For over a year, retail and hospitality employers have been anxiously awaiting the issuance of the U.S. Department of Labor’s (DOL) final overtime regulations—regulations which many had predicted would impact retail and hospitality employers more than most. Among their biggest fears was that the DOL would make changes to the duties test, increase the salary minimum to the highest level contemplated, and simultaneously disallow inclusion of bonuses to meet the salary minimum. Luckily, the DOL decided not to include any of those proposed changes in the final regulations. However, the changes that retail and hospitality employers will be required to implement by December 1, 2016 are expected to impact retail and hospitality businesses in a profound and negative way. According to David French, senior vice president for government relations at the National Retail Federation, a major industry group representing retailers and chain restaurants, “DOL’s new overtime rules are a massive failure. They are a failure of the regulatory process. They are a failure to listen. And, most of all, they are a failure to face reality.”   

In this article, we summarize the changes in the new regulations of most interest to retail and hospitality employers, review their projected impact on the retail and hospitality industries, and offer guidance for retail and hospitality employers as they prepare to comply with the final rule. As discussed below, the new rules will likely impact a wide variety of job titles, have a negative impact on employee morale, and will consume precious time and resources.

 Summary of the Key Changes

• The new minimum salary level for the executive, administrative, and professional employee exemptions under the Fair Labor Standards Act (FLSA) will be $913 per week, or $47,476 per year. The new salary requirements will apply to the FLSA’s executive, administrative, and professional exemptions. Employees who do not meet the new salary requirements when the final regulations become effective on December 1, 2016, will no longer qualify for one of these exemptions, which means they will have to be paid overtime compensation when they work more than 40 hours in a workweek. 
• The minimum salary level will be adjusted every three years to track the 40th percentile of the lowest wage Census Region, whether that is the Southeast or one of the other four Census Regions.
• For the first time, employers will be able to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the standard salary level.  However, to qualify for inclusion in the salary minimum, bonuses and incentive payments must be made on a quarterly or more frequent basis. The regulations also allow employers to make a catch-up payment at the end of a quarter to make up any shortfall in the nondiscretionary 10 percent portion of the salary amount. Notably, although nondiscretionary bonuses, commissions, and other incentive payments still will count toward the total compensation requirements for the highly compensated employee exemption (HCE), employers cannot count such payments toward the minimum salary requirements for the HCE exemption.
• The total compensation requirement to qualify for the HCE exemption will increase from $100,000 per year to $134,004 per year, which is based on the 90th percentile of earnings for full-time salaried workers in the United States, without regard to regional differences.
• The effective date of the new regulations is December 1, 2016, which is a Thursday.  This means that employers that start their workweek on a Sunday or a Monday will need to implement any required changes prior to December 1 in order to be in compliance.
• The total compensation requirement for the HCE exemption also will be adjusted every three years so that it continues to correspond to the 90th percentile.

Our May 18 article, “Storm Clouds and Silver Linings for Employers: An Analysis of the DOL’s Final FLSA Part 541 Regulations,” provides an in depth analysis of the final rule and a comparison to the changes that were proposed.

The Projected Negative Impact on Retail and Hospitality Employers

The National Retail Federation, which has been a very vocal opponent of the changes in Washington, D.C., believes that the changes will have a profound impact on retailers and chain restaurants. Some of the most important impacts they have projected based on studies and surveys conducted on this issue are: damage to employee morale, especially among managers who are reclassified as nonexempt employees; reclassification of jobs across job titles as opposed to just by salary; a slow down or freeze in hiring; an increase in the number of part-time workers; and a tremendous increase in payroll and operations costs.

For example, a study commissioned by the National Retail Federation concluded that the vast majority of retail and restaurant managers who participated in a survey reported that the conversion of managers from exempt to nonexempt status would have negative consequences for managers and customer service employees. In addition to hampering their ability to truly manage, many surveyed managers believed they would make less money as nonexempt employees due to lost bonus opportunities that would accompany the loss in their ability to manage and control outcomes and profitability for their establishments. This, in turn, will adversely impact employee morale and place limits on career advancement.

According to the results of a study conducted for the National Retail Federation by Oxford Economics (a leading global economic advisory firm founded with Oxford University), the change in the exemption threshold to more than $808 per week, will affect more than at least 1.7 million workers and cost businesses $5.2 billion a year assuming, unrealistically, that they do not make changes to offset their increased costs. According to the study, the changes will disproportionally impact businesses operating in rural states, where there is a larger percentage of currently exempt employees who will be subject to the overtime rules as a result of the coming changes.

The study opines that businesses in the retail and hospitality sectors would not pass along those increased labor costs to customers but rather will make significant adjustments to the structure of their workplaces in order to recoup the billions of dollars in added costs that likely will be imposed through the new regulations. Based on its analysis of relevant academic research and interviews with retail and restaurant industry experts, the study predicts that employers may use the following strategies to absorb the additional labor costs:

• lowering hourly rates of pay;
• cutting bonuses and benefits;
• reducing employee hours;
• hiring more low-wage and part-time employees;
• reducing the number of salaried executive positions; and
• automating back-of-the-house functions.

The study predicts that as a result of the impending changes, workplaces will become more hierarchical, that lower-level employees will find it harder to rise into the executive ranks, and that retail and hospitality companies will encounter difficulties developing talent and promoting internally because of a narrower pipeline of talent.

A recent survey of the National Retail Federation’s members revealed that a wide range of professional jobs will be affected by the changes—from store managers and assistant store managers and restaurant general managers and assistant managers, to buyers, merchandisers, recruiters, accountants, analysts, designers, and graphic artists.  Many companies reported they would slow or freeze hiring for new full-time positions. Retailers surveyed estimated that it will take up to five hours per affected employees to make adjustments and cost $3 million to implement.

The National Restaurant Association and the American Hotel and Lodging Association have also been very vocal opponents of the changes on behalf of their restaurant, hotel, and lodging members. In a press release issued after the final rule was announced, the National Restaurant Association stated that

the threshold for exempt employees in the final regulations is still too high.  Restaurants operate on thin margins with low profits per employee and little room to absorb added costs. More than doubling the current minimum salary threshold for exempt employees, while automatically increasing salary levels, will harm restaurants and the employer community at large.

During the regulatory process, the American Hotel and Lodging Association told the DOL that

the proposed changes will severely impact small business owners, especially those in rural communities, who operate under tight budget margins that can’t offset the substantial increase in labor costs the proposed changes will undoubtedly create for employers. This will result in unintended consequences that will ultimately harm the very employees that the rule purports to help, preventing their advancement and opportunity and keeping the industry from continuing to grow and create jobs.

Preparing For the Changes

While the final regulations may be subject to congressional challenges or litigation, retail and hospitality employers should presume that implementation of the new regulations will not be delayed past its effective date of December 1. Accordingly, employers should be developing and finalizing their compliance and communications plans now.

As we reported in an earlier post, many retail and hospitality employers already have taken substantial steps in modeling the costs of complying with the anticipated changes and considering measures to address the anticipated morale issues that compliance will bring. Our May 3 article, “Retailers Share Struggles and Strategies in Preparing for Overtime Changes,” discusses the preparations they have undertaken and the various compliance options they were considering just prior to the issuance of the final regulations. Now that the changes are final, those businesses will need to redouble their efforts in this regard and fine tune their modeling in light of the final regulations. Those employers that have not yet taken steps to prepare, will need to begin their preparations. 

Two important preliminary considerations are (1) whether and how to use outside counsel in the process and (2) whether to expand the review and analysis to other “hot button” wage and hour issues, e.g., how breaks are handled, how tips are handled, and how overtime is calculated. It may be useful to affiliate with outside counsel for some or all of the analysis in order to cloak the results in the attorney-client privilege. It may also be a good time to conduct a full wage and hour audit to identify all potential issues and make any required changes at the same time as whatever changes that will be mandated by the changes to the overtime rules. Both of these preliminary issues should be evaluated before beginning to analyze the impact of the overtime changes.

The five key steps for employers to take in order to analyze the impact of the overtime changes on their businesses and devise a plan for compliance are as follows:

Step 1: Collect and Analyze Salary and Pay Information

This analysis should identify all currently exempt employees who are being paid below the new salary minimum of $47,467. Employers should also look at the impact of bonuses and incentive pay on overall compensation since changing the structure of those payments may be one of the options employers will be able to consider to ensure compliance. This analysis should focus on identifying any geographic differences or differences based on the volume of sales at stores, restaurants, and hotels in question across job classifications.

As part of this process, employers may also want to examine the numbers and job titles of exempt employees who are currently being paid above the new threshold and consider whether there will be a compression effect on those employees. If an employer chooses to comply with the final salary regulations by increasing salaries at the bottom of the pay scale, the employer may need or want to increase the salaries of those who are paid above the new minimum as well—for purposes of perceived fairness, retention, and morale.

Step 2: Collect and Analyze Information Regarding Work Hours and Staffing Needs

Employers should collect the most valid information possible regarding the number of hours its exempt employees are working on a weekly basis—including the number of hours they are spending outside of work conducting work activities on their mobile phones and via email and the amount of time they are spending traveling. This may be quite difficult given that many employers do not require their exempt employees to record their work time. Analyzing badge swipe data may be useful for this purpose. However, employers may also need to obtain such information through formal surveys, informal surveys, direct observation, interviews, or some other method. Having this information will help employers conduct an analysis of the potential costs of converting some or all employees in a particular exempt classification to nonexempt. 

Employers should also collect data on their staffing needs and usage to determine patterns across locations and operating times. Data on staffing usage can be used to identify and predict the amount of overtime hours that may be required if exempt employees are reclassified. It also can be used to maximize efficiency and eliminate unnecessary labor hours.

Step 3: Consider Potential Changes to Meet the Expected Amendments

While they undoubtedly all will be costly and have an impact on morale, there are several different options retail and hospitality employers can consider to meet the requirements of the new regulations. 

• Increase the salaries of some or all exempt employees to the new minimum. Employers may want to consider treating all job titles in the same way, or they may want to create tiers within job titles based on the sales volume of their stores, restaurants, or hotels, or based on their geographic locations.
• Reduce or eliminate bonuses, commissions, and incentive pay for those exempt employees whose total compensation may meet the new minimum—and increase their salaries by these bonus, commission, and incentive amounts.
• Restructure bonus, commission, and incentive pay programs to meet the requirements of the new regulations that they be paid on a quarterly or more frequent basis, thereby allowing employers to continue to incentivize managers to grow sales at the stores, restaurants, and hotels they manage.
• Reclassify exempt employees that don’t meet the new minimum and pay them hourly. This option will also require employers to educate these employees about timekeeping requirements, meal and rest breaks, and other wage and hour requirements and will likely require the employer to implement other steps to minimize the amount of overtime worked, such as changing staffing levels in certain locations and at certain times to eliminate unnecessary overtime hours.
• Reclassify exempt employees and change their compensation structure to pay them on a commission or fluctuating-workweek basis. As with the prior option, this option will also require employers to educate these employees about timekeeping and wage and hour requirements and will likely cause employers to implement other steps to minimize the amount of overtime worked, such as changing staffing levels in certain locations and at certain times to eliminate unnecessary overtime hours.

Employers will also need to keep in mind that they may need to change their benefit plans for employees who are reclassified as nonexempt. It may also make sense to consider changing or creating new timekeeping practices and systems for employees who are reclassified as hourly employees. Time clock systems, for example, will not capture compensable work performed by employees off-site via mobile phone or email or while traveling.

Step 4: Model Potential Changes

After collecting the data and analyses referenced above, an employer can begin the process of developing models as to the potential costs and effects of the different ways to respond to the proposed regulations. For example, an employer may calculate the potential costs of increasing all exempt employees to a new minimum salary level, then separately calculate the potential costs of converting some or all exempt employees in a particular job classification to nonexempt, hourly employees, e.g., analyzing options for reclassifying employees by geographic area or by the sales volume of their stores, restaurants, or hotels. Calculating various combinations of these costs will provide employers with a better understanding of the effects of these changes on their organizations.

Employers should also consider other potential consequences that may accompany such changes. For example: Will the employer’s benefit plans need to be modified? Will any timekeeping practices and systems need to be changed if managers are reclassified as hourly, nonexempt employees? How will changes in the compensation of currently exempt employees affect the internal equities in the compensation of the employees above and below them? What will the promotion track for managers look like after the changes?

In addition, employers should consider the intangible consequences of the changes that may not directly translate into dollars and cents. Retail and hospitality employers should consider the risks associated with managers becoming dissatisfied with their newly nonexempt roles and evaluate whether this factor will weigh against reclassification—and if so, identify ways to mitigate the adverse consequences to the management workforce.

Step 5: Consult and Prepare Key Stakeholders for the Changes

There are many stakeholders who will play a role in meeting the requirements of the overtime changes and they all should be educated and consulted as part of the process. Operations and management executives and supervisors will need to be educated as to the DOL’s proposed changes, as well as the potential effects on the business and on employee relations. Labor relations and human resources professionals possess important information about employee engagement and morale and will need to respond to any labor and/or employee relations issues that arise as a result of changes the company may implement. Benefits, payroll, and timekeeping professionals also have a role to play as changes may need to be made in all of those areas in order to comply with the new regulations. Finally, financial executives will need to take into account the changes in their budgeting processes. The earlier the process of consulting and educating these various stakeholders is started, the better the chances of having an effective and cohesive plan in place to meet the December 1 deadline.

Conclusion

The new changes to the overtime rule will undoubtedly have an enormous impact on the retail and hospitality industries—from increasing costs to potentially damaging the management pipeline. However, retail and hospitality employers that take the steps listed above to evaluate the full picture and impact of the changes will be able to make the decisions necessary to comply with the new rules by their effective date of December 1, 2016, and in a manner that causes minimal business disruption.

Ogletree Deakins will continue to cover the final regulations in depth on our Wage and Hour blog in addition to the firm’s Overtime Solutions Center, which includes a variety of resources on the overtime rule and is frequently updated.  Retail and hospitality employers may also want to participate in the National Retail Federation’s #DOLfail campaign on social media and/or reach out to Congress legislators to let them know that the changes will have an enormous and negative impact on their businesses.

For a detailed discussion of how the new regulations will affect California employers, join us for a one-hour webinar, “What Do The New DOL Overtime Requirements Mean for California Employers?,” on Tuesday, May 24, 2016.