Why Wal-Mart’s minimum wage hike makes business sense

February 19, 2015, 6:27 PM UTC

If you’re tempted to view Wal-Mart’s (WMT) announcement that it will raise the minimum wage of its associates to $10 per hour by 2016 as a publicity stunt, nobody can blame you.

After all, income inequality and the struggles of the working poor and middle class have dominated political debates and the news cycle. Wal-Mart is America’s largest employer, with many of its workers making the federal minimum wage or close to it. As such, the firm has been at the center of efforts to shame Corporate America into doing more to help boost workers’ fortunes.

In the past, Wal-Mart has announced initiatives aimed at helping veterans and the American manufacturing industry that sounded nice in press releases but were not necessarily effective efforts to solve national problems. But Thursday’s announcement of a minimum wage boost, and a less heralded but equally important effort to give workers more regular scheduling, is a bold move, and one that will likely help the retail giant’s workers and the company alike.

Zeynep Ton, a professor of operations management at MIT’s Sloan School of Business, argues in her recent book The Good Jobs Strategy that retail firms have long misunderstood the value of their human resources and the benefits that can be reaped by investing more in their workforce. She writes:

Retailers view store labor as a cost driver, not a profit driver. And labor is not just any cost. After the cost of goods sold, labor is the largest cost for most retailers. Perhaps more important, labor is the largest controllable cost. In a pinch, retailers cannot quickly cut other large expenses such as the cost of the products they sell or their retail costs, but they can quickly and fairly easily reduce what they spend on training, benefits … or the total number of employee hours.

Not every firm, however, takes this approach. Ton studied the operations of four successful low-cost retailers: QuickTrip convenience stores, Mercadona and Trader Joe’s supermarkets, and Costco to study how they managed to compete on both price and service.

Ton’s research makes one thing quite clear: A modern retail store is an incredibly complex machine. For instance, a typical supermarket carries nearly 39,000 products, runs 100 promotions a week, and serves 2,500 customers a day. When management tries to run such an operation with poorly trained and poorly paid workers, things are bound to go wrong.

In her book, Ton uses the example of the now-bankrupt Borders book store. She examined data from 1999 through 2002 at over 250 Borders books stores and found that its efforts to cut costs by understaffing were actually hurting the company’s sales in the long run. Tellingly, Ton found that despite heavy investment in inventory software, “one in six customers who approached a salesperson for help experienced a phantom stockout.” In other words, Borders was able to convince a customer to come into its store to buy a product, but failed to convert that sale because workers simply couldn’t find the item.

Companies like Trader Joe’s, however, don’t suffer from these problems. Ton says full-time employees there earn anywhere from $45,000 to $60,000 per year. Trader Joe’s workers are also trained thoroughly so that they can complete a variety of tasks in the store. If fewer checkout workers are needed for a certain stretch of time, no problem—the store manager can order clerks to help stock the shelves.

Better pay also encourages workers to give better customer service and makes them less likely to leave. Indeed, the four companies Ton highlights have much lower turnover rates than the industry average, which also helps the bottom line.

Critics of Ton’s arguments say that what works for Trader Joe’s or Costco may not work for everyone. Both of those stores employ fewer workers and sell far fewer products. People don’t go to a Walmart for service, but for rock bottom prices and little more. Indeed, there’s a limit to how much Wal-Mart can invest in its workforce while still competing relentlessly on prices.

But even the critics have to admit that more and more companies, from retailers like The Gap to health insurers like Aetna, are starting to rethink the strategy of keeping wages as low as possible. That’s because workers are still a vital ingredient to any company’s success, and there is value, while admittedly difficult to measure, in keeping workers happy, motivated, and thankful for their jobs.

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