McArdle on Costco vs. Walmart

Megan McArdle explains why and how Costco and Walmart have very different business models and serve different functions. We can’t expect Walmart to pay like Costco (or Trader Joe’s).

I’m going to quote here the same paragraphs David Henderson quoted at EconLog:

In other words, Trader Joe’s and Costco are the specialty grocer and warehouse club for an affluent, educated college demographic. They woo this crowd with a stripped-down array of high quality stock-keeping units, and high-quality customer service. The high wages produce the high levels of customer service, and the small number of products are what allow them to pay the high wages. Fewer products to handle (and restock) lowers the labor intensity of your operation. In the case of Trader Joe’s, it also dramatically decreases the amount of space you need for your supermarket … which in turn is why their revenue per square foot is so high. (Costco solves this problem by leaving the stuff on pallets, so that you can be your own stockboy).

Both these strategies work in part because very few people expect to do all their shopping at Trader Joe’s, and no one expects to do all their shopping at Costco. They don’t need to be comprehensive. Supermarkets, and Wal-Mart, have to devote a lot of shelf space, and labor, to products that don’t turn over that often.

Excerpted chart:

Notice the major difference in revenue per employee.* 

McArdle goes on to discuss how some people really need those low prices at Walmart:

That’s not the only reason that the Trader Joe’s/Costco model wouldn’t work for Wal-Mart. For one thing, it’s no accident that the high-wage favorites cited by activists tend to serve the affluent; lower income households can’t afford to pay extra for top-notch service. If it really matters to you whether you pay 50 cents a loaf less for generic bread, you’re not going to go to the specialty store where the organic produce is super-cheap and the clerk gave a cookie to your kid. Every time I write about Wal-Mart (or McDonald’s, or [insert store here]), several people will e-mail, or tweet, or come into the comments to say they’d be happy to pay 25 percent more for their Big Mac or their Wal-Mart goods if it means that the workers are well paid. I have taken to asking them how often they go to Wal-Mart or McDonald’s. So far, no one has reported going as often as once a week; the modal answer is a sudden disappearance from the conversation. If I had to guess, I’d estimate that most of the people making such statements go to Wal-Mart or McDonald’s only on road trips.

However, there are people for whom the McDonald’s Dollar Menu is a bit of a splurge, and Wal-Mart’s prices mean an extra pair of shoes for the kids. Those people might theoretically favor high wages, but they do not act on those beliefs — just witness last Thanksgiving’s union action against Wal-Mart, which featured indifferent crowds streaming past a handful of activists, most of whom did not actually work for Wal-Mart.

Yeah, pretty much that. I would gladly pay more for better service and better paid employees–in fact, I do. But I’m a college-educated person in the top 5% of US income-earners. I go to McDonald’s only on road trips. I go to Walmart only if we ordered something special through their online catalog and need to pick it up in their store. I pay $13500 a year so my kid can play with blocks at a Montessori school. I’m not the typical customer, and probably you also aren’t.  Neither are any of my philosophy colleagues who criticize these stores.

Try this experiment, which works especially well in Northern Virginia. Look at the cars in the Trader Joe’s parking lot (Mercedes C300s, BMW 335is, etc.) and then the cars in the Walmart parking lot (Nissan Versas, Toyota Corollas, old Honda Civics).

*Revenue per employee is not the employee’s marginal product, by the way.

McArdle’s final word:

This is not actually just a piece on how Wal-Mart can only pay low wages — I don’t know how much more they could afford to pay before they started to lose customers (or the board kicked the CEO out), and neither does anyone else writing about this. I’m actually interested in the larger point: the way that things most people rarely think about — like the number of products that a store carries — have far-reaching effects on everything from labor, to location, to customer service and demographics. We tend to look at the most politically salient features of the stores where we shop: their size, their location, the wages that we pay. But these operations are not so simple. They are incredibly complex machines, and you can no more change one simple feature than you can pull out your car’s fuel injection system and replace it with the carburetor from a 1964 Bonneville.


  • It may be useful to also look at it from the consumer’s point of view. The motivation is the same for shopping at Walmart as for shopping at Costco: to lower the unit cost of shopping and capture long-term maximum utility.

    This is possible at Walmart because Walmart’s business model involves whittling-down their costs as far as they will go, by keeping labor costs low, negotiating special and exclusive deals with suppliers, and leaning heavily on economies of scale.

    But being a Costco customer requires that the customer pay substantial up-front costs. Most notably: the membership fee, the ability to either pay cash for everything or qualify for a Costco AmEx card, and the ability to store large quantities of food at home.

    It is certainly worth paying these costs if you can afford to do so; shopping at Costco saves me a lot of money. But not every customer has that kind of wealth; and those lower-income customers are the ones who choose Walmart instead.

    • John Alexander

      Just a comment on your last point. If one is opposed to Wal-Mart, one could band together with like-minded neighbors and shop at Costco and divide what is purchased.

      • Les Kyle Nearhood

        …Or form your own co-op. Or pay more at mom and pop stores and never find what you want. Or, just shut up about Walmart already.

      • Sean II

        That’s just rich-people thinking, innit though?

        Part of what makes poor people poor is that they’re not so great at four things required by your plan: creativity, harmonious social cooperation, forethought, and arithmetic.

        One of the services Walmart provides is….it does those things so poor people don’t have to. In other words, Walmart is the co-op that was formed for the purpose you describe.

    • TracyW

      I’m not American. But I understand from Megan’s post that Costco doesn’t stock as wide a range of products as Walmart.

      So it’s not just a matter of being able to afford to bulk buy, it’s also a matter of affording more shopping time (to visit two places) or really limiting yourself.

    • Theresa Klein

      I’m just curious how if Costco saves you a lot of money, why it is still not cheaper than Walmart. Or is it?
      Is the membership fee a hurdle that separates the poor from the middle-class, so you don’t have to shop with the unwashed masses, or are you objectively spending less money?
      Or are you a consumer that actually uses up a lot more toilet paper and canned goods per month than the typical Walmart customer so you’re making it up in volume?

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  • Ted_Levy

    “Revenue per employee is not the employee’s marginal product, by the way”

    I’m not sure if this is Jason’s addition or in McCardle’s original, but either way it counts as evidence of the presumed (and likely accurate) level of economic ignorance among the readership…

    • Jason Brennan

      @Ted: It’s mine.

      Certain Marxists read this blog, and I assume, based on experience, they don’t understand this stuff. Not meant to be an insult to the many readers that know mainstream economics.

      • Ted_Levy

        I found it more amusing than insulting, and you’re right to be cautious. I recall when I worked the front counter for McDonalds I noted that I brought in over $100/hr (in 1971 $!), that this must be my marginal value product. But I was only 16, so perhaps the error may be forgiven. 🙂

        • Chmee

          I can’t remember what the min wage back then was, $1.25 or $1.50? I’ll assume the higher. When I started working for them in ’76 I think I got about $2.25.
          Some pretzel logic here; Assuming their margins are about 3% (I’m guessing here, other food service jobs I had were in that ball park) that would mean that your pay consisted of about 1/2 of their bottom line if you produced $100 of sales each hour. I guess you could look at it as though they split 1/2 the profits with you. I’m probably being too simplistic, and maybe not even thinking about it correctly, the actual accounting is more complicated.

          • Ted_Levy

            Yes, Chmee. Much more complicated. Also very different. In fact, McDonalds could be running at a loss and I could still have a positive marginal value product, so it has nothing to do with their margins. But you do make Jason’s general point. 🙂

  • Pierre_Corneille

    I generally agree with this post and with McCardle’s article. But one thing that bothers me is that the comparison ought to be not between Costco and Walmart, but between CostCo and Sam’s Club.

    But again, I think I agree with the argument.

  • Steve

    So why doesn’t Costco pay their employees less and pocket the difference? Do they need to be paying their employees so significantly more on average in order to maintain their business model?

  • Sofia Caden

    Costco stock currently trades at a premium of roughly 63.2% to retail giant Walmart’s. http://bit.ly/1hMQaLv

  • nunyabidnessfoo

    Trader Joe’s is actually incredibly inexpensive. I do most of my shopping there vs Kroger because it’s cheaper than Kroger, the customer service is far superior, and the store and the clientele are less aesthetically displeasing. I don’t really know how they stack up to Walmart because I avoid Walmart like the plague. If I’m going to give my money to spoiled billionaires (a friend of my sister is a nanny for one of the Waltons so I have heard stories), I’d at least want to be surrounded by people who aren’t the dregs of society. If I need to go to a big box store I’ll hit Tarzhey.

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