Retail’s Big Mistake: Why Slashing Payroll Cuts into Profits

When sales are down and the quarterly report is due, a common strategy for retailers to boost profits is to cut labor. Payroll is the second-largest expense for most stores, so reducing associates’ hours is a fast, easy way to make the numbers work. But this quick fix is “business school thinking gone wrong,” according to Wharton professors of operations, information and decisions Marshall Fisher, Serguei Netessine and Santiago Gallino. It is imperative for retail companies to recognize that employees are the most valuable asset on any sales floor, especially now. Increased competition from online shopping threatens the very existence of many physical stores, so top-shelf service can make the difference between a customer making a purchase or walking out in frustration.

In their latest research, the professors make the case for having an adequate, well-trained staff as the long-term solution to stable profit margins. They also unveil a mathematical approach they have devised to help companies determine how much staffing is needed at which locations. The research is captured in a paper titled, “Setting Retail Staffing Levels: A Methodology Validated with Implementation.”

“Understaffing stores and undertraining workers was never a good idea, but it’s especially bad now, because it takes away the biggest advantage traditional stores have over e-tailers: a live person a customer can talk with face-to-face,” the professors wrote in an article for Harvard Business Review. They joined the Knowledge@Wharton radio show on Sirius XM (listen to the podcast above) to talk about their work and share the embedded lesson for retailers who don’t want to become the next statistic. Nearly 8,000 stores closed in 2017, according to investment banking firm UBS.

To be fair, the professors said, retail is a tough business with extremely high turnover. For many managers, underinvesting in training for employees who could be gone in six months anyway seems like a sound decision.

“It’s easy to criticize when you’re not in their shoes, and it’s totally understandable,” Fisher said. “At the end of the day, you’ve got an earnings report if you’re publicly traded, and you’ve got to think about that.”

But temporary reductions in personnel or hours often become permanent or cyclical, and stores get caught in what the professors describe as a downward spiral until there is little or nothing left. “Cutting cost is OK if you’re cutting fat, but if you’re cutting muscle, that does more harm than good. And we see this in the data that we analyze,” Fisher said.

Using statistical software tools, the professors created the following three-step methodology for retailers to set staffing levels at each store location:

Use historical data on revenue and planned and actual staffing levels by store to estimate how revenue varies with the staffing level at each store. Use employee absenteeism to help you: If an employee does not show up for work at the last minute, check sales impact.

Using historical analysis as a guide, validate the results by changing the staffing levels in a few test stores.

Implement the results chain-wide and measure the impact.

The professors employed this method with several retailers, including a large specialty retailer, with significant results. For one retailer, right-sizing the staff in 168 stores over a six-month period produced a 4.5% revenue increase and a nearly $7.4 million annual profit increase, after accounting for the cost of the additional labor.

“I hope that our methodology can help retailers start thinking about sales impact of labor,” Netessine said. “All retailers think about, for example, sales impact of marketing activities. Should we put more marketing into Facebook or newspapers or TV? But very, very few retailers systematically think about what is the value-added of an extra dollar of labor in a particular store. In some stores, it’s negative. And in some stores, it’s a huge positive effect. Our experience in working with probably dozens of retailers at this point is that, over the years, they’ve been cutting, cutting, cutting, so there is usually a big impact of adding labor to the store.

Teach Them Well

The key to retail success isn’t just setting the right staffing numbers. The professors advocate for employees to be trained properly in both the products and the processes of the store.

“One surprising thing we found is that when you train store employees on a particular product, it’s not that they increase sales of only that product. What we found is they actually increase sales across a product category,” Netessine said. “We surveyed tens of thousands of employees, trying to understand what it is exactly that they learned. And what we found is that the training gives them overall confidence about the entire line of products.”

Fisher shared a personal story to illustrate how a well-educated salesperson is an asset on the floor: He enjoys backpacking with his son, so he went to a local store in suburban Philadelphia called Out There Outfitters to buy a rain jacket. The store uses a service called ExpertVoice (formerly Experticity) to train associates on the various products, so the salesperson easily explained the features and materials of each rain jacket in stock.

“I walked out having made a purchase,” he said. “That’s the value of training. You have a broad assortment. You explain it to the customer, and they know they don’t have to go somewhere else because they’ve picked the best choice for them.”

Some retailers are reluctant to spend what they may consider lost time on training when they could have an employee on the floor. But that’s a mistake, the professors say. Their research found that for every hour a month an employee spent on simple online training, the revenue from that employee went up about 6% that month.  This training doesn’t have to be a formal, disruptive affair. ExpertVoice offers online modules that employees can complete on their smartphones during downtime, for example.

“I would like to think that our research can help emphasize the fact that employees are a huge asset for the retailer, that the way to think about them is as partners in the success that the company can have going forward,” Gallino said. “Being able to train them, retain them, assign them to the right times of the day or the right store throughout the chain is key to the success of the company and also for the employees to have a rewarding job.”

Digital exerts even greater pressure on brick-and-mortar locations to offer shoppers a reason to put down their devices, get off the couch and drive to the store. That’s where great sales associates can help, Gallino noted.

“What I’ve been hearing from retailers is that they see that their physical presence needs to become more experiential,” he said. “If you want to give customers a good experience when they go to the store, then this goes beyond knowledge about facts of the product. It’s being engaged, greeting the customer, learning how to interact with him or her.”

Added Netessine: “We looked at what people care about once they come to a physical store, and inevitably how knowledgeable employees are comes out as No. 1.”

The bottom line is that employees are an essential part of any retail operation’s top line, the professors said. It’s time for CEOs to manage beyond the numbers and see employees as something more than an expense.

“Retailers are struggling to maintain the top line, and we’re talking about things that can add 5% in the staffing, 6% for an hour of training,” Fisher said. “So, I think the key points are this is a gold mine opportunity for retailers.”