A reader (Fratman) said that his class discussed whether or not the rise of Wal-Mart was “ethical”. It has been approximately two weeks since he asked about my thoughts on that matter, and I’ve been thinking it over during that time.
You already know I’m crazy about the place, but this is the first time I’ve been asked to put my thoughts on their specific business practices into writing. So I’m going to sit here, start speaking as if I were having a cup of coffee with Aaron, and hope it is somewhat coherent.
Before I get started, it is important to learn my history with the company. It may help you understand my perspective:
- Kansas City, the area where I grew up as a kid, saw some of the very first Wal-Marts when they were tiny 18,000 square foot stores that nobody knew about or heard of anywhere else in the country. I was born in the early 1980s and I remember shopping at Wal-Mart when they were brown colored, had food courts, no groceries, and were small. In my mind, sometimes it still is a small town store because I know people who even met Walton when they worked in the original stores!
- One of my extended relatives made millions of dollars working his way up from the bottom of Wal-Mart, becoming a manager, then a regional manager, and investing in the stock. He came from a small town and just out worked everyone. He retired ten years ago or so.
- One of my other extended relatives is currently a janitor for Wal-Mart.
- I own shares of Wal-Mart Stores, Inc., as do my companies.
- I’m so crazy about the place, having studied it since childhood, that I have a replica Wal-Mart Supercenter in my office display cabinet, next to a replica Wal-Mart delivery truck, a framed stock certificate and three copies of Sam Walton’s autobiography.
We Must Clarify the Question to the Point It Is Focused and Crystal Clear
Thus, the question you are putting before me could best be stated as, “Is the rise of Wal-Mart consistent with right behavior and the goodness of human character?” It could also be stated with a qualifier “in the society of the United States” but I think that is an easier test to pass so let’s stick with the former, which requires more scrutiny and is harder to answer in the affirmative.
Next, We Must Lay Out the Historical Facts
Now, we need to go through the entire evolution of Wal-Mart and determine if the things that made it what it is today were ethical. You can actually read all of the company’s stockholder reports going back to the 1970′s on the corporate website so you can see exactly what they did at the time.
Part I – The Early to Mid Years
#1: Focus On Turnover Rather Than Profit Margins
We know that Sam Walton founded Wal-Mart when he was 44 years old. He had previously operated five-and-dime stores. He believed that he could generate greater profits by focusing on lower profit margins and greater inventory turnover. That is, if he sold at a 30% markup instead of a 100% markup, but he could turn his inventory 10x more frequently, he would make 3x as much absolute profit.
(Please note I’m not going to get into the math of why that is true, but it is a function of the DuPont Return on Equity formula, which I explain at Investing for Beginners at About.com, a division of The New York Times. You can read that article if you want to discover how Walton came to that conclusion. That particular mathematical formula was discovered by scientists at DuPont chemical in the early 20th century and Walton was a graduate of the University of Missouri-Columbia so he knew how it worked. It breaks down return on equity, or shareholder net worth, into the three core components and can isolate which is responsible for absolute profit. Also, Walton’s wife, Helen, was college graduate, which was unusual for a woman at the time. She they had a knowledge base that most merchants didn’t because they wanted to educate themselves.)
At the time he made this decision, Walton had:
- No cost advantages
- No special relationships with vendors
- A limited about of money
He wasn’t the only one doing this. K-Mart was significantly larger than Wal-Mart but was located mostly in urban areas. Sol Price out on the West Coast was doing the same thing, as were a handful of other merchants. These men met in trade groups, like all retailers did, and some owned full price department stores, too. They shared ideas even though they were competitors.
The Question: Was Walton’s decision to focus on a smaller markup and try to get higher sales turnover ethical? If he failed, he would have lost his shirt and gone bankrupt. Other companies, such as the much larger K-Mart, were already using the business model to some degree, and he was paying the exact same price as all other merchants for his goods.
My Answer: I would say this decision was absolutely ethical. No one was harmed here because, if he had turned out to be wrong, the other stores would have gotten more market share after Walton’s store closed. The vendor was still paid the exact same price and the employees in Walton’s store were still the same. He and his family bore the risk just to see if the community preferred it more. Furthermore, a considerable percentage of the global and American economies used this model so Walton didn’t even create it.
#2: Focus on Under or Non-Served Rural Towns That No One Else Wanted
Instead of focusing on big cities like K-Mart and Sears, Helen Walton convinced her husband that small town people would be happier to shop at a store in their own neighborhood. She argued for smaller stores in smaller towns that currently had few, if any, retailers. I, personally, grew up in one of these towns that had one of the first Wal-Mart’s and my extended family owned a retail store (sporting goods).
The Question: What it ethical for this small town entrepreneur to focus on small towns instead of big cities, like all of the other retailers?
The Answer: I say yes. He was free to open a store just like any other entrepreneur and if the community didn’t like it, he would go out of business. He still had no advantages other than his mind and work ethic.
#3: Reinvest Your Profits and Expand Your Store Foot Print
Instead of taking dividends out of his business like most small business owners, Walton decided to drive the same old pickup truck, live in the same house, and keep his personal needs small so he could open new stores. This was a unique behavior not particularly common.
The Question: Did Walton have an ethical obligation to pay out his earnings as dividends or in the form of a higher salary to him and his wife?
The Answer: There was nothing unethical about choosing to reinvest his earnings and live modestly. Some people want a Mercedes. Sam Walton didn’t. He loved owning stores. So he spent his money on what he loved and built new locations. Nothing changed about the business model yet.
#4: To Make Your Employees “Think Like Owners” Recruit Hardworking People, Most With Nothing More Than a High School Degree, Get Them to Invest Alongside You and Own Part of Their Stores
Sam Walton kept expanding and realized not all managers thought like owners. You want someone who loves their business, who wants to make sure the floors are clean and the fixtures have fresh light bulbs. He devised a plan to have managers, most of whom were nothing more than high school graduates, invest their savings in the Wal-Mart company and own part of the store they managed. This gave them an equity stake and a source of low-cost capital to expand. Both parties benefited substantially. The more successful the manager, the higher his paycheck. He had an incentive to keep the store running and treat it like a small town merchant, which at this point, they still were.
At this point, each individual store was its own partnership or limited partnership so there wasn’t one “Wal-Mart”. There were dozens of small, tiny retailers in surrounding towns, each of which had different ownership structures, debt, real estate, etc.
As Walton put it:
Whatever money we made in one store, we’d put it in another new one, and just keep on going. Also, from Willard Walker [the first manager] on, we would offer to bring the managers we hired in as limited partners. If you had, say, a $50,000 investment in a store, and the manager put in $1,000, he’d own 2 percent.
Wisely, though, Walton kept control. He never let managers buy more than $1,000 per store and of that $600 was a bond issued to Wal-Mart and $400 was to buy 4 shares of privately owned stock at $100 per share. The managers were guaranteed interest at 4.5% annually. (One of my favorite stories was a man named Gary Reinboth, who would find managers who didn’t want their share. He’d call Sam and beg to buy it and Sam would let him, so he owned more of the little company as time passed.)
The Question: Was it unethical for Walton to raise money from employees and make them part owners in the business?
The Answer: Absolutely not! This is one of the best cases of win-win in history. A good manager was able to own part of a business he wouldn’t have been able to afford without saving for another 10 years by partnering with Walton. The type of men hired during this stage wouldn’t have been able to go to a place like IBM and get a job – most never went beyond basic education and had no other experience. There were exceptions, but these were regular folks that Sam was overseeing.
#5: Build a Distribution System to Keep Costs Low
Sam Walton realized, after the first few stores, that much of the product cost came in the form of freight paid to other companies that delivered merchandise. A tube of toothpaste may cost $1 but he may have to pay 15 cents to get it delivered. That was money going toward gas and the delivery company that had to come out of his customer’s pocket.
Choosing, again, to reinvest his earnings instead of buy a nicer house or better clothes, Sam consulted people in the industry and built a big distribution center that was as automated as possible so that his vendors could ship everything to a single location. He had Wal-Mart buy some trucks and make deliveries to the individual stores.
It was easier on the vendors, who didn’t have to make multiple shipments, and he was able to save money on his items, cutting his cost of toothpaste from, say $1.15 to $1.07. Since his philosophy was to target specific margins, he passed the $0.08 savings on to his customer. Wal-Marts employees, manager / owners, and Walton himself were still making just as much money. Only the gas companies, the freight haulers, and the folks who made cardboard boxes to handle the multiple shipments weren’t.
But he was still so small, no one noticed. Sears and K-Mart could have crushed him in a heartbeat.
The Question: There are two ethical questions in this stage of Wal-Mart’s development:
- Was it wrong for Walton to reinvest his profit instead of spending his gains, and construct a distribution center?
- Was it wrong for Walton to pass those savings on to his customers instead of keeping the profit for himself?
The Answer: In the first instance, I’ve already established there is nothing wrong with spending or reinvesting your money. Freedom in the United States means being able to chose how much of your paycheck you put away, how much you invest, how much you spend, or how much you give to charity. No one would seriously suggest that we should force people to give away a specific percentage of their income or spend all of their paycheck. So, to question 1: Absolutely ethical. We already established that. Plus, anyone could have built their own distribution system if they had saved their money, too. At this point, we’re talking about a single facility that certainly was nothing special.
For the second question: Was it wrong for Walton to give the money he saved to his customers instead of keeping it for himself? My answer is: This was absolutely ethical. Wal-Mart was earning the exact same percentage profit on each item. This was the entire crux of his business model, which we established in item #1 was ethical.
He could have paid his employees more money but then Wal-Mart wouldn’t be selling at his targeted margins. (A few years later, instead, at Helen’s urging, they instituted the employee profit sharing and stock ownership plan. Employees, most of whom were women who were migrating to small towns after their families no longer farmed in the 1960′s, were able to buy ownership in the company. This put them in the same position, on a proportional basis, as Walton. If the business succeeded, they made money, if it failed, they lost money.)
Given his choices, I think it is absurd to the point of comedy to insist that passing the savings on to his retail customers to give them lower prices was somehow immoral, which is the extension of the word unethical. No one of any intelligence can argue that with a straight face.
Part I Summary
The birth of the Wal-Mart System now includes the key components we discussed:
- Individual stores ran as individual partnerships with the manager investing money alongside Sam Walton and his family, giving them equity and an incentive to manage it well. At this point, a Wal-Mart store was approximately 18,000 square feet because that is all they could afford to build. By the late 1970′s this figure had reached 40,000 to 50,000 square feet.
- Smaller, targeted profit margins that remain consistent, hoping volume turnover on the inventory more than compensates for the lower prices you offer customers.
- Save money by reducing inefficiencies, including building your own distribution center. Don’t keep any of the savings for yourself, pass them all on to the customer since your profit margins remain the same as called for in your business model.
- Focus on small, rural towns where there is little to no service so customers will want to shop with you, avoiding giants like K-Mart and Sears who didn’t think places like that justified the investment.
- Reinvest virtually all of your earnings, live in the same house, drive the same truck and live in the same small town.
The question then, becomes, was anything Sam Walton did during this period unethical? Is there any part of the business plan that you think is evil or doesn’t serve society? At this point, he is barely a blip on the national radar. He is certainly prosperous, but given that he is in so much debt he can hardly afford to sleep at night, you wouldn’t know it. He has risked everything to build those handful of stores and, far from breaking any laws, I don’t see anything on that list that I think was immoral or unethical.
That means we have to move on to the modern day Wal-Mart Stores, Inc.
Part II – The Modern Day Wal-Mart
#1: Consolidate the Individual Stores Under One Company
The individual Wal-Mart partnerships ceased to exist and a new Wal-Mart Stores was formed, lowering costs further because there were only one set of tax filings, one set of accounting records, etc. Everyone knew this was going to someday lead to an IPO so the company could raise money, like countless firms before them.
The Question: Was it unethical to consolidate all of the individual businesses under one parent?
My Answer: Are you kidding! This was one of the best things ever. The managers, who owned their part of the company, voted on it and voted on the valuation. It was approved and it was easier on everyone. The customers weren’t affected at all. All of those managers who had the sense to hang on to their ownership are now obscenely rich.
At the same time, Walton was able to approach a major life insurance company and get one, giant loan to pay off all the overwhelming smaller debt he had, making the payment lower and reducing the stress he faced each day.
To get to this point took more than a decade. He is still just showing up in backwater towns in Missouri, Arkansas, Kansas, and the surrounding areas, building stores and doing what he loves.
#2: As the Company Expands, Get Tax Advantages from Local Communities to Build New Wal-Marts, Effectively Lowering Costs
When Wal-Mart builds new stores, they sometimes go to a community and get special dispensations such as not paying property tax or having roads built at public expense to service the new business. Of course, Wal-Mart does bring jobs to the community, as the argument goes.
The Question: Is it ethical to seek public financing to create new businesses in a community?
My Answer: This is the only thing about Wal-Mart Stores that I think someone can honestly argue might be considered unethical simply because the same type of deals aren’t available to smaller merchants. However, on the other hand, you have several truths such as:
- There is nothing stopping the smaller merchants from becoming larger merchants, just like Sam Walton did (I mean, my own extended family built a seven-figure sporting goods store that competed with Wal-Mart and made them a very comfortable living; they had no money or connections when it was founded so, frankly, to complain that it is impossible is the talk of incapable people bitching that there are more talented and harder working folks in the world. It’s not easy to do, but it can be done.)
- The tax incentives are always handed out by publicly elected boards or appointed people accountable to publicly elected officials so, through the democratic process, people have the ability to say yes or no to a Wal-Mart coming to their community.
So this one, I can see someone arguing that this specific behavior crosses a line but, like I said, on the other hand the public is the one that chooses, through democracy, to give these incentives to attract business and anyone who is capable of building a large enough organization can get them for him or herself.
Part III – My Thoughts on Frequent Criticisms of Wal-Mart
They Don’t Pay Their Employees Enough
I feel incredibly strongly about this one. In fact, I have family members that work for Wal-Mart.
- If you have any drive or work ethic at all, you can work your way up the organization. The manager of a Wal-Mart Super Center is paid $90,000 to $100,000 per year plus the opportunity to earn a 0% to 100% bonus based upon store performance and the chance to take ownership in the company by purchasing shares of stock, just like Sam Walton did. You can get into that position within 15 years if you have any modicum of talent. If you aren’t there, it’s your own damned fault. From there, you can get into the higher company jobs, which pay really well.
- Why should someone be paid more than $22,000 per year for cleaning floors? That is a serious question. When I was young and had no skills or work experience, that is what I was paid. If I never progressed beyond that, it is what I would still be paid. In fact, Aaron started out as a janitor at a local factory, working during the summers. If he never went to college or never learned finance, people think he should be paid more – what – just because he’s been there a long time? What kind of inhumane, sick, twisted, sadistic world is it where men and women are able to demand something simply because of seniority? That is blasphemy.
- For the people who argue that someone can’t support a family on the wages paid to Wal-Mart entry-level workers: 1.) they chose not to get a better education and 2.) they chose to have children (unless they were raped, which is a statistically insignificant figure in the current argument on the ethics of Wal-Mart). Why is someone “entitled” to a specific wage for a job that requires no or little skills because of THEIR OWN life choices!? There is nothing wrong with not going to college and there is nothing wrong with having kids young. But if you do it, don’t complain about the results. Own your decisions. That is what freedom is! It is not society’s fault you have kids and aren’t skilled. You can fix the situation – go get qualified for something. Become a plumber. Or a copy machine repair man. Or an accountant. Those professions pay more.
- Does Wal-Mart pay its employees any less than a small town retailer would have paid its employees? If Wal-Mart ceased to exist tomorrow, any who believes the small town retailers that replaced it would be providing health care and decent wages is delusional. Why? Like I said, my extended family has owned retailers in small towns for generations – everything from gas stations and sporting goods stores to community banks to car washes. I grew up hearing the stories and meeting the people. It was minimum wage, at best, in almost all cases. But Wal-Mart has a consolidated work force so it is easier to attack. You can’t criticize tens of thousands of small town employers spread out throughout all fifty states. The big, bad corporation is easily identifiable.
The Bottom Line
How can someone call Wal-Mart’s advantage “unfair”? Seriously? I think it is more fair than almost anything else in life because I can’t go into the NBA – I’m not 7’11″ tall and no matter how hard I try, I never will be. But I can start a store tomorrow and compete with Wal-Mart. Will I have the same advantages they do in the beginning? No. But I will have advantages they don’t, such as the ability to build an incredible customer-focused service experience, which will allow me to charge higher prices.
To complain about Wal-Mart is to really complain about the choices of Americans exercising free will. It is to say that you, your friends and your neighbors cannot be trusted to spend your money – which represents time you sold and worked hard to acquire – because you are too stupid to know what you want. It is the worst kind of arrogance. Typically, it is only displayed by those who haven’t had to venture out into the real world and have no concept of how human nature works. Instead, they grow bitter that human nature doesn’t more closely resemble what they think it should be.
As for the fact that, as you rightly pointed out, Wal-Mart has never put anyone out of business, rather consumers did that by shopping there instead of with a competitor: What your professor is saying when she insists that it is unfair to expect people not to go into a Wal-Mart to save money is that they have no accountability for their choice. They “can’t help themselves”. Again, it is the worst sort of cynicism typically bred by those with little talent themselves. (You know, I can’t help but point out that Saudi Arabia uses that same argument against a woman when she is raped – it was her fault for being attractive to the man; he has no culpability. I have no pity for that type of tripe. Our lives are shaped by our decisions, both good and bad. We cannot control what happens to us but we can control our response to those things.)
It’s sad, but it’s true. I’d bet a hell of a lot of money that I could go into business against a person like that and following all the same rules, within a year, drive them into bankruptcy. Why? I work harder. I’m obsessed. And I LOVE meeting people’s needs in exchange for cash, which I can use to do other things with or give away to charity. It fuels me like coal thrown into the fire of a locomotive. So when my competitor was at home watching television, I’d be pouring over figures for the day. When he or she was taking their kids to the dentist, I’d be scouting out locations for new stores.
You see, men like me don’t want to get money. We want to make money. It is about the achievement. That is the underlying driving force. It has nothing to do with wealth per se. You already know I live on less than a school teacher does, have nothing of value in my home or office, and for years was too cheap to even buy a car!
Most of the time when people whine about unfair competition where there is none, it’s just them attempting to convince themselves that they aren’t as terrible in the cold, harsh weighing system of the free market economy as everyone else realizes they are.
That is it. Sorry, but this response is almost 4,500 words thus far and I’m not in the mood to go back and edit it. Plus, I’ve got plans for tonight so over and out …