Industry Spotlight: Conversation with Wharton Professors Marshall Fisher, Santiago Gallino, and Serguei Netessine

One of retailers’ top strategies for eliminating costs and boosting profits is cutting labor. While this may seem like a quick and easy way to meet those goals, it can be detrimental for a retailer in the long-term. The University of Pennsylvania’s Wharton School professors of operations, information, and decisions Marshall Fisher, Santiago Gallino, and Serguei Netessine dive into this topic in their research paper, “Setting Retail Staffing Levels: A Methodology Validated with Implementation” and the Harvard Business Review piece, “Retailers Are Squandering Their Most Potent Weapons.” Their research shows that when optimal staffing is applied systematically, it can add as much as 20% to the revenues of existing stores.

That’s why it’s critical that retail companies realize that employees are not expendable, but the most valuable asset on the sales floor. While online sales still impact the existence of physical stores, so do the customer service and store experience that associates provide. We chat with the professors about why we need to think about retailers in the context of their retail life cycles, how retailers can account for optimal staffing and training to impact their revenue, and how major retailers are reacting to the tight labor market.

We’re at an interesting point in our retail story. Legacy retailers and big-box stores are declaring bankruptcy just as other retailers are thriving with a combination of experiential retail and direct-to-consumer approaches. Can you summarize where we’re at in the retail world right now, how we got here, and where we’re headed?

Professor Serguei Netessine: When we started in this line of work in the early 2000’s, the retail companies that started as mom & pop businesses grew into something large but unsophisticated. A lot of them lacked very basic technologies -- no traffic counters, no sophisticated forecasting tools to predict demand. For example, Home Depot grew like gangbusters just opening stores. They started feeling pressure from online stores then and that changed more over the years. Most products are purchased in stores but the gross rate for eCommerce is much higher than brick and mortar stores. There’s an invasion of global brands, massive expansion of indices. These are two big trends culminating into what we see now, which is massive bankruptcy of relatively unsophisticated players. If you don’t change the business model and become more sophisticated with data analytics and start thinking multi-channel strategies, you tend to die.

Professor Marshall Fisher: The 70’s were the golden age of retailers -- you could think of a lot of great retailers emerging from that era and now maturing. There’s a retail life cycle comprised of stages -- start-up, high growth, maturity, and decline -- and as a retailer goes through those stages, life changes for them. Retailer commentators often look at individual retailers who are struggling to navigate the transition from growth to maturity and falsely conclude that all of physical store retailing is in trouble.

There are three ways retailers can grow: 1) open stores, 2) increase sales within existing stores (comps store sales), and 3) omni-channel sales. Opening stores is a powerful lever initially, but over time, as you add more stores and have a bigger store base, the next store you open has less of an incremental impact on revenue. By contrast, increasing comp store sales has a bigger and bigger impact as you add stores, because any idea you have for improving store performance impacts a much larger base of stores. So the relative effectiveness of these two levers changes over time.

The skills you need in each stage also differ. Opening stores is an execution game. Retailer execs in this stage are constantly managing a ‘to-do’ list. But growing comps store sales is an idea game. For example, you need to think about the topics we wrote about in our article such as optimizing staffing levels and training. Retailers begin as execution players, opening more stores to grow sales, but at some point they need to shift to focus more on comp store sales, and then they need to become idea players. One example of that is Walmart. In their early high growth store opening execution stage, they disdained to hire MBAs. Now that they’ve matured and need to play an idea game, they are aggressively hiring MBAs.

In your HBR article, you really tackle a topic that’s important to us: how retailers can account for optimal staffing and training. How are they doing that right now?

Professor Santiago Gallino: I’ve seen that there’s an overemphasis on historical sales to predict future sales and using that prediction to generate staffing levels. That process has become the essence of staffing decisions, and if you have the prediction that your sales are going down, you will tend to cut your staffing levels. I believe that staffing can be a weapon to increase sales, but if you staff your stores based on decreasing sales, you’ll continue to cut your staff and end up in a negative spiral. You’ll naturally start to put more pressure on reducing staffing levels but that’s not necessarily capturing the value that staff have on the floor.

In the article, we suggest an approach that can capture the impact a particular employee can have in addition to the forecast of sales by looking into natural deviations between the plans they make and the actual deployment of labor. Our hypothesis in this approach is that the sales staff is not only capturing the sales that will naturally occur in the store, but also can be a factor that can increase sales if they're well-trained and have the right tools.

Netessine: This is a self-fulfilling prophecy -- if you forecast sales will be low and you cut your staff, your sales will go down. You keep doing it again and again, you end up with a bare bones staff that cannot sell much.

Why have retailers historically turned to cutting training/employees as their first cost-reduction measure?

Fisher: Store labor is the second biggest cost, after cost of goods sold, for most retailers, and it can be cut quickly by simply reducing hours for part timers. This is especially tempting with a few weeks to go in the quarter and a retailer needs to cut costs to make their earnings per share promise to Wall Street. But obviously store sales staff are needed to generate revenue, and if you cut too much, for every dollar you save on payroll you’re losing several dollars due to reduced revenue. I think retailers tend to go overboard on cutting retail staff because they know the cost of staffing, but they lack a good way to measure the revenue benefit of staffing. The method described in our article gives them a way to measure the benefit.

Gallino: In the current context, this is particularly bad. Customers are still going to their physical stores to get a good experience and customer service. This idea of reducing labor as a way of cutting fat could be cutting much more than fat and it can actually hurt you. This is often what we see happening.

How do you measure the value and customer service boost you get with additional employees on the floor and not cutting them?

Gallino: The idea is using absenteeism as a natural experiment. If you have a store of 30 employees and two don’t show up, but you don’t see a change in sales, that could be a hint that you probably don’t need those two guys. But if you see a much larger drop in sales than anticipated, the value is much larger. That’s the intuition that absenteeism can tell you the real value of the employee that’s hard to get when you’re just forecasting.

Fisher: To expand further on Santiago’s idea, suppose you normally have 30 people in a store and one day only 27 show up, so you’re down 10%. What happens to revenue? If it’s unchanged, that suggests the store is over staffed, and you could cut people. On the other hand, if revenue is down 10%, that suggests a linear relationship between staffing and revenue. You could probably add 10% to staffing and see a 10% increase in revenue, which for most retailers is a great deal. You can experiment -- you think you need 30 employees, so you could try 27 (10% less) and see if sales declines. That would tell you the relationship between revenue and staffing. What we found is that this experiment has been done more or less automatically with retailers because of absenteeism, which fluctuates. You would see some exogenous variation in staffing levels and could analyze that to see the impact that staffing has on revenue. For a retailer where we applied this approach, we found some stores were overstaffed and you could cut payroll, but others were understaffed. We increased their staffing levels by 10% and got a 5% increase in revenue, which had a huge positive impact on profit. But there has to be a balance between benefit and cost.

Netessine: That balance point is very different for each store and there are many factors that will impact how many people you need in each store. This will usually depend on competition, store managers, how good employees are. Our methodology is to look at each situation store by store. Let’s come up with a store-specific schedule rather than make it a blanket rule for the entire chain.

Looking at the current labor market and how tight it is, some employees can leave easily with the slightest perk. How has the tight labor market impacted the research you did and how retailers approach training?

Netessine: One aspect that becomes important is if you look at what retailers have done over the years, it is the increase of part-time labor. To fill the gaps in the schedules, they rely on part-timers who are cheaper and who don’t get any benefits. There’s additional research that shows it’s not a great idea because part-time labor isn’t as high-quality, skilled in selling, or as committed, which can backfire. Even in a tight market, the retailer has to think really hard about whether or not they want part-timers filling these gaps. The answer usually is “no”.

Fisher: Costco is a data point that has a lot of lessons in it. They treat their employees extremely well and have very low turnover. I think this is always a good idea but an especially good idea in a tight labor market when you can’t let someone leave and replace them readily. You look at some retailers and the employees turnover faster than the product -- it’s a revolving door. Again, this is cost management gone awry. It would appear that paying them minimum wages and flexing their hours is cost-efficient but harsh on the employees, which causes them to leave. That turnover is super high-cost.

Gallino: Costco is a unique but remarkable example. This is an anecdote but I was living in Philadelphia five years ago and was a huge Costco customer. I left and came back, and I could recognize more than half of the employees at Costco. They wear nametags with the year they were hired, and it’s hard to find an employee that hasn’t been there for eight-nine years. It’s challenging to make that claim with other retailers. I agree with Marshall that there’s a lesson to see how much of an impact that’s had on them. We’re also seeing this in hiring with companies like Starbucks, who are upleveling the benefits they have. They’re seeing the value of keeping their employees.

You also touch on the lack of training: the onboarding process for hourly retail workers is really out of the consumer’s view. Can you elaborate on what training looks like today?

Netessine: The reality is that most retailers just don’t train their employees to any large extent. You can see why -- why invest in training if you only see them leaving in a couple of months? You end up with employees who aren’t familiar with products and might know less about the store than the customer. That’s also a problem.

Sometimes a bad employee is worse than no employee at all. If you want your labor to actually drive sales in a positive way, it’s best to train them. For example, we looked at online training, where employees watched videos and answered questions. Sales goes up drastically because employees can answer questions and generally appear more confident and knowledgeable across categories.

How are retailers focusing on reducing turnover?

Fisher: Walmart is taking to heart treating their people better and training them on process steps like how to stock a shelf or where to direct customers. We take them as indicative, a leading indicator of the industry becoming more cognizant of reducing turnover and more cognizant of happier employees. Wegmans and other private grocery retailers like H-E-B and Publix are all exemplars of well-run retailers who treat their store staff well. I took an industry group through a Wegmans. In interviewing the store manager, they asked him what he does first thing in the morning. He said he checks in with employees to make sure they’re happy. If they’re not happy, nothing is going to go well. It’s an inverted pyramid, with store staff at the top. H-E-B and Publix are the same way with that inverted philosophy.

What advice do you have for retailers for where they can start investing in their employees?

Fisher: Every retailer is unique and it’s all on a case-by-case basis.

Gallino: Look at the data -- sometimes if you ask a retailer what cost turnover is having or what the value staff is adding, they don’t have the answer because they haven’t looked at the data carefully. This is a big mistake because you can’t make good decisions if you don’t know your own numbers.

Netessine: They all have data but often don’t know what to do with it. They need to speak with someone who can understand the numbers and make decisions from there. There are two ways for them to grow this capability of data analysis and innovation -- by building it internally or partnering with a start-up who can do it for you. I’ve seen it work both ways. Growing internally is hard, but not impossible. It’s very hard to get to highly qualified data analysts to work on data analytics. That’s why they sometimes reach out to [PhD’s like] us, or they partner with start-ups.

For more information on this topic and research from Professors Fisher, Gallino, and Netessine, check out Knowledge@Wharton.