Cheaper always better?

Ten years ago, circa 1995, as a cash strapped graduate student in California, I bought a pair of trousers from Costco for $28. This seemed a perfectly reasonable price to pay. In the last month or so, with a reasonably well paying job, I bought three pairs of trousers for about $30.

So what happened?

Trousers, unlike my area of expertise - semiconductors, are not getting cheaper because we have better designs, or that we can make more trousers from the same amount of cotton or wool.

The answer to the question "So what happened" is not that easy. But once it is analyzed, it explains many other seemingly unrelated issues.

The foremost is productivity: people in the US are working more efficiently therefore producing more in the same amount of time. Whether it is stitching buttons or making trousers fly off the shelves, we are doing more in the same amount of time.

Next is average wages: for the amount of work produced people are getting paid less. So the cost per pair of pants has gone down. This gets even more stark when we look at the countries that are making these trousers. Earlier it used to be the Dominican Republic or Puerto Rico, countries that are cheaper than the US but not by much. Today it is Bangladesh, India and Sri Lanka. The same dollar gets many more trousers made in these countries. The search for cheaper places will continue. It will not be long before the
Republic of Congo or Rwanda will become stable for business and they will be cheaper than India.

Third is economies of scale: With Walmart and Costco getting into the business of serving practically every aspect of human need, it is a lot easier for them to "squeeze" suppliers and transporter, and thus make it cheaper to buy and cheaper to transport goods. Net effect is that the supplier has smaller margins as do the
transporters.

Fourth is lowered services: Have you tried getting help with finding something specific in Costco or Walmart? They have adopted different approaches. Costco has very few but highly trained people
who do everything from pointing out where items are stocked, being the cash clerk and disposing off trash. Walmart hires low wage workers with little or no training to restock shelves. They may or may not
be able to help you with finding your things. Essentially you are on your own. This effect is seen everywhere: you talk to an ATM rather than a teller, a broken DSL connection takes days to fix,
it is harder to switch long-distance carriers today that it was ten years ago. In effect, the quantity and quality of services have gone down, hence cheaper.

Fifth is lowered profit margins: I have touched on this in the third point. But, Walmart is happy with a net profit of 2.7%. With sales pushing several hundred billions of dollars, it is a lot of cash. Also, expense per employee is low enough since there there are little or no incentives like profit sharing, stock options,
pensions. All this makes them work in a very lean fashion.

Sixth is comparison shopping: Pre-internet comparison shopping was restricted to physical comparison through newspapers, junk mail or actually visiting several stores. Now, wonderful tools like Bizrate.com or Dealtime.com will let you do that in a fraction of the time and compare many more stores. A great "deal" will tempt any user to pass up shopping at his local store (even if he likes the floor manager or the sales person) and buy it from an internet place or a store across the town.

So what is the fallout of all this?

Firstly, the goods are generally cheaper than ever before, even after accounting for shipping. The tax implications of buying outside the state are still unclear, but it is something that actually makes it worthwhile to buy off the internet today.

Secondly, there is a lot more variety and choice when you buy from Amazon. The Amazon apparel store is like Macys, Target, Bloomingdales, Lands End and many others in one. You can look for exactly the correct number of pleats you want in front of trousers which are the exact shade of green that you want.

Thirdly, shopping at Walmarts and Amazon will close down the last of the mom and pop stores, and even perhaps many of the medium sized players. The grocery stores vs workers union struggles of S. California in 2004 essentially highlighted the inability of Safeway and Albertsons to compete with Walmart in the business of selling groceries. The closing down of small store fronts will profoundly affect communities. By being small and a tad inefficient, they supported more workers. They also kept communities in a certain balance by not allowing the owners to treat the employees badly. Today there is effectively only the government that can twist the proverbial arm of Walmart to provide health benefits to its workers. By removing the personal touch to shopping, the shoppers have no loyalty to the shop, the owner or the product. They will happily take their business to the next cheapest vendor. This will make the system inherently unstable. Today's success story will not have enough foot traffic or "eyeballs" passing through it tomorrow and after a little struggle will go into chapter 11. The downtowns in prosperous communities will have nothing but galleries and restaurants. Restaurants will be owned by chains or will provide high-end entertainment to its rich clientele. This will similarly lead to the Walmartization of the restaurant business
too.

Fourthly, even large companies will continue to work towards cheaper goods and smaller margins. This will lead to tremendous instability in the financial health of these entities. A small delay, a small change in the price of oil, a small change in the salaries of the truck drivers, a small error in estimation of inventory etc will all lead to massive fluctuations in the stock price. With highly automated stock trading setups in place
a ten percent fall will trigger automatic sales leading to a dramatic drop in stock price quite disproportionate to the actual gap in estimated earnings and reported earnings.

Fifthly, to keep the prices low the companies cannot afford to hire trained staff or provide on job-training. The workers will work for years without maturing as employees and will remain entrenched in the lowest salary bracket. Even as their families grow their salaries will not grow. The expected upward mobility in job, salaries are expected and even necessary to have happy and stable families. In the absence of this upward mobility the families are effectively moving lower into and economic quagmire making it harder for the children to rise above it. The family issues aside, there will be a gradual deterioration of services provided. There will be more errors in processing of bank statements to filling prescriptions to putting together computers. There will me more and more people at the other end of helplines who have no idea how to fix your issues.

Finally, the only way to grow profits and satisfy the insatiable demand of Wall Street to grow the bottom-line is to sell more goods. To buy those goods the customers have to spend more. However, for
all the above reasons the salaries cannot be expected to increase. So the savings rates have to fall. This is already being seen. Americans are saving less than they ever have. This will force families to have ever decreasing financial buffer to tide over lean patches. With job cuts, lay offs becoming increasingly common, the country will head to a socio-economic disaster.