Saturday, December 03, 2005

The economics of Costco, Sam's and Wal-Mart

This ABC News article "Buying Luxury At a Bargain Store" is more than silly. It claims, "The discount chains aren't abandoning their middle-class roots, but they are trying to reach out to higher-income shoppers. And while they run the risk of alienating the price-conscious, it is a risk they are willing to take." But this is nothing new, so much so that I wonder where the writer has been for the last several years.

Costco and Sam's have long been more than half-gallon mayonnaise jars, meat packages of sufficient size to feed a platoon, or bulk packages of cereal, toothpaste and Arizona tea. I'm not sure of Sam's specifics, but Costco has had very, very nice jewelry at prices far less than normal retail, and in recent years it has increased its selection of platinum jewelry. Like any smart business, Costco and Sam's will not neglect any opportunity to increasingly specialize in excellent, less expensive substitutes that their customers will want. And there's a reason they offer high-end electronics, higher-end sports and exercise equipment, and luxury jewelry: though Costco and Sam's aren't intrinsically "upscale," their typical customers have significantly higher incomes than Wal-Mart and Target shoppers. There are two reasons why that is so.

The first is the membership fees, called "sunk costs" in economics. Poorer people cannot as easily afford the initial $50 at the beginning of a shopping year, so many will instead forego that pay slightly higher costs at the margin. Second, poorer people tend to have low or nonexistent savings to finance long-term consumption. They cannot as easily afford a $10 package of several cereal boxes, not when they must buy other things. Instead, they can only afford short-term consumption, like $2 per box of cereal, which is nonetheless likely to be cheaper than the local grocery store. Also, even if they could afford a membership fee or a bulk price, their lower savings means they place a higher marginal value on having more cash on hand than receiving the greater value for their money. Update: catching up on some Cafe Hayek, I found a comment from a few days ago at the end of this discussion, suggesting what I did, that it's the membership fees that keep poorer people out of Wal-Mart.

The difference in business models, and the subsequent delineations in the stores' respective clienteles, are not as clear to certain New York Times staff writers. That story from July touts Costco's ability to pay higher wages while still offering lower prices, though it ignores most things come in bulk. Fitting with the Times' agenda, it's another obvious snipe at Wal-Mart's business model of lower wages to provide lower prices on individual items, and it is ignorant of the clientele differences I've stated above. Costco's CEO can brag all he wants about offering $13 dress shirts and threatening to stop selling Starbucks, but Wal-Mart's benefits are greatest for the poor, and the poor aren't going to buy too many dress shirts or much Starbucks coffee. Nor will the poor be too concerned about the higher quality meats that Costco and Sam's have, or that the Costco in Brookfield, Connecticut, has lobsters and fresh salmon. Costco attracts a different type of shopper, that's all.

Side note: I myself was never too impressed by Costco's dress shirts. They're ok, but unless they're a name brand, my particular consumer preference is to spend more at a department store. I bought a 100% cotton, French-cuffed shirt last weekend at Macy's, on sale for just $30. My three shirts before that were from the Men's Wearhouse, 100%-cotton and true wrinkle-free, regular price of $45 each. I find a distinct difference in quality.

Furthermore, anyone who has shopped at both Costco and Wal-Mart, as I have, can readily observe the differences in labor. Wal-Mart stockers need little more than adequate strength, mobility and agility to remove items from boxes and place them on shelves. Costco and Sam's Club, however, are warehouses in the guise of retail stores. Their stockers need to be able to operate forklifts and hydraulic lifts, and they won't perform those jobs for typical Wal-Mart wages. Conversely, paying Costco wages to Wal-Mart employees would necessarily make Wal-Mart prices more expensive, depriving poor people of the low prices that improve their purchasing power more effectively than any increase in the minimum wage.

The article also notes, "Retail analysts say despite recent dips in consumer confidence, the demand for luxury goods this year is surprisingly strong." Surprisingly? It should not surprise any rational person that consumer confidence surveys are poor indicators of the strength of retail sales, let alone the actual strength of the economy, even if we use "moving averages" of several months. While consumer confidence has dipped primarily because of high gas prices, and sometimes Iraq is counted as a factor, GDP growth has still been very strong. What matters is what consumers do, not what they say.

As I've said before, surveys are meaningless compared to real action. CNN could generate a thousand surveys where people say higher gas prices aren't discouraging them from buying automobiles that consume more fuel. However, the real story is in actual sales numbers, and as practically everyone knows, the last few months in particular have seen a huge decline in SUV sales. Likewise, "consumer confidence" can illustrate the greatest pessimism in years, but in the end, what's important are retail sales figures. Similarly, there's always pessimism when holiday shopping starts. Year after year, the same economists and analysts are quoted, the same preachers of doom who warn of bleak outlooks. Even if they can't predict lower sales, they predict lower growth in sales. And things still turn out pretty well, especially with the great growth in online shopping. I've really taken a fancy to online shopping for how it minimizes search costs.

The primary measure of consumer confidence, the Confederence Board's monthly survey, is put to a mere 5000 American households, which we can probably reckon at about 25,000 to 30,000 people out of a population of 300 million. In my mind, that begets two questions: can we really extrapolate overall consumer sentiment from just 1/10000 of the population, are their feelings any indication of what's really happening in the overall economy, and therefore, isn't it dangerous to put stock into their perceptions that could be very wrong? It's nearly as bad as Federal Reserve arrogance in trying to "tweak" the economy, because they supposedly know how much economic growth is too much. As Don Luskin said, that necessarily leads to the idea that Fed economists know how much employment is "too much," because GDP growth is new jobs as well as greater production from existing ones: "See what I mean about a conspiracy to keep you poor and stupid – and to tell you it's for your own good?"

The ABC article quotes Emme Kozloff, a senior retail analyst at Sanford C. Bernstein: "The U.S. consumer has developed a higher sense of taste, a higher sense of fashion and expectation...Luxury and good taste are no longer limited to the elite." Indeed, and I attribute this to capitalism. I sided with Alex Tabarrok of Marginal Revolution, who recently gave thanks for capitalism and its abundance. It is technology that, for almost all Americans today, has eradicated dirt floors, sweltering homes in summer and freezing homes in winter, and many diseases that once ravaged us. Medical technology has made it possible for anyone to spend just several dollars on a few days' worth of cold medicines and not miss a few days of work. Even if you have paid sick leave, it means your employer doesn't lose money by paying you when you aren't producing. Your employer therefore won't have to compensate by charging its customers higher prices and/or paying you a lesser wage.

Russell Roberts at Cafe Hayek cited a New York Times column (surprising to me because it was allowed) that cited differences between "the poor" of just three decades ago and "the poor" today. But it is never government that promotes real technological advancement, no matter how much it pours into subsidies. It is capitalism, the wealth it created, and the further increases in wealth that a capitalist economy promoted. There is much technology that, when new, was so expensive that only "the rich" could afford it at first. Once upon a time, any indoor plumbing was a luxury, let alone the ability to choose between hot and cold water. The high prices worked as they should have, encouraging others to supply such goods. As new market entrants sought to compete, the successful ones improved the technology of production by making it cheaper and more efficient, driving down the prices for the consumer. Over time, many things originally made for "the rich" became so abundant that people of lower incomes, eventually including "the poor," could afford them. It happened with indoor plumbing, refrigerators, TVs, then VCRs. The process continues today with DVD players and cable TV, and look how increasingly common cell phones are. If lower-income people work a little more or are a little more thrifty, they can afford one; perhaps not a plan where they can talk all day but, still a basic one.

Some new technology was created with the common man in mind, like Henry Ford's Model T, yet it's usually the case that the preceding technology, which led to if not facilitated building the new, required "catering to the rich" capitalism before it. And capitalism is based on free markets: the freedom of every producer and every consumer to engage, or elect not to engage, in peaceful and voluntary transactions with other peaceful individuals of their choosing. It's not just the freedom of "the rich" to spend their greater wealth. It's the freedom of everyone else to provide goods and services to "the rich" so they can earn higher incomes, and that won't happen if the rich are taxed down to everyone else's level.

Kennedy said, "A rising tide lifts all boats," meaning that prosperity spreads to everyone. Similarly, heavy graduated taxes don't force "the rich" to sail the sea of prosperity with the anchor down; heavy graduated taxes are more like polluting the ocean, which affects everyone, and out of spite because "the rich" can supposedly enjoy it more. I've said before with regards to Hugo Chavez' economic lunacy, "A poor person does not prosper by trading only with other poor; a poor person prospers by continually creating things of value that 'the rich' can buy, and then trading with other poor."

I was at Rockefeller Center last night, doing a little shopping and taking pictures of the tree. It reminded me of something Dr. Ikeda, my undergraduate microeconomics professor, told our Micro I class. One of his friends once wondered at a grocery store how a farmer so far away knew he wanted this particular produce. Relatedly, how did someone know I wanted a digital camera? How about the coffee mug and New York City photo book that I bought at the Metropolitan Museum store? They were pretty expensive by any measure, and no doubt I could have shopped around and saved money, especially by buying substitutes. However, it was a matter of search costs.

Of course, none of the workers involved knew that I specifically wanted those items, but central planners in their arrogance believe they would know. I have greater faith in someone who has the freedom to produce something that I have the freedom to buy, than in a central planner who decides what I need or do not need and necessarily orders people to produce. Orwell's 1984 is famous for its nightmare of "Big Brother is watching," but just as frightening is that Oceania's centrally planned economy couldn't provide enough of basic things, like nails and razor blades.

The same store has a selection of watches, and one ladies' watch was really, really pretty, gold with a link bracelet. Very simple in design, but extremely elegant. I was tempted to buy it too for my best friend, but I'm not yet sure. Meanwhile, I must add that I rather enjoyed chatting with the bubbly and fetching young woman behind the counter. She was obviously flirting with me, and it was tempting to ask her what time she got off...but that isn't my style.

On a final note, the ABC item mentions a man who worried his girlfriend might find out he bought her necklace at Sam's. Perhaps it's because I've been so influenced by Austrian economics, but I see no reason you should be afraid that the other person will discover you got it at a great price. In fact, the recipient should be doubly happy: purchasing a near-equivalent at the best possible price economizes your income, which if anything makes it possible to purchase more and/or better things for the same amount of money. Perhaps I'm just idealistic with relationships, because I always thought it doesn't matter when the person is supposed to love you for who you are.


Anonymous Anonymous said...

Hello. I find your blog very interesting. Since you have mentioned Walmart here I would like to tell that I do not find it that great as the others may. The thing is that the customer service is far from being perfect. I was going to return the purchase in two days after I bought it and the manager told me I could not do that. What is worse he did not give me the serious grounds for that. I was disappointed and went to this great site to post a complaint.

Tuesday, August 05, 2008 9:37:00 AM  
Blogger Perry Eidelbus said...

You didn't provide any details on your purchase. Was it software? A movie? At any store, some things cannot be returned no matter what, for health/sanitary reasons, if it's a disposable item that's clearly been used, or if it's media that's been open (and potentially copied).

Not long ago, I tried a Norelco electric razor. Wal-Mart took it back and refunded my money with no hesitation, after I explained it did nothing but tear up my face. After a week my skin still wasn't "used to it," and it was even giving me pimples. I've returned a couple of frying pans that turned out to be not the right size, again getting a refund with no hesitation.

You linked to an interesting site with lots of complaints. This one complains about a certain Wal-Mart always being out of stock on most things. How can it stay in business, then? Why do people even bother going there, if it's always out of stock?

Thursday, August 07, 2008 12:12:00 AM  

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