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If you pay attention to tv news at all, you have heard time and again about workers demonstrating/striking for higher wages, higher benefits, etc.

There is nothing wrong with this and there are circumstances where such complaints are justified.

But there many examples of such actions putting companies out of business or forcing unacceptable tax increases.  So it can go too far.  And there are many examples where such demonstrations are part of a broader anti-capitalism campaign whose goal is disruption and destruction.

Worker wages are part of business costs.  What happens if those costs go up?  Who does and who should pay?

If you can take a small slice of time to understand the simple model which follows, the next time you see or hear about a wages demonstration or run across a budding anarchist, you can make a rational argument, understand one when you hear it, or recognize a hustler (they are legion).

Background

In an earlier life I worked in a business software company.  During that time I was in professional services sales and later on the business acquisition team.  Before that I worked as a management consultant.

All three jobs required me to have a grasp of business economics.  In the first case to understand what the potential customer could afford and in the second to help understand where management consulting should be applied.

Most people lack knowledge in this area because they do not encounter it, and college graduates may not even have taken a class in the subject.

Explaining business economics to the public is a key reason Scott Walker, Governor of Wisconsin, was able to stop the grasping state government unions from grasping further.  It is a simple, understandable model.

Basic Business Economics

Company profits are the usual basis for demonstrator complaint (genuine or otherwise).  The reason for this is that the public, and the media, can internalize that single number.

Citing a company’s or industry’s profit numbers – in dollars – complainants say that everyone is being ripped off and that the workers should have a “fairer share”, to borrow from our current President’s quaint social engineering lexicon.

Perhaps a particular company’s profits are excessive, perhaps not.  One thing is certain, the dollar amount of profit by itself has little to do with whether workers should be paid more.

Here is the base model used by every non-governmental enterprise

Business Cost + Desired Profit = Required Product Price

“Business Cost” is every cost the business incurs, such as: wages and benefits, taxes, advertising, maintaining and building new facilities, materials used to make the product, the cost of buying a product for resale, etc.

“Desired Profit” is across all types of products sold.  Profits fund upcoming Business Costs and provide dividends to stock holders who invested in the company.  In some companies it is the minimum they can accept, in others it is more of a product price component.

“Required Product Price” is the price point for products which is needed for the whole business model to work.  In practice, the actual consumer price can be at that level or above, depending upon the company’s competitive position.

When wages are raised, it has to come out of profit or be added to cost.  If it cannot be absorbed, product prices will rise.

Walmart

Walmart makes approximately 5% profit on each product sale.  95% of the product price is Walmart’s Business Cost.

The consumer pays the Desired Product Price or higher.  So if you purchase a $10.00 product from Walmart, for example, the company makes 50 cents in profit.

For 2013, Walmart had sales of 466 billion and a profit of 27 billion or 5.8%.  And they have happy shareholders.  They also have on-going operating and inventory costs across 11,000 stores worldwide.

How about the workers?  In Walmart’s case they could raise wages by as much as 50% while not disturbing their business model.  If you want to understand why: http://fortune.com/2013/11/12/why-wal-mart-can-afford-to-give-its-workers-a-50-raise/

Suppose they raised wages for their 1.4 million employees by 150%?  Prices would go up because, practically speaking, that cannot be done without raising costs.

Walmart would undoubtedly not do this as it would break their model as the low-priced alternative that also encourages investment.

McDonalds

How about McDonalds and all the noise that workers should be paid $15/hr.  First, McDonalds is not a single business entity like Walmart.  It is made up of 35,000 individually owned stores globally with 14,000 in the US.  Workers in each restaurant are employed by the local owner.

Doubling wages in each local McDonalds would raise business cost and consumer prices.  The average owner currently makes between 45-55,000 annually so there is no realistic way for him to absorb a doubling of wages other than to raise prices.

The McDonalds dust up is a hustle; a campaign to simply redistribute income from business owners to workers and a ploy to convince workers to unionize. If successful they would move on to others like Burger King. I doubt that this will work.

Who Should Pay

In the model where increased costs cannot be absorbed, prices rise, and we pay.  Should we?

Those with the money probably are not particularly bothered if their fish sandwich goes up in price by $1.  As is usual with altruistic ideas about “fairness”,  the middle class would be the ones hurt.

What about consumer goods across the board?  Same story, just worse.

It makes sense that when a company can absorb wage increases they should consider doing so.  It does not make sense for consumers to take a hit because of wage negotiations inside a company – or because of some errant government policy for that matter, such as doubling the minimum wage.

Summary

The bottom line is if a business cannot absorb its Business Costs, it will either raise prices or go out of business.  In other words, when workers and unions lobby for higher wages they are often lobbying for more money from you.

And if they are repeatedly successful at that and prices rise, you will go elsewhere if you can and the business they preyed upon will cease to exist.

Reasonable situations like Walmart right now, will not affect prices and only have a slight impact on shareholder dividend – the 1% if you will.

 

All things need to be kept in balance or things start to break.

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