[Orin Kerr, June 9, 2008 at 11:06pm] Trackbacks
U.S. Senate Discovers The Problems With Big Government:
At least when it comes to the Senate's government-run restaurants.
Bill Poser (mail) (www):
Leaving aside the chestnuts about how the government can run anything and business is so great, does anybody know what exactly went wrong with the Senate food service and how, if it all, it was a consequence of it being a government operation?
6.10.2008 12:16am
A. Zarkov (mail):
"... what exactly went wrong with the Senate food service and how, if it all, it was a consequence of it being a government operation?"

What went wrong was the employees were paid too much in salaries and benefits. If the food prices reflect the true labor costs then the meals get too expensive and people take their business elsewhere. The only way around that is to subsidize the meals with tax payer money. Politicians like to be generous to workers with other people's money, and that's a consequence of being a government operation.

If you look at the pre-tax revenues for employees at various companies you will see why wages are what they are. Walmart earns about $10,000 per employee per year. If Walmart were to give it's employees the medical benefits many people think they deserve, then it would reduce Walmart's return on tangible capital (the right number to look at) to less than a riskless T-Bill. Therefore Walmart would have to change its business model away from low wage and low prices. But people really like the low prices.

Apply the above analysis to a food service operation and you will see why the government-run version lost money.
6.10.2008 12:41am
Snarky:
First of all, I would not call a restaurant or even several restaurants "big" anything, much less "big government."

I think Feinstein said it well:


"It's cratering," she said of the restaurant system. "Candidly, I don't think the taxpayers should be subsidizing something that doesn't need to be. There are parts of government that can be run like a business and should be run like businesses."
6.10.2008 12:54am
Oren:
Zarkov, that logic is contradicted by the experience of Costco which pays twice WM's starting wage and included generous health benefits and yet still manages to keep prices low through generally efficient (and amazingly customer-friendly) policies combined with solid management on all levels. The old pablum that you have to stiff the employees in order to be successful just doesn't cut it anymore (unless you have some explanation of why Costco is somehow immune to the general rule -- which I'd love to hear).
6.10.2008 1:04am
OrinKerr:
Snarky writes: "First of all, I would not call a restaurant or even several restaurants "big" anything, much less "big government." "

Irony sometimes calls on the author to invert meaning.
6.10.2008 1:21am
David M. Nieporent (www):
But Sen. Robert Menendez (D-N.J.), speaking for the group of senators who opposed privatizing the restaurants, said that "you cannot stand on the Senate floor and condemn the privatization of workers,
What the hell does that even mean? "Condemn the privatization of workers"? He thinks all workers ought to be government employees?

"I know what happens with privatization. Workers lose jobs, and the next generation of workers make less in wages. These are some of the lowest-paid workers in our country, and I want to help them," Sen. Sherrod Brown (D-Ohio), a staunch labor union ally, said recently.
"...with someone else's money," he added. "After all, I'm a Democrat."
6.10.2008 1:34am
L.A. Brave:
Oren:
1) Costco and Walmart are in similar, but nevertheless materially different businesses.
2) Walmart has higher net margins (90% higher), gross margins (120% higher), return on assets (50% higher), and return on equity (58% higher).

You can scope the numbers out here: WMT, COST
6.10.2008 1:42am
A. Zarkov (mail):
Oren:

"... that logic is contradicted by the experience of Costco"

Costco has 70,000 employees and annual pre-tax revenues of $1.5 billion (2005). That yields $21.4k per employee. Compare that to Walmart which has 2.1 million employees at $16.3 billion (2005) pre-tax revenue. That yields $7.76k per employee. Thus Costco has almost 3 times the revenue per employee.

Actually it's an error to compare Costco to Walmart since they operate on very different business models. Costco targets a more affluent suburban shopper who buys in bulk. They locate their stores to service this market, and they offer a limited but changing portfolio of goods. Costco is a warehouse store while Walmart is more like a conventional department store offering a wide variety of standard goods.
6.10.2008 3:32am
A. Zarkov (mail):
Oren:

For your pleasure and education, below find an excellent post from DeLong's website. You can find the original here. Go to the post by sd. He discusses exactly how Costco differs from Walmart.



Here we go again - another fawning profile of Costco and their enlightened labor practices, with the implicit assumption that Wal-Mart and other retailers could match Costco's wages is only they weren't so "greedy."

This is simply wrong. Spectacularly wrong. Wrong wrong wrong. Let me explain why.

Costco runs a fundamentally different format with a fundamentally different value proposition that other retailers. A retailer's major costs are:

1) Cost-of-goods
2) Occupancy (i.e. the building)
3) Labor

Now let's compare:

1) Costco's cost-of-goods is essentially the same as any other retailer, adjusted for product mix.

2) Their occupancy costs are a lot lower. There are two reasons for this. First, Costco is a destination store that people go to in order to stock up on select items. You don't typically see people hitting Costco on the way home from work to pick up a couple of things for supper. Because of this, Costco does not have to offer substatial locational convenience to its customers, which allows it to operate far fewer stores than other retailers. A single Costco store can draw customers from a wide radius because its an occasional destination store. Thus the sales productivity of any given square foot of Costco retail space is much higher than that of a Wal-Mart or a traditional supermarket (that's why they are so bloody busy on Saturdays). Other retail formats cannot replicate this, because they serve the substantial unplanned convenience shop need - picking up a few things for supper. Higher sales per square foot means lower cost of square footage per dollar of sales.

Second, Costco stores are less capital intensive than other retail stores. The aisle gondolas in a Wal-Mart or traditional supermarket - with their extensive shelving for small pack size items - are actually very expensive. Huge steel warehouse racks that you can park pallet loads of 5lb Corn Flakes boxes are cheap. But not everyone wants 5lbs of Corn Flakes, at least not every time they shop. In addition, Costco stores are poorly lit and not very nice. People put up with this for a once a month trip to load up the pantry, but prefer a more pleasant experience for their routine shopping needs.

3) Labor costs are a function of labor rate (how much you pay employees) and labor productivity (how much sales volume an employee can serve per unit of time). As pointed out above, Costco's labor rates are higher than other retailers. But their labor productivity is also higher - MUCH higher in fact. And it has nothing to do with Costco's employees being happy, healthy and proud. It has everything to do with the fact that Costco's store format doesn't require much labor. First, dropping a pallet full of merchandise in the middle of the floor or on a warehouse rack requires almost no labor. Manually stocking shelf after shelf with individual boxes of spagetti takes a ton of labor. Second, it takes the exact same cashier labor to scan a $15 10 box multi pack of cookies as it does to scan a $2 single box of cookies.

For these reasons, Wal-Mart's total labor costs, as a % of revenues, are actually HIGHER than Costco's. Indeed if Wal-Mart's labor productivity were as high as Costco's they could (and almost certainly would) fire hundreds of thousands of employees. A Wal-Mart job may well may a shitty wage but shitty > zero.


As long as most people prefer the traditional retail experience for most of their shopping trips (and they do; I've seen the customer research data), it will be impossible for Wal-Mart or the traditional supermarkets to match Costco's economics. And without Costco's economics, it is indeed impossible to pay workers a high wage and still give the customer low price

s.
6.10.2008 3:41am
Sam Hall (mail):
"As long as most people prefer the traditional retail experience for most of their shopping trips (and they do; I've seen the customer research data), it will be impossible for Wal-Mart or the traditional supermarkets to match Costco's economics. And without Costco's economics, it is indeed impossible to pay workers a high wage and still give the customer low price "

Anybody know what Walmart pays in their Sam's Club stores?
6.10.2008 6:26am
A. Zarkov (mail):
"Anybody know what Walmart pays in their Sam's Club stores?"

A very good question. At least superficially Sam's Club has the same business model as Costco. But having never been in a Sam's Club I don't know for sure. Is Sam's Club a separate corporation from Walmart?
6.10.2008 7:07am
10ksnooker (mail):
What went wrong is the demand curve went way up, the performance curve went way down. Typical of every government program. Take the proposed healthcare and study the Massachusetts plan -- all that happens is the demand becomes infinite and the supply finite. Then it goes broke, unless they throttle back on the supply like they recently did in England when they took beds out of hospitals to limit demand and lengthen lines.

All free does is make demand infinite. Try it yourself the next time you see a 'free something ad'. See how long the lines get and how quick the supply runs out.

After watching the Soviet Union for tens of years struggle with empty shelves and no supply, you would think people like Comrade Obama, as smart as he is alleged to be, surely a debatable point, would know this. Communism doesn't work -- err sorry, I meant collectivism,
6.10.2008 8:30am
Prof. S. (mail):

"Candidly, I don't think the taxpayers should be subsidizing something that doesn't need to be. There are parts of government that can be run like a business and should be run like businesses."


Candidly, Ms. Feinstein, that's what we've been saying for decades.

I also want to applaud David M. Nieporent who is spot on with his earlier comments.

This definitely sounds like the group I want running my healthcare system.
6.10.2008 9:16am
Alex Denmark (mail):
And we want these people to run health care? Count me out.
6.10.2008 9:20am
cboldt (mail):
The employees have generous options going forward.
(Text of S.2967)
6.10.2008 9:34am
ClosetLibertarian (mail):
The problem is wages aren't linked to productivity. FYI, Congress is freezing privatization competitions (A-76) for other parts of government.
6.10.2008 9:43am
Aultimer:
Oren never said Walmart and Costco are the same, he only said that the purported approach of Walmart, to pay poorly and with poor benefits, isn't the ONLY way to make money.

L.A. Brave's numbers back that up nicely, and further suggest that Walmart could apparently afford significantly more employee cost while remaining a more attractive stock than Costco.
6.10.2008 11:31am
A. Zarkov (mail):
Aultimer:

"L.A. Brave's numbers back that up nicely..."

How's that? Margins are irrelevant in this context. It's revenue per employee. If you up labor costs you have less left over to provide a sufficient return on capital.

Return on equity is not the same as return on tangible capital. Tell me how at a pre-tax revenue per employee of $7,760, Walmart is going match the benefits of Costco without raising prices? A medical plan covering a family costs something like $500 per month of $6,000 per year. That leaves a per employee revenue of $1,760. Walmart would be better off investing in T-Bills than opening a new store. Return on tangible capital tells you exactly how efficiently a company runs its enterprise.

Currently Walmart Stock sells at a P/E of 14. Do you think the stock would be attractive at a P/E of 62? Or even half that? You need to tell us what numbers you use in the universe you live in.
6.10.2008 12:37pm
Smokey:
Aultimer:
Oren never said Walmart and Costco are the same, he only said that the purported approach of Walmart, to pay poorly and with poor benefits, isn't the ONLY way to make money.
OK then, this is where the rubber meets the road: Aultimer and Oren can get together, draw up a business plan, and open a store like Wal-Mart, but with much better pay and benefits for the employees.

I'm sure your intentions are admirable. But what you are proposing is impossible. Not just unlikely; impossible. The only way to claim that it could be done is to conflate Costo with Wal-Mart. They are entirely different business models [also, one thing that was left out of Zarkov's post above in point #2 is the fact that Costco pays substantially less for store rental than Wal-Mart, because Costco stores can be away out in the boonies, while Wal-Mart stores require a premium location.

Lots of corporations would just love to eat some of Wal-Mart's lunch, while paying employees more and giving greater benefits. But that is as impossible as "free" health care.
6.10.2008 12:55pm
Oren II:
Walmart would be better off investing in T-Bills than opening a new store.
Precisely. As you pointed out earlier, the sales per sq. ft. of retail space for Wal-Mart is much lower than Costco. That leads to the inexorable conclusion that there are just too many WMs -- the additional stores that they open in an area do not generate new sales, they parasitize sales from the existing ones.

Incidentally, while we are on government subsidies, why don't we include in the WM total the amount of government benefits claimed by WM's employees. (NB: I don't for a second believe the wacky numbers quoted by the "report" but the principle is indeed true: State governments subsidize WM's low wages).

At any rate, Aultimer is right -- I'm not implying that WM should adopt Costco's labor policies but rather that it is entirely possible to compete very well while still paying quite well. Specifically, I wanted to rebut (or maybe just oppose) Zarkov's diagnosis that the problem was that wages were too high -- wages can be kept high while still making a good profit.
6.10.2008 1:36pm
Chrisc:
Aultimer and Oren II: You seem to be saying that you admit Walmart is not in the same business as Costco, but that Costco never-the-less shows that Walmart can afford better pay and benefits. By the same token Google or Berkshire Hathaway make great money while paying their employees a great deal more. Clearly if Warren Buffet can rake in the dough at an investment company then all Walmart (or Costco, for that matter) needs to do to compete and reimburse their employees better is to adjust their business practices to be an investment company instead.

(I'm not even going to touch just how "inexorable" the conclusion is that because warehouse stores can be spread apart that discount stores should also be spread apart.)
6.10.2008 2:01pm
A. Zarkov (mail):
"Specifically, I wanted to rebut (or maybe just oppose) Zarkov's diagnosis that the problem was that wages were too high -- wages can be kept high while still making a good profit."

What you are saying is Walmart should simply go into a different line of business so they can pay their workers more. You have not told us how Walmart can stay in the business they're in and raise salaries. Do you think Walmart is simply inefficient?

Like Walmart, the food service business has low markups and is labor intensive. Even very high priced restaurants don't pay well (other than the chief), the waiters depend on tips. The only way the Senate restaurant can go into the black is to raise prices or lower wages. If they raise prices the customers will go somewhere else or bring their lunch.
6.10.2008 2:04pm
Oren:
Do you think Walmart is simply inefficient?
Yes. For one, I think they have at least twice as many stores as they reasonably need -- by increasing the density of their stores they may succeed in drawing some sales away from other retailers but they also reduce their efficiency. This strategy looks successful in the short run but is not sustainable as each store increases fixed costs and labor costs while drawing significant sales away from their other locations.

At any rate, WM is just as beholden to government subsidies (in the form of benefits for their workers) as the Senate restaurant is. The least one can say for Costco et. al. is that their employees are not a drain on the State's resources.
6.10.2008 2:24pm
Mr L (mail):
At any rate, WM is just as beholden to government subsidies (in the form of benefits for their workers) as the Senate restaurant is. The least one can say for Costco et. al. is that their employees are not a drain on the State's resources.

Yes, shame on Wal-Mart for employing seniors and the disabled. Better that they should never be hired in the first place! Fortunately, Wal-Mart's proactively taking steps to correct this imbalance with physical requirements and other measures designed to discourage those who are 'a drain on the State's resources.'
6.10.2008 3:04pm
OK lawyer (mail):
What galls me is that these are the same folks that want the government to run everything.

It would be like Phil Jackson saying, "Kobe, you just won the MVP, are pretty much regarded as the best player in the world right now, almost brought us back from 20+ points down on the road against the team with the best record, single handedly defeated the defending champs in 2 of our games, so I am not going to play you the rest of the season."

I simply cannot understand it. It is actually making my head hurt.
6.10.2008 3:51pm
D Palmer (mail):

What went wrong was the employees were paid too much in salaries and benefits. If the food prices reflect the true labor costs then the meals get too expensive and people take their business elsewhere. The only way around that is to subsidize the meals with tax payer money. Politicians like to be generous to workers with other people's money, and that's a consequence of being a government operation.

If you look at the pre-tax revenues for employees at various companies you will see why wages are what they are. Walmart earns about $10,000 per employee per year. If Walmart were to give it's employees the medical benefits many people think they deserve, then it would reduce Walmart's return on tangible capital (the right number to look at) to less than a riskless T-Bill. Therefore Walmart would have to change its business model away from low wage and low prices. But people really like the low prices.

Apply the above analysis to a food service operation and you will see why the government-run version lost money.


M. Zarkov, I don't agree. I didn't see any mention of expensive food. What I read about was boring, static menus and mediocre quality. In the best Soviet Union tradition, workers, their pay unfettered by responsibility for quality, live up to their lack of responsibility.

Good waiters in top restaurants can make 6-figure incomes. line cooks and even bus boys are paid well. Food prices are astronomical, portions are tiny, yet the wait for a table is measured in months.

The government is not Walmart. Profit should not be a factor in this kind of operation. The goal should be to pay a reasonable wage and break even. I don't need the Senate food service to provide additional income to supplement education in the US. Just pay for itself.
6.10.2008 4:47pm
LM (mail):
It's interesting that this whole thread proceeded from A. Zarkov's speculation that the restaurants failed because employees were overpaid. For what it's worth:

In a masterful bit of understatement, Feinstein blamed "noticeably subpar" food and service. Foot traffic bears that out. Come lunchtime, many Senate staffers trudge across the Capitol and down into the basement cafeteria on the House side. On Wednesdays, the lines can be 30 or 40 people long.

"It's so bad that the Senate hasn't yet figured out that House 'Taco Salad Wednesday' trumps any type of entree they have to offer," said Ron Bonjean, a former press secretary to both the House speaker and the Senate Republican leader.

"Those who think the House and Senate don't talk enough clearly haven't been in the Longworth cafeteria on the House side at lunchtime recently. Senate staffers have been flocking there for better food, more options, and you get some exercise to boot," said Brian Walsh, spokesman for Sen. John Cornyn (R-Tex.),who frequently dines on the other side of the Capitol.

In the past 10 years, only 20 new items have been added to the Senate menus. So rare are new entrees that last year's arrival of daily fresh-made sushi was treated in some senatorial quarters as if a new Nobu had opened in the Capitol dining room.

If I'm not mistaken, the essential failure of Communism wasn't that the workers were lavishly overpaid.
6.10.2008 4:56pm
LM (mail):
D. Palmer beat me to it. Sorry for duplicating.
6.10.2008 4:58pm
D Palmer (mail):

Even very high priced restaurants don't pay well (other than the chief), the waiters depend on tips.


And you, the restaurant owner, and the server benefit from this arrangement.

I'm sure that you, like me, expect to pay from 15%-20% more than the amount of the bill in the form of a tip.

Let's say that the restaurant owner decided to raise the average wage of the staff to what they currently receive in wages + tips (keep in mind that most servers share some amount of their tips with the bar and bus staffs). Here's what happens:

1. The average server makes less money as FICA and income taxes are withheld from the check.

2. The highest performing servers make far less money as their wages are now fixed. As a result, they leave to go work at restaurants that allow them to make the most money for their efforts, and the quality of service at the restaurant declines.

3. The restaurant owner adds a profit margin to the higher wage expense, pushing up food prices by more than the incremental increase in wage costs. Plus, because the business owner has to contribute 7% of gross wage to SS, the base labor cost increase is MORE than just a dollar for dollar trade of tips for wages.

So, in summary, by eliminating tips and paying a higher salary we get: poorer service and an increase in food prices greater than the amount of extra wages received by employees.

The communists would be proud.
6.10.2008 5:12pm
Whadonna More:

A. Zarkov
"L.A. Brave's numbers back [] up [the fact that the WalMart way isn't the only way to make money] nicely..."

How's that?


Costco makes money - to wit: positive net margins, return on assets and return on equity. So does Walmart, and then some. That was the only assertion.

You and Smokey are flogging the strawman called "Walmart would be as MARKET COMPETITIVE if they paid at Costco levels". That wasn't the claim.

To bring it back - the issue isn't whether the Senate Dining Room is competitive with (for the sake of argument) the Union Station food court or with the Army Navy Club on salary and retail prices - the issue is whether the operation can be made profitable (or even break-even) while paying more than the minimum possible wages. Zarkov says no, I say yes.
6.10.2008 5:15pm
A. Zarkov (mail):
Oren:

"Yes. For one, I think they have at least twice as many stores as they reasonably need --..."

You're telling us that Walmart doesn't know retailing well enough to avoid cannibalizing it's own business. How many retail stores have you run? If Walmart is so inefficient than how come someone hasn't come along and put them out of business by selling cheaper?
6.10.2008 7:10pm
A. Zarkov (mail):
"... the issue is whether the operation can be made profitable (or even break-even) while paying more than the minimum possible wages. Zarkov says no, I say yes."

The Senate restaurant pays well above minimum wage, and that's why the opposition does not want to privatize it. They know another vendor will lower wages to avoid losing money. Now evidently the Senate restaurant also had poor service and a limited menu adding insult to injury. Moreover if it's so easy to break even while paying good wages, how come no one has managed to do it?
6.10.2008 7:20pm
A. Zarkov (mail):
Whadonna More:

"Costco makes money - to wit: positive net margins, return on assets and return on equity. So does Walmart, and then some. That was the only assertion."

No that was not the only assertion. Let me repeat Oren's assertion in full:
"Zarkov, that logic is contradicted by the experience of Costco which pays twice WM's starting wage and included generous health benefits and yet still manages to keep prices low through generally efficient (and amazingly customer-friendly) policies combined with solid management on all levels. The old pablum that you have to stiff the employees in order to be successful just doesn't cut it anymore (unless you have some explanation of why Costco is somehow immune to the general rule -- which I'd love to hear)."
That sure sounds like asserting that Walmart could pay salary and benefits as generous as Costco's. But as my analysis shows Walmart's business model does not apply to Costco. No one has said where the money for the increase in salary and benefits is supposed to come from, other than asserting that somehow Walmart is inefficient because it has too many stores and could raise wages by becoming more efficient while remaining in the same business.
6.10.2008 7:30pm
Whadonna More:

A. Zarkov (mail):

The old pablum that you have to stiff the employees in order to be successful just doesn't cut it anymore (unless you have some explanation of why Costco is somehow immune to the general rule -- which I'd love to hear)."


That sure sounds like asserting that Walmart could pay salary and benefits as generous as Costco's.

Not to me.


Moreover if it's so easy to break even while paying good wages, how come no one has managed to do it?

"Easy" isn't the standard. Most restaurants fail, but many don't.
6.11.2008 12:01pm
D Palmer (mail):

Moreover if it's so easy to break even while paying good wages, how come no one has managed to do it?


At least in the case of the Senate restaurant I suspect it is because there was never an expectation that they would break even.

Why do you think that the House operations make a profit? It's not just because they pay their people less, it's also because the managers know that if they lose money they lose their jobs.

This is why so many government run 'businesses' lose money by the bucket full. Employees get paid regardless of performance and eventually most become complacent and do anly the minimum necessary to keep their jobs.
6.11.2008 12:33pm