Economics

What a New Benefit From Starbucks Teaches Us About the Future of Employer Provided Health Insurance

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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.

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12 replies »

  1. No company goes into money to lose money.

    Exploiting workers for profit? Your kidding! Schultz would never do this! It would be bad for Starbucks image to raise wages to $9/hour like Walmart or $10/hour like McDonald’s this week.

    The “partners” are not partners, they are young and old and given no respect by Schultz.

    Even the promotion of Starbuck payment cards discourages tipping for good service.

  2. I think companies in general can learn something from the way Starbucks takes care of their employees. By offering employees with 20 hours of employment and more a health insurance package it demonstrates the level of care, respect and appreciation they have for them, and in return I’m sure those employees take care to represent Starbucks in a very positive way.

  3. As a professional insurance broker for nearly 30 years, why do we want to make the employer based system the enemy? Many companies and state governments offer these benefits to their employees at no cost to them. Huge nontaxable benefit to the employee.

    Why do we want to further burden the Federal tax system and move more people on to Government dependency? What’s wrong with hard work, ingenuity, and self reliance?

    The employer based system started off as a way to attract good talent. This has not changed. Starbucks understands this. A $15 min. wage sounds good. To the forward thinking employer, however, $10 plus health benefits and maybe a retirement plan or educational enhancement is a better way to serve the employee and give them a better start, while also
    enjoying a tax deductible benefit to the employer.

  4. I think it’s much easier for Starbucks to afford to offer health insurance to its employees who work at least 20 hours per week than for others in the fast rood and retail industries. Its staff is overwhelmingly young and healthy which makes them cheap to cover on a self-insured basis as compared to what it would cost its employees to buy comparable coverage on an exchange where they would have to pay higher premiums to subsidize older and sicker members. More importantly, Starbucks can charge a very high price for its product compared to what the ingredients and containers cost.

    Other national retailers put most of their independent competitors out of business. Think Home Depot and Lowe’s vs. independent hardware stores, Staples and Office Depot vs. independent stationary stores, CVS and Walgreen vs. independent pharmacies. Starbucks, by contrast, provides a high price umbrella for independent restaurants to compete easily on price. The bottom line is that Starbucks is a different business model that is not readily transferrable to the generally low wage restaurant and retail industries.

    I don’t think the college tuition benefit will affect its approach to health insurance one way or the other anytime soon.

    Separately, as the minimum wage increases, it’s likely that we will see more automation as customers use kiosks or tablets to place their orders and pay for them instead of interacting with a human employee. I’m told that in Western Europe where the minimum wage is much higher than in the U.S., there are far fewer employees per restaurant than in the United States and probably fewer restaurants per capita as well.

  5. Economists assume, realistically or not, that both employers and employees are (a) rational and (b) fully and accurately informed about the trade-offs they face in their daily living.

    How realistic those assumptions are — especially in regards to what employees know — can be questioned.

    An interesting experiment might be to calculate by what amount Starbucks would increase cash take-home pay of employees it if did not sponsor health insurance and then ask employees outright which option they prefer: A, getting that extra cash and then going on their relevant ACA exchange or B, continue the present set up.

    We do not have those data, so economists do the next best thing: theorize what a fully informed, rational employee would prefer. That is how we use economic theory to make predictions. It is, admittedly, not a perfect substitute for actual data of the sort I describe above. And even then, one can always question the validity of responses to choices among hypothetical options.

  6. I know nothing about Starbucks, but almost all other companies in food and hospitality do NOT want to retain their employees. They want them to leave after a few months or years, before they start to complain about working conditions and/or demand higher wages.

    Next, to expand on a point made by Dr Reinhardt. The ACA exchanges are not wildly generous to all workers. Picture a Starbucks worker age about 30 and making $24,000 a year.

    On the exchange he must pay between$150 and $200 a month, and he might get a lousy high deductible plan.

    Whereas the benefit at Starbucks might a modest deductible plan for $50 a month after the employer pays most of the premium.

    There is NO easy substitute for employer premium money.

  7. Taxes still complicate this picture, in that there are significant tax advantages for employers and employees where an employer-sponsored health benefit plan is in place. This is where the group exchange model and defined contribution funding from employers comes into play. I take a somewhat different view from others here who view the individual exchange and government tax credits as the future dominant model, in that these tax considerations will play a role for employers large enough to incur a tax penalty for not offering a qualified health benefit plan for their employees.

  8. The dice could roll the other way and employers in the future may start offering pumped up health insurance to entice workers with a promise to “bring you back from the dark corners of the exchange.”

    Hard to predict which direction this will go. Like Yogi Berra I am afraid of making predictions, particularly about the future.

    “The irony is that in many important ways, ObamaCare has achieved a good part of this erstwhile Republican dream which, of course, is why Republicans now hate him for it. It was naughty of Obama to steal a Republican idea like that.”

    The genius of the ACA is that all possible eventualities in the future will be traceable to its intent.

    Single payer system – ahh the ACA started the ball rolling sire.

    Competitive insurance in the market place – that was the ACA’s intent all along, can’t you see?

    Cash-based practices with HSAs – of course, it was the ACA that was the catalyst.

    Status quo – well the ACA never intended to change things dramatically.

    The ACA is protean in design. It promises to fulfill anyone’s model of a perfect healthcare, although it won’t satiate everyone’s model equally.

    In a sense it’s like the primordial soup. All possibilities forthwith are plausible, probable and improbable and, most importantly, intended towards that outcome.

    It can never lose.

  9. Over the years, I have come to realize that “cynic” is just another word for “realist,” although one would not normally associate the word “realism” with economists who more often than not are idealists whose dicta of an ideal society envision the perfect society that actually exists, believe it or not — albeit on Planet Econ which is positioned right behind Pluto on an orbit that hides it permanently from earth-view. It was, in fact, their idealism that precluded economists from noticing the financial crisis as it was brewing.

    That said, I agree with the authors’ analysis, except for their sentence “Workers who opt into exchanges can now obtain health insurance at an actuarially fair price.” I don’t think they meant that. Community rating is not actuarially fair, even with high deductibles.

    Time was (in the 1990s) when Republicans and many economists (myself included) dreamt of an insurance system that was independent from employment. We envisaged a parallel system of individually bought fully portable insurance, sold on exchanges (like those offered by large employers in-house) and heavily subsidized by government for low-income people, into which Americans with employment-based, non-portable and ephemeral employment-based insurance could tumble. Gradually, that process would erode employment based insurance for all but the largest companies or companies with high-wage workers. To speed the process, the tax-preference accorded to employment based health insurance was to be eliminated. That was the vision.

    The irony is that in many important ways, ObamaCare has achieved a good part of this erstwhile Republican dream which, of course, is why Republicans now hate him for it. It was naughty of Obama to steal a Republican idea like that. Any replacement of ObamaCare by Republicans would slouch heavily toward ObamaCare, which could be embarrassing (See Coburn-Burr 2009 vintage).

    If Starbucks starts moving its employees onto the exchanges, we should not be surprised.

  10. More evidence that If economists ran the world, we’d live on a very ugly planet

    Is the less cynical take that Obamacare gave these guys the option of doing something good (offering an important new employee benefit) while doing well (cutting back on a serious expense) ?

  11. The other thing to note is that Starbucks is in Seattle and although most of its corporate staff are very well paid we recently passed legislation raising the minimum wage to $!5 an hour (I think highest in the US) so they might feel financial pressure to jump to that early (this ia a long multi year phase in) and drop health care in exchange

    He recently was quoted as saying,

    “Schultz said that when Starbucks totals up the amount it spends on pay, plus benefits for each employee, everyone earns more than $15 an hour “in addition to that we pay more than the minimum wage in also every place we do business.”

    But if Starbucks were required to pay $15 an hour, those benefits could be at risk.

    “If it goes to $15 an hour we’d have to assess whether or not we could continue to do those things,” Schultz said.”

    http://www.kirotv.com/news/news/starbucks-ceo-assess-benefits-if-15-hr-minimum-wag/nfG6t/

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