The Low Price Effect

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THE LOW PRICE EFFECT

The Low Price Effect

Blake M. Whitmore

Robert Morris University – Illinois

Introduction

In 1962, Sam Walton founded Wal-Mart in Bentonville, Arkansas around his philosophy of “Always Low Prices.” On October 31, 1969 Wal-Mart became incorporated and publicly traded on the New York Stock Exchange in1972. From there on out the company picked up extremely rapidly. By 1988, Wal-Mart was the most profitable retailer in the United States. By 1990, Wal-Mart outsold K-Mart and by 1991 Wal-Mart outsold Sears in retail, making it America’s largest retailer. Wal-Mart was a growing success and the company is now the world’s third largest public corporation (“Global 500,” 2012), the biggest private employer in the world, employing more than two million employees (Alexander, 2012, ¶5), and the world’s largest retailer (“2011 Top 250 Global Retailers,” 2012). The success of the company globally has been largely due to the ability to keep prices low on essentials from groceries to household goods, but the low prices do come at a cost, even though the cost might not be as evident as a higher price tag on the shelf. These low prices have caused Wal-Mart to be featured in a number of news stories relating to the ethical treatment of their employees and the devastating effect of Wal-Mart Supercenters on U.S. towns and cities. Because Wal-Mart’s treatment of their more than two million employees affects all U.S. taxpayers and it is the main cause for the desire of Wal-Mart employees to unionize, it is in Wal-Mart’s best interest to improve the benefits and standards of treatment towards said employees.

In 2004, Dr. Arindrajit Dube and Ken Jacobs of UC Berkley published a study entitled “Hidden Costs of Wal-Mart Jobs.” The study showed that the average Wal-Mart employee required $730 in taxpayer-funded healthcare and $1,222 in other forms of assistance, such as food stamps and subsidized housing, to get by annually. With over 44,000 Wal-Mart employees in California alone, Californian Wal-Mart employees rely on about $86 million from taxpayers every year. Although this study was done in 2004 and Wal-Mart has been made fully aware of the effect of their “Always Low Prices” guarantee, Wal-Mart made a statement in late 2012 claiming that they will reduce the number of new hires in 2013 that receive health care benefits (Hines, 2012, ¶ 1). This blatant disregard to the ethical issues at hand has caused the public to begin to look closely at Wal-Mart. It is now not uncommon for individuals to claim they boycott Wal-Mart and Sam’s Club, a subsidiary of Wal-Mart. This has also lead to Wal-Mart employees wanting to take action themselves.

In July 2012, Wal-Mart faced accusations that employees attempting to organize a union were fired; this claim was both incredibly bold and highly illegal (Woodman, 2012, ¶ 1). The claim was never proven, but it did begin to raise questions about Wal-Mart’s opposition to unions. It is understandable that Wal-Mart would fear and oppose unions. Large companies and unions have been in a struggling battle since the beginning of unionization of employees. One of the oldest and most well known labor unions, the United Auto Workers (UAW), attracted a lot of media attention in the first few years of the 21st century when they were blamed for the automotive industry crisis of 2008-2010. In an article in USA Today, CEO Robert Miller commented on the deliberations with union leaders and the bankruptcy of Delphi, at the time the world’s second largest automotive supplier: “We made a good faith effort, and we were having constructive discussions, but our resolution is very complicated” (Carty, 2005, ¶ 3). Unions take away the power from these big name companies and if unions get too greedy and refuse to budge on wages and benefits then they have the power to potential drive that company into the ground.

Unions do serve their purpose; they help organize a leadership among the employees as a whole to make it easier and better to negotiate wages, benefits, and worker conditions with the company. If the company offered reasonable wages, benefits, and worker conditions preemptively then employees would not feel the need to organize and pay union leaders. Union fees are not something employees want to pay; rather they feel it is necessary to the well being of all company employees. Wal-Mart is not a different story in anyway. Wal-Mart could avoid the threat of unionization by preemptively improving employee wages and health benefits. It would not only raise the good faith of employees, but also of customers, the U.S. taxpayer.
Methodology and Findings

According to Wal-Mart’s Statement of Ethics, “The values that guide our decisions and our leadership are the 3 Basic Beliefs: respect for the individual, service to our customers, and striving for excellence.” This is mainly in reference to their customers, however it does also apply to employees. In the section titled “Wage and Hour”, Wal-Mart assures the reader that they fully comply to all laws and regulations pertaining to wage-and-hour issues, including off-the-clock work, meal and rest breaks, overtime pay, termination pay, minimum-wage requirements, wages and hours of minors, and other subjects related to wage-and-hour practices. There is nothing illegal that Wal-Mart is doing to their employees, which has been proven, however legal does not always mean moral.

The number one issue with Wal-Mart is benefits. As of October 2005, Wal-Mart's health insurance covered 44% or approximately 572,000 of its 1.3 million U.S. workers (Bernstein, 2005, ¶ 11). In comparison, Wal-Mart rival and wholesaler Costco insures approximately 82% of its eligible workers (Cascio, 2006, ¶ 4). It is not just as simple as how many employees are covered, but also the quality of the coverage. Costco workers pay just 8% of their health premiums; at the same Wal-Mart workers pay 33% of theirs (Cascio, 2006, ¶ 4). Between the combination of low wages and the poor coverage, Wal-Mart employees can barely keep their head above water. Wal-Mart employees struggle to cover the costs of their expensive health care bills, and in turn, they look for government assistance.

It is not just health benefits that concern Wal-Mart employees. When looking to the future Wal-Mart employees rarely are prepared for retirement, resulting in an older work force needing, once again, better health benefits. According to an article published in the Harvard Business Review, “Ninety-one percent of Costco’s employees are covered by retirement plans, with the company contributing an annual average of $1,330 per employee, while 64 percent of employees at Sam’s Club are covered, with the company contributing an annual average of $747 per employee.” Using the comparison of Costco to Wal-Mart as empirical evidence, it is clear that Wal-Mart does have options and they are not doing everything that they could to improve employee life.

Beneath the issue of benefits is the issue of low wages. Without the comfort of good benefits employees struggle to provide their own, however their wages are so low they cannot afford to pay for their own benefits. The average wage at Sam’s Club, a subsidiary of Wal-Mart, is around $10 an hour, while the average wage at Costco is $17 an hour (Cascio, 2006, ¶ 3). Although from a business standpoint it appears Costco is paying employees way too much, from an ethical standpoint they are paying employees what they deserve and what they require to survive. Costco has uncovered a major benefit to paying employees a higher wage, a much lower turnover rate of employees. Costco has one of the lowest turnover rates in the industry at just 17%, while Wal-Mart has a turnover of 44% (Cascio, 2006, ¶ 5).

When looking at Costco and Wal-Mart side by side it becomes evident that the better you treat employees, the better they will react towards the company. Costco also has one of the lowest employee theft figures in the industry (Novinson, 2012, ¶ 2), and that is not a coincidence. In addition to low employee theft rates, as of July 2004 only about 13% of Costco’s employees were unionized, and the number does not appear to be growing. Why? Because Costco treats their employees with the respect and dignity they deserve. Costco listens to employees and takes into consideration their demands. When grocery store workers in California picketed in 2004, Costco avoided issues by settling separately and privately, increasing wages to meet needs and increasing contributions to pension plans (Frey, 2004, ¶ 3).

When looking at the wages and benefits of employees it is important to look at the company profit margins. A profit margin is the percentage of selling price that turned into profit. In order to find the profit margin divide the net income by total revenue for a given amount of time. In order for companies to raise wages and improve benefits money must come from somewhere else, and the first place to look is out of the profit margin. Profit margins of publicly owned businesses are all available to the public on YCharts, “the financial terminal of the web” according to crunchbase.com. Costco’s profit margin always stays a little over 1%. At its highest, in February 2013, Costco’s profit margin was 2.20%. Wal-Mart’s profit margin is higher than Costco’s, and it fluctuates often. At one of its highest points, in January 2011, Wal-Mart’s profit margin was 5.20%. At its lowest point in the past 5 years, it was still higher than Costco’s profit margin, at 3.03% in October 2011. For the 2012 year, Wal-Mart’s profit margin was 3.51%.

The profit margins might seem small as percentages, but looking at the raw numbers things become much more clear. In Wal-Mart’s 2012 annual report it shows that total sales generated $443.9 billion. The profit margin, or 3.51% of the total revenue, was $15.80 billion. Wal-Mart also paid $11.3 billion back to shareholders through dividends and share repurchase throughout 2012. The majority of the remaining money was invested into a variety of projects including expanding and building new stores throughout the United States, United Kingdom, and South Africa. During expansions Wal-Mart added 52.2 million square feet through 1,160 additional units, as reported by Wal-Mart in their 2012 annual report. On the other hand, in Costco’s annual report for 2011 they built 52 additional units. Wal-Mart built more than 22 times the number of new stores in 2012, than Costco built the year prior.

The vast differences between Wal-Mart and Costco are evident on the surface, but things get tricky when considering what options Wal-Mart has to budget money to improve employee wages and benefits. Companies are not required to pay dividends, however if Wal-Mart quits paying out dividends then shareholders will abandon Wal-Mart and move on to the next company willing to pay out to shareholders. Costco is newer than Wal-Mart by a little over two decades. The problem and fear of losing shareholders is one that a lot of older companies have, where as newer companies learned from past mistakes.

Conclusions and Recommendations

Wal-Mart has had a tarnished image for years now due to the low wages and poor benefits provided to employees. In order to improve their image they must improve the overall well being and happiness of their employees. In order to afford to raise wages and improve benefits for employees Wal-Mart must decrease their profit margin. Unfortunately reducing pay to shareholders could cause more harm than good, so the money must come out of the investment towards expansion projects. This would be the best possible solution.

Wal-Mart is growing too big, too fast. If Wal-Mart decreased the number of new units they built, they could raise their employees above the poverty line, help provide better health care to their employees, and eliminate the low price effect. Wal-Mart could keep their low prices and continue to grow, only at a slower pace. In turn employees would no longer feel the need to unionize and the employee-employer relationship would improve.

It is evident that Costco is the leader in employee treatment in the general retail industry. Many other companies in the industry also have low wages and poor benefits. Comparing Wal-Mart and Costco shows an outstanding amount of empirical evidence that Wal-Mart needs to be aware of the needs of their employees and to meet those needs. Meeting those needs would improve the life of the employees, the overall health of the economy, and the burden on American taxpayers.

After making changes to the budget and improving employee wages and benefits, Wal-Mart could continue to survey employees to make sure that their voice is continually heard in order to keep the threat of unionization low. Although unions have a purpose and a place in this country, they can often get greedy too. Wal-Mart could continue to slow down the expansion of their stores as well. Making all of these adjustments could in fact eliminate the low price effect on taxpayers and improve the life of 1.3 million Wal-Mart employees.

References

2011 Top 250 Global Retailers. (2012, January). InNRF Stores. Retrieved May 20, 2013, from http://www.stores.org/2011/Top-250-List

Alexander, R. (2012, March 19). Which is the world's biggest employer?. InBBC. Retrieved May 20, 2013, from http://www.bbc.co.uk/news/magazine-17429786

Bernstein, A. (2005, October 19). A Stepped-Up Assault on Wal-Mart. InBloomberg Businessweek. Retrieved June 3, 2013, from http://www.businessweek.com/stories/2005-10-19/a-stepped-up-assault-on-wal-mart

Boyles, D. (2006). Big Boxes on the Plains. (cover story). American Enterprise, 17(5), 38.

Carty, S. S. (2005, October 8). Delphi files Chapter 11 after union, GM talks break down. In USA Today. Retrieved May 20, 2013, from http://usatoday30.usatoday.com/money/industries/manufacturing/2005-10-08-delphibankruptcy_x.htm