Starbucks, which taught America to love lattes, made news this week with the announcement of a new tuition benefit for its partners (Starbucks-speak for employees). At first glance this move seems like simply another benefit in Starbucks relatively (for its industry) generous compensation package. In particular, Starbucks has long been heralded for providing health insurance for all partners working more than 20 hours per week. It is this connection to health insurance that we wish to explore. While Howard Schulz the founder and current CEO of Starbucks has long said the firm offers health insurance because it is the “right thing to do” for their employees, we have always suspected a more profit maximizing goal for this compensation decision. If we put on our strategy hats (we are both members of Kellogg’s Strategy Department), we can deduce that as a profit-maximizing firm, what Starbucks giveth with tuition benefits it may soon taketh away from health insurance benefits. In the process, Starbucks may be heralding the demise of employer sponsored health insurance, something we have predicted in previous blogs.
While Starbucks is nominally a fast food firm, it seeks to hire a different kind of employee than its competitors. Starbucks employees are more productive (i.e. they generate more revenue per employee) and they are expected/required to contribute to the warm environment Starbucks offers its customer. From its creation, Starbucks has positioned itself as the “third place” in American society, i.e. a place to gather that was neither home nor work. This is why chatty and productive employees (think, college educated individuals looking for full-time employment or a struggling actor waiting for his big break) are worth more to Starbucks than they would be to one of its competitors such as McDonalds. While McDonalds may now offer a competitive latte, no one would mistake it for a third place.
Starbucks must, on a daily basis, find ways to attract and retain its employees. Rather than simply pay them more (an expensive proposition), Starbucks has long exploited a unique feature of the American employment and health insurance markets. Private firms are generally able to offer health insurance for rates that are far less than their employees can obtain in the individual insurance market. As a result, Starbucks can attract workers with a package of wages and health benefits that is worth more to the employee than a similar amount of compensation paid entirely in wages. Given that many of their competitors are not seeking to hire the same kinds of employees, Starbucks can retain part of this spread within the firm. Workers who highly desire health insurance, whom more often than not are the types of workers Starbucks would like to hire, are delighted by this wage/benefit package.
The Affordable Care Act changes this calculus. Workers who opt into exchanges can now obtain health insurance at an actuarially fair price. That wage/benefit package from Starbucks doesn’t seem so attractive any longer. Many would rather take an all-wage package elsewhere – a package that featured higher wages, albeit without health benefits – and apply some of those higher wages towards the price of a cheap silver or bronze plan on the exchange. This is particularly true when we consider that Starbucks offering health insurance benefits makes their employees ineligible for the large subsidies on the exchanges.
Facing this situation, Starbucks needs to look to a different fringe benefit with the same two characteristics as health insurance: (1) that Starbucks can obtain the benefit at a discount, and (2) that the benefit is attractive to the kind of employee that Starbucks wishes to hire. Enter the tuition benefit. Starbucks has apparently used its purchasing clout to obtain a discounted tuition from Arizona State University for its online undergraduate degree program, and is passing on the discount to its workers. Because this program does not make strategic sense unless Starbucks has a purchasing advantage, we expect more details about the discount to emerge in the fullness of time.
As in the case of health insurance, do not believe for a moment that Starbucks is offering tuition benefits as a public service. Indeed, the language that CEO Schulz used to describe the tuition benefit is strikingly similar to his description of why the firm offers health insurance benefits: “I feel so strongly this is the right thing to do and Starbucks as a company is going to benefit in ways that probably we cannot identify today.” We suspect that Schulz knows full well how the company will benefit. We also suspect that, despite its protests the contrary, Starbucks will eventually announce that it is dropping insurance coverage in favor of higher wages. The company is too savvy about its benefits to miss this obvious move.
We should also note that this is not a question of “right” and “wrong” or a greedy corporation slashing benefits. Instead, it is about Starbucks (and likely other firms) realizing its employees are better off getting their wages from their employer and their insurance from and insurance company. That is why, beyond being an interesting business strategy example, Starbucks’ recent moves offers a glimpse into the future (or lack thereof) of employer health insurance. Ultimately, what we are seeing is the not so gradual erosion of one of the primary benefits of employer health insurance, i.e. the pricing benefits of group coverage. With the creation of individual insurance exchanges, Americans no longer need their employer to provide their health insurance. In fact, given the nature of the fairly generous tax subsidies they may no longer want their insurer to offer them insurance. As a result, as we have previously predicted, many employers and particularly those with a large number of low-income employees will stop offering health insurance. To borrow a phrase from Schulz, in this new economic environment this choice will be the “right thing to do” for their employees.
Firms that previously took advantage of the inefficient individual insurance market will have to look to other strategies. This week the firm that brought us the Frappuccino we have may have also brought us the first strategy for this new context.
avid Dranove, PhD is the Walter McNerney Distinguished Professor of Health Industry Management at Northwestern University’s Kellogg Graduate School of Management, where he is also Professor of Management and Strategy and Director of the Health Enterprise Management Program. He has published over 80 research articles and book chapters and written five books, including “The Economic Evolution of American Healthcare and Code Red.”
Craig Garthwaite, PhD is an assistant professor of management and strategy at Northwestern University’s Kellogg Graduate School of Management.
Dranove and Garthwaite are the authors of the blog, Code Red, where this post originally appeared.