Do higher wages mean higher profits?

18th September 2012

So will this be the winter of our discount supermarkets? Perhaps not.

Despite the economic gloom a number of upmarket brands have proven more resilient than many would have expected. John Lewis, for example, posted impressive results for the first half of 2012. In its supermarket arm Waitrose operating profits grew 29% while overall John Lewis saw an impressive 60% leap in pre-tax profits taking in £144.5m in the six months to the end of July.

Meanwhile the fortunes of the country's largest retailer, Tesco , have been quite different. Over the same time period profits fell for the first time in 20 years, dropping 15% compared with the same period last year.

So how do we explain this phenomenon?

An argument could be made that the recession has hit those at the lower end of the income spectrum hardest. As such those who were already shopping at discount retailers may have been forced to cut back on their spending.

This was certainly the angle taken by The Mirror in its coverage of the story with falls in profits linked to "hard-pressed families trim grocery bills to make ends meet".

While that may certainly explain a part of the story, however, it does nothing to address the rising profits of higher-priced outlets. Perhaps there we could look to the Bank of England's explanation of the impact of its quantitative easing (QE) programme.

According to Larry Elliott, the Guardian's economics editor, the richest 10% of households saw the value of their overall assets increase of between £128,000 and £322,000 as a direct result of the policy. That should pay for plenty of weekly shops at the local Waitrose.

Certainly the fact that the downturn has disproportionately hit those on middle to lower incomes has made the current recession something of a historical anomaly. As David Cay Johnston wrote for Reuters back in March (albeit focusing on the US rather than the UK):

"The aftermaths of the Great Recession and the Great Depression produced sharply different changes in U.S. incomes that tell us a lot about tax and economic policy.

The 1934 economic rebound was widely shared, with strong income gains for the vast majority, the bottom 90 percent.

In 2010, we saw the opposite as the vast majority lost ground.

National income gained overall in 2010, but all of the gains were among the top 10 percent. Even within those 15.6 million households, the gains were extraordinarily concentrated among the super-rich, the top one percent of the top one percent.

Just 15,600 super-rich households pocketed an astonishing 37 percent of the entire national gain."

Given that the policies enacted in the US have been mirrored by those on this side of the Atlantic we can expect a similar result here. But perhaps those companies who are successfully navigating the challenging environment can offer ways in which to bridge this growing divide.

The price of happiness

For economic commentators who have long bemoaned the high cost of labour in developed markets it may come as a surprise to hear the chief executive of Whole Foods, the US retailer specialising in organic and healthy produce, boast of how much he pays his staff. Yet that is exactly what Walter Robb does.

Robb told Yahoo Finance that employees of the company earn $15 an hour, some $3 more than those who work at retail behemoth Walmart. Some traditional economic models would see this as putting Whole Foods at a competitive disadvantage – either they will have to raise the cost of goods or suffer reduced profit margins on sales – but Robb says it helps lower staff turnover by increasing loyalty.

So how successful is the strategy? Well Whole Foods Market Inc. reported a 32% rise in fiscal third-quarter profits as a number of customers moved away from conventional supermarkets.

Perhaps a common thread linking the success of the Whole Foods and John Lewis brands are the way in which they view employees. Robb's description of his "Team Members" as stakeholders in the business, alongside shareholders and customers, bears a striking resemblance to the partnership structure of John Lewis that is means employees "share in the profits and have a real say in determining [the firm's] future".

While investors should not get hung up on a narrow set of examples, it is nevertheless interesting that these companies have apparently been able to manage their way through a crisis while many of their rivals have struggled. Enfranchising employees in the business offers them a tangible long-term incentive to work hard and also demonstrates a commitment to the individual by the employer.

Other firms may want to take note. The Bank of England points out "UK labour productivity stands out as being weak relative to historic episodes; [and] it is also weak compared to other countries in the recent crisis". It may go against old models to empower workers, but if the crisis has taught us one lesson it is that relying on conventional wisdom for solutions is a risky strategy.

 

More on Mindful Money:

Survival of the fittest

Has Tesco had its time?

In brands we (mis)Trust

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