Will the introduction of the National Living Wage drive a rise in costs and unemployment or can it spark a new age of cost control and productivity via technology and new methods of working?
The rise in the National Minimum Wage, to the so-called Living Wage, has been set at £7.20 an hour, with the setting of the Voluntary Living Wage at £8.25. These minimum wage rises, as well as fall in the pound and cost of inflation, all act to erode margins further. This will be felt most by businesses in low-paid sectors such as retail and hospitality, and how these businesses decide to absorb or pass on this cost will have a great influence on their performance and future.
Traditional balancing of the books
What options do firms have available to them to deal with this increased cost?
The most obvious and simplest of choices is to increase prices. Whitbread for example, the owners of the large coffee chain Costa, announced last year that this would be their plan of action - better keep an eye on the cost of your cappuccinos!
Another alternative is that businesses might absorb the higher costs by reducing profit margins (albeit unlikely), as well as the rates at which overtime and bonuses are paid. Reducing headcounts through redundancies and slow hiring, reducing pay rises for other staff, cutting hours, hiring a cheaper workforce of under 25s and reducing investment plans, all present an array of ‘quick win’ solutions.
Harnessing more productivity from better paid employees
On the other hand, businesses may look to improve efficiency and productivity to offset the cost rather than relying primarily on traditional cost reduction tactics, as explored by Capgemini last year in “Retailers and the Budget - counting the cost of the Living Wage”. A study by the Harvard Business Review, 'The High Cost of Low Wages' provides evidence that higher wages can increase productivity. The investigation compared Costco and Walmart’s Sam’s Club, which together account for 90% of the 'warehouse retailer’ market in the USA. It was revealed that Costco pays their staff on average 72% more than Sam’s Club and offers more employee benefits.
Costco’s employment model is clearly more expensive per head, but appears to be offset by higher productivity through more loyal and productive employees.
The numbers say it all. Costco generated 15% higher sales from 38% fewer employees, translating to $21,805 in operating profit per hourly employee compared with $11,615 at Sam’s Club. This would indicate that Costco’s better paid, highly motivated, and productive workforce more than offset its higher costs.
Similar results have been seen in the UK with the John Lewis Partnership (JLP). Under the partnership model staff are awarded a bonus, which is in line with the organisation’s performance creating incentives for the staff to see the business succeed. JLP says its “ultimate purpose is the happiness of all its members” and with a higher than average pay, an annual bonus typically between 10 and 20% of salary, and a rewarding benefits scheme they certainly do well to fulfil that aim. JLP’ staff absence levels are half of the average in the retail sector, staff turnover is lower and productivity higher as employees feel they can influence the way their organisation works given their stake in its success.
Costco and JLP are just two cases where a more employee-centric business model has increased staff motivation. Both are good examples of what the Low Pay Commission calls 'total factor productivity' - the efficiency with which companies turn capital and labour into output, rather than employing fewer people.
While it might be impossible for retailers to copy and paste these business models in to their own, they can learn from and adopt parts which will deliver benefits.
Reaping digital efficiencies
There are huge opportunities for retailers to harness new technologies. For example, the Internet of Things (IoT) whereby objects, devices, buildings and vehicles can be embedded with chips or sensors to allow these ‘things’ to collect and exchange data - the potential for productivity gains is immense. For instance, pairing IoT with biometric recognition in stores could lead to customers being able to leave the store without queuing to pay. This would boost productivity as well as reducing costs and provide the customer with a more convenient experience. A win-win.
The IoT uses live data allowing retailers to predict customer needs and creates digital business opportunities. Using the IoT retailers have an exciting new opportunity to look across their end-to-end supply chain to find efficiencies. An example will be the ‘connected kitchen’. Gartner predicts that by 2020 we will have a ‘connected kitchen’ with sensors which feeds live data. The idea behind this is to allow food industries to create an optimal ordering system whereby their stock is managed automatically resulting in reduced waste and labour and ultimately, increased profits. This, of course, has a greater potential concerning sustainability.
Artificial intelligence (AI) is another area which businesses are now starting to take advantage of. The intelligent technology allows retailers to increasingly automate routine work as well as to learn and adapt to improve functions. This could be anything; current uses range from analysing social media to take advantage of current trends to using hospitality software to take the laborious, time consuming job out of stock taking. AI allows for deep mining of data to allow businesses to predict what consumers want to buy based on previous behaviour. This is currently being developed by Amazon through ‘anticipatory shipping’ where machine learning algorithms predict and deliver goods without input from the consumer. If the consumer is not happy with the purchase a return can be made free of charge. If retailers know what consumers want, they can then automate ordering so that their products are in the right place at the right time, enabling an optimisation of the supply chain.
Operating models to accommodate the Living Wage
As well as leveraging digital technology, UK retailers could boost performance by altering their operating model. For example, a retailer could benefit greatly from sharing its support services thus reaping economies of scale. Functions such as finance, IT, HR and procurement could be centralised and shared between stores or geographies thus avoiding repetition and allowing for a reduced head count and higher efficiency. Starbucks is a classic example. Over the years it has achieved significant economies of scale through purchasing by negotiating long term contracts with coffee farmers and purchasing coffee beans in bulk discount prices.
Joint ventures could also provide a useful operating model for many businesses. Businesses of any size can use joint ventures to strengthen long term relationships or to collaborate on short term projects. They allow access to new markets and distribution networks, can increase capacity, can allow access to greater resources, technology and finance and also reduce risk as costs are shared with a partner.
Franchising is another popular avenue businesses take. This route allows for quick growth of your business, generating high financial returns for relatively low risk as your franchisees pay to buy outlets in your chain. The number of locations can grow rapidly without tapping into much of your own capital or needing to request financing.
The hike in the National Minimum Wage will increase wages to 60% of median earnings by 2020. This takes the UK into uncharted waters, giving it one of the highest wage rates in the OECD, on par with France and Slovenia. In both of those countries, unemployment is about 10%; the UK currently sits around 5%. However, rising wages shouldn’t be seen as a burden but rather as a blessing in disguise, as it provides opportunities for companies to innovate and develop their business models. Through the exploitation of digital technologies and adapting operating models it is possible for retailers to boost performance to offset costs instead of reducing head count to compensate.