Future of Retail: Companies That Profit By Investing in Employees

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Mark Lennihan / AP

Travelers pass the Apple store, in New York City's Grand Central Terminal.

Ideally, a capitalist economy is constantly becoming more efficient. The benefits of that newly gained efficiency, however, are not always uniformly distributed. Sometimes it goes to business owners in the form of higher prices, sometimes to consumers in the form of lower prices, and other times to labor as increased wages.

You don’t have to be an economist to know that for the past generation, workers have gotten the short end of this particular stick. Corporate profits have gone steadily up, consumers have been offered an increasingly wide selection of affordable products, but wages for most of us have stagnated.

The reasons for this trend are familiar: Globalization has flooded the world labor market with cheap workers from China, India and elsewhere. Good paying manufacturing jobs have migrated overseas, while the U.S. has been left with low-wage, low-skill service jobs like that of a sales associate in the nation’s many retail outlets. Meanwhile, an era of global corporate competition has forced companies to ruthlessly seek to cut expenses wherever they can, keeping wages and benefits in these sorts of jobs depressingly low.

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But what if the logic behind viewing retail labor as an expense to be cut, rather than as an asset to be invested in, is unsound? Zeynep Ton, a Professor of Operations Management at MIT’s Sloan School of Management, argues just that. Her research has shown that by underinvesting in their employees, retailers are actually making their operations much more inefficient, and therefore much less profitable.

This is an area that Ton has been studying for ten years, and what she has consistently found is that companies that buck the status quo and invest heavily in their workforce actually are able to not only compete with their competitors on service but on price too. In a paper she published in the Harvard Business Review earlier this year, she writes:

“Highly successful retail chains — such as QuickTrip convenience stores, Mercadona and Trader Joe’s supermarkets, and Costco wholesale clubs — not only invest heavily in store employees, but also have the lowest prices in their industries, solid financial performance, and better customer service than their competitors.”

Increased Expenses, But Lower Prices?

When Ton first started talking about the results of her research to retail industry executives, they were skeptical. “What I kept hearing from industry people was that investing in employees makes a lot of sense if you differentiate based on the products you offer or service, but it wouldn’t work for low-cost retailers,” she says. “That’s why I specifically studied low-cost retailers. If you can do it in low-cost you can do it anywhere.”

(PHOTOS: Mall of America Mallscapes)

The reason retailers Ton studied were able to spend much more on labor and still compete on price is that there are all sorts of efficiencies that become unlocked once you have a highly trained, highly motivated workforce. Running a modern retail store is an incredibly complex task. According to Ton’s research, a typical supermarket carries nearly 39,000 products, runs 100 promotions a week, and serves 2,500 customers a day. Store employees must constantly shift inventory from storage into the right shelves to meet demand, which fluctuates constantly. She writes:

“In my field visits, I consistently found that with so many products, promotions, and storage areas, a task that ought to be simple—such as shelving toothpaste—is not. Such a surprisingly complex operation requires something uniquely human: judgment. Poorly paid, poorly trained, and poorly motivated employees have to monitor which products have sold, decide what to keep on the selling floor and what to move to and from backrooms, and remember which backrooms contain which items.”

In addition, these workers must help shoppers and decide whether they should focus on customer service, restocking, or tending to promotions. “When these nitty-gritty, ongoing operational issues are handled by low-paid employees at understaffed stores, the consequences for operational execution can be severe,” Ton writes.

Ton tells a story of when she was studying the now-defuct Borders, a company she says was well-respected for having one of the most advanced IT systems for tracking inventory and merchandise. What she found was that one in six items of merchandise at Borders was misplaced. “You can have the best information technology in the world, but if your products aren’t where they’re supposed to be and your employees can’t find those products, you’re going to lose a lot of sales.”

(PHOTOS: Stores That Are No More)

These sorts of mistakes lead to what Ton calls “retailing’s vicious cycle.” Cutting labor costs will help in the short run, but when poorly paid, unhappy employees then promote those same operational mistakes; profits fall, starting the whole cycle over again.

Retail’s Virtuous Cycle

The four stores that Ton looked at in her study, however, take a different approach. Writes Ton in her study, “In addition to healthy sales and profit growth, they have substantially higher asset and labor productivity. Employees have higher pay, fuller training, better benefits, and more convenient schedules than their counterparts.” For instance, full-time employees at Trader Joe’s earn $40,000 to $60,000 a year. Costco makes an effort to offer opportunities for advancement — with around 98% of store managers being promoted from within. QuickTrip maintains a huge “floater” staff to allow employees to take more vacation and sick time, and at the Spanish supermarket Mercadona, employees go through extensive cross training so that everyone can do a variety of tasks. This allows scheduling to be predictable, as any employee can fill in for another at a moment’s notice.

When workers are well trained and a retail operation is fully staffed, operational failures like missing merchandise are severely mitigated. And when employees are paid and trained well, they are much less likely to leave. Indeed, turnover at all the stores Ton studies in her report are much lower than the industry average, which reduces the need to invest in training new employees.

Customer Service in the Age of E-Commerce

While investing in human resources may have always been a good strategy, it is one that is more important now than ever for brick-and-mortar retailers. The headlong rise of e-commerce has put extreme pressure on retailers to become more efficient, and to justify their existence to customers. Those who want huge selection, low prices, and no service can find that online, without the hassle of leaving their living rooms.

(MORE: Which Retailers Have the Most Satisfied Customers?)

Alison Paul, a retail consultant for Deloitte, says that traditional retail is not dead by a long shot, but it needs to be retooled, and one big component of that is investment in employees. “Retail has had a culture of keeping labor costs under control,” she says. “But there’s a slow revolution happening. There’s been a shift from retailers pushing goods to consumers being able to pull what they want from a variety of different places that didn’t exist five years go. Retailers are recognizing that their key differentiator could be that person standing in the store.”

The retail landscape is increasingly dominated by stores that have adapted to this new reality. Retail success stories like Lululemon and Apple have highly trained, engaging and engaged sales associates who offer a unique expertise that will motivate a shopper to eschew the convenience of the internet shopping for a traditional brick-and mortar experience.

The Future of Retail?

Recessions are famously great opportunities for businesses to invest and reinvent themselves. Though there is a lot of uncertainty that business leaders have to contend with, many retailers have used the recession as an excuse to bolster their cash positions and trim fat from their operations. And with interest rates at historic lows, now is a great time to invest in the long-term health of your labor force. So will retailers pour their recently gained efficiencies into their labor force, ushering in a new era where stores compete on service rather than just on price?

Paul says that, among her clients, “It’s really all over the board. We’re seeing some retailers really take advantage of their cash position and invest.” But it takes real courage to pour a lot of resources into a strategy like this when the future of the world economy is so uncertain. Paul has other clients that are “really more tentative and taking kind of a wait-and-see approach. But I think they’re going to be left in the dust.”

This is the first in a series of articles on the future of retailing.

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