Here's the Real Reason Wal-Mart Raised Wages

By Markets Fool.com

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Source: Wal-Mart.

Wal-Mart announced last week that it will be raising wages, and this news generated some negative feelings among both investors and Wall Street analysts. Many seem to believe that the company is putting employees and corporate image above investors with this decision. However, that's a shortsighted point of view. When digging below the surface, investors in Wal-Mart stock have good reason to applaud the company's latest wage increase.

It's not about image
Starting in April, all Wal-Mart U.S. employees will be making a minimum of $9 per hour, and by February of next year the company is planning to have all of its employees making $10 an hour or more. This is considerably above the federally mandated minimum wage of $7.25 per hour. In addition, Wal-Mart is offering a series of benefits for employees, such as a new training program providing more opportunities for professional development and the possibility of higher salaries in the future.

Wal-Mart has been heavily criticized for its low salaries and poor working conditions over the past several years. The company has taken a lot of heat from both employees and the general public, so one possible way of interpreting the salary increase is that Wal-Mart has given in to the pressure. Or maybe the company is just craving some positive publicity.

Another line of thinking in a similar direction is that Wal-Mart is looking to provide better income for its employees, many of whom are also Wal-Mart shoppers, to increase their buying power and hence the company's sales. However, this argument is not very solid from a mathematical point of view. The company will be reportedly spending nearly $1 billion extra per year with this increase, and only a fraction of that money can be expected to come back to Wal-Mart via higher sales, since company employees will necessarily spend less than 100% of the wage increase at the company's stores.

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Wal-Mart is doing the smart thing
Several factors have probably paid a role in Wal-Mart's decision to raise wages. Many states and local governments are raising the minimum wage above $9 per hour, so maybe management came to the conclusion that the increase was inevitable sooner or later.

However, the move also makes a lot of sense when considered in the context of Wal-Mart's long-term needs and business strategy. To begin with, lower hourly wages per employee don't necessarily mean lower expenses for the company.

Costco pays much higher salaries than Wal-Mart, in the neighborhood of $20 per hour. However, a 2006 article in Harvard Business Review compared overall wage costs for Wal-Mart and Costco, and it concluded that Wal-Mart could be spending more money than Costco because of its much higher employee turnover and associated expenses.

Also, salaries and other working conditions have a big impact on customer service and the overall experience, which obviously affects revenues over time. Costco's global membership renewal rate was an astronomical 87% in the last quarter, and the company is the highest-ranked player in its industry according to the American Customer Satisfaction Survey, with a satisfaction score of 84, versus a score of 80 for Wal-Mart's Sam's Club.

Costco is delivering impressive growth rates. Comparable sales excluding fuel and foreign exchange fluctuations jumped 7% in January. Wal-Mart, on the other hand, announced an uninspiring increase of 1.5% in comparable sales in the U.S. during the last quarter, while Sam's Club's comparable sales excluding fuel grew 2% during the period.

Wal-Mart CEO Doug McMillon admitted in the latest earnings press release that the company needs to improve the shopping experience, and a more talented and motivated workforce sounds like a smart way to make progress in that direction. At the end of the day, higher salaries could mean lower employee turnover costs and higher revenues because of more streamlined shelves and better customer service.

Employees are not only an expense line in the income statement; they are also a valuable resource for a company, perhaps even the most important resource when it comes to building a healthy business in the long term.

So, to sum it up, what's good for Wal-Mart employees is probably also good for the company's customers and investors.

The article Here's the Real Reason Wal-Mart Raised Wages originally appeared on Fool.com.

Andrs Cardenal has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.