on cutting both soft and hard benefits."
When an employer cannot force a permanent two-tier system, a temporary two-tier plan may provide some cost relief. "Union new hires would be subject to 'break-in' wage rates," Pilegge explains. "Break-in wage rates are a percentage of the prevailing union wage rate, with the percentage increasing over some period of time. For example, it may take a new hire three years to reach the prevailing wage rate. The new hire would receive 70 percent of the prevailing wage rate in year one, 80 percent in year two and 90 percent in year three. In year four and beyond, there would be parity in the union wage rates for all union employees. The real savings are in the first three years of employment and are contingent on the amount of turnover among employees with four or more years on the job."
Crandall notes that "two-tier systems create, in effect, two classes of employees who are doing the same or similar work for different rates of pay. This presents potentially formidable employee relations problems in cases when there exists a labor-grade and wage-scale system." In many regions where employers have installed two-tier compensation plans, however, employee opposition has been muted because alternative job opportunities are limited.
"It is only natural for employees to feel resentment toward their employer and even toward their fellow employees in a two-tier situation," says attorney Bernstein. "Some of that resentment can be diminished by implementing a two-tier system that allows the employees in the lower tier to work their way up to the upper tier over time. Another way to reduce or eliminate the animosity is to allow the lower-tier employees to elevate to the higher tier whenever there are vacancies at the higher level. While these examples do not result in all of the economic gain a company may have hoped for, they do have the effect of reducing or eliminating much of the low morale and animosity that most two-tier systems generate."
Two-tier compensation plans are just one of the more radical approaches in a range of methods for resetting wages that also includes salary increases below the rate of inflation and lower incentive plan payouts. These strategies have become common in nearly all sectors and regions, and they have helped push real wage changes into negative territory for almost two years. With global competitive pressures now affecting most U.S. industries, two-tier plans are here to stay.
Adapting Payroll Systems For Two-Tier PlansThe difficulty of adjusting a company's payroll system to accommodate a two-tier compensation plan depends on the degree of automation involved and the extent to which the payroll software allows for user modifications, according to Scott Mezistrano, senior manager of government relations for the American Payroll Association in San Antonio, Texas. "It's up to human resources to provide the new wage rates and their effective dates, and then payroll implements those changes," he says. "Either programmatically or manually, payroll will have to keep track of the two separate employee groups and modify the rates according to the two-tier structure." Automated systems can be programmed to record hire dates and make the appropriate rate changes. "You can program almost anything, given the right amount of lead time and money to put toward programming staff," Mezistrano says. The complexity of the task hinges on the adaptability of the software. Older systems may not support added variables, but new systems usually allow for a number of user modifications. Some union contracts call for different methods of calculating overtime for different groups of employees, including those defined by two-tier systems. Special programming may be required in the time-and-attendance system to track these rules and calculate the right overtime amounts. "A company might set up a system of compensation codes which indicate the rules for how each group is paid," Mezistrano says. "Every new employee is assigned a code so that the time-and-attendance system and the payroll system follow the rules for that code." CFOs can determine whether their company's systems will allow for modifications by talking to the data programming or IT staff about the changes that will be necessary to implement the two-tier plan. The programming staff can then work with the software provider to make the necessary adjustments. Legal Considerations"With the recent re-emergence of two-tier compensation plans, we can expect to see a return of some of the legal and practical issues that typically accompany systems that pay lower wages or benefits to new workers," says E. Fredrick Preis Jr., attorney with McGlinchey Stafford in New Orleans. Employers who implement these plans generally intend eventually to phase out the higher-paying jobs, he notes. "However, before the phaseout is complete, there is a stage where enough of the higher-paying jobs still exist to create jealousy and dissatisfaction among the newly created majority consisting of lower-paid workers. Employers who are considering two-tier plans need to weigh carefully the immediate benefit versus the potential long-term detriment," he advises. A growing number of two-tier plans include lower pay and inferior health-care coverage or higher cost-sharing for new hires. "This creates the potential for legal concerns, such as a rise in discrimination lawsuits based on disparate treatment or disparate impact," cautions Christine M. White, attorney at McGlinchey Stafford. "For example, an employer may put in place a two-tier system for pay or benefits at a time when its workforce consists in greater part of workers who do not belong to a protected class of individuals. But then, through fortuitous circumstances, a larger number of minority workers are hired under the new, lower pay scale. Such a situation could lead to disparate-impact claims." Federal law prohibits employment practices that may be facially neutral but have a disproportionate impact on a group protected by Title VII of the Civil Rights Act of 1964. The best protection against disparate-impact claims is a careful analysis of which individuals will fall above and below the cutoff line for the different pay rates. "If it appears that such a two-tier system will, in fact, have an adverse impact on certain protected classes, the plan should be reconsidered," says Howard L. Bernstein, partner with Neal, Gerber & Eisenberg LLP in Chicago. "Such an analysis may be impossible, however, since the people who usually will fall below the line and receive the lower wages have not yet been hired." |