Why Wal-Mart Will Never Pay Like Costco
By Megan McArdle 2013-08-27T18:29:29Z
I found this link to my old employer on one of our many local housing blogs this morning. It’s an old piece on the high wages paid by Trader Joe’s, Costco and a handful of other outlets. The text in the link: “A not-so-subtle message for Wal-Mart: Big retailers can pay decent wages and thrive. [ Atlantic]” Here’s a clip from the article:
The average American cashier makes $20,230 a year, a salary that in a single-earner household would leave a family of four living under the poverty line. But if he works the cash registers at QuikTrip, it's an entirely different story. The convenience-store and gas-station chain offers entry-level employees an annual salary of around $40,000, plus benefits. Those high wages didn't stop QuikTrip from prospering in a hostile economic climate. While other low-cost retailers spent the recession laying off staff and shuttering stores, QuikTrip expanded to its current 645 locations across 11 states.
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. 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?
I wrote about this last spring in regard to Wal-Mart and Costco. 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. I produced the following graphic to sum up the differences that these two strategies produce:
(*Walmart figures include Sam’s Club, which despite having more stores, is much less profitable than Costco.)
What do you see? 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. That $40,000 figure is for an assistant manager, and seems to include mandatory overtime. To this let’s add a third reason: QuikTrip is a convenience store, a business that bears minimal resemblance to a department store, the category into which Wal-Mart falls. I mean, yes, you can buy candy at both places, but you can also buy a candy bar at the movie theater, and I still wouldn’t head to my local Wal-Mart for a 3:30 p.m. showing of "The Butler."
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).
Both these strategies work in part because very few people expect to do all their shopping at Trader Joe’s, and no one expects to do all their shopping at Costco. They don’t need to be comprehensive. Supermarkets, and Wal-Mart, have to devote a lot of shelf space, and labor, to products that don’t turn over that often.
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.
That’s not the only reason that the Trader Joe’s/Costco model wouldn’t work for Wal-Mart. For one thing, it’s no accident that the high-wage favorites cited by activists tend to serve the affluent; lower income households can’t afford to pay extra for top-notch service. If it really matters to you whether you pay 50 cents a loaf less for generic bread, you’re not going to go to the specialty store where the organic produce is super-cheap and the clerk gave a cookie to your kid. Every time I write about Wal-Mart (or McDonald's, or [insert store here]), several people will e-mail, or tweet, or come into the comments to say they’d be happy to pay 25 percent more for their Big Mac or their Wal-Mart goods if it means that the workers are well paid. I have taken to asking them how often they go to Wal-Mart or McDonald's. So far, no one has reported going as often as once a week; the modal answer is a sudden disappearance from the conversation. If I had to guess, I’d estimate that most of the people making such statements go to Wal-Mart or McDonald's only on road trips.
However, there are people for whom the McDonald's Dollar Menu is a bit of a splurge, and Wal-Mart’s prices mean an extra pair of shoes for the kids. Those people might theoretically favor high wages, but they do not act on those beliefs -- just witness last Thanksgiving’s union action against Wal-Mart, which featured indifferent crowds streaming past a handful of activists, most of whom did not actually work for Wal-Mart.
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.”
This is not actually just a piece on how Wal-Mart can only pay low wages -- I don’t know how much more they could afford to pay before they started to lose customers (or the board kicked the CEO out), and neither does anyone else writing about this. I’m actually interested in the larger point: the way that things most people rarely think about -- like the number of products that a store carries -- have far-reaching effects on everything from labor, to location, to customer service and demographics. We tend to look at the most politically salient features of the stores where we shop: their size, their location, the wages that we pay. But these operations are not so simple. They are incredibly complex machines, and you can no more change one simple feature than you can pull out your car’s fuel injection system and replace it with the carburetor from a 1964 Bonneville.
bloomberg.com
...What do you notice? Costco has a more highly paid labor force--but that labor force also brings in a lot more money. Costco's labor force, paid $19 an hour, brings in three times as much revenue as a Walmart workforce paid somewhere between 50-60% of that. (There's a bit of messiness to all these calculations, because of course both firms have employees who don't work in stores--but that's the majority of their workforce, so I'm going to assume that the differences come out in the wash.)
This is not because Costco treats its workers better, and therefore gets fantastic productivity out of them, though this is what you would think if you listened to very sincere union activists on NPR. Rather, it's because their business model is inherently higher-productivity. A typical Costco store has around 4,000 SKUs, most of which are stacked on pallets so that you can be your own stockboy. A Walmart has 140,000 SKUs, which have to be tediously sorted, replaced on shelves, reordered, delivered, and so forth. People tend to radically underestimate the costs imposed by complexity, because the management problems do not simply add up; they multiply.
One way to think about this is Thanksgiving dinner: how come you, who are capable of getting a meal on the table 364 nights of the year, suddenly find yourself burning things, forgetting the creamed onions in the microwave, and bringing the mashed potatoes to the table a half an hour late? Because when you're cooking sixteen things instead of four, it is not the same as cooking four four-item meals. There are all sorts of complex interactions involving things like heating times and oven space, and adding more people to the problem, while probably necessary, itself multiplies the complexities.
Walmart has tried to reduce ("rationalize") the number of SKUs, but they were forced to backtrack and restore over 8,000 items to their stores. That's because most Costco shoppers are opportunity shoppers--they buy whatever is on sale at the moment, and supplement with frequent trips to the grocery store. Many Walmart shoppers, on the other hand, rely on the store for the majority of their needs--it has to be everything to everyone. That's really expensive, and it requires a lot of labor to keep track of all of those SKUs, figure out where to shelve them, etc. Walmart uses a lot more labor per sale than Costco does because it sells more than one kind of gum, and not always by the 24-pack.
You know how your husband hates going to Costco because you have to stand in line for twenty minutes? That's another part of Costco's low labor costs. Except for its very busiest days, like Black Friday, Walmart keeps more registers open, which speeds your passage through line, but also wastes expensive worker time standing at the checkout and waiting for people to come by. Again, this is not just some idiosyncratic decision that the stores have made because, well, people are different: customers will wait in line at Costco because they don't go there very often. At Walmart, which is many peoples' grocer, clothier, and auto supply shop, long lines would cost them a lot of business.
Costco's higher revenues are also a function of their demographic. Costco shoppers have an average income of $85,000--not surprising, because Costco tends to locate itself in affluent suburbs. Walmart shoppers are what the firm calls "value driven shoppers" which is to say, there's not a lot of spare money lying around the house, just waiting for an opportunity to buy a 6-lb wheel of Camembert. Value driven are very price conscious, and willing to forgoe things like service or artful displays in order to shave an extra 50 cents off the weekly shaving cream budget. If you've been wondering why Walmart seems serenely unworried that last Friday's labor action will touch of a boycott, this is why. If you took all the people in my twitter feed expressing excitement about a new era of labor organizing last Friday, I'd be very surprised to learn that they had spent as much as a thousand dollars between all of them at a Walmart last year.
Meanwhile, to speak more directly to Matt's point, Costco's margins are lower than Walmart's because they're basically a grocer with a sideline in televisions and kitchen gadgets. Margins are very slim in the grocery business: it's a big part of peoples' budgets, it's not particularly fun shopping, and people have a good sense of what the prices would be because they shop very frequently. Plus the losses to shrinkage and spoilage are very high. On the flip side, no matter how bad a recession gets, people still buy groceries, so those margins are pretty safe; if that weren't the case, we'd have lost all our grocers, along with our national dignity, in 2009.
Costco is doing very well for a grocer, but very poorly for a department store, the category to which Walmart technically belongs. Target, the store that is most like Walmart (albeit with a younger, more upscale demographic), has a profit margin of 4.1%.
One final thing that's worth pointing out is that Costco doesn't even make money selling the groceries and the six person hot-tubs. Their annual membership fee revenue exceeds their net profit--which is to say that the actual business of selling stuff is operating at a loss. They're charging you an annual fee to buy stuff at or near cost. That's a model that works really well with their basically affluent customer base, and not incidentally, a model that allows you to worry a bit less about your cost of sales. Sam's Club tries to do the same thing, but caters to a lower-income clientele and makes a lot less money despite having more stores.
The point of all of this is to say that while it might be true that Walmart could make more money by adopting Costco's labor model, there's no particular reason to think that this would be so. The differences in their labor models are not just some sort of personal preference, or ideological choice*; they're responses to the way that labor needs to be deployed to do the quite different things that these stores do. We say that "they're competitors" because they do compete with eachother in some markets, for a handful of SKUs. But very few people could replace their trips to Costco with visits to Walmart, or vice versa. Despite the superficial similarities (cheap stuff in large store) they're really very different, and you can no more graft one's labor model onto the other than you can buy a single pack of gum in the Costco checkout...
thedailybeast.com
Wal-Mart vs. Costco III, Why My Critics Are Wrong
By Megan McArdle 2013-08-30T15:33:08Z
Well, my piece on Costco Wholesale Corp., Trader Joe’s and Wal-Mart Stores Inc. has attracted a lot of heated argument. Why did I use worldwide figures instead of U.S. figures for revenue and profit per employee? Why didn’t I point out that Costco’s profit margin is much lower than Wal-Mart’s? (Aside from the graph in which I pointed that out, anyway.) And if Costco’s business model is so much better than Wal-Mart’s, maybe Wal-Mart should start putting stuff on pallets, huh?
First things first: I used worldwide figures because international profit figures aren't broken out separately on its financial statements. But how much difference that distinction would have made is unclear. Both companies get about two-thirds of their revenue from their U.S. operations, which is also approximately the percentage of their employees who work in the U.S.
Now about that profit margin. In fact, I did address this, in the earlier post that I linked. To wit: the fact that one firm operates at a profit margin of 1.7 percent doesn’t mean that all firms should operate at a profit of 1.7 percent. Amazon has an effective profit margin of 0 percent, but that doesn’t mean that every other firm in the country should follow suit. For that matter, why not compare Costco’s returns with Apple’s 22 percent?
You know the answer, right? Running a tech company is much riskier than running a grocery store. You have to spend a lot of money developing products that might not pan out. And then some moron can invent a product that eliminates the need for what you sell, as happened to Kodak and Polaroid and about a zillion other technology firms. The survivors tend to have high returns, but a whole lot of money got burned on the way to producing those few winning companies. Grocery store margins, on the other hand, are razor thin, but it’s unlikely that anyone is going to come along and invent something to replace what you sell.
An industry might need higher margins for all sorts of reasons: Revenue might be seasonal, or cyclical, or the industry might rely heavily on leverage, or long-term leases, so that you need some padding to cover your debt payments. This is why the returns for an industry group tend to cluster together, even in competitive industries: Groceries have lower margins than department stores, which have lower margins than insurance, which has lower margins than pharma.
If you were a prospective shareholder in one of those firms, or industries, you wouldn’t just look at the margin on sales; you’d want to look at how risky that margin was. You’d also want to know how much capital was needed to produce that margin, a statistic that is known, appropriately enough, as “ return on invested capital.”
And if you were a shareholder who had already invested your money in one of these firms, you’d scream bloody murder if your high-margin tech company suddenly decided to cut profit margins to grocery store levels. There goes the retirement fund!
Wal-Mart’s profit margin is about twice what Costco’s is. But its ROIC is only marginally higher: 13.77 percent vs. 12.88 percent. The company needs to put a lot more money into warehouses, trucks, whizzy computer systems, and cinderblock stores in order to generate those profits -- not surprising given the complexity of its supply chain, and the number of products it offers. Owners of capital generally ask to be compensated for using it to build stuff, rather than spending it. Wal-Mart is no exception. If it targeted Costco’s ROIC, rather than its own, Wal-Mart could free up a bit of money -- about a billion dollars. If it gave two-thirds of that billion to its 1.4 million U.S. workers, each worker would get about $470, or $9 a week...
bloomberg.com
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stationarywaves.com Ryan Long
It may be useful to also look at it from the consumer’s point of view. The motivation is the same for shopping at Walmart as for shopping at Costco: to lower the unit cost of shopping and capture long-term maximum utility.
This is possible at Walmart because Walmart’s business model involves whittling-down their costs as far as they will go, by keeping labor costs low, negotiating special and exclusive deals with suppliers, and leaning heavily on economies of scale.
But being a Costco customer requires that the customer pay substantial up-front costs. Most notably: the membership fee, the ability to either pay cash for everything or qualify for a Costco AmEx card, and the ability to store large quantities of food at home.
It is certainly worth paying these costs if you can afford to do so; shopping at Costco saves me a lot of money. But not every customer has that kind of wealth; and those lower-income customers are the ones who choose Walmart instead.
bleedingheartlibertarians.com |
