Wal-Mart: Preemptive Planning Provides Powerful Positives

| About: Wal-Mart Stores, (WMT)

Summary

Wal-Mart received positive press and negative coverage following their wage increase.

The timing should encourage switching costs by bringing more applicants to Wal-Mart.

Costco joined the list of companies raising wages which eliminates any potential relative change in cost advantages between the big three.

Incentives to take on higher jobs should be focused on the opportunity for better duties, not just an increase in pay.

Would you leave your job to work the exact same hours for the same pay on a cash register?

Wal-Mart (NYSE:WMT) received positive press coverage for raising minimum wages in their stores, but the retail giant suffered substantial price declines amid less favorable coverage from analysts. Investors were logically worried about the impact on future earnings of higher wage costs and the potential impact on Wal-Mart's competitive position. Since the stock bottomed out in November they are up about 20% compared to the S&P 500 climbing about 1% over the same period. Of course, the dramatic disconnect is simply due to Wal-Mart's share price falling too far and the choice of measurement period coinciding with the lowest prices for Wal-Mart.

Expectations

As an analyst I take a somewhat different approach. I see pressure on earnings, but I also see the potential for minimum wage increases across the country to occur over the next few years. If those increases in minimum wage occur, then Wal-Mart will look brilliant for raising wages earlier. The positive aspect has nothing to do with coverage and everything to do with worker incentives. Unemployment rates are still falling across the country and raising wages before any federal increase allowed Wal-Mart to have an advantage in recruiting the best of the available workers. While workers could still opt to leave Wal-Mart if a higher federal minimum wage narrows the pay gap between working for Wal-Mart and other similar jobs, that transition still requires uncertainty. Essentially, Wal-Mart is moving first to create "switching costs" for new employees.

Switching Costs

The concept of switching costs is more common when talking about consumer goods and services. The switching cost is the research and work that must be done in reaching the decision to change a behavior. For instance, AT&T (NYSE:T) and Verizon (NYSE:VZ) did a great job of encouraging high switching costs that allowed the companies to protect their margins. This strategy exploits a failure in modern economic theory. The economic theories are usually built on the premise of perfect competition; the reality is that the economy primarily resembles oligopolies and customers do not have access to complete information. The strategy was great for both AT&T and Verizon, but Sprint's (NYSE:S) new CEO opted to wage a price war against AT&T and Verizon. Sprint went from airing weak advertisements with no clear value proposal to airing advertisements designed to give customers the information they actually needed (price and conditions) to make a switch.

Wal-Mart's decision to raise wages earlier creates similar switching costs. An employee working for Wal-Mart that wants to leave faces the challenge of putting together another "job search". Low wage positions may often refuse to post the wages in the job posting which makes the job search a more depressing process.

I believe this strategy will result in Wal-Mart having a better workforce than they would without the raises. Due to the time it takes to train employees, I still expect earnings to take a hit for the first year or two. Beyond two years, I expect the picture to change with employees having longer average tenure (lower turnover costs) and higher productivity. Keep in mind that Wal-Mart is not unionized and can still terminate employees that fail to produce value at the new wage levels.

Competition from Costco and Target

Have most of my readers shopped at Costco? Did you find the employees moved faster or slower than the average Wal-Mart employee? As Mr. Kershner points out, Costco's minimum wage is going to a range of $13 to $13.50. Previously it was $11.50 to $12. Those higher wage levels have done nothing to make their employees more complacent and shareholders have demonstrated faith in Costco's strategy. The company trades at 29 times trailing earnings and offers a dividend yield of only 1.06%.

If there is any company that is directly competing against Wal-Mart in the area of providing low prices on groceries, Costco would be the company. If Wal-Mart needed to raise prices to accommodate their increase in wages, it would be reasonable to believe that Costco would need to do the same with their increase. Target (NYSE:TGT) could be seen as another low cost leader, but Target is also raising wages in an attempt to acquire more productive workers.

I still have yet to see any analyst explain how all of the low cost leaders raising wages at the same time leads to permanent margin compression for the industry. It is the low cost leaders that establish the prices and the resulting margins.

Incentives to Take on Higher Jobs

There is one area where I politely disagree with Mr. Kershner. There is a common dogma regarding higher wages and increased responsibility. If you are currently working and were offered the opportunity to work the exact same total hours and receive the exact same pay for running a cash register at Wal-Mart, would you take it? I don't think this is a hard question for most people. Working a cash register, or collecting carts in the parking lot, are simply unappealing jobs. More advanced jobs are not simply better because of higher wages; they also carry several other benefits that don't show up in the "total compensation" of an employee.

More advanced jobs carry more recognition and more interesting work. It is the opportunity to work on more challenging tasks that should drive people on to bigger and better goals. While money is a powerful motivator at the bottom of the income spectrum, the importance of each additional dollar declines significantly as wealth increases. It is my opinion that people do respond to these incentives. I don't believe higher wages alone are sufficient to encourage people to take on more work. It is certainly reasonable to say that longer total hours would require higher total pay, but I don't see a narrowing of the gaps within the pay structure causing employees to scorn the potential for advancement.

Conclusion

Wal-Mart's decision to move quickly was intelligent and should be positive for the company over the long haul. Costco's decision to establish their own significant increase in rates reflects a clear understanding of the importance of having the first pick when it comes to drafting from the pool of job-seekers.

Even if management of each of the retail giants was incompetent (an absurd premise), the similarity of strategies would prevent any from gaining a relative cost advantage and using it to undercut the others.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WMT over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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