The predicament of Fort Worth, Texas-based Pier 1, which reported losses that widened to $56.4 million in the first quarter from $23.2 million a year earlier, reflects the quandary of employer-sponsored health care for service businesses whose low-wage employees are the face of the company to customers.

Analysts see reducing health care costs as a short-term savings that would likely harm employee morale, increase attrition rates and lead to deteriorating customer service.

“When you actively reduce costs at a company where the selling environment is such a big part of the brand, you have to be careful that you don’t damage the brand,” says Bryan Gildenberg, chief knowledge officer at retail research and consulting firm Management Ventures. “There’s a much greater risk in the high-touch, high-service model of retail of disenfranchised employees hurting business performance.”

Part of what Pier 1 CEO Alex Smith is calling a “cost-efficiency mission” is to cut employees’ hours in some stores to disqualify them from health benefits.

In May, hourly employees were told the number of work hours needed to receive health care benefits would increase. The next month, Pier 1 executives raised the number of stores it would close from 60 to 100. Then employees in Ohio, Colorado and Texas were told they would not be allowed to work enough hours to receive health care.

One assistant store manager in Ohio who makes $11 an hour and has worked at Pier 1 for several years feels betrayed.

“They are slashing the throats of the people who have been there the longest,” says the assistant manager, who spoke on condition of anonymity because talking to the press could mean termination. That employee’s hours were cut to 22 hours a week on average from 32 hours a week. Meanwhile, the company has hired part-time employees at $7 an hour who are working 31 hours a week—one hour shy of the 32 needed for health care benefits.

Pier 1 declined to comment or to confirm the policy changes, saying the company does not discuss personnel matters publicly.

Balancing part-time and full-time labor costs is common in retail. Annualized savings from cost reductions—which also include layoffs at the company’s Fort Worth headquarters, refining the management structure and closing 100 stores—will amount to $150 million, Smith told analysts during a recent conference call.

Cutting labor costs may be the norm for troubled retailers, but it is also a sign of desperation, says Leon Nicholas, a retail analyst at Global Insight, and is reminiscent of last-ditch efforts of defunct retailers Caldors and Bradlees. The problems of Pier 1 are compounded by what he sees as a lackluster strategy to sell more goods.

“Unless the fundamental problem is employee costs, [cutting those costs] doesn’t fix the fundamental problem,” Nicholas says. “Pier 1 hasn’t addressed fundamentally how to compete with Wal-Mart and Target at the bottom end and the boutiques at the higher end. They’re in the middle, which is no place to be in retail.”

—Jeremy Smerd