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Labor Pains

The shift to part-time workers, temps, and independent contractors may cut costs and offer more flexibility. But beware union discontent and the IRS.

1Jan

Last August, 185,000 employees of United Parcel Service of America Inc., incensed by the expanding use of part-time, lower-paid workers at the company, walked out in one of the most publicized work stoppages in years. Although the strike settled within 15 days, UPS estimates it cost the company more than half a billion dollars.

In 1993, independent contractors and freelance workers at Microsoft Corp. sued the software giant for denying them benefits, even though they signed contracts explicitly stating they were not employees. In July 1997, in a ruling that sent shock waves through Silicon Valley, the Ninth Circuit Court of Appeals ruled against Micro-soft--a decision that may ultimately cost the firm $20 million.

Since Delta Express pilots agreed to a new contract in December 1995, their union has been crying foul. The problem, say union officials, is that Delta Air Lines Inc. threatened to mothball the 737 fleet unless pilots for those planes agreed to less money than other company pilots. Delta Express pilots eventually caved in. Delta has since reported record profits in eight successive quarters, a fact that has some Delta Express pilots seeing red.

Given these news stories, you might think the rise of the alternative work force has left both workers and employers disgruntled and disenchanted. Indeed, given the problems--unhappy employees, nasty lawsuits, even nastier strikes--brought on by the hiring of so-called flexible workers, a sane observer might consider the alternative work force more curse than cure for corporate employment ills.

Think again. The alternative work force, which ranges from the lowest-paid temporary secretary to the regular part-timer at UPS to the highest-paid independent computer contractor, is spreading like wildfire. While unemployment has shrunk to its lowest level in decades, the use of part-timers has swelled.

According to the Bureau of Labor Statistics (BLS), in fact, the number of part-time workers nearly doubled from 1970 to 1994, while the number of full-timers rose only half as fast. What's more, the number of independent contractors and temporary workers has skyrocketed. Although exact numbers are hard to pin down, some experts estimate that there are as many as 30 million alternative workers in the United States today, nearly a quarter of the entire labor force.

This trend is no fad. Rather, economists and business consultants say the rise of the flexible work force flows from a fundamental shift in how companies do business. "This all stems from the move to just-in-time manufacturing," says David Hofrichter, vice president and managing director at compensation consultancy The Hay Group Inc., in Chicago. "You can't have just-in-time manufacturing without just-in-time workers," he states. Indeed, Edward Lenz, senior vice president of the National Association of Temporary and Staffing Services (NATSS), a trade group in Alexandria, Virginia, points out that 81 percent of firms surveyed by The Conference Board say they bring on contingent workers to cope with demand fluctuations. And William Halal, professor of management at George Washington University, estimates that contingent workers could make up 50 percent of the U.S. labor force by the year 2005.

While such prognostications raise eyebrows in business circles, Halal may not be far off. When CFOs have marching orders to raise corporate earnings 10 percent every year--and thus raise the share price of the company's stock--they have little choice but to cut costs at every turn. The company payroll makes an obvious target. On the whole, flexible workers earn a lot less money than do traditional employees. And the further down the corporate ladder, the wider the wage gap. Full-time temporaries, for instance, barely make half what full-time regulars make. What's more, only one in four is eligible for employer-provided health insurance. "This trend toward temporary workers will be difficult to reverse," says Gary Becker, Nobel laureate and professor of economics and sociology at the University of Chicago. "Fringe benefits have risen higher than straight wages. By using temporary workers, companies can get rid of these costs."

But at what price? Hiring alternative workers can have unforeseen, and often devastating, effects on a company's bottom line. "For openers, you end up with a situation where you have employees working side by side, doing the same job but making differing wages," says Reg McGhee, a spokesman for the United Auto Workers. "All it does is breed resentment." And when such resentment boils over, the results--as the UPS strike illustrates--can be costly.

As if the potential for labor unrest weren't bad enough, companies must also be mindful of scrutiny from another source: the Internal Revenue Service. Tax collectors are very interested in whether companies are trying to duck tax obligations by designating workers as contractors. "The move to part-time and contingent workers is supposed to save money," warns Robert Ginsburg, research director at the Midwest Center for Labor Research, a private research and consulting firm in Chicago. "But in the long run, it will come back to haunt a lot of companies."

SEISMIC SHIFT

Most corporate executives realize that the road to the flexible work force is filled with potholes. "We constantly weigh whether we should continue going this route," says Terry Geremski, CFO of Guilford Mills Inc., a Greensboro, North Carolina-based textile supplier that uses independent contractors. "We're looking for consistency from our workers, and that's tough to maintain with independent contractors." Some CFOs note also that the high turnover rates of many alternative workers can cause serious security headaches. And at high-tech corporations, finance executives worry that relying on outside workers may deplete talent. Says Jim Walker, CFO at San Jose, California-based Diamond Multi-media Systems Inc., an Internet multimedia supplier, "You end up in a situation where some of your expertise is transitory."

That loss of control can be particularly damaging to a service company. As Steve Mazda, CFO at mattress retailer Nationwide Discount Sleep Centers, in Philadelphia, points out, an alternative worker may not be on the company payroll, but customers don't know that.

"In our business, the independent contractor delivering the mattress is the last person a customer deals with," says Mazda. If that independent contractor screws up, he says, customers blame the company, not the contractor.

Still, Mazda says he likes using flexible workers. Roughly a third of his salesmen are retirees who work part-time for the company. "They show up on time, they're meticulous, and they know the business," he says. Others believe that by hiring flexible workers, companies can curry favor with regular staffers. Geremski notes that Guilford Mills hires independent contractors to perform semiannual maintenance work. "The work is done over the holidays, a time when our regular employees would just as soon be at home," he says. Adds Hofrichter, "From a company standpoint, a flexible work force is really a neat way to provide security for a core group of employees."

Labor leaders aren't biting. "This argument about creating stability for core workers is wrong," says Rand Wilson, spokesman for the International Brotherhood of Teamsters. "What you're really doing is selling out the future."

Nevertheless, industry-association spokespeople note that in this era of low unemployment, companies often have little choice but to hire alternative workers. That's particularly true in the high-tech sector, where alternative workers typically possess considerable technical know-how. Says Pat Cleary, vice president of human-resources policy at the National Association of Manufacturers (NAM), "The truth is, it's getting harder to attract and keep qualified people. Thus, companies are willing to take them on their own terms."

HAVE IT YOUR WAY

For a growing legion of consultants and independent contractors and freelancers, those terms include not working full-time. "This move to alternative workers is normally presented as employers taking advantage of the poor workers," says Dwight Lee, professor of economics and enterprise at the University of Georgia in Athens. "But it's not the case that everybody wants to work full time." In fact, most polls, says Nelson Litterst, manager of legislative affairs for the National Federation of Independent Business, a small-business advocacy group in Nashville,"show 70 percent of workers prefer alternative arrangements."

If you're an independent contractor, what's not to like? In many cases, highly skilled independent contractors get paid a whole lot of money. At the same time, they maintain their independence. "Generally speaking, our independent contractors like to roam," says John Rogers, CFO at Cognex Corp., a Natick, Massachusetts-based maker of machine vision systems. "They don't want to be tied down to one company." Rogers says Cognex's independent contractors get paid good money for not being tied down--anywhere from $50 to $100 per hour. That's often more than the company's regular employees get paid. "But unions say, 'Let's stop this organized corporate oppression,'" fumes NAM's Cleary. "Hell, if I were an independent contractor at Microsoft or another high-tech firm, I'd tell the union, 'Give me my surfboard and get out of my way.'"

Many flexible workers don't have it quite so good, however. Unlike independent contractors, the lion's share of temporary workers and on-call laborers say they do want regular full-time work. The problem is, they can't find any. On the whole, temporary workers are younger, less educated, and less white than independent contractors or permanent full-time workers. For them, temporary work isn't about the high life or flexible schedules. It's about survival. "For some people," Becker says, "temporary work is all they can get."

But as Hofrichter points out, "We've got the lowest unemployment rate in a long time. How do you square that with people saying we're losing jobs?" Part of the squaring has to do with how the government keeps its statistics. In many instances, the Department of Labor considers alternative workers to be gainfully employed. What's more, most part-timers actually put in full-time hours. According to the BLS, 80 percent of part-time workers--some 20 million people--work 35 hours a week.

Government regulation hasn't helped level the playing field, either. In the 1980s, lawmakers in more than 30 states enacted legislation making it easier for employees to sue their employers for wrongful termination. The result, however, was that employers simply started hiring more laborers who couldn't sue them--temporaries, on-call workers, and the like. "These restrictions have clearly made permanent employees less attractive to employers than temporary workers," says Lee.

SEEING RED

But given the success of the Teamsters' strike at UPS, labor seems poised to fight back. Union watchers note that the restoration of full-time jobs may be the one issue organized labor can actually rally support for these days. "Employers want to undermine good full-time jobs by shifting to part-time, temporary, or casual help, or by subcontracting premium jobs to outfit that work for cheap," says Wilson. "The benefit of being in a union is you can do something about it."

Already, labor leaders have pleaded their case to the National Labor Relations Board (NLRB), which is currently hearing oral arguments on the rights of alternative workers to unionize at three U.S. firms. (Currently, workers hired from temporary agencies or labor brokers are deemed to be jointly employed, and therefore not allowed to join existing bargaining units without consent of both employers.) In preliminary discussions of one case, involving the Jeffboat Division of American Commercial and Marine Services Co., in Indianapolis, union lawyers argued that the Teamsters should be allowed to represent certain welders and steel fitters supplied by an outside firm. While officials at Jeffboat declined to comment, the labor lawyers noted that the current NLRB doctrine has simply been outstripped by the explosive growth of the flexible work force. They may have a point: The NLRB doctrine regarding alternative workers dates back to 1973.

Observers note that the NLRB's decision, which had been on hold until the board filled two vacancies, could have serious fallout for any company that hires alternative workers. Given the green light to unionize millions of alternative workers, organized labor could gain untold leverage in future negotiations. That, in turn, could trigger a domino effect, with escalating wages eating into corporate profits. "If labor's right, then they're going to be signing up new members in record numbers," says NAM's Cleary, "If we're right, labor's going to have a tough, tough time."

THE TAXMAN COMETH

If organized labor threatens companies on one side, the taxman looms on the other. Of late, the IRS seems only too eager to define "flexible workers" as full-time employees--a ruling that can have costly tax implications. "The IRS is getting tough on this," admits Cognex's Rogers. The current IRS 20-factor test is a complicated rebus of a checklist (see sidebar, facing page). But even satisfying its requirements is no guarantee that employers are on solid ground. "We actually built the IRS 20-factor [test] into the contract that our independent contractors sign," says Rogers. "But if you've got an independent contractor who's been working at the same company for a year or more, that person is probably an employee." And experts note that misclassifying employees as independent contractors can have some serious consequences. "This can be really expensive if you make a mistake," warns Jeffrey Braff, a labor specialist at Cozen and O'Connor, a Philadelphia law firm.

Tell that to Microsoft. In the late 1980s, the company started farming out some software testing and production editing to freelancers. According to lawyers familiar with the company, the freelancers signed contracts expressly stating that they were not employees of Microsoft and were not eligible for benefits.

Apparently, the IRS begged to differ. In 1990, applying the 20-factor test, it determined that the freelancers were indeed Microsofties. That decision meant Gates & Co. had to shell out retroactive withholding taxes, plus interest, as well as pay a penalty for misclassifying the employees. But that's not the end of the story.

Emboldened by the IRS decision, some freelancers turned around and sued Microsoft for excluding them from the company's benefits program. And last July, the Ninth Circuit Court of Appeals ruled that Microsoft had wrongfully excluded them from some of the benefits.

The case has other high-tech executives sleepless in Silicon Valley. "We watched the Microsoft case as very interested spectators," says Diamond Multimedia's Walker. "It's something you have to be aware of." NATSS's Lenz believes the Microsoft contract language was not specific enough. But as Braff says bluntly, "Just because someone is working on an as-needed basis, they're not necessarily independent contractors." And observers point out that scores of companies have agreements that are no more specific. Says Lenz, "If you told companies that use temporary workers that they'd have claims against their company pension plans, they'd be horrified."

B-SCALES AND BEDBUGS

While the Microsoft case points up one snag when hiring flexible workers, it's not the only one. Recent studies show that employers who believe they're cutting costs by hiring contingent workers may be mistaken. According to Stanley Nolan, professor of management at Georgetown University, employers tend to fixate on wages and benefits, often ignoring other costs incurred by alternative workers. Nolan notes that temporary workers are generally less productive than regular employees. Moreover, he says that money invested in bringing a contingent worker up to speed may never be recouped. "Because temporaries do not have long service at the client company," he explains, "the company is unlikely to recover training costs."

Undoubtedly, however, the greatest casualty in the rise of the alternative work force is esprit de corps. "You want a labor force that identifies with the company," points out Becker. But the constant hiring and releasing of staffers can make it difficult for a laborer to remember the name of the guy working next to him, let alone identify with a company. "Certainly, one of the downsides of contingent workers is continuity," agrees Cleary. "It can make it difficult to build teamwork." The gap in wages between permanent and alternative workers doesn't foster a sense of corporate oneness, either.

That doesn't bode well for some U.S. airlines. In the 1980s, American Airlines Inc. started paying new pilots less than veteran pilots, even when the pilots flew the same planes and routes. Soon, other airlines followed suit. The pay structure for new hires was called a B-scale, although it was called other things by members of the Air Line Pilots Association (ALPA). But the pilots had little choice but to go along with B-scales. In the wake of deregulation, most airlines were hemorrhaging cash. Says one industry observer, "The airlines told the pilots, 'If you don't accept this, your employer and future pension payer may not be around much longer.'"

With the airlines staging a dramatic turnaround over the past five years, ALPA has been able to whittle away at the hated two-tiered systems. But now, it appears these arrangements are making a comeback. With the arrival of low-cost outfits like Southwest Airlines Co., several carriers, including United Airlines Inc., Delta, and US Airways Group Inc., have adopted two-tiered systems for pilots flying non-hub-and-spoke routes. Airline watchers say executives at other carriers are weighing similar plans. Officials at the airlines and ALPA, who apparently don't want to stir up bad memories, avoid the term "B-scale." "To me, it's not a B-scale," says Mike Oakey, an ALPA spokesman at US Airways. "With B-scales, you can only make a certain amount, period. With this, you can pump up your W-2 by flying more miles." Responds one airline official, "Fly more hours to make the same amount of money? Sounds like a B-scale to me."

It sure does. At US2 (US Airways's forthcoming regional airline), pilots will be making around 25 percent less than pilots on US Airways's mainland routes. But Oakey defends the arrangement, noting that the pilots at US2 will come strictly from the ranks of US Airways. "Becoming a captain on US2 will be a promotion for a mainland co-pilot," he says. And at Delta, officials say the new pay structure saved jobs. Without it, says spokesman Bill Berry, "we would have had to pull out of markets."

Still, the two-tiered pay scale probably won't do much for morale. Karen McGuffey, a spokeswoman for ALPA at Delta, admits that it has caused "some dissension in the union toward management." And that dissension has been further compounded by the numbers coming out of Delta headquarters--an astonishing eight straight quarters of record profits.

Of course in the long-run, says Ginsburg, paying commuter pilots less could eventually dampen those profits. Unhappy pilots, he notes, may not be overly concerned with on-time arrivals. Or with soothing passengers' worries over delays. Worse, they may not go out of their way to fly the most efficient routes--critical to an airline's profitability. In the long run, Ginsburg says a two-tiered pay scale could wind up costing an airline millions. "As CFOs well know," he says, "it's the little things that add up."

The news could get worse.

John Goff is a contributing editor at CFO.

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