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The Costco Challenge: An Alternative to Wal-Martization?

By Moira Herbst

Archives - Dates and Topics

2005 – online

July – August 2005

July 4 – 10 click here for related stories: labor movement

7-07-05, 8:43 am

Critics believe that Wal-Mart should play the role General Motors played after World War II… [and] establish the post-world-war middle class that the country is so proud of. The facts are that retailing doesn’t perform that role in the economy. Retailing doesn’t perform that role in any country. —Wal-Mart CEO Lee Scott, April 2005

To workers and union leaders, it is a familiar refrain. These days, the story goes, consumers demand low prices, meaning goods must be produced and sold cheaply — and retail wages must be kept as low as possible. Companies like Wal-Mart insist they’re feeling the squeeze and must pay workers poverty wages — even while netting $10.5 billion in annual profits and awarding millions to top executives.

But there’s another company that is breaking the Wal-Mart mold: Costco Wholesale Corp., now the fifth-largest retailer in the U.S. While Wal-Mart pays an average of $9.68 an hour, the average hourly wage of employees of the Issaquah, Wash.-based warehouse club operator is $16. After three years a typical full-time Costco worker makes about $42,000, and the company foots 92% of its workers’ health insurance tab.

How does Costco pull it off? How can a discount retail chain pay middle-class wages and still bring in over $880 million in net revenues? And, a cynic may ask, with Wal-Mart wages becoming the norm, why does it bother?

A number of factors explain Costco’s success at building a retail chain both profitable and fair to its workers. But the basic formula is one the labor movement has been advocating for decades: a loyal, well-compensated workforce means a more efficient and productive one.

The Union Difference

Though only about 18% of Costco’s total workforce is unionized, union representation creates a ripple effect and helps determine labor standards in all stores. The Teamsters represent about 15,000 workers at 56 Costco stores in California, New York, New Jersey, Maryland and Virginia. Workers are covered by West coast and East coast contracts, negotiated in February and April of last year.

“The agreements lock in wage and benefits packages that are the highest in the grocery and [discount] retail industries,” said Rome Aloise, chief IBT negotiator for Costco and Secretary-Treasurer of Local 853 in San Leandro, Calif.

Costco passes on similar compensation packages to its non-union workers; the contracts act as templates for other stores’ employee handbooks.

“The union contracts raise the bar and set the standard for all employees,” explained Aloise. “Still, while the company extends wage and pay raises to non-union employees, only union members enjoy benefits like seniority-based promotions, a grievance procedure and minimum hours for part-time workers,” he added.

The Payoff of Better Pay

Strong union representation isn’t the only reason Costco jobs are so well compensated; the company itself has an unusually forward-looking corporate philosophy.

Costco CEO Jim Senegal has said: “We pay much better than Wal-Mart. That’s not altruism. It’s good business.”

Chief Financial Officer Richard Galanti explained: “From day one, we’ve run the company with the philosophy that if we pay better than average, provide a salary people can live on, have a positive environment and good benefits, we’ll be able to hire better people, they’ll stay longer and be more efficient.”

A 2004 Business Week study ran the numbers to test Costco’s business model against that of Wal-Mart. The study confirmed that Costco’s well-compensated employees are more productive.

The study shows that Costco’s employees sell more: $795 of sales per square foot, versus only $516 at Sam’s Club, a division of Wal-Mart (which, like Costco, operates as a members-only warehouse club). Consequently Costco pulls in more revenue per employee; U.S. operating profit per hourly employee was $13,647 at Costco versus $11,039 at Sam’s Club.

The study also revealed that Costco’s labor costs are actually lower than Wal-Mart’s as a percentage of sales. Its labor and overhead costs (classed as SG&A, or selling, general and administrative expenses) are 9.8% of revenues, compared to Wal-Mart’s 17%.

By compensating its workers well, Costco also enjoys rates of turnover far below industry norms. Costco’s rate of turnover is one-third the industry average of 65% as estimated by the National Retail Foundation. Wal-Mart reports a turnover rate of about 50%.

With such rates of employee retention, Costco’s savings are significant. “It costs $2,500 to $3,000 per worker to recruit, interview, test and train a new hire, even in retail,” said Eileen Appelbaum, Professor at Rutgers University’s School of Management and Labor Relations. “With Wal-Mart’s turnover rate that comes to an extra $1.5 to $2 million in costs each year.”

Other analysts of the retail industry agree that happier, well-compensated workers help generate bigger profits. George Whalin, president of Retail Management Consultants in San Marcos, Calif., disagrees with many of Wal-Mart’s critics, but said: “There’s no doubt Wal-Mart and many other retailers could do a better job taking care of their employees. The best retailers do take care of their employees — Nordstrom’s, Costco, The Container store — with fair pay, good benefits and managers who care about people. You have fewer employee issues, less turnover and more productivity. It lessens costs to the company.”

Still, Wall Street analysts intent on cutting up-front labor costs tend to frown upon Costco’s model. “Costco’s corporate philosophy is to put its customers first, then its employees, then its vendors and finally its shareholders. Shareholders get the short end of stick,” said Deutsche Bank analyst Bill Dreher.

But Costco’s stock has quadrupled in the past ten years, and has in the past year inched closer to Wal-Mart’s per-share-price. In fiscal year 2004, Costco recorded record sales and earnings. While Wal-Mart continues to profit and expand, its stock has lost value — in recent months it is 16% off its 52-week high — as sales have been more sluggish as gas prices cause customers to cut back on driving to and from the store. The negative publicity around the company has also caused some damage.

Of course, other factors besides low turnover and employee productivity are responsible for Costco’s efficiency. The company has a wealthier customer base than Wal-Mart’s; these customers buy higher-margin goods, purchase in bulk and have steadier spending habits. Costco also saves millions because it does not advertise.

More Than Hot Air

Besides the efficiency of its workforce, another reason Costco can afford to pay more is that it cuts the fat from executive paychecks. The overall corporate philosophy is that workers deserve a fair share of the profits they help generate — not just a pat on the back or a new job title like “associate.”

For example, while CEOs at other major corporations average 531 times the pay of their lowest-paid employees, Sinegal takes only 10 times the pay of his typical employee. His annual salary is $350,000, compared to about $5.3 million awarded to Wal-Mart’s Lee Scott.

After California Costco workers ratified their Teamster contract last March, CEO Jim Sinegal said Costco workers are “entitled to buy homes and live in reasonably nice neighborhoods and send their children to school.”

That the company’s stated ideals match up with workers’ paychecks helps explain employee loyalty at Costco.

Originally from El Salvador, 28-year-old Cesar Martinez has worked at a Redwood City, Calif. Costco for 10 years, serving as a Teamster shop steward for seven years. His pay is now up to $19.42 an hour, which he estimates brings him $43,000 per year.

“There’s a feeling here that the company takes care of its employees and wants to share the profits. We feel compensated fairly,” Martinez said.

“I’ve stuck with it so long because I like the job. And the salary is solid and we have a pension that gives me security into the future. That’s important to me,” he added.

By contrast, some Wal-Mart employees experience the supposed care for “associates” as empty rhetoric. Forty-two-year-old Rosetta Brown, a Sam’s Club employee in Chicago, Ill., for example, stands back each morning when managers and associates gather for the Sam’s Club cheer.

“I refuse to do it,” she said. “I don’t believe the company lives up to what they’re cheering for,” she said.

Rosetta, mother to five children ranging in age from three to 25, does not feel well compensated at $11.34 per hour after five years. She is also suing Wal-Mart, parent company to Sam’s Club, for costs associated with a herniated disc she suffered when she said she was locked in while working the night shift.

Twenty-seven-year-old Jason Mrkwa, who works as a frozen foods stocker in Independence, Kansas, also stands back when it’s cheer time at his store. But he insists he doesn’t hate Wal-Mart: “I’m not another disgruntled employee. I like my job. I just feel cheated with the pay I get.” He started at $7 per hour five years ago, and now makes just $8.53 per hour.

Julie Molina, 38, has worked at Costco’s South San Francisco store for 19 years. “People stick around — most people in my store have been there ten years more. No one in retail makes as much as we do. Plus it’s a good working environment.”

Molina attributes the positive working environment in large part to the Teamsters’ presence. “It works really well now. When problems arise management comes to the union for advice. But without the union I’m not sure what would take place. Would they treat us like Wal-Mart treats its workers? You hear horror stories,” she said.

Of course Costco is not paradise — “On a local level, some managers don’t play fair — they might harass workers, fire them unreasonably or pattern bonuses unfairly. That’s where union representation is the real advantage,” explained Rome Aloise.

Into the future, the question will be which model of employee compensation predominates in retail — the high road of Costco or the low road of Wal-Mart.

“When companies like Wal-Mart are setting the standard, we have to ask: Do we want to live in a country where the largest employer pays below poverty-level wages, whose workers cannot afford health care?” says Paul Blank, chief spokesperson of Wake Up Wal-Mart, the United Food and Commercial Workers’ new campaign to change the company’s practices. “Or do we want Americans to enjoy a decent income and a sense of security in return for their work?”

Costco v. Wal-Mart: How They Stack Up

Global Workforce
Wal-Mart: 1.6 million associates
Costco: 113,000 employees

U.S. Workforce
Wal-Mart: 1.2 million
Costco: 83,600

U.S. Union Members
Wal-Mart: 0
Costco: 15,000

U.S. Stores
Wal-Mart: 3,600
Costco: 336

Net Profits (2004)
Wal-Mart: $10.5 billion
Costco: $882 million

CEO Salary + Bonus (2004)
Wal-Mart: $5.3 million
Costco: $350,000

Average Pay
Wal-Mart: $9.68/hour
Costco: $16/hour

Health Plan Costs
Wal-Mart: Associates pay 34% of premiums + deductible ($350-$1,000)
Costco: Comprehensive; employees pay 5-8% of premiums

Employees Covered By Company Health Insurance
Wal-Mart: 48%
Costco: 82%

Employee Turnover (estimate)
Wal-Mart: 50%
Costco: 24%

Sources: Wal-Mart, Costco, Business Week, Forbes.com

From Labor Research Association