Why does FCA have an $8 per hour competitive labor cost advantage over GM?
As the former Director of Labor Economics at FCA, I have been fielding a lot of questions recently as to why there is a such a large competitive labor cost gap between GM and FCA. So, for what it is worth, here are my thoughts. There are a number of demographic and economic reasons for this competitive advantage. In addition, over the years, there have been some significant differences in strategic decision-making relative to workforce composition and compensation matters, including situations where the companies either elected to embrace or reject certain economic elements of pattern bargaining. I will attempt to explain these factors as I highlight a few of the major drivers of the $8 per hour competitive gap in this article. Throughout this article, I have made some key assumptions and have taken a high-level approach in conducting my analysis. Therefore, any calculations should be viewed as illustrative and directional. Hopefully, after reading this article you will have a much better appreciation for the significant impact that strategic decision-making can have on a company’s overall labor costs.
According to the Center for Automotive Research (CAR), all-in UAW hourly labor costs for GM are estimated to be $63 per hour versus $55 at FCA, giving FCA a competitive labor cost advantage of $8 per hour worked in the United States.
In this article, I will focus primarily on three key labor cost elements (workforce composition, profit-sharing and 2015 signing bonus amortization) that I consider to be key drivers of the $8 per hour competitive labor cost gap. In addition, I will provide commentary with respect to “Other” labor cost elements that may contribute to the labor cost gap as well. See the table below for a brief summary.
Workforce composition has a significant impact on the composite labor costs of the Detroit 3 Automakers. In a nutshell, a company’s overall labor costs will decrease to the extent that the company can introduce more lower cost employees into its workforce mix. Essentially, Traditional employees are those hired before October, 2007 and In-Progression employees are employees who are hired subsequent to that date. Many In-Progression employees are still migrating through the wage progression chart and have not reached maximum wage rates yet. In addition, they have lower vacation entitlements and may still be growing into full health care coverage eligibility. For these reasons, In-Progression employees, on average, are typically less expensive than Traditional employees. It is conceivable that the all-in cost of In-Progression non-skilled employees, on average, may be $15 to $20 per hour less expensive than Traditional non-skilled employees. The difference really depends on where the In-Progression employees fall in the wage progression scale (8-year grow-in prior to the new 2019 Agreement that has now reduced it to a 4-year wage grow-in period). Notwithstanding the fact that FCA has been on a significant hiring spree for the last few years, for purposes of this analysis, I am going to assume that the gap between the cost of Traditional non-skilled employees and In-Progression non-skilled employees is $15 per hour. Therefore, in theory, every one percentage point difference in workforce composition relative to In-Progression employees may translate into a $0.15 per hour difference in the composite labor cost rate.
There are several ways to introduce In-Progression employees into the automaker’s workforce. The most common way is through the backfilling of Traditional employees as a result of normal attrition (e.g., retirements, terminations, quits, deaths). Another way is by offering special attrition programs (e.g., retirement buyouts) to Traditional employees in order to encourage them to retire and then backfilling them with less expensive In-Progression employees. All three Detroit automakers recently negotiated special attrition program offerings with the UAW as part of their 2019 Agreements, enabling them to reduce their composite labor costs in due time. The last way is by simply expanding the company’s U.S. manufacturing footprint and adding new hourly UAW jobs (see FCA job growth in the chart below).
Under the 2007 Agreements with the UAW, both GM and FCA were subjected to a 25% cap on what was previously called “Tier II” employees, those hired after October, 2007 and before October, 2015 (now part of the In-Progression employee group). As part of the bankruptcy Addendums negotiated with the UAW in 2009, the 25% cap on Tier II employees was lifted for both GM and FCA through the end of the 2011 Agreement (September, 2015). Therefore, in theory, both companies could hire as many Tier II employees as they wanted until the expiration of the 2011 Agreement. Again, in theory, at the beginning of negotiations in September, 2015, the old 2011 Agreement would have expired and accordingly, one could present a case that the companies and the UAW had the ability to negotiate the removal of the newly reinstated 25% Tier II cap (if applicable) and/or develop a new workforce composition model, or to modify any other contractual elements for that matter.
There were many potential alternatives to this Tier II cap approach that either company could have envisioned well in advance and then tabled to the UAW during 2015 Bargaining. Potential workforce composition alternatives may have included an “Equal Pay for Equal Work” concept, increased utilization of temporary employees, increasing wage progression periods for new hires or perhaps eliminating the Tier II cap and migrating all Tier II employees to a higher (but lower than Traditional employee) wage structure. Any one of these concepts or combination of these concepts would assist in mitigating overall labor costs.
As allowed for in the 2009 Addendum, FCA expanded its U.S. manufacturing footprint and accordingly hired a significant number of Tier II employees through the expiration of the 2011 agreement (and beyond). The chart below (Automotive News) indicates that FCA has doubled its hourly UAW workforce since 2011, whereas GM’s hourly UAW workforce has shrunk over that same timeframe.
As it turned out, during 2015 bargaining, as lead company, FCA and the UAW initially negotiated a new two-tier model that provided an attractive increase to the wage structure of Tier II employees (with no Tier II cap requirement). However, the UAW membership sent a message, loud and clear, to the automakers that they were no longer interested in any form of two-tier approach, by voting down this first tentative agreement with FCA. The second tentative agreement was ratified by the UAW membership. It effectively eliminated the two-tier system but incorporated a couple of the other alternative workforce composition approaches highlighted earlier (increased wage progression period for new hires and higher utilization of temps) in order to assist FCA in mitigating overall labor costs. It should be noted here that, for all intents and purposes, the existence or non-existence of a reinstated 25% Tier II cap in September, 2015, in effect became a moot point.
Recent news articles suggest that FCA is comprised of ~64% In-Progression employees versus ~40% at GM – a difference of ~24%. If we assume these levels of In-Progression employees and that every one percentage point is worth $0.15 per hour as highlighted above, this would suggest that $3.60 (nearly one-half) of the $8 per hour competitive labor cost gap between the two companies may be attributable to differences in workforce composition. Clearly, FCA’s strategic decision to expand its U.S. manufacturing footprint has had a significant impact on its overall workforce composition and consequently this workforce expansion ultimately assisted in mitigating its U.S. composite labor cost rate.
The second significant labor cost variance between the two companies is attributable to differences in profit-sharing payouts. As we will see, these differences relate to a few key elements including; differences in overall financial profitability, differences due to the relative size of the companies (2011 GM pattern profit-sharing formula) and variances due to the negotiation of a different profit-sharing formula at FCA (2015 FCA pattern profit-sharing formula). I believe that there is value in highlighting the payout history, calculating differences and translating them to a cost per hour worked basis (assuming 2,000 hours worked per employee annually) in order to understand the impact of this element on the overall competitive labor cost gap. The years below refer to the profit-sharing plan year – actual payments would have been made to UAW members in the first quarter of the subsequent year.
As you can see, over the past 8 years, differences in GM versus FCA labor costs relative to profit-sharing payouts have been significant (perhaps as high as $3.50 per hour in the 2015 and 2016 plan years). This analysis suggests that differences in the profit-sharing checks paid in early 2019 (based upon 2018 corporate financial performance), account for $2.38 of the current $8 per hour competitive labor cost gap (assuming 2,000 hours worked per employee annually throughout this section).
I believe that there is some value in looking at the modifications that were made to the profit-sharing formula during 2011 UAW Negotiations (GM lead company) and 2015 UAW Negotiations (FCA lead company). As we will see, strategic decisions that were made by GM surrounding the profit-sharing formula had a direct impact on the magnitude of the competitive labor cost gap with FCA over the past 8 years.
2011 UAW Agreement
As lead company in 2011, GM modified the old, complicated profit-sharing formula and in the process satisfied the UAW’s desire to have a profit-sharing formula that was easy to understand, linked directly to audited financial statements and more transparent to members. The formula was quite simple – basically employees would receive $1 for every $1 million (or $1,000 per $1 billion) of GM’s North America profits. Both Ford (second company to bargain) and FCA (third company to bargain) accepted the GM profit-sharing formula pattern with minor administrative modifications.
In effect, by structuring the profit-sharing formula and setting the economic pattern this way, GM may have inadvertently advantaged FCA (or disadvantaged themselves) due to FCA’s smaller size along with a scalability issue that is inherent in the GM formula. The best way to explain this issue is by providing an illustrative example as follows. If GM had 48,000 employees at the time and the company was able to generate North American profits of $7 billion, then the 48,000 GM-UAW employees would receive profit-sharing checks of $7,000 ($1,000 per $1 billion formula). In contrast, all else being equal including profit margins, etc. – if the smaller FCA had 24,000 employees (50% of GM), in theory, one may expect that FCA could achieve $3.5 billion in North American profits (again 50% of GM). However, in this case the 24,000 FCA-UAW employees would only receive profit sharing checks of $3,500 ($1,000 per $1 billion formula), half of what their GM counterparts would receive (even though corporate performance on relative terms may be on par). While FCA’s profitability was not as high as GM’s during the course of the 2011 Agreement, by looking at the chart above, one can see that there is a scalability issue with the GM formula. From a labor cost competitiveness perspective, FCA was clearly rewarded for making the strategic decision to adopt the GM profit-sharing pattern in 2011. This scalability challenge continues to exist at GM today. In general, as highlighted in the example above, as you grow your workforce you effectively pay more in profit-sharing per employee and vice versa.
2015 UAW Agreement
The UAW selected FCA to be the lead company in 2015 and leading up to negotiations, the union suggested that they wanted to address the scalability issue inherent in the GM formula. There were a number of options including developing a sliding-scale approach that could apply as a pattern for all three automakers. For example, if a company had 40,000 employees - the profit-sharing formula would be $1,000 per $1 billion in profits, if a company had 32,000 employees – the profit-sharing formula would be $1,250 per $1 billion of profits, etc.
As an alternative, the FCA bargaining team proposed to modify the profit-sharing formula to $800 for every 1% of North America profit margin. This formula clearly addressed the scalability issue inherent in the GM model discussed earlier - the UAW accepted and ratified the new concept. So, in effect, FCA set a new pattern for profit-sharing in 2015. Consequently, during 2015 UAW Bargaining, both GM and Ford decided to retain their $1,000 per $1 billion profit-sharing formula rather than moving to the new pattern developed by FCA. It should be noted that GM and Ford elected to retain the same basic model again this year during 2019 UAW negotiations. In contrast, the FCA formula was modified to $900 for every 1% of North America profit margin. In addition, the $12,000 profit sharing cap no longer exists at any of the Detroit 3 Automakers.
I realize that hindsight is always 20/20, however, had GM followed the FCA profit-sharing pattern, GM may have enjoyed some fairly favorable economic gains over the duration of the 2015 Agreement. The calculations below are illustrative and directional only - actual payouts are contingent upon elements such as employee eligibility, compensated hours, etc. As outlined in the chart below, GM’s competitive labor cost gap with FCA may have diminished by up to an estimated $1.63 per hour, on average, over the term of the 2015 Agreement, had they elected to adopt the new FCA profit-sharing model. In addition, GM may have saved up to nearly $650 million in cash over the term of the 2015 Agreement.
2015 Signing Bonus
The third labor cost variance element that I would like to discuss dates back to the 2015 UAW Bargaining signing bonuses. When FCA set the economic pattern during 2015 UAW Bargaining, the company provided signing bonuses of $3,000 for In-Progression employees and $4,000 for Traditional employees (assume that the average payout was $3,600). In contrast, GM decided to pay “pattern plus” as their UAW members were granted bonuses of $8,000 for permanent employees (presumably both Traditional and In-Progression employees) and $2,000 for temporary employees who were on-roll for over 90 days at the time of signing.
It is my understanding that, for accounting purposes, both GM and FCA typically amortize the cost of the signing bonuses over the four-year term of the agreement. That said, looking at permanent employees only, GM paid $8,000 versus FCA’s average payout of $3,600 = $4,400 total difference per employee or $1,100 per year once amortized. This higher signing bonus may have added up to $220 million in incremental cost to GM versus matching the FCA pattern (assuming 50,000 eligible GM-UAW employees). Furthermore, the decision by GM to pay “pattern plus” signing bonuses translated into an estimated $0.55 per hour ($1,100 / 2,000 hours) competitive labor cost disadvantage versus FCA over the term of the 2015 Agreement (assuming 2,000 hours worked per employee annually). This analysis does not contemplate additional costs that GM may have incurred with respect to the payment of $2,000 signing bonuses to eligible temporary employees.
There are obviously other components that contribute to the $8 per hour competitive labor cost gap. I would suggest that the remaining explanations are primarily related to items such as operating pattern differences (e.g., impacts shift premiums), overtime levels (FCA typically works more overtime than GM), utilization of health care benefits and demographics. Some of these differences will be favorable and others will be unfavorable to the individual companies and will likely offset each other to some extent. Having said that, it is entirely possible that GM’s workforce composition (more Traditional and perhaps older employees than FCA) may drive up GM’s labor costs since these higher-seniority employees may likely have greater vacation entitlements and possibly higher health care costs on average.
Additional economic differences may be attributable to the magnitude of annual lump sum bonus payouts. When FCA set the economic pattern in 2015, annual lump sum bonuses were designed to be 100% variable in nature as the magnitude of annual payouts were primarily linked directly to plant-specific performance relative to certain World Class Manufacturing (WCM) metrics and achievements. In contrast, according to the Center for Automotive Research (CAR), the annual lump sum bonuses in GM’s 2015 Contract were characterized as $1,000 performance bonuses and $500 quality bonuses. It is difficult to say whether or not GM’s bonuses were more “fixed” than “variable” in nature, or location-specific vs. company-specific or whether or not there is any direct linkage to key performance indicators associated with their “GMS” manufacturing system. These differences may too explain part of the labor cost gap.
In summary, it is entirely plausible that the remaining labor cost variance of $1.47 per hour in this analysis may be rationalized by the above-noted types of differences.
In summary, a significant portion of the $8 per hour competitive labor cost gap between GM and FCA may be attributed to strategic decisions relative to a few key factors including the following;
Workforce composition – significant expansion of FCA’s U.S. manufacturing footprint has enabled the company to take advantage of a higher percentage of less expensive In-Progression employees
Profit-sharing formula – firstly, GM set a pattern that was favorable to FCA during the 2011 Agreement and secondly, GM decided not to pursue a modified profit-sharing formula that was established by FCA as the pattern during the 2015 Agreement
2015 Signing Bonus – GM decided to pay “pattern plus” level bonuses to its UAW workforce
In addition, as highlighted above, had GM adopted the 2015 FCA pattern relative to signing bonuses and the profit-sharing formula, it is possible that the four-year cost of the 2015 UAW Agreement to GM may have been lower by close to $900 million (i.e., ~$220M signing bonus and ~$650M profit-sharing – these cost estimates do not include FICA).
Finally, as a result of the new 2019 Agreements with the UAW, the competitive labor cost gap between GM and FCA should shrink over the next few years as the reduction in the wage progression period from 8 years to 4 years will somewhat mitigate FCA’s advantage associated with a higher proportion of In-Progression employees. However, I believe that it may have been in GM’s best interests to adopt the FCA profit-sharing formula this year, even if the UAW insisted on the revised rate of $900 per 1% of North America profit margin that was negotiated with FCA. If you run this new FCA profit-sharing formula through the table above, assuming that GM’s projected financial results over the 2019 Agreement are consistent with those of the 2015 Agreement (with similar headcounts), GM may be better off by over $1 per hour with potential four-year savings of up to ~$450 million using the revised FCA model.
After reading this article, I hope that you now have a much better appreciation for the significant impact that strategic decision-making has on a company’s overall labor costs as well as the complexity associated with labor cost analysis.
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