Wal-Mart’s Crash Course in Labor Economics

Wal-Mart’s Minimum Wage Breakdown
Wal-Mart plans to raise the wages of hourly workers because it didn’t have much choice as minimum-wage rates rise and the labor market tightens.
Bloomberg, February 23, 2015

Last week, we learned that Wal-Mart was giving the lowest-paid of its hourly employees a raise. In a blog post, Wal-Mart Chief Executive Officer Doug McMillon said that as of April, the company will pay a minimum of $9 an hour. That is $1.75 more than the federal minimum wage of $7.25, which has been unchanged for almost six years. Next February, Wal-Mart’s lowest hourly rate will rise to $10. All told, about a half-million Wal-Mart workers in the U.S. will be affected.

There has been lots of theorizing about why the nation’s largest retailer did this: See this, this, and this. But I have a much simpler explanation: The Wal-Mart business model is broken.

As in any complex situation, there are many nuances and wrinkles: This was inevitable; state minimum-wage laws had already mandated those minimums (or higher) in at least two-thirds of Wal-Mart’s stores. In the years since the last federal minimum-wage increase, many of Wal-Mart’s employees had fallen below the poverty level and the strengthening economy has made it harder to attract and retain employees.

There is also the issue of the negative PR generated by Wal-Mart’s low, low wages. As we discussed back in 2013, many of its full-time employees receive a full array of federal and state welfare. Wal-Mart has become the nation’s largest private-sector beneficiary of taxpayer-supported public assistance (see “How McDonald’s and Wal-Mart Became Welfare Queens“). Indeed, the U.S. taxpayer has been subsidizing the wages of this publicly traded, private-sector company to the tune of $2.66 billion in government largess a year.

Although many factors contributed to the move, the simple reason for the increase is because Wal-Mart has stopped growing. Same-store sales have been little changed or declining for some time now. When we look at the underlying causes, the company’s workforce, and how it is managed, are the prime suspects.

Zeynep Ton, a professor at MIT Sloan School of Management, explains the underlying management error:

Labor is seen as a cost driver rather than a sales driver. Managers do not have much direct control over sales, almost never making decisions on merchandise mix, layout, price, or promotions. But managers do have control over payroll costs and are evaluated regarding whether they meet weekly or monthly targets for payroll as a percentage of sales. At times these pressures have been such that Walmart managers have put pressure on employees to work off the clock.

With a bonus structure designed to drive down labor costs, guess what Wal-Mart managers did?

Cutting on salary and benefits, however, didn’t necessarily lower costs. About 44 percent of Wal-Mart’s hourly staff turns over each year. That’s a lot of people, because the company employs 2.2 million workers worldwide. Hiring replacements is a costly and time consuming process.

Consider competitors such as Costco: It has average hourly wages of$20 and a turnover rate of “17% overall and just 6% after one years employment,” according to the Harvard Business Review. HBR estimates the full cost of “replacing a worker who leaves is typically 1.5 to 2.5 times the worker’s annual salary.” That is no small chunk of change.

That is before we get to the PR black eye Wal-Mart has repeatedly inflicted on itself. Consider the charity food drive it held to feed the hungry at Thanksgiving. Why was this noble effort problematic? Because the beneficiaries were the companies’ own starving employees. Its own employees couldn’t afford to buy food at Wal-Mart.

Not paying your employees enough to shop at your own store is a second-order issue. As Daily Beast writer Daniel Gross noted, Wal-Mart has failed to learn the first lesson of Henry Ford:

Walmart’s same-store sales are falling as the surrounding retail market surges. What’s the problem? By screwing its workers with low wages, the nation’s largest private-sector employer is preventing a huge chunk of the American workforce from shopping at its stores.

Where the numbers can really start to add up for Wal-Mart is in the indirect costs associated with how management treats its employees. These all seem to be having a substantial affect on growth. Consider this parade of horribles detailed at Gawker as a result of these management practices:

• Lost sales from in-store customers

• Permanent loss of customers who get frustrated and defect to Target and Costco

• Generally surly attitudes among workers, diminishing the Wal-Mart shopping experience

• Employees who leave the company the first chance they get

True, it is tough to measure some of this. However, as Costco has shown, well-paid and happy employees tend to equal satisfied customers. Unhappy employees and unhappy shoppers is very likely the corollary of this.

Wal-Mart has shown that it can be pragmatic on some issues often associated with the political left. The company’s solar efforts, for example, are second to none in the U.S. To be sure, the decision to go solar when you own lots of flat roofs in the Sun Belt was simply math.

The same is probably true of its wage increase: The rebounding economy meant that Wal-Mart may have had little choice but to increase pay.  It was long overdue.

Originally published here:  Wal-Mart’s Minimum Wage Breakdown