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Wednesday, August 24, 2011

Sardines at Midnight

Sardines at midnight? If the mood should strike me, I can zip down to the local Safeway store here in Belmont, California, which is open 24/7, and be back with a can in 20 minutes. My biggest problem would be choosing from among Thai, Canadian, Polish, or Norwegian sardines packed in water, olive oil, tomato-basil, or soybean oil.

So what? It’s darn near a miracle, that’s what, and would seem so to most inhabitants of today’s world and everyone in yesterday’s world. Leonard Read’s phrase “The Miracle of the Market” was only a slight exaggeration. I won’t attempt to describe how markets miraculously motivate and coordinate the actions of the thousands of people who cooperate in providing me with sardines. Nobody can do that better than Leonard Read did in his classic “I, Pencil.” If for some reason you haven’t read it, stop now and do so.

The increased quantity and quality of the conveniences available to us are really amazing. We should stop to think about them from time to time, paying special attention to the incentives that brought them about.

I have vague memories of the Fisher Brothers grocery store where my mother took me around 1950. The place was tiny and the selection limited. Looking back, I wonder about its cleanliness: The owners kept sawdust on the floor to soak up spills. Later they built a supermarket that was much larger but still only a pale precursor of today’s Safeway. A mix of union coercion, government regulation, and perhaps just plain custom kept all supermarkets closed after six p.m. Monday through Saturday and all day Sunday. A working woman had to scramble to get her shopping done before closing time or join the mob on Saturday.

Our local Safeway was remodeled a few years back. Over the perfunctory objections of the union, management installed scanners. Five checkout lanes replaced eight, and waiting time was drastically reduced. Now the clerks seem to enjoy swiping the goods over the scanner. Some do it with the grace and aplomb of a ballerina. Sometimes they finish faster than I can fumble for my credit card and swipe it through the machine.

Credit cards and the machines that accept them are themselves pretty amazing. There were no credit cards in the days of the Fisher Brothers, though they might have extended their own credit to a steady customer. The machine at Safeway validates my credit card and completes the transaction within seconds. How does it do that? More important, how does it do it economically, given the store’s razor-thin profit margins?

As part of the remodel, they laid faux wooden floors and installed special lighting for ambiance—a term that would have baffled the Fisher Brothers. They added a deli, an organic section, and a sushi chef. Those things fascinate me even though I don’t care to partake of them.

Then there’s the “Safeway Club” card. Most retailers offer such things these days. The bargains I get from using the card and the customized coupons are worth the minor sacrifice of privacy. So my eating habits are in a database somewhere. I care not.

As mentioned, supermarkets operate on notoriously low profit margins. From each dollar of revenue, Safeway brought 1.4 cents down to the bottom line in 2010. If someone pilfers a can of sardines, there goes the profit on about 70 more cans. And then there’s corporate income tax. Safeway’s rate was 33 percent for 2010. Of course, corporations don’t really pay taxes; people do. That burden falls on shareholders, employees, and customers, most of whom don’t realize this.

Competition is fierce. Lunardi’s on the opposite corner is a comparable supermarket that gives Safeway a vigorous run for its money. A few miles away, Trader Joe’s and Whole Foods are bustling with high-end customers. There is no Walmart nearby, but Costco and Kmart are but a short drive away. So Safeway struggles to position itself between low-end and high-end competitors.

Shrinkage is a problem for all retailers. This term refers to pilfering by customers or employees, and again the slim profit margins can easily get pilfered away. Safeway’s shrink rate is a company secret, as are the countermeasures it deploys, but it does report progress on that front.

How well have the owners of Safeway been compensated for risking their capital? Just so-so. Earnings per share dropped from $2.21 in 2008 to $1.55 in 2010 but are now recovering. Notwithstanding declining earnings, they have raised their dividend each year but it is still a rather modest 2.3 percent. Investment advisory service Value Line gives Safeway high marks for both timeliness and safety, but I’m not tempted.

Do I love Safeway? Not really. I’m very pleased about my relationship with it, but I reserve my gratitude for the fact that governments haven’t yet ruined it. It’s not for lack of trying—our local planning commission and planning staff are constantly harassing it with petty regulations and subsidized competition in the form of a weekly farmers’ market. 

Of course Safeway tries to entice me with marketing ploys. High-margin items are prominently displayed. You run a gauntlet of these displays to reach the pharmacy in the back. There are trashy magazines to look at in the checkout line and candy bars up for mindless grabbing. None of this bothers me. I’m all grown up and can take their enticements or leave them.

Am I loyal to Safeway? Not entirely. When I want a sandwich I cross the street to Lorenzo’s, a tiny family-owned shop. They’re a friendly and hard-working bunch, under the same ownership for 26 years, and they always seem to be busy. They have many loyal customers here in Belmont, and provide good job experience for the high school kids they hire, some of them sons and daughters of previous employees. And yes, they make good sandwiches. Watching them hustle is part of the fun of going there. So is the look in their eyes when they speak of the satisfaction they get from their work.

Sometimes I go to Kmart for bargains despite the distance. The clerks seem not terribly bright, and the clientele is mainly lower-class, but the savings on cat food and paper towels make the trip worthwhile. Sears and Kmart merged a few years ago, and the combined firm has been struggling ever since.

The stock fetches a hefty 38 times earnings and pays no dividend although its debt burden is low. Seems like a tempting short sale.

Besides the goodies available to me, I’m pleased about the influence I exert every time I spend a dollar in a competitive market. Ludwig von Mises called this “consumer sovereignty.” Actually this was a rare instance where Mises was somewhat off-base. As sellers of labor services, we naturally want high wages and salaries, but we are also highly motivated by nonmonetary considerations like working conditions. Dave and Marta, owners of Lorenzo’s, might well pass up better-paying jobs with Safeway or Walmart because they like their independence and their customer relationships. Recognizing that producers may pass up monetary profit opportunities in favor of other values, Murray Rothbard rejected Mises’s phrase in favor of “individual sovereignty.” Consumers and producers jointly determine what is produced—consumers don’t hold all the cards. Still, as consumers we exercise considerable sway over what gets produced and in what quantity and quality, leaving aside government intervention.

Speaking of Walmart, it has been trying to penetrate the San Francisco Peninsula for years but has advanced no farther than Mountain View, 35 miles south of San Francisco. The city of Belmont, 20 miles south, owns a piece of land that seems like a dandy Walmart site, but the political elite in our town wouldn’t allow it. A lot of Walmart’s customers would be lower-income people; around here, that means they’re likely to be minorities, particularly Hispanic people, so there’s an element of racism here.

A (Dollar) Tree Grows

Walmart has been held at bay, but Dollar Tree slipped past the barricades. This national chain acquired a moribund shoe store in our town and was able to convert it to its own brand without any special permits. Oh my, the howling! We’re Belmont! We want boutiques and artsy-craftsy shops! But Dollar Tree has done a land-office business since day one. It’s not uncommon to see a Mercedes or a Lexus in the lot, driven perhaps by some of the same howlers.

Its operation is pretty amazing. Everything is priced at a dollar (plus 9.25 percent on most items, extracted by you know who). I returned from my fact-finding trip with a peanut bar, a pack of four pens, a bag of non-licorice sticks, a bag of cashew pieces, a small bouquet of artificial flowers, a pack of four alkaline AA cells, 48 ounces of soda, and a can of Pringles-like chips, each one dollar. Some of this is junk, but shopping there is just so darn much fun! Management must be well aware of that psychology.

Dollar Tree must drive the good people at the Bureau of Labor Statistics batty. What would they do with four ball point pens for a dollar when compiling the Consumer Price Index? That’s perhaps a tenth of the inflation-adjusted price of 25 years ago. The low price is probably due to Dollar Tree’s acumen in scooping up remainder stocks at very low prices more than anything else. Yet this price would contribute to the idea that price inflation is low and therefore the Fed has done a good job of managing our money.

Dollar Tree’s margins, amazingly, are double those of Safeway. And they take credit cards. Though I feel a tinge of guilt when I swipe my card and trigger a merchant fee, I shouldn’t because handling cash is expensive too. It’s unfortunate that the new restrictions on bank debit-card fees may result in the end of debit card use at places like Dollar Tree.

The Great Recession of late is nowhere to be seen in Dollar Tree’s stock chart, and in fact the shares have tripled over the past three years. The downturn clearly attracted lots of cost-conscious customers. DLTR pays no dividend, although they have been buying back shares—a tax-efficient strategy often used in lieu of a dividend.

Perhaps the most important aspect of the three chains I have highlighted, from my point of view as a consumer, is the competition they face. That’s what keeps them scrambling to earn my dollars.

A field trip to a local Safeway, Kmart, or Dollar Tree, or one of their competitors, should be part of every economics curriculum, along with one to a mom-and-pop operation like Lorenzo’s. All of us when we go shopping should think about the amazing goods and services we get and the incentives that keep them coming.

At the time of publication, the author held shares of Dollar Tree, Inc.

  • Warren Gibson teaches engineering at Santa Clara University and economics at San Jose State University.