March 14, 2007
Costco ‘Raises’ the Bar on Wages
By Tom Ryan
Continuing to put its employees needs over investors, Costco Wholesale Corp. last week announced plans to increase wages for its hourly service workers in its U.S. stores.
When the raises kicked in March 8, scale for service assistants, such as parking lot attendants, was bumped up to a range between $11 and $18.30 an hour from the $10 to $17.50 previously paid. For service clerks, including cashiers, the scale range increased to between $11.50 and $20 an hour compared with $10.50 to $19.17 before.
At the top of the scale, which typically takes about four and a half years, employees will receive an “extra check” of at least $2,200 every six months.
The last time Costco raised entry-level wages was six years ago. “We always want a wide gap between us and the competition,” Coscto’s CFO Richard Galanti told the Seattle Post Intelligencer. “It shows in the quality of our employees…It’s what our founders want to do in paying a family wage.”
But the timing could have been better at least in the eyes of investors.
The retailer reported a 16 percent drop in second quarter profits. Although the earnings slide was expected due in part to one-time charges to tighten its consumer-electronics return policy, Costco also lowered its third quarter profit forecast–causing shares to lose 2.5 percent of their value last week.
Some investors have long contended Costco is too good to its employees, with shareholders suffering as a result.
“From the perspective of investors, Costco’s benefits are overly generous,” Bill Dreher, an analyst at Deutsche Bank Securities, told The Wall Street Journal back in 2004. “Public companies need to care for shareholders first. Costco runs its business like a private company.”
Costco pays some of the highest wages at retail, provides excellent benefits, and has even shown a strong willingness to work with unions. Fans claim this enables the chain to attract and retain good employees. Strong customer service may be part of the reason Costco appeals more to higher-income shoppers than Sam’s Club and B.J.’s.
But investors–as ‘investors’–claim they have rights too, and companies should be primarily working for their behalf.
“Costco seems to do a little more than what shareholders would like,” said Edward Weller, an analyst at ThinkEquity Partners. “But Costco likes to keep it simple and likes to have their employees treated well.”
Costco’s top line growth also remains healthy. U.S. same-stores climbed five percent in the quarter, and membership renewals in the period reached almost 87 percent, an all-time high.
But investors are hoping a more a mean and lean approach–including a tighter lid on worker costs–could help more of Costco’s revenues trickle down to the bottom line. Over the holiday quarter, Costco’s net margins of 1.7 percent paled in comparison to Wal-Mart’s 4 percent rate.
Mr. Galanti declined to detail how the wage increases would impact future profits, but he said lifting entry-level wages could cost the company up to $3 million a month.
“That’s the cost of doing business,” Mr. Galanti said. “There are other expenses we can offset.”
But that probably won’t make many on Wall Street happy.
“Given that it sounds like they haven’t done it for a number of years, it’s about time,” said Dan Geiman, a financial analyst at McAdams Wright Ragen, of the raises. “But it will impact their earnings. That’s something to watch out for.”
Discussion Questions: Do you think Costco is being overly generous to its store employees and not doing right by shareholders? How important is the wage element in both the competitiveness of a retailer and its top and bottom line performance?
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As Gene Hoffman once taught me, “you can spend dollars but you can’t spend percentages.” Other smart folks have long reminded us that investment is for the long term, not for the next fiscal quarter. If Costco’s vocal investors and analysts are so intelligent, why don’t they go operate a company of their own?
Costco has a business model that relies on having good employees and therefore they must be taken care of. I disagree that the employees are being put ahead of the investors. It’s in the investors best interest that Costco hire employees who are a step up in class. In fact, if Costco were to replace their work force with marginal employees willing to accept a lower wages, Costco would not be able to maintain their same level of operations. Costco is not going to dummy down its workforce. I agree with other posters that Costco is not running a charity. Both Costco and their employees know what they are worth and that’s what they will be paid. Costco is not going to pay someone who is only worth $7 an hour an $18 per hour wage. Just the same way Wal-Mart does not pay a $7 per hour employee $18 per hour. Not all retail employees are created equal. Just the same way, I can find a lawyer for $70 an hour or one for $180 an hour. Believe me, there is a difference.
I applaud Costco for creating a good environment for their workers. This is long term thinking that will eventually trickle down to the investor. As a manager of a sales team, my experience has always been that a happy employee is a more productive employee.
Just because the results of a raise in pay on the bottom line are hard to quantify does not make it a bad decision. Another example would be trade shows. You may get some leads and talk to some people right after the show, but there are countless others who have seen your commitment to attending that show. You never know when one of those people will become a customer or WHY they became a customer, unless you ask very pointed questions.
Ultimately, this comes down to commitment. If this CEO wants to build a solid foundation for Costco with customer service as a business cornerstone, so his customers are always treated in excellent fashion and are loyal, this would be some of the best advertising money he could spend.
The stock analysts’ evaluations are laughable at best and heartless at worst.
What would they say if it had been six years since some raises were blended into the compensation structures at their companies?
Both Richard and Kenneth are right on the money–literally. We’ve got to let go of this assumption that investors and stockholders somehow are smarter than everyone else. Frankly they are generally a shortsighted and fickle group. When an EX Fed. chief can mutter one word and send the market into a tissy, these are not the people I look to for leadership in the marketplace. So good for Costco for finding its own path.
Ancient business advice said “don’t muzzle the ox that treads the corn.” Maybe investors were just smarter 2,000 years ago.
All that said it would be good to see Costco employees ramp up the service a little. In my experience it is generally hard to find someone who can help you. There are times employees work away virtually oblivious to the customers walking around.
And even with that said…Costco is far and away my favorite shopping experience. We even had our anniversary dinner there–but hey, that’s just the kind of sweet romantic guy I am.
Costco is looking at the increase as a strategic move. What is one of the top costs in running their business? Labor. Costco realizes the cost of turnover. Paying the associate more reduces turnover. A seasoned associate is more productive over time because of their experience, therefore, increasing tenure, reducing training, hiring, recruiting, etc. Customer service is enhanced because of the experience. If there was a survey of how many times when a customer asked a sales associate where something was in the store and got a blank stare it would be high. The more experience equates to more customer satisfaction.
Costco continues to use the right approach to employee retention and loyalty, and it translates to their best of class Club business. One of the reasons Costco does so well on a store by store comparison to other Clubs is in store service. That’s accomplished by having knowledgeable, dedicated, customer-focused personnel who really know how to help members.
Do you think if Costco took a 1% margin increase on their products that they would lose their customers and erode sales? Not likely, and that 1% would more than offset the wage changes they instituted…. They have a differentiated offering than their competitors and “Invest” in maintaining that important advantage.
Absolutely not. Costco is a leading class retailer, among the best in the world. It goes without saying that Costco has considered the earnings implications of such a move, and has also done its homework related to what it takes to recruit, hire and retain the best talent. Associate–read Human–interaction is a critical moment of truth in the shopping experience anywhere, and failure to invest in it at store level will almost always hurt.
Costco’s net profit and return on assets may be lower than Wal-Mart’s in the last year, but they’re not running a charity and they know it. Average raises in the 5-10% look generous in today’s climate but may be offset by other cost reductions that observers can’t see. If Costco is going to be true to its culture and establish a “best of class” position as it expands into new markets, it needs to be less focused on making the analysts happy on a quarter-by-quarter basis.
The equations driving this discussion seem to be a bit off. To say that paying higher salaries equates to not doing right by investors, or conversely that one must pay low salaries to do right by investors, doesn’t make sense at many levels.
In the most simplistic mathematical model, yes, paying more in labor reduces the bottom line. If only business were that simple. In the service sector, the quality of the service performed can be a significant factor in driving financial performance. In the context of Costco–would Costco be the company it is today if it simply paid (a la Wal-mart) the lowest wage it could get away with paying? Whether Costco pays the right amount, too much or too little depends on many other factors that are being skipped in the discussion. What value does Costco get for the salary it pays (are its employees significantly more skilled than the competitors’; do they deliver significantly higher service levels; does Costco save on other costs (e.g., health care?) by paying more in salaries, etc.)? Once we analyze the total value received, we can better opine on the cost and ROI.
There is that old saying…you get what you pay for. In all my store and warehouse labor experience, it is never what you pay, it is what you get from associates. Productivity’s greatest demon is work rules. Happy, well motivated associates will outperform others by many factors. Costco associates are happy and very productive. They understand that without customers, there is no business. Costco’s sales per square foot is almost twice the competition. This does not happen without good associates. This may be a good example of where accountants and analysts don’t make good senior executives. A company is more than just the numbers. Costco is doing a great job for investors and should not change course.
Running a business takes risks and some decisions do not always make Wall Street happy in the short term. An employee is your best extension of the brand…so I view the announcement as a positive–Costco recognizes the value of its employees and wants to retain and attract the best. Of course, operational prudence is required and you have to look at the ROI of the investment. Costco had a poor performing quarter–but that doesn’t mean that they should not cut back on investing in improving the brand and the business. Companies that continue to make hard decisions rather than reacting short term to quarterly returns will be committed to their brand performance over time.
Across the retail industry, the average length of service of store-based employees is typically in the 6 to 8 month range. It is a transient group with little loyalty who pays lip service to customer service. Often store employees must travel long distances to the high-rent districts where the retail stores typically prosper. Usually, store employees don’t learn about their work schedule until a couple of days before the week starts. They are typically underinsured or have no insurance. A great many regard their jobs as transitional to some other career.
The retail workplace is rarely a high spirited, fun place to work. Employees must be on their feet for hours. Often they are asked to lift heavy boxes and material, deal with unreasonable customers, and even more unreasonable managers. The retail store is all too often a tough place to work.
I’m sure most shareholders could make the leap of faith that a good workplace will tend to be the breeding group for good customer service. Yet, retailers continue to struggle to reach this mark.
What are the elements for a great work place? The Container Store, Starbucks and many others show us the way. Now Costco has broken out of the pack to offer a higher wage. That’s an essential piece. But many other elements need to be considered, including: learning culture, rewards, reasonable scheduling, health insurance, ample breaks, career path definition, technology, and assistance for long commutes.
As I read all of the postings above, it occurred to me that no one has mentioned that the Costco Employee’s are investors as well.
Costco encourages and offers payroll deductions for stock purchases, as well as through their 401k plan. If the employees feel they have an interest in how the company does, they tend to be a more dedicated asset and worth trying to hold on to. They have just a much to lose if not more then anyone else. Costco’s success is their retirement and future just like any investor.
Investors who are critical of Costco’s decision to raise wages appear not to value sustainable growth and perhaps are missing the connection between employee satisfaction, customer satisfaction, customer loyalty and profits. I will admit, I am not a financial analyst, yet my experience in organizational development has given me first hand knowledge of the relationship between high turnover and lost opportunity in terms of sales and customer service. These “investors” appear only to be interested in making a fast dollar and have no interest in the long-term viability of companies. I applaud Costco for their decision and their commitment to upholding the values of the founders. I only wish more companies recognized the importance of taking care of the employee so the employee will take care of the customer and that an 5 per cent increase in the retention of either nets more profit than a 5 per cent decrease in expenses.
I have to chime in here as well.
A specific study from Towers Perrin always comes to my mind first, but it’s just one piece of an enormous body of research over the decades that demonstrates a clear, direct relationship between the way we treat our front-line employees and the way they treat our customers.
At my client Maritz, we’ve applied that data and more to specific performance-improvement initiatives that use non-cash, non-compensation incentives for very specific objectives.
So it’s no stretch, logically, to apply that reasoning to compensation, and practically laughable to think that a company could abuse its people into focusing on the customer.
Think of a few ways this issue plays out on the selling floor:
–The data shows that the employee’s attitude toward Costco will translate into the customer’s attitude toward Costco.
–Better wages and benefits attract a better educated applicant, who stays around longer, and so can presumably think faster on her feet (and, knowing the stock and how things work, has more options) when a customer needs help.
–Conversely, imagine a minimum-wage employee with no health benefits and a very sick child at home. When a customer needs help, can that staffer even hear the request over the noise of her own worries–let alone focus on finding a solution that’s going to create customer delight?
“From the perspective of investors, Costco’s benefits are overly generous,” Bill Dreher, an analyst at Deutsche Bank Securities, told The Wall Street Journal back in 2004. “Public companies need to care for shareholders first. Costco runs its business like a private company.” What a narrow-minded comment. Each week, many of us who contribute to RetailWire see the benefits from customer loyalty to brand identity, for the store which has the most knowledgeable, helpful, and friendly customers. Only an investment man would say that the shareholders come first. It seems to me the stakeholders come first,and that includes everyone who comes in contact with the company, especially the employees on the sales floor.
Long-Term: Happy Employees = Happy Customers.
As a big Costco fan, I have no problem with the wage increases. But, I think they ought to leverage these higher-than-average wages to get better than average store employee performance and improved customer service, which I’m not sure they do.
When compared against other clubs, supermarkets, or discounters, they do fine. But, as an “upscale” club, they really could compare themselves to department stores and they don’t do as well in that comparison.
As another poster mentioned, I’ve seen employees at the register and elsewhere talking among themselves many times, as if the customers weren’t there at all. And, there seems to be virtually no dress code, as untucked shirts, wrinkled clothes, dirty sneakers, etc. all seem to be ok.
But, they are still my favorite.
There’s a red state/blue state angle here that doesn’t get mentioned much. If you go to blue state websites such as Democratic Underground, which has about 100,000 members, Costco is a constant subject of (generally adoring) conversation. These people will go way out of their way to support Costco, in large part because of its treatment of its workers.
Needless to say, Wal-Mart gets the opposite treatment.
It may seem to be a small thing, but committed customers are worth their weight in gold. They don’t shift to another store to save a couple of bucks, and they talk up their favorites to their friends.
Speaking personally, I won’t shop at a store that I believe mistreats its employees. My local grocers have happy, well-paid employees and I pay a bit more to shop there without complaint.
Companies have given the shareholders everything they want and gone out of business because consumers don’t buy the products and employees don’t stay. Companies have gone out of business by giving the customers everything they want and not making a profit.
Keeping everything in balance is what is most important and Costco appears to be doing this. Investments in different parts of the business need to be done at different times. Costco is not running a charity; they are running a business. By paying higher rates, they can hire more skilled employees and keep them. Payoffs are in better morale, more customer service, and less turnover at the very least. Costco is not losing sales so I applaud their move.
Costco made the right move. The comments above all focused on the right thing. Does the wage increase really negatively effect the bottom line?
Three points to consider:
1. Let’s not look at employees as a commodity or an asset, let’s put them in the same camp as investors who are looking for a return. These employee investors are looking at a return on the time they invest in their job. Just as there are smart long term investors who have bought and made money over the years investing in Costco these employees have done the same thing and should be rewarded.
2. As stated above, look at the whole cost of employment and turnover more; numerous studies have shown that companies with lower turnover and a more highly engaged workforce are more profitable. (Just look at Wal-Mart’s turnover problem; even though they are not really a bad employer, they have some 55% turnover–that means they have to replace over 700,000 workers a year and this does not count for growth. Even if only 10% were unhappy when they left, that is one hell of a class action suit waiting for something to happen.
3. A Gallup poll shows that more then 70% of the employees in America are either nearly disengaged or totally disengaged in their job. You don’t see those people at Costco.
Costco CEO James Sinegal makes around $600,000 a year and has stock options worth about $20 million. Bob Nardelli of Home Depot made $23 million/year salary plus a bonus of $200 million when he left the company. Costco’s wage increase will cost them $3 million per month, which is less than the difference between Sinegal’s and Nardelli’s compensation. So Costo shareholders get a world-class CEO as well as thousands of better workers for a total price that’s less than a CEO alone. The great buys at Costco aren’t just on the shelves.
There is a direct relationship between the wages earned and the ability of a company to not only attract the best people, but also expect more from them. Costco’s reputation has been built by attracting the best, training them right and treating them right to retain them. The model works.
The investor who looks only at the bottom line and not the long term strategic positioning of a company does a disservice to the retailer by demanding that it change the model. There are lots of examples where a change in the model to satisfy the short term investor demands has resulted in declining fortunes of the retailer. Look at the most recent…Home Depot.
Investors can vote their dissatisfaction by selling their shares. It’s the American way.