Description
Two-Tier Wages
In this chapter we talked about the implications of different pay-level strategies for costs and revenues. We Saw examples both of employers seeking to control/reduce pay levels and of employers increasing pay levels. Here, we continue our earlier discussion on how U.S. automakers have used two-tier wage structures to control labor costs and consider what might happen going forward. Also important is their use of profit sharing as a way to keep fixed labor costs under control and to make labor costs move more in line with profitability, so that labor costs decline when profits decline and labor costs increase when profits increase. That reduces the problem of having high, fixed labor costs when the company is under financial duress.
As we noted earlier, automobile production in the United States has declined over time. Employment has too. At the beginning of this century (January 2000), the motor vehicle and parts manufacturing industry (including both domestic and overseas owned U.S. producers) employed about 1,300,000 in the United States. That number bottomed out at 660,000 in 2009 during the recession and bankruptcies of that era. As of January 2020, it was back up to 976,000, or about 25% less than in January 2000. (We use January 2020 here to avoid the temporary effect on employment of the pandemic in 2020. For example, employment was down as low as 627,000 in April 2020.) Looking only at motor vehicle manufacturing (without parts), employ-
ment in January 2000 was 292,000, hitting its low of 123,000 in 2009, and growing to 235,000 by January 2020.74 Consider that, according to Bloomberg, in the late 1970s, GM alone had U.S. employment of labor costs, proximity to the large U.S. market, and access to export markets elsewhere, has, by contrast, grown its production and employment significantly over time.
As we saw earlier in this chapter, a two-tier wage structure allows a company to pay new hires at a lower wage. That is a major tool in reducing labor costs. At the Big Three (GM, Ford, Fiat Chrysler), as a result of their most recent contract agreements with the United Automobile Workers (UAW), the hourly wage for Tier 1 workers is $32.32 (up from $28 previously). In contrast, the wage for Tier 2 workers is up to $17 to $29.94, up from the previous $17 to $28. New hires start at $17 and progress through higher wage rates over time. For already employed Tier 2 employees at GM, under the previous contract, it took 8 years for a Tier 2 employee to progress to the top $28 rate. Under the new contract at GM (https://uaw.org/wp-content/uploads/2019/10/56100-UAW_hourly-1.pdf) that runs through 2023, in contrast, it will take already employed GM 20% and 45% of Big Three hourly employees, depending on the company, are on the Tier 2 wage scale. Thus, the savings are substantial.
In the GM-UAW contract, there are also separate wage rates for “GMCH” (GM Components Holdings) employees and for “CCA” (GM’s Customer Care and Aftersales) employees. The GMCH rate starts at $16.25 and tops out (after 8 years on the job) at $22.50. The CCA wage rate starts at $17.00 and tops out (again, it appears after 8 years) at $31.57. There are also “supplemental” (temporary) employees at the GM (and the Big Three). These employees also have lower wages ($16.67) and have the least job security, offering the company a way to easily reduce headcount when demand declines. In addition, there are flex temps and part-time temps. 77 Finally, it appears that, except for Tier 1 employees, the retirement plan is switched from a defined benefit to defined contribution plan (a 401k-discussed in Chapter 13) and there is no retiree health care benefit.
Discussion Question
(pick and answer one of the three questions below):
Besides Tier 1 employees, what are the other categories of hourly workers at GM? How many categories are there? How does the wage rate of each compare to that of Tier 1 employees?
How much more would it cost if all Tier 2 employees at GM were paid the same as Tier 1 employees are paid today? How much more will it cost in each of the four years of the recent contract to implement the contract agreement to move current Tier 2 employees to Tier 1 wage levels over time? Hint: Use the information on the percentage of employees who are Tier 1 and Tier 2. Compute the average wage in each year and multiply it times the number of employees in each Tier and multiply by 2,080 hours per year.
Refer back to our earlier exhibit (Exhibit 7.1) and use the difference in average hourly compensation (which includes benefits costs) between GM and Toyota/Honda to compute the labor cost difference between them.
Unformatted Attachment Preview
Compensation
(Chapter 07: Defining Competitiveness)
Jie (Jasmine) Feng, Ph.D.
Associate Professor in Human Resource Management
Rutgers | School of Management and Labor Relations
Compensation Strategy: External Competitiveness
• External competitiveness refers to the pay relationships among
organizations—the organization’s pay relative to its competitors.
• Pay level refers to the average of the array of rates paid by an
employer.
• (base + bonuses + benefits + value of stock holdings) / number of
employees.
– Pay mix is the various types of payments, or pay forms, that make up total
compensation.
• Pay level and pay mix decisions focus on two objectives.
– Control costs and increase revenues.
– Attract and retain employees.
2
Control Costs and Increase Revenues
• Labor costs = (pay level) times (number of employees).
• The higher the pay level relative to competitors, the greater the
relative costs to provide similar products or services.
• Paying above the market depends on employer returns and if the
return translates into revenues that exceed the cost of the strategy.
• Higher labor costs are sustainable only when the product is better or
when the product better matches consumer preferences.
• Examples:
– American Airlines went through bankruptcy and merged with USAir in 2014 and
now competes against Southwest Airlines.
– There is growing concern that Southwest’s labor costs are or may become a
problem.
3
Attract and Retain the Right Employees
• Different employers set different pay levels; that is, they deliberately
choose to pay above or below what others are paying for the same
work.
• One company’s pay comparisons differ when looking at base wage or
total compensation.
4
Exhibit 7.4 – Two Companies: Same Total Compensation,
Different Mixes.
This shows that
organizations can and do
vary in how closely they
match the “going rate.”
5
What Shapes External Competitiveness?
• These factors act in concert to influence pay-level and pay-mix
decisions.
6
Labor Market Factors
• Economists describe two basic types of markets:
– The quoted-price market (Amazon).
– And the bourse (eBay).
• In both the bourse and the quoted market, employers are the buyers
and the potential employees are the sellers.
• If the inducements offered by the employer and the skills offered by
the employee are mutually acceptable, a deal is struck.
7
Labor Market Factors How Labor Markets Work
• Theories of labor markets usually begin with four basic assumptions.
–
–
–
–
Employers always seek to maximize profits.
People are homogeneous and therefore interchangeable.
The pay rates reflect all costs associated with employment.
The markets are competitive, so there is no advantage for a single employer to pay
above or below the market rate.
• Understanding how markets work requires analysis of the demand and
supply of labor.
– The demand side focuses on the actions of employers – how many they are hiring
and what they are willing to pay.
– The supply side looks at potential employees – their qualifications and what pay
they are willing to accept.
8
Exhibit 7.6: Supply and Demand for Business School
Graduates in the Short Run
9
Labor Market Factors Labor Demand
• If $60,000 is the market-determined rate for business graduates, how
many business graduates will a specific employer hire?
• The answer requires an analysis of labor demand.
– In the short term, an employer cannot change any other factor of production other
than human resources.
– Under such conditions, a single employer’s demand for labor coincides with the
marginal product of labor.
• The marginal product of labor is the additional output associated
with the employment of one additional person, with other production
factors held constant.
• The marginal revenue of labor is the additional revenue generated
when the firm employs one additional person, with other production
factors held constant.
10
Labor Market Factors Marginal Product
• Assume a consulting firm provides services to 10 clients.
• The firm hires a third person, who brings in four more clients.
• The marginal product is the change in output associated with the
additional unit of labor.
– The marginal product of the third person is four clients.
– But adding a fourth employee generates only two new clients.
• Diminishing marginal productivity results from the fact that each
additional employee has a progressively smaller share of the other
factors of production with which to work.
• In the short term, the other factors of production are fixed. Until those
factors change, each new hire produces less than the previous hire.
• The amount each hire produces is the marginal product.
11
Labor Market Factors Marginal Revenue
• Marginal revenue is the money generated by the sale of the marginal
product, the additional output from the addition of one more person.
• An employer will hire until the marginal revenue generated by the last
hire is equal to the costs associated with employing that person.
12
Labor Market Factors Labor Supply
• The behavior model (of potential employees) assumes:
– Many people are seeking jobs.
– They possess accurate information about all job openings.
– And no barriers to mobility exist.
• As the assumptions change, so does the supply.
– If unemployment is low, offers of higher pay may not increase supply.
– If competitors quickly match offers of higher pay, the employer may face a higher
pay level but no increase in supply.
– Some firms find lowering the job requirements and hiring less-skilled workers a
better choice than raising wages.
13
Modifications to the Demand Side Compensating
Differentials
• Adam Smith argued that individuals make decisions based on the
alternative with the greatest “net advantage.”
• If a job has negative characteristics then employers must offer higher
wages to compensate for these negative features.
• Such compensating differentials explain the presence of various
pay rates in the market.
– Although the notion is appealing, it is hard to document.
– Due to the difficulties in measuring and controlling all factors that go into a netadvantage calculation.
14
Modifications to the Demand Side Efficiency Wage
• According to efficiency-wage theory, high wages may increase
efficiency and actually lower labor costs if they:
– Attract higher-quality applicants, lower turnover, increase worker effort, reduce
shirking behavior, and reduce the need for monitoring.
• The underlying assumption is that pay level determines effort.
• Utility theory can help compare the costs and benefits of different pay
level policies.
• Research shows that higher wages actually do attract more qualified
applicants – but also attracts more unqualified applicants.
• An organization’s ability to pay is related to the efficiency wage
model.
• Rent is a return (profits) received from activities that are in excess of
the minimum (pay level) needed to attract people to those activities.
15
Modifications to the Demand Side Sorting and Signaling
• Sorting is the effect that pay strategy has on the composition of the
workforce—who is attracted and who is retained.
• Signaling is a closely related process that underlies the sorting effect.
– Signaling theory says employers design pay levels and mix as a strategy that
signals to prospective/current employees the behaviors sought.
• An employer that combines lower base pay with high bonuses may be
signaling that it wants employees who are risk takers.
– A study of college students approaching graduation found that both pay level and
mix affected their job decisions.
• Both pay level and pay mix send a signal, which results in sorting
effects – who joins and who stays with the organization.
• Signaling works on the supply side of the model, too, as suppliers of
labor signal to potential employers.
16
Modifications to the Demand Side Reservation Wage
• Economists describe pay as “noncompensatory.”
• What they mean is that job seekers have a reservation wage level
below which they will not accept a job offer.
• No matter how attractive the other job attributes.
• A reservation wage may be above or below the market wage.
• The theory seeks to explain differences in workers’ responses to
offers.
– Reservation levels exist for pay forms too, particularly for health insurance.
– A young graduate may require health care insurance to take a job.
17
Modifications to the Demand Side Human Capital
• The theory of human capital holds that higher earnings flow to those
who improve their potential productivity by investing in themselves.
• It assumes people are paid at the value of their marginal product.
• In general, the value of an individual’s skills and abilities is a function
of the time, expense, and effort to acquire them.
• A number of additional factors affect the supply of labor.
–
–
–
–
–
–
Geographic barriers to mobility among jobs.
Union requirements.
Lack of information about job openings.
The degree of risk involved.
The degree of unemployment.
Nonmonetary aspects of jobs.
18
Product Market Factors and Ability to Pay
• The supply and demand for labor are major determinants of an
employer’s pay level.
– An employer’s pay level is constrained by its ability to compete in the
product/service market.
– Product market conditions to a large extent determine what the
organization can afford to pay.
• The two key product market factors that affect the ability of an
organization to change what it charges for its products and services
are:
– Product demand.
– Degree of competition.
19
Product Market Factors and Ability to Pay Product
Demand
• Labor market conditions (and legal requirements) put a floor on the
pay level required to attract sufficient employees.
– The product market puts a lid on the maximum pay level that an employer
can set.
• If the employer pays above the maximum, it must either:
– Pass on higher costs to the consumers.
– Or hold prices fixed and allocate a greater share of total revenues to cover
labor costs.
20
Product Market Factors and Ability to Pay Degree of
Competition
• Employers in highly competitive markets are less able to raise prices
without loss of revenues.
• At the other extreme, single sellers of a highly demanded product can
set any price they choose.
• Other factors besides product market conditions affect pay level and
compensation decisions.
– The productivity of labor.
– The technology employed.
– The level of production relative to plant capacity available.
• These factors vary more across than within industries.
21
Product Market Factors and Ability to Pay A Different
View: What Managers Say
•
•
•
•
In one study, managers were asked to make wage adjustment recommendations
for several positions under various scenarios.
Level of unemployment made almost no difference.
Company profitability was considered a factor for higher management, but not
when managers considered individual pay adjustments.
Managers believed that problems attracting and keeping people were the result o
poor management rather than inadequate compensation.
•
•
When the unemployment rate is high, companies make pay cuts.
Either outright or with furloughs, pay freezes, and/or reducing 401k
contributions.
•
A national survey found pay was the most often cited reason among highperforming employees for leaving a job.
Employers did not feel the role of pay was as meaningful.
•
22
Product Market Factors and Ability to Pay Segmented
Supplies of Labor and (Different) Going Rates
• Consider how a hospital staffs and pays its nursing positions.
•
The segmented supply results in nurses working the same jobs on the same shift,
but earning significantly different pay and/or benefits.
•
This is a case of people flowing to the work.
Relative
Hourly
Wage
Benefits?
Fee Paid by
Hospital to
Agency?
Nurse Type
Description
Regular
Full-time employees
100%
Yes
No
Pool
On call, part-time employees
132%
No
No
Registry
Agency employees who can work for
multiple area hospitals. Benefits
paid by agency.
150%
Yes
Yes
Travelers
Agency employees from outside the
area who are sent on extended
assignments (e.g., six months) to
hospitals around the country.
Benefits paid by agency.
150%
Yes
Yes
23
Organization Factors Industry, Employer Size, and
People’s Preferences
• The industry in which an organization competes influences the
technologies used.
• Qualifications and experience tailored to particular technologies is
important in the analysis of labor markets.
• There is consistent evidence that large organizations tend to pay more
than small ones.
• The relationship between organization size, ability to pay, and pay
level is consistent with economic theory.
• Better understanding of employee preferences of pay forms is
increasingly important in determining external competitiveness.
• However, there are substantial difficulties in reliably measuring
preferences.
24
Organization Factors: Organization Strategy
• A variety of pay-level and mix strategies exist.
– Some employers adopt a low-wage, no-service strategy.
– Others select a low-wage, high-services strategy.
– Still other employers use a high-wage, high-services approach.
• A variety of pay-level strategies may exist within some organizations.
• Efficiency wage argues that some firms have
efficiency reasons to pay higher wages.
• Observable benefits of higher wages may be
higher pay satisfaction, improved retention,
and higher quality and/or performance.
• Ultimately, higher
wages must bring
something in
return, such as
higher productivity
and/or innovation.
25
Relevant Markets
• Defining the relevant markets is a big part of figuring out how and
how much to pay.
• Every organization operates in many labor markets, each with unique
demand and supply.
• Managers must define the markets that are relevant for pay purposes
and establish the appropriate competitive positions in these markets.
• Three factors are commonly used to determine the relevant labor
markets.
– Occupation (skill/knowledge required).
– Geography (willingness to relocate, commute, or be a virtual employee).
– Competitors (other employers in the same product/service and labor markets).
26
Defining the Relevant Market
• Little is known about how employers choose their relevant markets,
but, if the markets are incorrectly defined:
• The estimates of competitors’ pay rates will be incorrect.
• And the pay level and pay mix inappropriately established.
• The data from product market competitors (as opposed to labor
market competitors) are likely to receive more weight when:
–
–
–
–
Employee skills are specific to the product market.
Labor costs are a large share of total costs.
Product demand is responsive to price changes.
The supply of labor is not responsive to changes in pay.
27
Globalization of Relevant Labor Markets: Offshoring
and Outsourcing
• Work flowing to lower wage locations is not new.
• Improved communication and connectivity accelerated the trend.
• Characteristics of some jobs lend themselves to offshoring.
• While large differences in labor costs cannot simply be ignored,
there are other factors to consider in deciding where jobs will be.
• Countries with lower average labor costs also tend to have lower
average productivity.
• There may be other risks, such as intellectual property theft.
• Agency theory tells us that companies must devote resources to
systems that monitor worker effort or output.
• Customers’ reactions must be considered.
28
Competitive Pay Policy Alternatives What Difference
Does the Pay-Level Policy Make?
•
Compensation theories help understanding the variations in pay levels,
but are less helpful in understanding the mix of pay forms.
•
Three conventional pay-level policies are to lead, to meet, or to follow
competition – Newer policies emphasize flexibility.
29
Competitive Pay Policy Alternatives Pay with
Competition (Match)
• The most common policy is to match rates paid by competitors.
• A pay-with-competition policy tries to ensure that an organization’s
wage costs are approximately equal to those of product competitors.
– And that its ability to attract applicants will be approximately equal to its labor
market competitors.
• Classical economic models predict that employers meet competitive
wages.
• While this avoids placing an employer at a disadvantage in pricing
products, it may not provide a competitive advantage in its labor
markets.
30
Competitive Pay Policy Alternatives Lead Pay-Level
Policy
• A lead pay-level policy maximizes the ability to attract and retain
quality employees and minimizes employee dissatisfaction with pay.
• It may also offset less attractive features of the work.
• An entire industry may pass high pay rates on to consumers.
• A number of researchers have linked high wages to ease of attraction,
reduced vacancy rates and training time, and better-quality
employees.
• Pay satisfaction helps explain the influence of pay level on quits.
• A lead policy can also have negative effects.
– It may force the employer to increase wages of current employees too, to avoid
internal misalignment and murmuring.
– It may mask negative job attributes that contribute to high turnover later on, such as
boring assignments or hostile colleagues.
31
Competitive Pay Policy Alternatives Lag Pay-Level Policy
• A policy of paying below-market rates may hinder a firm’s ability to
attract potential employees – called a lag pay-level policy..
• But if coupled with the promise of higher future returns, it may
increase commitment, foster teamwork, and increase productivity.
• How long this promise works, in the face of flat or declining stock
markets, is unknown.
• Unmet expectations probably have negative effects.
• Additionally, it is possible to lag competition on pay level but to lead on
other returns from work.
32
Competitive Pay Policy Alternatives Different Policies
for Different Employee Groups
• In practice, many employers go beyond a single choice among the
three policy options.
•
They may vary the policy for different occupational families.
•
Or vary the policy for different forms of pay.
•
Or they may adopt different policies for different business units that face very
different competitive conditions.
33
Competitive Pay Policy Alternatives Not by Pay Level
Alone: Pay-Mix Strategies
•
Alternative pay-mix
policies include
performance driven,
market match, work/life
balance, and security.
•
How managers position
their organization’s pay
against competitors is
changing.
•
Emerging alternatives
focus on total returns
(beyond financial
returns) and offering
choices among these
returns.
34
Consequences of Pay-Level and Pay-Mix Decisions:
Guidance from the Research
• External competitiveness has two major consequences which affect:
• Operating expenses, employee attitudes and work behaviors.
35
Consequences of Pay-Level and Pay-Mix Decisions:
Efficiency
• A variety of theories make assumptions about the effects of relative
pay levels on an organization’s efficiency.
•
Research on the effect of pay-level policies is difficult because companies’ stated
policies often do not correspond to reality.
•
Beyond opinions, there is minimal evidence of the consequences of different policy
alternatives.
•
In the absence of satisfactory evidence, the least-risk approach may be to set both
pay level and pay mix to match competition.
36
Consequences of Pay-Level and Pay-Mix Decisions:
Fairness and Compliance
• Satisfaction with pay is directly related to the pay level—more is
better.
– But employees’ sense of fairness is also related to how others are paid.
• Provisions of prevailing wage laws and equal rights legislation must
also be met.
• Pensions and health care are considered economic security and are
regulated to some degree in most countries.
• Employers must use caution when sharing salary information to avoid
antitrust violations.
• No matter the competitive pay policy, it needs to be translated into
practice – the first step is to use a salary survey (Chapter 08).
37
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