Some years ago, while I was still head of labor relations for a building products company, I was meeting with the newly appointed CEO. We were discussing an upcoming labor negotiation, the first on his watch. He was a bit skeptical when I told him I was quite sure we could identify enough productivity to cover the full cost of the negotiations, and perhaps a bit more. I walked him through the preliminary value creation opportunities the team had identified and what outcomes might be possible. He did what any CEO would do; he probed, poked, and challenged. He asked about details, assumptions, risks, contingency plans. He also asked why I thought the union would agree to our proposals. I took this opportunity to explain the value creation approach to negotiations.
A key element to this approach is the upfront agreement with senior management that whatever value creation opportunities are found and realized become the pot of money to be shared between the company and union during negotiations. We will explore this in much greater detail in the future. However, the important thing to note is that reaching a shared understanding of the approach with the CEO is critical. Just as we looked at building trust with the union through competence in last month’s blog, Building Trust in Value Creation Negotiations, you must also build trust with your CEO and other senior leaders by demonstrating competence, not only through your negotiations prowess but through your business acumen and financial literacy.
This month, I wanted to share a simple technique you can use to estimate settlement costs. It is equally useful to get a ballpark figure of the value creation opportunities you will need to deliver a cost neutral contract (or to respond to your CEO in the elevator when she asks you what it will cost to get a deal). Once you become comfortable with the calculations, you should be able to do this in your head – or at the very least on your smart phone calculator – in just a few seconds. Of course, you will eventually need to develop and present a full costing model, but our focus here concerns demonstrating your keen financial discernment.
In some companies, the accepted way of reporting the costs of a labor agreement is by reporting the year-over-year incremental costs. Despite union assurances to the contrary, this does not reflect the true cumulative costs of the agreement. I cringe whenever I hear the term “fuzzy HR math,” but, unfortunately, there is some truth to it. This fuzzy math would report that a three-year settlement of 4%-2%-2% is only slightly higher in cost than a 2%- 2% -4% agreement. As a business partner with special skills in labor relations, you should be able to discuss the true impact to the business, and understand that the difference in front loading the agreement in this example costs about $600,000. If you aren’t sure about this, please contact me so I can help you be ready for the next time the CEO asks about costs.
Here is the situation. There are 300 represented employees earning an average hourly rate of $18.00 in a 3-shift operation. Contracts normally run for three years. Let’s use 2%-2%-2% to represent a low to modest settlement, and 3%-3%-3% as the top settlement. Start with the 2% figure. The first year wage increase would be 36 cents. Employees work a bit over 2000 hours a year, so the cost is just over $720 per employee. Multiplied by 300 and we have $216,000. In a three year contract, you are going to pay this increase 6 times for a total of just under $1.3M. Just to be clear on the calculation, the first year wage increase is paid on all the hours worked over the three years. The 2nd year wage increase is paid in years 2 and 3, and the final wage increase is paid in the third year. We still have to account for the impact pay raises have on other items, such as taxes, holidays, and vacations, and the rule of thumb for this is a multiplier of 30% or $390K. Rounding the total cost equals around $1.69 million. The calculator gets $1.75M. Add a 50% increase for the top settlement of 3%-3%-3%, and you get a figure of just over $2.5M.
This series of calculations takes less than 15 seconds to recreate on a calculator. Yet, by going through these calculations, you are now ready to give your CEO a solid range of what a settlement should cost. You also have a ball park figure for the amount of value creation opportunities you will need to share at your next negotiations preparations kick-off meeting.
Next month, we will build on some of these lessons by examining how you might determine a value for changes that improve your operation, but lack true hard dollar reductions.
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