Sausage comp 2.preview

Crony Capitalism: How the Sausage Is Made

It is surprisingly hard for many people to understand that government regulation is often more of a boon to big business than it is a burden to them, but the current debate on minimum wage serves as a simple illustration.

When I saw a recent headline: Costco CEO: Raise The Minimum Wage To More Than $10 Per Hour, my first thought was, “How does this guy benefit from a higher minimum wage?”, and my second thought was, “Aha!” I cracked the code in an instant. Costco I thought, must pay more than $10 per hour already, while its competitors must pay less. That means Costco would not be affected at all by an increase in the minimum wage to $10, while any of its competitors that pay below $10 per hour could see their business models severely impaired. And so it is.

Costco’s minimum salary is $11.50 per hour while Wal-Mart pays new workers only $8. Costco is very light on service and very high on efficiency, with each customer spending much more per visit than Wal-Mart customers. A skillful, efficient workforce is integral to Costco’s business model. On the other hand, Wal-Mart has myriad employees, some of whom do nothing but greet customers, and with lower priced items and higher customer volume, each employee-customer interaction generates only modest revenue to the company.  Its larger but lower-cost sales force is the only way for Wal-Mart to keep volume up and prices low.

Costco’s current CEO, Craig Jelinek, as well as its former CEO and founder, James Sinegal, claim that they pay more to their employees because it’s the right thing to do, and it is, but not morally right as they imply, just right for their business model.

Here are the numbers that prove my point.  Costco makes $617,623 in revenue and $14,973 in operating profit annually for each of its 160,000 employees, while Wal-Mart makes a “mere” $203,182 in revenue and $12,091 in operating profit annually for each of its 2.2 million employees.  Costco makes much more per employee in sales and profit than Wal-Mart.  As a matter of fact, Costco could actually increase its pay to employees by $2,882 per year, or $1.39 per hour (assuming a 40-hour work week), before its profitability per employee fell to that of Wal-Mart.

If Obama’s so-called Fair Minimum Wage Act of 2013 were passed (which calls for minimum wage to be phased up to $10 per hour) and Wal-Mart had to increase its starting wage by $2 per hour, Wal-Mart would shut down marginally profitable locations, cut staff and demand more productivity per employee at retained stores, and raise prices across the board. These actions would hurt the lowest skilled employees who would be fired in favor of more productive workers, it would hurt employees who would lose jobs in areas no longer able to support a Wal-Mart, and it would hurt low income consumers who would no longer have a local Wal-Mart to shop at or who would have to pay higher prices all around and consume fewer goods overall.

Costco, on the other hand, would benefit from Wal-Mart’s higher costs as higher-end Wal-Mart shoppers would begin to go to Costco if their local Wal-Mart closed down or if the new higher price/lower service Wal-Mart experience no longer seemed worth it to them.

In this example, many people would be hurt by a higher minimum wage, from Wal-Mart employees to Wal-Mart customers to Wal-Mart shareholders, but Costco shareholders would benefit without a doubt.  And who is the largest Costco shareholder? James Sinegal, founder and former CEO of Costco, who still owns over $100 million worth of Costco shares–nearly five times as much as the third largest shareholder, current CEO and fellow minimum wage advocate, Craig Jelinek, who owns a still sizable $20 million chunk of Costco stock.

Sinegal and Jelinek simply “advocating” for a higher minimum wage to gain a competitive advantage doesn’t fully complete the circle of cronyism, however. Yes, favoring government regulation that benefits you over your competitors is the essence of crony capitalism, and I would go so far as to say that this sort of privilege-bestowed-by-government is both the primary purpose and original driving force behind the modern state. But the insidiousness comes when the mutual financial benefit is consummated, and in this case the circle is indeed completed.

After handing the reins of Costco over to Craig Jenilek in 2012, Jim Sinegal became a “bundler” for President Obama, raising $1.4 million for his re-election campaign.  I’m not speculating as to whether Obama’s Fair Minimum Wage Act of 2013 is pay-back to Sinegal (some say it’s pay-back to the unions who also benefit from an increased minimum wage) or if Sinegal supported Obama’s re-election simply because he knew the Democrat was actively trying to raise the minimum wage. Regardless of where the circle begins or ends, big money flowed into Obama’s campaign from someone who benefits financially from a higher minimum wage and Obama is now advocating for a higher minimum wage. Outside the circle, Wal-Mart’s largest shareholders, who were financial supporters of Mitt Romney in 2012, garner no sympathy from Obama for the danger his minimum wage proposal poses to them, or the benefit it promises their competitor.

Just for the record, I LOVE Costco–it’s my favorite store by far.  I go to Costco more than I go to all other stores combined and I never go to Wal-Mart.  I will continue to go to Costco (assuming they don’t revoke my membership for writing this article), but their samples will leave a sour taste now that I know that the chain’s fantastically wealthy owners would use the force of government to deprive low-skilled workers and low-income consumers the option to work and shop as they choose in order to take a little more for themselves.

8 thoughts on “Crony Capitalism: How the Sausage Is Made

  1. Be careful not to mistake “revenue” for “profit.” Believe it or not, it is rare for a company to be “profitable,” as profits are cash assets left over after paying for all of the operational costs of the company, such as cost of goods sold (COGS), inventory on hand, material inventory, and employee wages.

    • I agree that’s a common mistake, but I didn’t make it! Look again – I intentionally focused on operating profit to capture the cost of running the business before financing choices. But you bring up a great point. It is my contention that with the exception of very new industries, “economic profit” would go to zero as predicted, barring the competition-limiting impact of government. Positive economic profit is to me almost always a result of crony capitalism!

      Here’s a great explanation of “zero economic profit”: http://www.economicprofit.org/Zero-Economic-Profit.html

      • Besides, Matt, Costco’s business model gives them about $100 revenue per customer (about $5 BB) before that customer buys a thing – since you have to have a membership to shop there.

        Also, Costco sells a lot of manufacturer close-out or excess production items, in addition to pretty much everything else being bulk pricing. Don’t get me wrong, I shop there, but when you get $5 BILLION up front every year before you sell a thing, it’s no wonder Costco can afford to pay their employees more. I also suspect they support Obama because of Obamacare. A LOT of employers would like to get out from under paying for health insurance for their employees, and the long-term plan for Obamacare is government-funded health insurance.

        Costco can afford a higher-quality, more experienced employee than WalMart, but I’d be willing to bet a lot of their staff got their start in the workforce at a place like WalMart or McDonalds. I’ve read that their average tenure is longer than most retail establishments as well.

  2. Just wondering if you have ever read The Triumph of Conservatism? It discusses the history of crony capitalism during the Progressive era of the early 1900s. Quite interesting.

  3. I have always believed that Big Business loves Big Government. A recent example is the tax preparation industry opposing tax reform that would simplify the tax code. I also believe that the health insurance industry gave us the Affordable Care Act. The insurance industry benefits the most from the individual mandate.

  4. Hey monica. I didn’t see an email listed or I would have sent this there. But, speeking of crony capitialism, I wish you would expose the real reason we pay 3.50 a gallon for gas. As price point capitalists, we believe that true supply and demand should dictate the price of things in the market, especially when those things involve a commodity that dictates the entire stability of the economy. The reality is, capitalistic supply and demand economics has not been used to price oil since December of 2000. The main was reason we are getting killed on oil prices is speculation in the crude oil futures market which has been created, protected, and encouraged by the federal government…simply put, a future is a bet on the future price of oil…. Goldman Sachs or anybody else for example will agree to purchase a milllion barrels of oil at what they think the future price of oil will be…Obviously, this creates a false demand which screws the 290 million Americans not involved with oil…. The difference between speculation now, and before the year 2000 when oil was 25 dollars a barrel is you would physically have to take delivery of shipments then… In other words, political turmoil in a minimal oil-producing country like Egypt would not cause investors to bid up oil prices because of a “fear” in future disruption of supplies..The obvious reason is that investors did not want to be stuck with oil they couldn’t sell… Simply put, the supply and Demand princibles of the free market controlled the price…After the year 2000, speculators were allowed free access to place any bets they wanted without taking shipment, and ten years later, oil is 110 dollars a barrel. What makes things worse now is that these speculators are allowed to do this and pay only 10 percent down on their speculations (In others words, they have absolutely no risk when they place a wager). Even more asinine is that the federal government is giving these guys a hundred billion dollars a month stimulus to gamble in their billionare casino parlors, drive up gas prices, and decimate what little disposable income the middle class has left..So, with100,000,000,000 dollars of fed money recieved every month, they can buy a 1000 barrels of oil and have to only pay for a hundred up front, and then sell if there is an indication of increased supplies(safe money huh?)…. If these people were placing their bets in Vegas, I would not care.. But, when their wagers have a direct impact on the entire financial stability of the economy, it needs to stop. Non-delivery oil speculation needs to be banned, not regulated…Ask yourself a question; if non-delivery speculation was banned, true supply and demand capitalism dictated oil prices, and the 300 million middle class Americans had 2000 dollars extra a year in disposable income that their currently spending on artificially high gas prices, what would that do for the economy(the workers and the companies) .. Does it make any sense to allow a handfull of billionare gambling attics to screw the masses on a commodity that dictates the entire financial stability of the economy…If the media and talk show host made the masses aware of WHY GAS IS REALLY HIGH, things would change becuase there would be a revolt… Yes, China uses more oil now, and so does India, but the main reason were getting killed is speculaters. Just know everyone that the next time you’re sitting at the gas pump and feeling sick about an 80 dollar fill-up,have the satisfaction of knowing that you’re paying those ridiculous prices for the sole purpose of allowing a few billionaires to manipulate and rig the market through an artificial demand created by speculation…I have been reading a kindle book I can’t put down called Gas, 1.25 a gallon in six weeks… Its about allowing the free market to dictate the price of gas…A must read…

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