Executive Compensation, As A Competitive Tool

In an increasingly competitive world, companies wield compensation to give themselves an edge. 

With impressive margins, an ever expanding pie (of untapped markets and un-converted customers) and growing piles of cash on the books, Apple is proving to be exceptionally good at doing so.

As Adam Satariano and Hideki Suzuki write on Bloomberg, 

Last year was the second in a row that payouts at Cupertino, California-based Apple ranked among the most generous. Apple directors, who put CEO Tim Cook at the top of the heap last year, are using compensation to keep the team that transformed the iPhone maker into the most valuable technology company under co-founder Steve Jobs, who died in 2011. The urgency has increased in recent months as Samsung Electronics Co. and Google Inc. challenge Apple.

“It’s a retention strategy to keep the key executives who were present in the Steve Jobs era,” said Greg Sterling, an analyst at San Francisco-based Opus Research. “They want to be sure the actual talents that they bring to the company are retained, and also from a perception standpoint to retain confidence in the leadership.”

Since most of this compensation is (I think) in the form of restricted stock units that either vest this year and in 2016, or between this year and 2016, Apple should benefit from the execs’ expertise and experience over the next couple of years. In fact, based on their receiving more such grants every year, over the next few years, it is possible that Apple may be able to keep them around for the next several years. 

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Some additional thoughts, while we are on the subject of executive compensation:

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Happy Employees = Profitability? Or Profitability = Happy Employees?

In all the years I’ve shopped at Whole Foods or Trader Joe’s, for that matter, I’ve never met an unhappy employee.

The guys refilling the produce bins, the ones behind the sandwich counter (at WF) and the cashiers helping you part with your money – they are all unfailingly polite, friendly and helpful. [A cashier at Whole Foods once "told" me to buy strawberries instead of blueberries because there was a 2-for-1 sale on strawberries that day.]

Shopping at Costco, similarly, is a pleasant experience – though the folks there exude an air of competence and efficiency, in place of the friendliness at the other two places. 

It would be reasonable to therefore conclude that the steady growth and profitability of all three retailers is somehow related to the happiness/friendliness/efficiency demonstrated by their employees. It would also be logical to assume that perhaps these workers were paid more than their counterparts at other retailers. 

And you would be right. 

What would be wrong though, is to conclude that “Companies that invest in higher salaries for low-level employees find success in a competitive market“, as the tagline for a recent article in The Atlantic did. 

That’s the kind of correlation-causation conflation (alliteration, my new friend) that should make all thinking beings shudder. But why do they do it? Because it is beguilingly easy to do so (and we all do it on a daily basis).

In the case of Costco, Whole Foods and Trader Joe’s – what makes them profitable to begin with is a combination of the following: locating stores in affluent neighborhoods, not stocking a gazillion products and offering high-end, high quality and/or difficult to buy elsewhere, goods. 

Taken together, these conscious strategic decisions

(a) attract customers with the ability and the willingness to spend a lot of money (more money than what a typical Walmart shopper might spend, at least)

(b) enable them to control various operational costs (non-labor, non-wage costs)

(c) create conditions ripe for profitability

[As an aside, specific to Costco, its membership fees, which are of course almost all pure profit, act as a barrier to entry for those that might not be a good Costco customer…so it is likely using this to make sure that only a certain kind of customer steps in to its' stores.]

These companies’ labor practices, including higher wages, benefits, scope for advancement and training, complement their core business strategies, in two ways: 

Cost reduction (HBR article from 2006) because employees stay longer:

Costco’s practices (wages and benefits) are clearly more expensive, but they have an offsetting cost-containment effect: Turnover is unusually low, at 17% overall and just 6% after one year’s employment. In contrast, turnover at Wal-Mart is 44% a year, close to the industry average. In skilled and semi-skilled jobs, the fully loaded cost of replacing a worker who leaves (excluding lost productivity) is typically 1.5 to 2.5 times the worker’s annual salary. To be conservative, let’s assume that the total cost of replacing an hourly employee at Costco or Sam’s Club is only 60% of his or her annual salary. If a Costco employee quits, the cost of replacing him or her is therefore $21,216. If a Sam’s Club employee leaves, the cost is $12,617. At first glance, it may seem that the low-wage approach at Sam’s Club would result in lower turnover costs. But if its turnover rate is the same as Wal-Mart’s, Sam’s Club loses more than twice as many people as Costco does: 44% versus 17%. By this calculation, the total annual cost to Costco of employee churn is $244 million, whereas the total annual cost to Sam’s Club is $612 million. That’s $5,274 per Sam’s Club employee, versus $3,628 per Costco employee.

And increased sales (via James Surowiecki in The New Yorker):

The big challenge for any retailer is to make sure that the people coming into the store actually buy stuff, and research suggests that not scrimping on payroll is crucial. In a study published at the Wharton School, Marshall Fisher, Jayanth Krishnan, and Serguei Netessine looked at detailed sales data from a retailer with more than five hundred stores, and found that every dollar in additional payroll led to somewhere between four and twenty-eight dollars in new sales. Stores that were understaffed to begin with benefitted more, stores that were close to fully staffed benefitted less, but, in all cases, spending more on workers led to higher sales. A study last year of a big apparel chain found that increasing the number of people working in stores led to a significant increase in sales at those stores.

The reasons for this aren’t hard to divine. As Fisher, Krishnan, and Netessine show, customers’ needs are pretty simple: they want to be able to find products, and helpful salespeople, easily; and they want to avoid long checkout lines. For a well-staffed store, that’s no problem, but if you don’t have enough people on the floor, or if they aren’t well trained, customers can easily lose patience. One of the biggest problems retailers have is what is called a “phantom stock-out.” That’s when a product is in the store but can’t be found. Worker-friendly retailers with more employees have fewer phantom stock-outs, which leads to more sales.

But despite that, any of them could decide, tomorrow, that they can live with unhappy employees or with employees that make minimum wage and fewer benefits if such a move didn’t damage the bottom-line (such damage can come from some customers choosing to go elsewhere where employees are “fairly” treated – or – from their brands being damaged and reducing their ability to price products at a premium). 

And that’s where the progressive visions of their founders and CEOs come into the picture. 

John Mackey at Whole Foods and Costco’s Jim Sinegal (and Costco’s current CEO, Craig Jelenik) believe in paying their employees living wages and more. More power to them…I would do the same thing. But only if I was running a retail business that was structured to be profitable, to begin with. 

Swatch and the Swiss Watch Industry

The Swiss are to watches, what the Germans are to cars.

Their luxury watches continue to dominate the global market for luxury watches, and have seen impressive growth (32%) in value, over the last two years.

A lot of that success appears to be traceable to the Swatch group, both directly and indirectly.

Directly because Swatch, with its stable of brands (Omega, Logines, others and of course, the memorably “cute” Swatch brand itself), accounts for over 33% of all Swiss watch sales.

But more impressively and indirectly, it looks like Swatch is the “engine” that powers the rest of the Swiss watch industry -  supplying 70% of other swiss watches’ movements and 90% of the balancing springs, per an article in The Economist (which contributed the specific numbers cited above).

Talk about “supplier power”.

However, Swatch is not very happy with the state of affairs:

Swatch became the watchmaker to watch in the 1980s, when it merged two weak companies and launched Swatch watches as a relatively cheap brand (though not nearly as cheap as a typical Chinese timepiece). It remains dominant, in part, because other firms find it easier to let someone else go to all the trouble and expense of producing their watches’ most fiddly and essential components.

But Swatch now finds this arrangement irksome. It supplies parts to rivals (Swiss and foreign) which then spend lavishly on advertising. Swatch would like to curb its sales of components, to 30% of the Swiss total by 2018. The Swiss Competition Commission agreed to modest reductions in 2012. After lobbying by watchmakers, Swatch will make no more cuts this year, but next year it will probably try again.

The article doesn’t detail exactly why Swatch finds this arrangement irksome…perhaps those that it supplies then compete with Swatch (successfully?) in different markets and segments, leading Swatch to think that if it stops “arming the enemy”, its brands could be more successful? The problem with that argument, as the article notes, if it progressively cuts off supply, it will encourage its competitors to develop their own suppliers.

So unless its capacity were fixed and/or it thinks that the movements and springs were sources of major competitive advantage, would it not be better off profiting from its dominant supplier position?

Any thoughts on that, readers?

Why Should Only Amazon Enjoy Tracking Consumer Behavior?

Online Tracking As a Source of Competitive Advantage

For a very long time, one of the competitive advantages enjoyed by online retailers has been their ability to understand their consumers well. Very well, in fact. 

They know which pages you look at, for how long, in what order you shop for things, how much you spend, on average, every day, week or month, which two or three things do you typically buy together, etc. All of this is because of cookies and timers and “mouse-click” tracking. 

The result, in Amazon’s case (since they are always easy to talk about and understand) are recommendations tailored for each shopper, suggestions for “most frequently bought together” items, etc. Which then means customers are happier, more brand royalty, more revenue, higher stock prices despite little to no profits, etc., etc.

Cameras and Algorithms To The Rescue

Now, special cameras mounted inside mannequins, or in other strategic locations throughout stores are helping physical stores fight back. These increasingly powerful cameras (backed by increasingly powerful algorithms that can analyze the collected images in real-time) identify shoppers by age and sex and can “see” which displays attract the most attention and even which items on those displays, specifically.

In smaller stores, store managers and sales people might have done that or continue to do that, but with increasing labor costs and in stores with a lot of foot traffic, automation may help. As an example, 

Just knowing how many shoppers cross the threshold, and when, can be useful. American Apparel’s store managers thought they were busiest when sales peaked. They were typically off by two hours. Now the retailer gathers traffic data from cameras mounted above the doors and feeds that into its staff-scheduling software. When crowds come, the shops now have enough salespeople to serve them. As a result, sales are up “across the board”.

From what I can tell, this area is still in its infancy and one can expect what I call “furious innovation” to take place in the next few years…IF they can assuage privacy concerns that can otherwise nip any further innovation right in the bud.

GE “In Sources” Sources Of Competitive Advantage

The jury is still out on whether outsourcing caused Boeing’s Dreamliner problems or if it technology did it, as I noted in a recent post. It doesn’t look like the debate is going to end anytime soon…though the general press has concluded that outsourcing must take the blame.

Anyway, in this context, it is interesting to note, per a WSJ article (paywall) that GE Aviation, who will make and deliver more than 15,000 aircraft engines over the next 7 years (or more, if the pace at which new aircraft are made accelerates) is bringing “back” manufacturing to the US in two ways: 

1. Vertical integration, via acquiring parts suppliers (Avio, an Italian parts supplier was acquired late last year for $4.4B) and then opening plants in the US to make some of what the acquired companies made.

2. Actually shifting some of the work that overseas suppliers make today, back to the US. 

Why?

The strategy is aimed at safeguarding a key source of the industrial conglomerate’s sales. Aircraft engines account for about half of GE’s $211 billion order backlog, and the company can’t afford missteps as it gets ready to roll out new designs to power the next generation of commercial jetliners.

In the technology arena, many companies (including HTC and FoxConn too, if I remember correctly) started off as contract manufacturers at one point, but then rose up the value chain to launch their own brands and compete with their erstwhile partners. 

So will this become a trend and will we see more high-end manufacturing companies follow in GE’s footsteps? Perhaps.

Certainly worth keeping an eye on.

Target’s Price Matching – Clever Strategy Or Desperation?

Target’s recently announced price matching policy says that it will match select online retailers’ prices if the customer can prove that one of its online competitors is selling something at a lower cost than Target sells it for – either in its stores or online at Target.com. Interestingly if Target.com prices something lower than a store, the store will match its own online price.

A thought provoking article on HBR argues that Target is making a mistake by price matching on items in both its stores and at Target.com. The author compares to this to “self serve” vs “full serve” gas pricing and says that “in store” shopping, by virtue of offering a higher quality of shopping experience, should price items higher and that if at all price matching must be offered then only Target.com should match prices, not the regular brick-and-mortar stores:

Target should instead match prices of online rivals with a comparable “apples to apples” service: order from Target.com. If a customer sees a lower online price, Target will match only if ordered from Target.com. Some variations that take advantage of a retailer’s physical store presence can also be offered: discounted two-day shipping (pick-up) at a store, for instance. Brick-and-mortar retailers shouldn’t offer the best of both worlds by providing in-store shopping benefits at online prices. It encourages a consumer behavior that is destructive to brick and mortar stores in the long run.

But I see a couple of issues with this.

1) Assuming that Target.com matches online retailers’ pricing and brick-and-mortar Target stores price things higher, someone that orders from Target.com instead of, say, Amazon, will want to have the same or better

- Ordering experience
- Shipping experience (what will Target charge for shipping compared to Amazon?)
- Delivery and
- Return experience (the return process is the only one here where Target has an inherent advantage…but I am not sure its a huge factor in customers’  purchasing decisions).

Can they get the Amazon.com experience at Target.com?

2) Taxes - For big-ticket items, sales taxes are still a big deal. Agreed…online retailers’ advantage here is being gradually eroded because of sane tax laws, but this will take a few more years to be changed across the US. Until then, I can’t see someone wanting to give up $100 or $200 and buying from Target.com even if Target.com and Amazon.com have the same prices.

In an ideal world, I would agree with the “full serve vs self-serve” gas pricing analogy…but I think that the price matching strategy is a tacit admission, on Target’s part, that price is the only way it HOPES to retain consumers – especially that segment of shoppers (5%? 10%? 15%?) that might represent a few billion dollars in otherwise lost revenue. And even with them, it must be hoping that the taxes consumers have to pay on the price-matched items are not high enough to sway consumers’ decisions.

Another related thing I have often wondered about is from the standpoint of those that make or manufacture those items that are most “show roomed”.

Today, they probably don’t care…but tomorrow, if bricks-and-mortar sellers stop selling their goods because they just can’t compete with online retailers, doesn’t that enormously increase the “buyer power” of online retailers? How should these manufacturers and makers of goods respond to this trend, in their own long-term interest?