Strategy& research predicts that a federal minimum wage increase could dramatically reduce many retailers’ profitability; companies have four levers to improving profitability
New York, September 2, 2014 – Almost all retailers would be affected by a minimum wage increase, but it would hurt some more than others. While a higher minimum wage could raise some retailers’ total costs by 20-30%, others – mainly those with distinct business and labor models, such as Costco, Trader Joe’s, or Whole Foods – would be less affected, according to Fit for Growth* retail industry research by Strategy&, a member of the PwC network of firms.
For retailers facing a sizable decrease in profitability following a minimum wage hike, raising prices will not be enough. Those companies will have to re-evaluate their cost structures, and potentially their entire business models, to remain profitable. Their road ahead could be long and difficult, and Strategy& (formerly Booz & Company) predicts that they will need to follow one or a combination of four specific approaches to re-making their businesses.
“Raising the minimum wage – to $10.10/hour, for example, which is a figure that policy makers are considering – would send a shock through most retailers’ cost structures. Many spend between 8% and 15% of their total revenue on store labor costs, and we expect to see them spend 1.5%-3% points more,” said Deniz Caglar, Partner at Strategy&. “Given that many retailers have profit margins of only 3 or 4%, such a wage hike would set up serious hurdles for their overall profitability and force them to seek dramatic responses.”
The retailers that will be hurt less
Some retailers, such as Costco, Trader Joe’s and Whole Foods, already pay their employees over $10.10 per hour on average. For example, employees at Costco start at $11.50 per hour and earn nearly $21 per hour on average. These three stores have figured out unique business and labor models that work to their strengths. Trader Joe’s, for example, carries many fewer products than a typical grocery store and uses a high percentage of private brands. Their employees have a low voluntary turnover rate, minimizing negative impacts of constantly hiring and training new employees who are unfamiliar with the company’s business or culture .
The retailers that will really suffer
But many other retailers, including some of the world’s biggest discount stores, hire their new employees below foreseen minimum wage rates and thus face a larger store labor cost increase – as much as 15%-20% based on Strategy& estimates. Such an increase would threaten to significantly erode retailers’ profitability .
How retailers will need to respond
In response, most of the biggest retailers will be compelled to pull a mixture of four levers in order to alleviate potential profit pressures:
- Price increases: Some retailers may try straight price increases to offset cost pressures, but market competition will likely keep price increases minimal. “Retailers can only raise prices in small increments before they start to lose customers to their rivals,” said Caglar.
- More private brands and less choice for consumers: Some retailers will turn to higher-margin private brands and curate their product assortment towards higher margins, limiting choices for consumers. “The move away from store-brand products in favor of private brands with higher margins will probably result in fewer choices for consumers,” added Jaya Pandrangi, Partner at Strategy&.
- More pressure on employees: Actions will include increasing share of part-time employees, outsourcing labor when possible, reducing benefits (e.g., shifting employees to health insurance exchanges), expecting more productivity from store employees, reducing store hours, and reducing customer service labor (e.g., by pushing automation in stores and self service). “Long-term cost restructuring will lead to less convenience for consumers,” said Pandrangi. “Expect to see more self-service, shorter store hours and fewer employees on retail floors.”
- Radical cutbacks and cost reductions: With many of the low-hanging fruits having been cut already, many retailers will have to look broadly for savings, in their overall organizations and beyond labor cost. “But when retailers cut costs, they need to take care not to hurt those capabilities that differentiate them and that will enable them to grow in the future.”
“The main levers that retailers have to cope with a minimum wage increase are improving their gross margin and streamlining their cost structure, and we expect retailers to employ both in response to a wage hike,” added Caglar.
* Fit for Growth is a registered service mark of PwC Strategy& LLC in the United States.
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