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CHAPTER 14

WAL-MART: FRIEND OR FOE?

Economies of Scale, Low Prices, Low Wages, and Thinking outside the Box

The products that Wal-Mart sells are not known for being particularly durable or high fashion. The checkout lines are long, the stores are short on décor, and the service leaves something to be desired. Wal-Mart allegedly prices quaint competitors into oblivion, exploits workers, hires illegal immigrants to do their cleaning, and discriminates against women. Most of the corporation’s own products are outsourced, and its record for community service is less than stellar. There are Web sites, documentaries, and books brimming with Wal-Mart criticism. Oh, and—last but not least—Wal-Mart is the world’s most popular retailer. Why? Because the stores are open when shoppers need them, they sell almost everything they want, and their efficiency reduces the dollar cost of weekly groceries. Are they efficient to a fault? Can consumers shop there in good conscience? And what are the ramifications of their market power? This chapter examines the economics of the world’s biggest big-box retailer.

Tiffany and Company operates 55 U.S. stores, each with an average of 8,109 square feet of retail space—about the size of a baseball diamond—and each store has more than a few diamonds inside. Every Tiffany’s store is different. Some are triangular, some are square, some have ornate metal doors, and others greet customers with entryways of glass or carved wood. Customers are pampered with complimentary shopping consultants, fragrance samples, and a lovely, big box in which to nestle plenty of padding around crystal and glass purchases that seldom cost less than $100.

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Although they sell diamonds too, the “big-box” retailers are in most respects the antithesis of Tiffany’s. California Assembly Bill 178 defines a big-box retailer as a store with more than 75,000 square feet of floor space. Wal-Mart, Home Depot, Target, Kmart, Lowe’s, and Best Buy stores typically fit both the legal definition and the image the title conjures up—they’re big, largely indistinguishable concrete boxes filled with lots of things to buy at low prices with few amenities. Big-box retailers lack the elegance of a Tiffany’s and they sell a lot more plastic than crystal or glass, but the shoppers of the world love them. In this chapter, the focus is on the ultimate big box: Wal-Mart, the world’s largest retailer and the biggest corporation on earth. The story is similar for many other large discount retailers as well.

At the inception of Wal-Mart in the early 1960s, founder Sam Walton targeted towns of 5,000 to 25,000 residents, where his stores could enjoy a virtual monopoly as a discounter. Recently, Wal-Mart has raised its sights to include some of the world’s biggest cities, but it still enjoys a dominant share of the retail market. Wal-Mart operates more than 5,300 discount stores, Supercenters, Sam’s Clubs, and Neighborhood Markets in 10 countries. The 1,343 Wal-Mart discount stores in the United States cover about 98,000 square feet each—as much as two football fields—and sell 62,500 general merchandise items. Each of the 1,730 Wal-Mart Supercenters offers about 187,000 square feet (more than three football fields) of general merchandise, groceries, and pharmaceuticals, with 116,000 items in all. Each of the 552 Sam’s Clubs offers about 127,000 square feet of general merchandise and bulk items, and the 86 Neighborhood Markets average about 43,000 square feet and 38,000 items each. Net sales for all these operations total about $319 billion annually.¹

¹ See www.wal-mart.com and www.standardandpoors.com.

Wal-Mart is the most popular store in the world because consumers appreciate the convenience of one-stop shopping; the long hours; the vast selection; the ample parking; and, of course, the “every day low prices.” Large retailers such as Wal-Mart benefit from economies of scale, which exist when the average cost of providing goods decreases as the quantity increases. As stores get bigger, some costs don’t grow in proportion to the size of the operation. A store with 2,000 square feet might require only 1 manager, just like a store with 1,000 square feet, but the management cost per dollar of sales is lower in the larger store, where the cost can be spread across a larger volume of sales. A store with 100,000 square feet might need a team of 4 managers, but the fourfold increase in management is small compared with the 100-fold increase in floor space.

In these examples, it is evident that the cost of management grows proportionately less than the size of stores. If the salary of each manager is $50,000 per year and stores average $250 in sales per square foot, the cost of management is $50,000/$250,000 = 20 percent of sales in a 1,000-square-foot store, $50,000/$500,000 = 10 percent of sales in a 2,000-square-foot store, and $200,000/$25,000,000 = 0.8 percent of sales in a 100,000-square-foot store. Similar economies of scale are realized in terms of cash registers, loading docks, security arrangements, distribution systems, warehouses, and most types of staffing. A 2001 report by the McKinsey Global Institute credited Wal-Mart’s aggressive use of economies of scale, direct purchasing to eliminate wholesalers, management innovations that increased “competition intensity,” and high-tech product distribution systems with causing “the bulk of the productivity acceleration” in the retail sector between 1995 and 2000.

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Low prices boost consumer surplus, but not everything about low prices is good. Like other big-box retailers, Wal-Mart is often accused of predatory pricing, which entails toppling competitors with below-cost prices and then charging higher prices on gaining market power. Some people boycott Wal-Mart because the company’s aggressive discounting is a death knell for smaller shops that provide more services. Wal-Mart is blamed for closing locally owned pharmacies, groceries, and specialty shops, and for bankrupting bigger foes, such as toy seller FAO Schwarz Inc. To some people, the aesthetics of the shopping experience are meaningful, and there are irreplaceable elements of charm associated with traditional retailers that are lost in the big boxes. On the Doll Collecting page of About.com,² Denise Van Patten lamented FAO’s struggles to stay afloat and sell favorites, such as Breakfast at Tiffany’s dolls, while under increased pressure from major discounters: “You might be able to buy your fine dolls and toys cheaper at Wal-Mart than FAO Schwarz, but trust me, you aren’t going to feel the magic of toys and dolls at Wal-Mart, or make Wal-Mart part of your treasured Christmas tradition, the way you could at FAO.”

² This story is no longer available at About.com.

In terms of its lauded efficiency, one problem with Wal-Mart is that the prices may be too low; they may lead us to buy too much. Given the externalities of resource depletion, pollution, and postconsumption levels of municipal solid waste, Wal-Mart’s artificially low prices foil the moderating effect of higher prices that better reflect true societal costs.³ Consider the question of how many small kitchen appliances to buy. For about $50 apiece at Wal-Mart, a consumer can buy the Presto Pizzazz Pizza Oven; the George Foreman Lean Mean Grilling Machine; and more fryers, toasters, poppers, and food processors than you can shake a stick at. Suppose the Dough family would pay up to $65 for a fryer, up to $55 for a food processor, and no more than $45 for any of the other items. They can be expected to buy only the 2 appliances that are worth more to them than the $50 price.

³ When other retailers charge higher prices, it is not for the purpose of including externalities. Nonetheless, quantity demanded and external costs go down when price goes up for any reason. It is also important to note that higher prices aren’t always better. It is quite possible that prices at Tiffany’s are too high in the sense that they exceed the marginal cost of goods to society and result in inefficiently low consumption levels.

Here’s the rub: The price doesn’t reflect the full cost of an appliance. It doesn’t include, for starters, the pollution costs imposed by the production, packaging, transportation, use, and disposal of these products. Taxpayers cover some of the health costs via Medicare and Medicaid; pollution victims bear some of the medical and insurance costs; and the global climate, wildlife species, and future generations all bear some of the burden. Then there are the external costs of resource extraction, involving, for example, strip mines, mountaintop removal, oil drilling, and deforestation. Add to that the loss of nonrenewable resources and the burden of waste disposal. All of these costs are hidden but real. The World Conservation Union lists resource extraction and pollution among the primary dangers to 16,119 species currently threatened with extinction.⁴ The consumption habits of the average U.S. citizen require 25 tons of raw materials annually. More than one-third of our citizens live in counties where pollution levels exceed the National Ambient Air Quality Standards. Only 29 states have more than 10 years of landfill capacity left.⁵

⁴ See www.iucn.org/themes/SSC/redlist2006/threatened_species_facts.htm.

⁵ See www.epa.gov/ncea/ROEIndicators/pdfs/MSWGENMNG_FINAL.pdf.

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Wal-Mart prices may be artificially low for reasons beyond external costs. Some Wal-Mart stores have allegedly been cleaned by poorly paid illegal aliens, and others stand accused of not paying overtime and forcing employees to work “off the clock.” If health, environmental, and other hidden costs raise the kitchen appliances’ true prices from $50 to $60, only the one worth more than $60—the $65 fryer—should be purchased. The $60 social marginal cost (meaning the full cost to society of one more) exceeds the $55 and $45 benefits from the other gadgets. Because the appliances were priced below social marginal cost, our representative Dough family purchased twice the quantity that would best serve society. That becomes a real problem if the other 137,999,999 Wal-Mart shoppers behave the same way.

The Wal-Mart Corporation employs more than 1.5 million people. In 2005, Wal-Mart president and chief executive officer H. Lee Scott boasted that the company paid an average hourly wage of about $10.⁶ Critics point out that averages are skewed by the much higher pay executives receive (for example, Mr. Scott earned $23 million in 2004) and that the average pay for associates (as Wal-Mart calls its sales clerks) is closer to $8.50 per hour.⁷ A study by Arindrajit Dube and Ken Jacobs found that Wal-Mart employees in California earn 31 percent less in wages than workers at other large retailers.⁸ In part, this difference may reflect Wal-Mart’s vigilance against labor unions, which use collective bargaining to improve compensation packages and secure the fair treatment of workers. In 2004, a store in Jonquiere, Canada, became the first unionized Wal-Mart in North America, but in 2005 the company announced that it would close the store. In 2000, a week after meat cutters organized a union at a Texas Wal-Mart store, Wal-Mart announced that it would be completely phasing out its meat-cutting departments. These antiunion practices have raised the ire of the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO), a voluntary federation of labor unions, which has its own Web site devoted to Wal-Mart problems: http://aflcio.org/corporateamerica/walmart/main.cfm.

⁶ See http://slate.msn.com/id/2113954/.

⁷ Steven Greenhouse, “Wal-Mart, Driving Workers and Supermarkets Crazy,” New York Times, October 19, 2003, sec. 4, p. 3.

⁸ See www.wakeupwalmart.com/facts/berkeley-report.pdf.

Low wages can be a burden even to the broader population that enjoys the associated low prices: They can necessitate higher taxes because recipients of low wages must rely more heavily on public assistance. The Democratic staff of the congressional Committee on Education and the Workforce estimates that a Wal-Mart with 200 employees costs federal taxpayers $420,750 annually in public assistance for benefits such as health care, subsidized meals, energy, and housing.⁹ The problem of low wages is intensified by the fact that wages and prices at Wal-Mart influence wages and prices elsewhere. In order to compete with Wal-Mart prices, other retailers must cut their wages. For example, after striking for 5 months, unionized grocery workers in southern California agreed to cuts in pay and benefits in hopes of saving their jobs against a growing threat from Wal-Mart. In order to be Wal-Mart suppliers, producers face pressure to cut prices and, therefore, wages as well. Wal-Mart suppliers Huffy and Levi’s closed their last U.S. plants in 1999 and 2004, respectively, to reduce costs, enacting the ultimate wage cut for their workers by laying them off. Cutthroat practices at 1 retailer thus have a cascading effect on prices and wages at a whole line of suppliers and producers.

⁹ See www.nea.org/topics/walmart-fact.html.

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The general issue of compensation at Wal-Mart is magnified for women. In Selling Women Short: The Landmark Battle for Workers’ Rights at Wal-Mart (2005), author Liza Featherstone claims that a history of gender discrimination at Wal-Mart has led to what may become the largest class-action lawsuit in history: Dukes vs. Wal-Mart Stores Inc. The plaintiffs in the case note that, although two-thirds of Wal-Mart’s hourly workers are women, only one-third of managerial positions are held by women and fewer than 15 percent of store managers are women. They also assert that, since 1997, despite having higher average performance levels and lower turnover rates than men, women have earned less than men with the same seniority in every major job category.¹⁰

¹⁰ See www.walmartclass.com.

Supporters point out that although the demise of beloved local businesses is a problem, Wal-Mart merely offers consumers another choice. Each week more than 138 million customers worldwide choose to support Wal-Mart by shopping there, and 80 percent of Americans shop there at least once each year. If consumers cared more about the mom-and-pop bakery than the buck they save buying cake at Wal-Mart, they’d support mom and pop, right?

Well, not necessarily. The actions of shoppers may reflect the temptation to free ride on public goods, as discussed in Chapter 11. Charming downtowns and undeveloped wilderness areas, or green space, on the periphery of towns are public goods because 1 person’s enjoyment of them doesn’t interfere with other people’s enjoyment and because it is not possible to exclude people from enjoying these amenities when they exist. The temptation, then, is to free ride on other people’s efforts to preserve green space and, if the discount stores are built, to shop at them and hope that others will spend the extra money it takes to support a vibrant downtown. Just as you can’t have your cake and eat it too, you can’t have your lovely downtown cake shop and eat at Wal-Mart prices too!

Some communities have decided that the costs of a Wal-Mart exceed the benefits. Boxboro, Massachusetts, is among 248 communities listed on www.Sprawl-Busters.com as having successfully opposed new or bigger big-box stores. When Wal-Mart proposed a superstore for part of a Stafford County, Virginia, farm where George Washington lived as a boy and reportedly could not tell a lie about chopping down his father’s cherry tree, local opposition killed the idea. Consultants, such as Jon Schallert and Al Norman, travel to towns with new or proposed Wal-Marts to help smaller businesses consider how to stand their ground. Anti-Wal-Mart Web sites include www.AgainstTheWal.com, www.WalMartSurvivor.com, and www.WalmartWatch.com.

Wal-Mart, too, is thinking outside the box. After losing battles over the development of green space, in 2005 Wal-Mart pledged $35 million over 10 years toward its largest environmental endeavor: Acres for America. This program aims to offset the development of land for corporate use with the conservation of 138,000 acres of wilderness. In addition, each Wal-Mart location provides a $500 grant for an environmental cleanup project. The company is also a supporter of the Children’s Miracle Network, the United Way, National Public Radio, and numerous scholarship programs, among other charitable organizations. These are some of the ways in which Wal-Mart gives back to the communities that accept its stores.¹¹

¹¹ More information on Wal-Mart’s charitable giving is available at www.wal-mart.com.

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How are priorities established among vibrant downtowns, one-stop shopping, customer service, low prices, and the environment? The developed world faces these dilemmas as strip malls and superstores invade the turf of local merchants. With city centers on the endangered list, shoppers might be expected to vote with their pocketbooks, in which case megastores would not and could not stay on the scene because they wouldn’t have the monetary “vote” of the public. The very existence of big-box retailers would seem to demonstrate their desirability.

Alas, the acceptance criteria for large chain stores are not that straightforward. Countervailing forces in the retail market may prevent a fair “election.” For example, pocketbook voters may be tempted into free riding on the efforts and expenditures of others. Higher rent, lower volume, and more services for customers lead to higher prices in smaller stores. Although citizens might value the prosperity of their downtown enough to absorb the cost differential, they may consider their individual support to be inconsequential; as a result, they may rely on others to support the downtown shops while they seek lower prices elsewhere.

Wal-Mart has cut costs and shipping delays with innovations in the areas of satellite communications, computerization, product tracking, and streamlined distribution. The company also uses its influence to help suppliers cut costs and pass the savings on to Wal-Mart and its customers. Further efficiencies come from economies of scale, resistance against unions, and relatively low compensation levels for employees. All this leads to low prices that provide low-income shoppers with a higher standard of living. These benefits weigh against the associated costs, including the environmental costs of increased development, manufacturing, product transportation, and waste disposal; low wages and the tax burden of public services for low-wage workers; the alleged use of sweatshops, child labor, and undocumented workers; and the loss of historic downtowns and smaller stores. Our challenge, then, is to find ways to have consumers factor the full costs and benefits of discount shopping into their purchasing decisions or to purchase as if they did. Otherwise, consumers may collectively but unwittingly lose more than always low prices.