When Sam Walton opened the first Wal-Mart (NYSE:WMT) store in the 1960s, he had a simple business model in mind -- offer everyday low prices and build market share. The success of his business model hinged on three basic principles: buy in bulk, sell in bulk, and minimize operating costs.
After more than five decades, Walton's business genius is still the cornerstone of Wal-Mart's $476 billion empire. But in the recent past, the third principle of minimizing operating costs has taken a beating. Growth in operating expenses has outpaced revenue growth. And the latest development is that 21 U.S. states have raised their minimum wages starting this month, which impacts 1,400 Wal-Mart stores across the country. Let's unravel how this might affect Wal-Mart's bottom line.
Minimum wages unlikely to be a big blow ...
It's true that operating expenses are rising. During fiscal year 2014, Wal-Mart's operating expenses grew almost double the revenue growth rate. The primary reasons behind it were: lower than expected net sales, higher investment in e-commerce, global expansion, and increased international expenses.
There could be a similar trend at play in the current fiscal year, too. In the first nine months, growth in operating expenses has once again surpassed revenue growth as Wal-Mart continued to invest in e-commerce, smaller format stores, and paid a higher bill for health care costs. During the latest quarter ended October, Wal-Mart's U.S. segment reported an operating loss of 1.2% against the year-ago period.
While this isn't the best time for hiking wages, the increase in minimum wages in 21 U.S. states may not cause a big dent in margins. Wal-Mart's CEO Doug McMillon has affirmed that only 6,000 full-time workers out of 1.4 million employed by the company in the U.S. are paid the federal minimum wage of $7.25 per hour. The remaining full-time workers earn approximately $12.92 per hour, which is higher than the minimum wages being implemented by the 21 states.
As different states have different thresholds, the changes vary from a 2% increase to $8.05 per hour in Arizona to a 17% jump to $8.50 per hour in South Dakota. Washington, D.C., lifted minimum wages by $0.15 per hour to $9.47, which is the highest in the country.
To gauge the impact on Wal-Mart's operating costs, let's consider a situation where minimum federal wages of $10.10 per hour advocated by President Obama take effect. This is higher than any state rate. As seen from the chart below, this could raise operating expenses marginally. The actual impact could be even lower than what appears from the chart, since according to Reuters, Wal-Mart is planning to reduce the gap in the minimum premium paid to higher grade and lower grade positions.
... in fact, it could be a blessing
There are as many as three possible reasons that suggest that rise in minimum wages could be good for Wal-Mart.
- Last year, Ken Jacobs, chair of the Labor Center at the University of California, Berkeley, estimated that if federal minimum wage increased to $10.10 per hour, it could mean $31 billion more in earnings for 16.5 million workers across the country. It's well known that Wal-Mart's sales are directly related to the purchasing power of U.S. consumers. When millions earn more, it could actually move the needle for Wal-Mart's stagnating U.S. sales. Majority of the company's low-paid employees shop at Wal-Mart stores, so indirectly most of the wage hike could return to the employer itself.
- Better wages could motivate workers to perform better. Many times in the past few years, Wal-Mart has disappointed shoppers with bare shelves and long checkout lines. CEO McMillon told analysts in October that if these concerns can be resolved, it could be a $3-billion opportunity for the company. Though motivating workers is not the only solution as overall staffing has to be improved, but higher wages could encourage them to increase their current productivity.
- Wal-Mart has often faced criticism from labor activists, who accuse the company of paying very low wages. The retailer recently stopped health care benefits for 30,000 part time workers, which doesn't help either. The worker-based labor group Organization United for Respect at Wal-Mart (OUR Wal-Mart) has been demanding $15 hourly rate for the past three years, and has taken to campaigns and protests on the streets lately. In such a situation, the wage increase could soothe workers, and prevent work disruptions in the future.
What would Sam Walton say?
On the surface, one would think that Sam Walton might scoff at the minimum wage laws as it increases Wal-Mart's operating costs. But, going deeper, we see the hike has the potential to benefit Wal-Mart over the long-term, which could ease investors' concerns.
ICRA Online and Eshna Basu has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.