Sam's Club vs Costco: Do Lower Prices Trump Employee Happiness?

Wal-Mart, which owns the Sam's Club warehouse club, has come under fire for its labor practices, but a fresh round of layoffs at Sam's Club may have been needed to keep the brand competitive with its bigger rival Costco.

Jan 31, 2014 at 7:35AM

Wal-Mart (NYSE:WMT) may use a smiley face prominently in its stores and call its membership-required discount warehouse a "club," but the company often uses tactics that are less than friendly to keep prices down. The latest cold, but correct, move from the retailer comes as USA Today reported last week that the company's Sam's Club chain has laid off 2,300 workers -- with the layoffs being about half salaried managers.

Battle to be cheapest

Sam's Club and its two major competitors, Costco Wholesale Corp. (NASDAQ:COST) and the privately held BJ's Wholesale Club, are in a battle for customers. For many the choice comes down to cost. Price isn't the only factor, but if one of the three were appreciably more expensive, customers would be scurrying for one of the others. Wholesale clubs don't attract customers with frills -- all are pretty stark with a warehouse-like environment -- and having items for sale at the lowest possible price is the differentiator between these stores and traditional low-cost retailers like Wal-Mart or Target (NYSE:TGT).

Keeping prices low requires all three companies to be ruthless with vendors to negotiate the lowest prices. Warehouse clubs stock a limited inventory, often having only bulk sizes and one brand per product category. Wal-Mart, however, with these layoffs -- following a year when overall sales increased  -- shows a special willingness to streamline costs in any way it can. 

"A little less than half of the employees affected are assistant managers," according to Sam's Club spokesman Bill Durling. "Before the layoff, each club's fresh section -- which sells meat, poultry, seafood, dairy, produce, and baked goods -- had six managers. Half of those jobs have been eliminated."

By eliminating positions the company feels are unnecessary, Wal-Mart shows it'll do whatever it takes to keep costs down. The larger of its two competitors, Costco, has taken the other track, choosing not to have layoffs even when results make them a good idea or efficiencies make them possible.

Business Week reported in June that Costco pays its hourly workers an average of $20.89 an hour, not including overtime, while Wal-Mart/Sam's Club's  average wage for full-time employees in the U.S. is $12.67 an hour. Eighty-eight percent of Costco employees have company-sponsored health insurance while Wal-Mart said that "more than half" of its do.

That makes Costco a good citizen and a laudable employer, but is that best for customers?

Which is actually cheapest?

Cheapism.com surveyed prices on 38 typical grocery items at Sam's Club and Costco and found that Sam's was about $12 cheaper. When adjustments were made for different product package sizes, the site found Sam's about 3.6% cheaper. Overall, prices were about 40% lower than in a traditional grocery store.

Yahoo Finance compared all three wholesale clubs and Sam's came out on top in that survey too. "When shopping for a warehouse club, it comes down to individual preference. If you're looking for low membership cost, a generous return policy, and 24/7 customer service, Sam's Club is the way to go," the article said. Costco did have a slight lead in customer service, but in the price areas compared, Sam's Club was the clear leader.

The biggest and the baddest?

Of the three major warehouse clubs, Costco is the biggest having recorded net sales in 2013 of $103 billion -- a 6% increase.. Sam's comes in a distant second bringing in $56.4 billion in fiscal year 2013 -- an increase of 4.9% over 2012. Costco had 648 stores as of November 2013, while Sam's club has 621. BJ's, being privately held, does not report sales numbers, but the much-smaller chain has less than 200 stores.

Those numbers mean that Costco does significantly more business per location than Sam's Club. More sales per location means less overhead, which can either lower prices or increase margins. To compete with that, Sam's really only has two choice: increase sales dramatically or control costs ruthlessly.

What works best?

Costco has built a tremendous business on being a good employer. The company made a $2 billion profit on its $103 billion in sales. Wal-Mart's Sam's Club, however, had an almost identical profit of $2 billion on just over half the sales its competitor had. To accomplish this return for its investors, the company had little choice but to keep employee costs down and make cuts where it could.

Sam's Club could treat its workers better, find ways to rev up sales and not lay people off just because they can. That, however seems unlikely as Wal-Mart will likely maintain its profit margin at Sam's Club by continuing to use its leverage to purchase at the best prices possible while squeezing and eliminating labor costs wherever possible.

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Daniel Kline has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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