The Advantages of a Two-Tier Wage System

As businesses look to maximize efficiency and minimize cost, as well as stave off the impact of globalization, some businesses with active unions now take a new tack: a two-tiered wage system. This approach provides businesses with advantages ranging from basic cost reduction, in the short- and long-term, to higher profit margins and a more divided employee base.

In a two-tier wage system, the business owner negotiates with the union to install two separate wage structures for existing and new workers. Existing members of the union continue to receive pay, wage increases and benefits as defined by the previous agreement. New workers who join the union receive a lower starting wage, lower peak wage and often a less-substantive benefits package.

One of the advantages of a two-tier wage system is that the business enjoys a short-term cost reduction for all new workers that join the union. The total budget for wages and benefits the business must allocate goes down, while production remains consistent. The reduction in labor costs also lowers unit costs for each product. Lower unit costs allow the business to enjoy a larger profit margin on products by maintaining current pricing or to reduce prices to improve their competitiveness. For example, say the two-tier system leads to a 5-cent cost reduction per unit and the business produces 70,000 units per year. If the business maintains its current pricing, it makes $3,500 in pure profit.

The business also stands to see long-term labor cost reductions. As older, higher-paid union members retire, the business can replace them with less-expensive workers. For example, say a business has 1,000 employees and 100 of them receive a maximum wage of $38,000 per year as members of the higher wage tier. If 50 of them retire and the business replaces them with new workers earning a base pay of $26,000 a year, the business saves $12,000 per year/per employee, for a total annual savings of $600,000.

Two-tiered wage systems also provide the business with the advantage of a more divided work force. While workers receiving wages and benefits under the old agreement probably remain more or less satisfied, new workers receiving reduced pay and benefits for equivalent work often resent their better paid coworkers. This internal conflict among union members makes it more difficult for the union to bargain collectively, as new and senior workers view the situation in different terms. For example, when new workers want to push for wage renegotiation, senior union members maintain a vested interest in protecting their existing wages and benefits. The business, on the other hand, gets to avoid the issue while the union tries to sort out its internal strife.