Tuesday, March 25, 2014

When Higher Labor Costs Increase Sales Volume

There's this notion, "Lower labor costs are good for the rich." So some say.

Partly. In micro, yes. In macro, no. Directly and individually, yes. Indirectly and in aggregate, no.

Imagine if my company A sells widgets and competing company B sells widgets and companies C-Z sell other things but not widgets and the employees of companies C-Z buy widgets from A and B. If I unilaterally raise the wages 10% within company A but B doesn't follow suit, that's bad for my relative profit margin. (And it raises the question of whether B's larger profit margin is of more advantage then my potential increased worker loyalty and morale ... which could go either way.) But if all companies A-Z raise the wages, then A and B can both sell more widgets because the employees of companies C-Z have more money to spend.

When one company increases wages alone, it's playing a somewhat risky game. If workers feel more loyal and dedicated on account of the increase, that could boost production, reduce inventory shrinkage, and diminish costs from absenteeism and turnover. As a microcosm of the business world, the increasing company has to place a bet as to whether those advantages will make up for increased wage costs to keep profit margins as good as or better than those at competitors.

It's a different story when all companies engage in the same increase. The in-market competitive risk (seen in a unilateral increase) doesn't apply. Instead, since most products will have a lower mark-up to make up for wages than the amount of the wage increase, it's only a question of whether the increased wages of each company's customers boost sales volume and how much that boosts profits.

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