Wal-Mart's real cost of labor
By Jai Ghorpade
Beginning as a small retailer in Rogers, Ark., in 1962, Wal-Mart has grown to be one of the biggest corporations in the world, employing 1.3 million workers worldwide in 2003 in over 4,300 stores with sales around $256 billion. It sells everything: clothing, tools, toys, electronic goods, appliances and groceries.
Besides being big in size, Wal-Mart has revolutionized retailing in a fundamental way. Traditionally, retailers have shopped around and bought merchandise that was available on the market, capitalizing mostly on volume purchasing to negotiate favorable prices with sellers. Wal-Mart, on the other hand, is now in a position not only to negotiate price, but is also able to dictate quality, quantity, packaging and style. Because of its size and influence in the industry, sellers who do not honor Wal-Mart's demands can suffer adverse consequences.
Many reasons account for Wal-Mart's financial success and growth. Clearly, a major force behind its success was the vision, enterprise and daring of its founder, Sam Walton. He pioneered the "super center" retail phenomenon by capitalizing on the latest technology (e.g. bar code price scanners). He also instituted a supply chain policy that required stores to reorder stocks only as needed instead of keeping large amounts of goods in warehouses. And he mastered the art of low pricing.
While its "everyday low prices" shopper-centric business model makes Wal-Mart an attractive place to shop, it has a troubled history as an employer. Over the years, Wal-Mart has been accused of discriminating against minorities and women in hiring, wages and promotions, employing undocumented workers through some of its subcontractors and cheating hourly workers of overtime pay.
A massive class-action lawsuit by six women, who accuse the company of systematically paying women less than men and offering them fewer opportunities for promotion, is making its way through the courts. This lawsuit covers 1.6 million current and former employees and is the largest bias suit in U. S. history.
This dark side of Wal-Mart as an employer has been known for some time, but has been overshadowed by its financial success. Wall Street has not only cast a blind eye toward complaints by employee groups, but it has seen Wal-Mart's low-wage strategy as a plus, viewing the company as a shining example of a capitalist entrepreneur who squeezes productivity from its employees while paying them as little as it can get away with. In fact, this feature has been singled out by prominent Wall Street analysts in recommending the company's stock.
While there is widespread agreement that Wal-Mart is a low-paying employer, there is disagreement about its exact cost structure. To put this issue into perspective, it is useful to fall back on a distinction made by labor economists between labor rates and labor costs. Labor rates consist of the wages, salaries and benefits that are actually paid to employees for their services. Viewed from this perspective, Wal-Mart truly is a low-wage-rate employer. One estimate places Wal-Mart's average wage at $8.23 per hour, yielding an annual income of $13,861 which is below the estimated poverty level of $14,630.
Wal-Mart's famous low-wage structure was a significant issue in the recent strike by grocery store employees, with the employers claiming that they needed concessions from their employees in order to be able to remain competitive with the new Wal-Mart stores scheduled to open on the West Coast.
But the fact that Wal-Mart pays low labor rates does not mean that its total labor costs are low. In order to get an accurate count of its actual total labor cost, it is essential to take into account not only the labor rates but also the employee behaviors that it provokes and the resulting expenses that are incurred.
Specifically, it is essential to take into account cost of labor turnover and loss of productivity. In Wal-Mart's case, the facts are as follows: The company employs over 1 million workers. Its annual turnover in employees was estimated to be 70 percent in 1999. The company claimed that it was down to 45 percent in 2002.
Given this record, in order to find out Wal-Mart's true cost of labor, it is essential to calculate what it spends in servicing turnover, and also the cost of loss of productivity. Specifically, it is essential to calculate: separation costs (exit interviews, administrative costs, separation pay), replacement costs (advertising, interviewing, testing, travel/moving, processing new employees, medical examinations, staff time), training costs and reduced productivity.
One estimate given by Wal-Mart sources places its cost just to test, interview and train at $2,500 per new hire. If that is the case, and setting its annual turnover at 50 percent, Wal-Mart is spending about $1 billon on simply servicing some aspects of its turnover. When that is added to Wal-Mart's wage rates, its total labor cost becomes less appealing. And this estimate does include loss of productivity that can be attributed to a constantly changing work force.
A good indication of the dynamics of the interplay between a company's employment policy and its actual cost structure can be had by comparing two companies with widely divergent attitudes toward their employees. Business Week magazine recently assembled some data that compares Sam's Club, Wal-Mart's warehouse unit, with Costco, a company that says it is committed to an employment policy of high wages and good treatment of employees.
Sam's Club, following its parent company's model, paid lower hourly wages ($11.52 vs. $15.97), and covered fewer employees under its health plans (47 percent vs. 82 percent). But there were glaring differences in the operating results. Employee turnover at Sam's Club was higher than at Costco (21 percent vs. 6 percent), as were its labor and overhead costs (17 percent vs. 9.8 percent). With regard to financial returns, Sam's Club employees sold less merchandise per square foot ($516 vs. $795), and earned lower profits per employee ($11,039 vs. $13,647).
So, when Wall Street analysts praise Wal-Mart for being a low-wage-rate employer, they are only partially correct. Wal-Mart does pay low-wage rates, but it is by no means a low-labor-cost employer. In fact, the reality may be that Wal-Mart is paying much more for its labor than it appears on the surface, perhaps even more than it needs to, and getting less than some of its competitors in return.
Ghorpade is a professor of management at San Diego State University.
