Wal-Mart is not Costco; So Why Should it Pay Like Costco?

President Obama, the unions, and Democrats in general are attempting to force Wal-Mart to raise its minimum wage.

In Seattle, there is an absurd push by activists to raise the minimum wage to $15 per hour for fast food workers, retail clerks, baristas and other minimum wage workers.

Venture capitalist Nick Hanauer said there's no time to waste. What the nation needs is money in the hands of regular consumers. "A higher minimum wage is a very simple and elegant solution to the death spiral of falling demand that is the signature feature of our economy".

Trader Joe's Lesson

Sophie Quinton for The Atlantic says The Trader Joe's Lesson: How to Pay a Living Wage and Still Make Money in Retail

Many employers believe that one of the best ways to raise their profit margin is to cut labor costs. But companies like QuikTrip, the grocery-store chain Trader Joe's, and Costco Wholesale are proving that the decision to offer low wages is a choice, not an economic necessity. All three are low-cost retailers, a sector that is traditionally known for relying on part-time, low-paid employees. Yet these companies have all found that the act of valuing workers can pay off in the form of increased sales and productivity.

"Retailers start with this philosophy of seeing employees as a cost to be minimized," says Zeynep Ton of MIT's Sloan School of Management. That can lead businesses into a vicious cycle. Underinvestment in workers can result in operational problems in stores, which decrease sales. And low sales often lead companies to slash labor costs even further. Middle-income jobs have declined recently as a share of total employment, as many employers have turned full-time jobs into part-time positions with no benefits and unpredictable schedules.

QuikTrip, Trader Joe's, and Costco operate on a different model, Ton says. "They start with the mentality of seeing employees as assets to be maximized," she says. As a result, their stores boast better operational efficiency and customer service, and those result in better sales. QuikTrip sales per labor hour are two-thirds higher than the average convenience-store chain, Ton found, and sales per square foot are over 50 percent higher.

A Different Model

Yes, Ton, you are exactly correct. QuikTrip, Trader Joe's, and Costco do have a different model and it would behoove someone at MIT's Sloan School of Management to figure out differences in that model, and why retail sales at Trader Joe's beat those of Wal-Mart by 50% on a square footage basis.

Why Wal-Mart Will Never Pay Like Costco

Bloomberg writer Megan McArdle hits the nail on the head with her analysis of the situation in Why Wal-Mart Will Never Pay Like Costco.

Wal-Mart is trying to move into Washington, a move that said local housing blog has not enthusiastically supported. Hence, we’ve been treated to a lot of impassioned reheatings of that old standby: “Costco shows it’s possible” for Wal-Mart to pay much higher wages. The addition of Trader Joe’s and QuikTrip is moderately novel, but basically it’s the same argument: Costco/Trader Joe’s/QuikTrip pays higher wages than Wal-Mart; C/TJ/QT have not gone out of business; ergo, Wal-Mart could pay the same wages that they do, and still prosper.

Obviously at some level, this is a true but trivial insight: Wal-Mart could pay a cent more an hour without going out of business. But is it true in the way that it’s meant -- that Wal-Mart could increase its wages by 50 percent and still prosper?

Upper-middle-class people who live in urban areas -- which is to say, the sort of people who tend to write about the wage differential between the two stores -- tend to think of them as close substitutes, because they’re both giant stores where you occasionally go to buy something more cheaply than you can in a neighborhood grocery or hardware store. However, for most of Wal-Mart’s customer base, that’s where the resemblance ends. Costco really is a store where affluent, high-socioeconomic status households occasionally buy huge quantities of goods on the cheap: That’s Costco's business strategy (which is why its stores are pretty much found in affluent near-in suburbs). Wal-Mart, however, is mostly a store where low-income people do their everyday shopping.

As it happens, that matters a lot.  Costco has a tiny number of SKUs in a huge store -- and consequently, has half as many employees per square foot of store. Their model is less labor intensive, which is to say, it has higher labor productivity. Which makes it unsurprising that they pay their employees more.

But what about QuikTrip and Trader Joe’s? I’m going to leave QuikTrip out of it, for two reasons: first, because they’re a private company without that much data, and second, because I’m not so sure about that statistic. QuikTrip’s website indicates a starting salary for a part-time clerk in Atlanta of $8.50 an hour, which is not all that different from what Wal-Mart pays its workforce.

Trader Joe’s is also private, but we do know some stuff about it, like its revenue per-square foot (about $1,750, or 75 percent higher than Wal-Mart’s), the number of SKUs it carries (about 4,000, or the same as Costco, with 80 percent of its products being private label Trader Joe’s brand), and its demographics (college-educated, affluent, and older). “Within a 15–minute driving radius of a potential site,” one expert told a forlorn Savannah journalist, “there must be at least 36,000 people with four–year college degrees who have a median age of 44 and earn a combined household income of $64K a year.” Costco is similar, but with an even higher household income -- the average Costco household makes more than $80,000 a year.

In other words, Trader Joe’s and Costco are the specialty grocer and warehouse club for an affluent, educated college demographic. They woo this crowd with a stripped-down array of high quality stock-keeping units, and high-quality customer service. The high wages produce the high levels of customer service, and the small number of products are what allow them to pay the high wages. Fewer products to handle (and restock) lowers the labor intensity of your operation. In the case of Trader Joe’s, it also dramatically decreases the amount of space you need for your supermarket ... which in turn is why their revenue per square foot is so high. (Costco solves this problem by leaving the stuff on pallets, so that you can be your own stockboy).

Wal-Mart’s customers expect a very broad array of goods, because they’re a department store, not a specialty retailer; lots of people rely on Wal-Mart for their regular weekly shopping. The retailer has tried to cut the number of SKUs it carries, but ended up having to put them back, because it cost them in complaints, and sales. That means more labor, and lower profits per square foot. It also means that when you ask a clerk where something is, he’s likely to have no idea, because no person could master 108,000 SKUs. Even if Wal-Mart did pay a higher wage, you wouldn’t get the kind of easy, effortless service that you do at Trader Joe’s because the business models are just too different. If your business model inherently requires a lot of low-skill labor, efficiency wages don’t necessarily make financial sense.

If you want Wal-Mart to have a labor force like Trader Joe’s and Costco, you probably want them to have a business model like Trader Joe’s and Costco -- which is to say that you want them to have a customer demographic like Trader Joe’s and Costco. Obviously if you belong to that demographic -- which is to say, if you’re a policy analyst, or a magazine writer -- then this sounds like a splendid idea. To Wal-Mart’s actual customer base, however, it might sound like “take your business somewhere else.”

Think Beyond Minimum Wage

Profit per employee at Wal-Mart is $7,428. At Costco it's $10,625. Because of the difference in business model, it is illogical to assume Wal-Mart will have higher profit if only it paid Costco wages.

Activitists like Nick Hanauer and Zeynep Ton of MIT's Sloan School of Management need to go beyond their simplistic model of raising minimum wages and actually think about why things are as they are.

Neither one of them can distinguish a symptom of a problem from the problem. The problem is not that wages are too low, the problem is the Fed (central banks in general) are hell-bent on causing price inflation (and wages did not keep up).

The solution is to get rid of the Fed, not to raise minimum wages (which will only encourage businesses to seek ways to eliminate more employees).

Outsourcing

Manufacturing employment was devastated by outsourcing to China. Why? Global Wage Arbitration: Unrealistic employee costs made it profitable to move.

In Italy, in just this past month, an Italian factory owner moved company to Poland while staff are on holiday

Earlier this month, the owner of an electrical components factory in the north of the country waved his employees off on their summer holidays. Then, without informing them, he moved the entire operation, lock, stock and barrel, to Poland.

Fabrizio Pedroni, 49, said he was driven to the drastic course of action because his factory, located near the city of Modena, had not turned a profit for five years and he was being strangled by high salaries, crippling taxes and dismal rates of productivity.

Moving the factory to Eastern Europe was the only way of saving his company, which was founded 50 years ago by his grandfather.

I commend the Italian business owner for his move. The bureaucrats and socialists are of course howling like mad.

The difference between manufacturing and fast food, is the latter must occur locally. But force higher minimum wages and you are guaranteed to see more fast-food robots.

Robot Wars

Those with jobs will benefit from a hike in the minimum wage (but what about everyone else?). What about those on fixed income? What about the marginal worker who loses a job (or cannot get a job in the first place)?

If you do not know the answer, here's a hint: Robot Wars in China; Burger Flipping Robots Serve 360 Gourmet Burgers an Hour

For further discussion, please see World's Dumbest Idea.

Socialist fools never think about such things (until problems arise such as massive outsourcing to China or increasing use of robots instead of humans locally). Then instead of realizing what the real problem is, the socialists and union activists scream for tariffs to protect the jobs and taxes on robots. Somehow, in their twisted minds, its better for everyone in the country to pay twice as much as before for underwear if it saves 500 underwear manufacturing jobs.

Technology moves on. I do not claim that getting rid of the Fed will eliminate robots. However, the inflationary practices of the Fed coupled with misguided polices of bureaucrats and the artificial suppression of interest rates have exacerbated the problem.

Academic Wonderland

Here's the deal. The problem has gotten worse ever since Nixon closed the gold window. Removal of ties to the gold standard allowed central banks to inflate at will, and governments to spend at will (and both did). The result was shrinkage of the middle class and declining real wages for everyone but those in the top 10%.

I propose we attack the real problem rather than the symptom of the problem. Unfortunately, Zeynep Ton and thousands of others in Academic Wonderland would rather attack symptoms instead of problems.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com