As the world convened on the country of Brazil to passionately watch thirty-two countries compete for immortality on the FIFA World Cup stage, another epic battle unfolded between the sportswear giants, Nike and Adidas.
Much of how consumers interact with businesses is based on perception and taste, which is why so many resources are devoted to marketing and advertising. Through sponsoring the countries’ football teams and famous players and countless commercials and marketing ploys, the two brands geared up for a month long sporting festival that was sure to entice the consumers and bring in large chunks of revenue. Let’s take a look and see which industry leader came away with the upper hand.
Overall, you probably saw the Adidas logo more prevalent in the World Cup competition because of the official partnership the company has with FIFA. At around $70 million per four year cycle, Adidas has the rights to manufacture and sell the World Cup Brazuca game balls as well as the referee kit. Such a deal aligns Adidas with the FIFA logo on pretty much any advertisement, as we saw on ESPN’s virtual scoreboard. Needless to say, this deal, for any sportswear brand, is extremely lucrative since the brand was quite visible. Expenditures for the German company did not stop there, though. According to reports, Adidas spent $2.3 billion in advertising and marketing for the World Cup. High numbers, yes, but the ratio between the marketing budget and revenues in 2014 has held steady with the ratio during 2010’s World Cup in South Africa (10.1% and 10.7% respectively). The target revenue with this year’s World Cup was $21.2 billion.
Another indicator of Adidas’ exposure at the World Cup was their share price throughout the entire tournament. Starting on June 12th, Adidas was selling at $52.99 per share and ended the tournament at $50.22 per share. Initially, I had thought both corporations would see increased stock prices during the tournament, seeing as they would have extreme visibility and favorable marketing, but this $2.77 decline may actually be completely unrelated to the Cup. Just yesterday, Adidas agreed to a ten year, $1.3 billion kit deal with English football club, Manchester United. Despite the fact that this deal severs the thirteen year partnership Nike had with the football club, concerns were raised (and consequently stock prices lowered) due to the staggering price of such a deal. Thus, it is not certain whether the World Cup had a positive affect on Adidas’ share prices.
Lastly, and maybe foremost, Adidas’ triumph at the World Cup could’ve been cemented on the final day. Out of the thirty-two teams, Adidas sponsored nine with two of those nine making it to the World Cup Final (Brazil and Argentina). Furthermore, out of the 166 World Cup goals, 78 were scored with Adidas soccer cleats, which belonged to some of the tournament’s top performers including Lionel Messi (Golden Ball winner), James Rodriguez (Golden Boot winner), Thomas Mueller and Andre Schuerrle of Germany.
Although Nike did not have the official FIFA World Cup sponsorship, the Oregon-based company played as big of a role as its counterpart. As usual, Nike had the most aggressive, yet artistic marketing campaign for the event. You probably noticed their ‘Risk Everything’ campaign, which featured the cartoon versions of Brazil’s Neymar Jr., USA’s Tim Howard and Portugal’s Cristiano Ronaldo–all Nike sponsored athletes. Prior to the World Cup, Nike introduced their first ever football-only store in Rio de Janeiro which boasted Brazil’s World Cup kits and the boots Nike athletes would wear during the games. With such an extensive advertising scheme, its no wonder the company’s marketing expenses jumped 36% to $876 million in the quarter to end May.
Contrastingly, Nike saw share prices increase for the month of the World Cup, opening at $74.77 and closing at $77.95. This could have occurred for several reasons: Nike’s forecasted 21% growth in the global football business, its share of 80% of a $5 billion industry with Adidas or because of the potential the game of soccer has in the United States.
On field success for Nike was expected, as it out-kit Adidas with 10 sponsored countries including host nation, Brazil. Furthermore, 53% more players wore Nike boots than any other brand. However, a series of unfortunate events on the pitch, like Neymar’s back injury, Ronaldo and Portugal’s lackluster performance and Brazil failing to make it to the final hampered Nike’s exposure as the World Cup waned.
Adidas was the much more visible brand during the 2014 World Cup. In competition, their teams triumphed and it seemed like all the individual awards were also given to Adidas athletes. Beyond this, Adidas’ YouTube viewership during the World Cup eclipsed Nike’s by six million.
The future is bright for Nike, though. The buzz around the World Cup and for the Men’s National Team in the United States was created because of Nike’s marketing. The brand understands that while Adidas may hold a stronger foothold around the globe, it is in control of the largest consumer market in the world. With Major League Soccer growing in popularity, Nike is primed to capitalize on soccer equipment, apparel and footwear in the US. As far as I am concerned, Nike is well positioned to make a run at Adidas again in 2018.
“Young kids don’t have jewelry. They don’t have cars, but what they do have is the thousands of dollars worth of sneakers in their house,” says Troy Reed, father of young entrepreneur and founder of Sneaker Pawn, Chase Reed.
Sneaker Pawn, located in Harlem, New York, is the latest venture to capitalize on the budding sneaker culture that is prevalent within today’s younger generation. The shop, manned by Chase and his father, offers secured loans to people with limited edition or dead-stock sneakers, which are used as collateral. The two place a value on the sneakers by checking for odors and wear around the toe box and heel counter. Just like any other pawn shop, if the pawner wants to retrieve their sneakers he/she must pay the original loan back plus a storing fee, almost like interest. In the case that someone else makes an offer on the pawned shoe, the pawner is notified and has the right of first refusal, so long as they can provide the cash. When the sneakers sell for more, the pawner keeps 80% of the profit and the rest goes to the store. Besides lending money in exchange for kicks, Sneaker Pawn also customizes and refurbishes sneakers.
Chase and his father used to be the obsessed sneakerheads who would stand in line for hours and sometimes days for the newly minted Air Jordan and Nike limited releases. Like all entrepreneurs though, the two saw an opportunity to capitalize on this hobby. Chase, 16, sold his own collection of shoes (around 200 pairs) to gather the $30,000 of seed money for Sneaker Pawn.
The store is the current holder of some pretty exclusive kicks, such as the Kobe 9 Masterpiece, the Air Jordan 6 Infrared, and the Lebron X Crown Jewels, which are valued at $1,400–more than five times their retail price. The shop has seen immediate success amongst consumers as collectors have pawned their kicks to pay for funerals, prom dresses, and even a move from the Bronx to Brooklyn.
Sneaker Pawn is effective because it enables young people to have access to fast cash. Like Chase’s father said, kids do not always have jewelry or the expensive items that are normally used to borrow money against, but with so many investing in shoes that appreciate over time, their assets are much more liquidable.
Check out the New York Post’s article on Sneaker Pawn and check out some of the shoes the shop has to offer on their website.
Lululemon is an athletic-wear brand with a primary focus on yoga apparel. Having captured the attention of young women, Lulu has become quite popular across the globe. Lulu has been apparent in my own life because of my active mother and because of the [unfortunate] leggings trend that has nestled its way into the hearts of seemingly every woman. Lulu has been so successful because of the balance it has struck, making it’s clothing sensible and stylish while still maintaining it’s athletic roots.
Over the past year, however, Lulu has seen a slight fall from grace. In 2013, the company was under fire due to a recall for a line of yoga pants that were too sheer. In response, the founder of Lululemon Athletica, Chip Wilson, stated that customer’s fat thighs were to blame for the yoga pants being see-through. As a result, Wilson relinquished his chairman’s seat and Lulu’s CEO, Christine Day, stepped down. The company has since wilted. Considering Lululemon’s status in pop-culture and their current lack of direction, it is primed for acquisition by none other than the world’s leading athletic-wear brand, Nike.
Nike is no stranger to acquiring other brands, as it owns Converse and skateboarding company, Hurley (Nike also purchased Cole Haan in 1998 for $95 million and sold it in 2012 for $570 million). Right now, Lulu lacks a sense of direction. New CEO, Laurent Potdevin, has filled the holes with empty remarks on reclaiming the company’s creative destruction in the market, but the truth is Lulu is floundering. Through Nike’s experience in operations and marketing, it would be able to right this ship. Lulu would gain access to some of the best manufacturing plants and Nike’s rebranding of the company would bring back the positive image it lost hold of.
Financially, this purchase would make sense as well. Lululemon is a direct competitor of Nike. Buying the company would give The Swoosh increased market control and better pricing power. Moreover, Lulu is trading at a relatively inexpensive share price. In 2013, before the company ran into turmoil, Lulu was trading as high as $82 per share. If Nike attempted to buy the brand at this time, it would not have been feasible, as Lulu’s valuation would have been way too high. Since the debacle, though, Lulu is trading around $44 per share, making their valuation much more affordable.
As bad as Lululemon’s situation may seem, their immediate value to Nike would be tremendous. In terms of revenue, Lulu has gone from annual sales of about $453 million in 2010 to $1.6 billion for 2014. This indicates that Lulu is still growing and that it is still relatively popular. Lastly, while Nike does a fantastic job of marketing their clothes for both athletic an street-wear use, there are just certain styles that other clothing company’s manufacture or market more effectively. For example, on campus I never see girls wearing Nike leggings, but I always see them rocking Lululemon’s, recall or not. Its not that Nike’s yoga pants are poor quality, its that Lulu’s ability to be trendy and different has made their yoga pants more attractive. Adding their product to Nike’s line would only make Nike that much more profitable.
Rumors have surfaced that Apple plans to abandon the ubiquitous 3.5mm headphone jack. This story developed when Apple blog, 9to5mac, discovered that Apple submitted a design specification to its licensing program which would connect headphones using the Lightning port.
For Apple, this is a smart move. By removing the classic headphone port, Apple makes all previously designed headphones obsolete. This wipes out products of competitors, and maybe most importantly, it sheds more light on the significance of the $3 billion Beats Electronics acquisition. Rather than collaborating with Beats Electronics to create headphones with Lightning port accessibility, Apple now has the ability to earn exponentially more money from license fees and adaptor sales. The fact that such headphones would probably retain the iconic Beats logo only adds to Apple’s gain, as both brands are synonymous with current popular culture.
Moreover, this innovation, or business ploy, should instigate new technology developments from other competitors, only making Apple diverse and exclusive. Without a headphone jack, Apple perpetuates its own longevity by locking consumers in to purchasing more Apple products.
Sometimes the wellbeing of the customer is not considered at all. With this move, we stand to lose big time. Now that our beloved headphones are obsolete, we must either purchase bulky adaptors or new headphones all together. Those Beats Studio headphones you just bought? Yea, those are no longer functional, which means shelling out another $200+ to listen to music.
Its funny how the simplest changes result in huge revenues for a company. I can’t say I’m upset with the Beats acquisition or this news because its kind of ingenious. For a full read on this recent development, check out the article on Forbes.
From the following, we’ll try to unravel the economic mystery behind the giant e-commerce maketplace.
Consumer and Producer Surplus
These are very basic economic terms that ring true all throughout the world market, and for eBay, they are as applicable as ever. Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (this is how the demand curve is formed). Essentially, consumers and buyers on eBay have a predetermined price in mind that they are willing to pay for a certain item. They place a bid or select the ‘Buy It Now’ option if the actual sale price is less than or equal to their desired price. The surplus comes if the price the buyer actually paid is less than the predetermined price they originally desired before the transaction. Whether you are aware of this phenomenon is a different conversation, but no one ever pays for something at a price they do not want or cannot afford, alluding to the notion that all consumers are rational.
On the contrary, producer surplus is the difference between what producers (eBay sellers) are willing and able to supply a good for and the price they actually receive (this is what shapes the supply curve). As a seller, I certainly wanted to turn a profit, so the price I set was based on the retail price I, myself paid for the good, the research, and the fees that were incurred after each transaction. From these criterion, I set a price that aligned with consumer preference and producer preference. Surplus occured if the item sold went for more than had originally been intended, which is always a good sign!
The change in technology is also a cornerstone of economics. New developments in technology generally lead to increased production levels, which generates more transactions and cash flow. For example, Henry Ford’s implementation of the assembly line allowed for an increase in sheer volume of automobiles manufactured. At first, our eBay business was antiquated: we went to the post office to buy postages, which meant standing in long lines; we did not have an up to date inventory list; and our funds for purchasing goods were not liquidable, as my brother and I often debated over who would buy what. Not only does this create a messy operation, but its also not efficient. To fix this, to alter the technology and processes used, we implemented an organized inventory via Excel that calculated the fees we would incur after each transaction, the profit margins, and the quantity of goods remaining. Moreover, we began to use eBay’s automated shipping service. This saved us countless trips to the post office and it made the postages much cheaper. Lastly, and one of the most significant changes in technology, was our utilization of PayPal’s debit card. Instead of using our own bank accounts to purchase goods, we used PayPal, which was tied to our eBay account, to buy the shoes, Starbucks mugs, etc. This made the quick trips to stores much easier and it made our funds more liquidable.
For any enterprise, an increase in technology is vital. Technology is what enables production to increase and its what fuels the increasing demand in our society.
Donald Sterling, and the Sterling Family in general, has been the topic of discussion across all media outlets over this past month. Hopefully, we are nearing the end of this freight train, as the sale of the Los Angeles Clippers by Donald and Rochelle Sterling to former Microsoft CEO, Steve Ballmer, was approved by the NBA last Friday. The deal, which will oust the most infamous man in the NBA is worth a whopping $2 billion, making this sale the largest for any NBA franchise. While many are pleased to see Sterling officially out of the league, the price tag for such a removal has caused much conversation.
Prior to the sale of the Clippers, the acquisition of the Milwaukee Bucks by New York investors, Marc Lasry and Wesley Edens, was the largest in the history of the NBA at $550 million. For those non-sports fans, the Milwaukee Bucks have been notoriously irrelevant. Why? Well, Milwaukee is a very small NBA market (Quiz Question: What state is Milwaukee in? bet you thought about it for longer than you should have), they lack superstar athletes and for the last four seasons they have failed to achieve a winning record. Now, take a Clippers team that has been the annoying little brother to the Los Angeles Lakers and laughing stock of the entire NBA for the past thirty years and you can understand why a bid almost four times that of an acquisition that took place just a couple of weeks ago seems a bit excessive.
Mind you, Mr. Ballmer has been trying to purchase an NBA team for some time and, according to Forbes, he has an estimated net worth of $21 billion, so to him this deal neither hurts his pocket nor loses its luster. Here’s why: Ownership of any major sports team is a very exclusive club. Out of the 92 franchises (comprised of the NFL, MLB, and NBA), only a spoonful have gone up for sale over the last decade. A sports team is analogous to that of a bluechip stock; you usually hang on to them for an extended period of time, which is why we have these legendary families, like the Rooney’s and Buss’, who have owned franchises for decades. Therefore, when a team is on the market, much attention and interest is drawn from the richest in the world. I believe this situation with the Clippers drew much more appeal because of the given circumstances. The Clippers are located in the massive, star-studded LA market, which brings tremendous upside. Furthermore, the new owner (Ballmer) would be replacing not only the most hated man in the country but also an absolutely terrible owner. Steve Ballmer immediately becomes the savior of a headless organization and his business acumen from running Microsoft is sure to point the Clippers in a more progressive direction.
Many people have criticized this acquisition because of how poorly structured some of the contracts within the Clippers organization are. For example, the Clippers are merely tenants in the Staples Center, meaning they receive $0 for non-basketball revenue. I, however, still perceive this as a smart move. First and foremost, the Clippers were worth as much as anyone was willing to pay for them–more power to ya, Steve. No one complained when Magic Johnson and company purchased a struggling Dodgers team for $2.3 billion, now look where they are. Moreover, the Clippers local TV deal is set to expire after the 2015-2016 season. Given the market and recent success the team has seen, I would expect this new deal to be more than double the previous, only adding more cash to Ballmer’s pocket. Lastly, the real estate that the Clippers own could be redeveloped for better, more profitable commercial spaces.
I see this venture as a long-term one. Of course Ballmer will have to break even, but think about the future valuation of the Clippers in thirty years. If some of the more high profile sports property is sold in the mean time, such as the Lakers, Ballmer would definitely see an appreciation in his team’s value. Besides, when do you really see the value of a team decline?
My first job was definitely of the untraditional type. I was having a conversation with my best friend and my father about our childhood jobs, and I remember listening to them talk about working for a catering service and grocery store while I tried my hand at eBay. As we each shared our experiences, I found myself thinking about how eBay is pure economics. Of course, that was an obvious thought, I mean, eBay is a marketplace that connects vendors and consumers of ‘stuff’ over the internet, but when I took a minute to let this thought percolate, it certainly upholds basic economic principles.
I had known about eBay for some time; my father was an intense Power Seller in the early 2000s when the unique auction house was in its prime, selling Ugg boots and Nike Shox at ridiculous profit margins. I can recall those early Saturday morning runs to the shoe stores to purchase several pairs of the infamous boots and watching him meticulously write descriptions for each product. I didn’t fully understand the total operation of being a seller until I re-opened my father’s account in my sophomore year of high school. I realized my spending habits were greatly exceeding my allowance, but I didn’t want to have to work somewhere or for someone (its a millennial thing, I guess). I didn’t know much, so I decided to sell what I knew would make money, which was what my dad sold. I, along with my brother, sold newly released/limited edition Nike shoes, backpacks, and Starbucks mugs. We didn’t make a killing, like my dad, but we always managed to have a decent amount of cash in our pockets–and it definitely didn’t hurt my resume when applying to colleges. Looking back on these experiences, with some acquired knowledge about economics and finance, I’m better understanding the principles with which my business functioned.
Over the next several days, I will be looking at eBay through an economic lens examining technology, incentives, rationales, and utility.
For those living under a rock, Apple has once again made headlines as it plans to acquire current pop culture staple, Beats Electronics. According to Apple and multiple news outlets, the deal is set to be worth $3.2 billion. Apple isn’t the first popular brand to make such a lofty acquisition recently, as Facebook purchased messaging app, WhatsApp, for $19 billion and Oculus VR for $2 billion. Google has also pulled out the wallet and bought Nest for $3.2 billion– certainly, none of these deals have broken the backs of either company.
Many different conjectures have been published as to why Apple has selected Beats Electronics to be aligned with the brand. Some believe its because of Apple’s desire to hire Beats’ co-founder Jimmy Iovine, who is apparently a leading innovator within the music industry; others think its for the newly released Beats streaming service, which has utterly failed to compete against Spotify; and then there are those who simply believe Apple is floundering, running out of the creative ideas consumers have come to expect from the powerhouse tech corporation. This final theory may hold some weight considering the fact that Apple has followed the pattern of the other aforementioned corporations’ acquisitions.
Personally, I believe Apple made this move because (A) it places another product that has huge profit margins in Apple’s current lineup, and (B) perhaps for revitalizing/merging iTunes Radio with Beats’ streaming service. Whatever theory you believe, its definitely not the groundbreaking move that will recover some of Apple’s lost market-share to other technology companies. Maybe Apple has some ‘holy-shit’ idea up their sleeve that we don’t know about, but until then let’s just think of this as two iconic brands getting in bed together– a la Jay Z and Beyoncé.
As for producer/rapper, Dr. Dre, he can now be regarded as hip hop’s wealthiest mogul, surpassing Jay Z and P Diddy. Although people speculated that he would be the first billionaire out of the triumvirate, Forbes estimates that this deal will bring in about $480 million after taxes– leaving Dre $200 million shy of the illustrious billion dollar mark. Regardless, I can’t imagine seeing a Dr. Dre album releasing any time soon, especially after this huge pay-day.
One of the major programs that is integral to the George Washington University School of Business is Lemonade Day. The program is designed to immerse first year business students (myself) in an environment with elementary school children where we literally teach them the proper tools necessary to make a lemonade stand. The idea is that by learning about budgeting, accounting, profit and marketing, these fourth through eight graders will acquire the necessary tools to create and run a successful stand for the official Lemonade Day D.C. This program, which was actually introduced to the metropolitan area by a current School of Business student, is exactly the type of development I was referring to in my Dare to Dream post where I stressed the importance of programs that foster out nation’s young entrepreneurial minds. This past month, I was fortunate enough to try my hand at teaching these very principles.
I traveled to Roots Public Charter School, which educates first through eighth graders. The trek was about thirty to forty-five minutes in which I recognized absolutely nothing; this is either a testament to how insular GW is or to how little I get out. I expected to have children anxiously waiting for our arrival. I can remember how enamored I was with older kids at that age, so I was sure these children would be similar. I thought the students would be eager to learn about the primary business principles necessary to run a successful lemonade stand, and I certainly believed they would be willing to let me teach them. I was wrong, no doubt.
For starters, Roots is a tiny little school off the corner of a busy street. As I walked in, my immediate thought was how little funding the school must have. Not to say the school could not provide for its students, but the classroom seemed to double as a cafeteria/ recreational space and it was cramped. Furthermore, the primarily African American students appeared to have no real interests in the fact that several college students were standing before them. They continued to giggle and play around like any elementary school kids would do, and realistically, I should have expected this. Knowing myself, a reserved and shy character, I knew handling these kids and keeping them on task would be a bit difficult.
When we were introduced to the array of students, it was not clear whether they had known we were coming or had prepared for our arrival. About six tables were set up throughout the room. We helped the students grab chairs from the closet and we proceeded to form small groups so each of us could teach the lessons to a more intimate audience. Fortunately, I sat down with two students, Jalaw and Nikai, both fourth graders who were very much interested in the project.
Jalaw and Nikai were great. Like any fourth grader, when I mentioned the idea of a lemonade stand, their imaginations went one thousand miles per hour thinking of creative themes and designs for their storefront (Nikai wanted to make the lemon on their poster look like a diamond). Their eagerness and excitement definitely helped me because it made my job of asking them questions a lot easier. It was not hard to get them thinking about logistics, supplies, budgeting, etc. because I made the ideas tangible and relevant.
For example, when talking about logistics, Nikai wanted to know how much their lemonade should cost. I didn’t answer, I asked the question right back. He said, “Well, last time I had a lemonade stand we charged people three dollars and I made a lot of money.” While I tried to remain encouraging and positive, I attempted to steer him away from that price, as it was clearly too high given the amount of cups they were trying to sell. Instead, because they had been talking about playing music at their lemonade stand, I told them this, “Let’s put it like this: Who do you plan to sell to? Probably every day people like you and me, right? Especially if you’re going to be selling lemonade outside of a library, do you think normal people are going to pay such a high price for lemonade? If Jay Z came walking down the street, then I’d be with you guys…we could probably charge him $100,000 for lemonade!” By relating a business principle to something they could easily grasp and easily resonate with, they were able to laugh and understand that their price would most likely be too high. This made my time maneuvering in and out of topics much easier and a lot more entertaining.
The best part about Lemonade Day, though, was how I could see the light bulbs turning on in their heads. This was evident with Jalaw. As I continued to teach the two, the way Jalaw was picking up on things that I was saying and then responding back with relevant questions of his own suggested that the wheels in his head were turning. When we reached the point to talk about profit, I did not have to go through it with them step-by-step because Jalaw was working through it by himself with the information we created together. This was reward enough for my Lemonade Day experience. I realized (A) that any person can grasp these principles given the right opportunities, and (B) my skill of being a developer is real. As I taught Jalaw and Nikai, I realized that I do enjoy bringing out the potential in others. I created a stimulating and challenging environment for someone and I saw him improve because of it. If I received nothing else from Lemonade Day, at least I know I want to have more gratifying feelings similar to that.
I cannot stress enough the importance of this program. While it was definitely a foreign experience for me and the rest of the students, I believe it had a greater, more lasting effect on the children. I can remember back to my middle school days in which I attended a private school. We didn’t have any programs that gave us a hands-on experience with any real-life scenarios, like business. Honestly, I had no idea what budgeting was, but clearly, how hard could it have been to learn? Jalaw and Nikai now have a head start on thousands of kids across the United States. They had the opportunity to practice these important aspects of the business world early on and now their wildest aspirations of making a soda company and t-shirt line are more real than when I was ten years old and dreaming of creating a newspaper. Imagination is a powerful tool that should always be accessible no matter what age, but when it is paired with knowledge the combination is creatively destructive. Kids like Jalaw and Nikai, who can dream while remaining pragmatic, are the future of our nation’s innovation and financial prosperity.
By the way, the two surpassed their financial goal by making $149.
The topic of minimum wage has been under discussion for quite some time. It is one of the United States’ most controversial political issues because there are many different ideologies surrounding the proper value of the minimum wage floor. Over the past several months it has received much more attention due to President Obama’s State of the Union declaration of raising the minimum wage for all new federal contracts to $10.10. This comes just one year after he urged Congress to raise the minimum wage to $9 per hour in his 2013 State of the Union. Currently, the minimum wage stands at $7.25. The present-day wage contributes to about 49 million Americans (14.5% of the U.S. population) living impoverished.
Minimum wage is such a debated issue because of the paradigm it creates for unskilled laborers. Economists and politicians often argue that the wage levels should differ because unskilled workers are earning more money than they should. We have this predicament because it is difficult to place a value on labor in the first place. On the other hand though, skilled workers who may have been unemployed before taking a minimum wage paying job are now working for pay that correlates to living below the poverty line (a full-time employee earning $7.25/hour will make $15,000 a year, which is below the poverty level for a family of three). Moreover, other analysts and politicians (Republicans) argue that raising the minimum wage will result in less job creation and more unemployment. On a strictly economic and financial basis, I can understand this point of view. Logically speaking, why would business owners offer more jobs to prospective employees if they must allocate more money for wages? Economics is based on the belief that all decisions are made rationally, and rationally speaking, I would not provide job opportunities for people if it were more expensive for my business.
As an attempt to improve our nation’s current economic situation, President Obama has signed an executive order that will raise the wages of all new federal contracts to $10.10 per hour. Notice, this executive order only affects all new contracts, so, unless restructured, all old contracts will remain at $7.25 an hour. While this only makes a dent in the overall conversation of minimum wages, it is expected to affect more than 2 million employees. Furthermore, it will hopefully spark an initiative by our legislative branch to pass the Fair Minimum Wage Act, which will effectively raise the minimum wage to $10.10 for all laborers across the country by July 1, 2015.
In an attempt to understand minimum wage from all sides of the argument, I would like to outline three popular theories about the benefits minimum wage:
Stimulating the Economy
The argument can be made that raising the minim wage to $10.10 would stimulate the economy due to more money spent on goods and services. President Obama and additional researchers argue that lower-income workers, or those who depend on minimum wage, spend their earnings more quickly and locally than do higher-income workers. In fact, the Federal Reserve Bank of Chicago noted that every $1.00 increase in the minimum wage would increase the spending of a low-wage worker’s household by $2,800 yearly. This provides the local, small businesses with the customers and demand they need to maintain and expand their own labor forces. As a result, we would see a reduction in the nation’s unemployment rate. More specifically, our nation could be looking at 85,000 new jobs, which is 9,000 more than the job creation between November and December that yielded a .3% reduction in the unemployment rate. These small, yet impactful resultants of an appreciation in minimum wage would also affect the U.S. GDP by $22 billion. This stimulation is three fold. As the minimum wage increases, our blue-collar labor force is injecting our economy with discretionary income expenditures, which then fuels our local shops, and by reaction, our shop owners can begin to hire more laborers.
At the current wage rate, there are nearly 8 million workers who work full-time, yet they continue to live below poverty levels. These hard-working Americans, who rely on government subsidies, are struggling to provide basic necessities for their families. Not only would raising the minimum wage help these workers and their families, but it would also alleviate some of the pressures on the government to support such people. According to a study by the University of Massachusetts’s Arindrajit Dube, an Amherst Economist, the poverty rate would reduce by 1.7%, which would also erase more than half of the increase in poverty caused by the recession. This translates to almost 5 million people being lifted out of poverty. An increase in minimum wage would directly affect the wellbeing of millions of Americans who, at the current wage-floor, struggle day-in-and-day-out to supply the goods, which many of us take for granted.
Lastly, the council of Economic Advisers estimates that, when fully phased in, 28 million workers would see a raise in wages. According to the Fair Minimum Wage Act, the entire wage scale would appreciate due to inflation rates. This suggests that even those who are currently earning more than $7.25 an hour, such as $8.25 or $9.00, would also see their pay rise past the $10.10 mark. Although the nation’s inflation rate has been relatively steady (between 1.5% and 1.7% from 2012 through 2014) it is important that our laborers are able to keep up with the rising costs of goods and services.
What if a spike in minimum wage wasn’t as beneficial as politicians and economic analysts make it out to be? What if, from a callous business perspective, an increase in wages was completely impractical? By examining a simple supply-demand graph regarding wage floors and those employed, we can hypothetically observe what would happen if minimum wage rises to $10.10.
*Disclaimer: All values, except for the minimum wage prices, were arbitrarily chosen for the sake of simplicity and illustration.
In a perfect world, where micro/macroeconomic principles are fully applicable (never going to happen), all decisions are rational and based at the margin where marginal benefit equals marginal cost. In such a theoretical world, there is an equilibrium minimum wage value that would accommodate all perspective employees and all business owners looking to hire. On the graph, this quantity demanded and supplied is 150. The problem with this idea though, is that (A) unemployment will always be present in an economy, as there are frictional and cyclical unemployment levels that arise due to the ebb and flow of an economy, and (B) this ambiguous wage would be so low for the employees that they would not be able to support themselves or their families. This, I believe, is the general predicament with minimum wage. Employers believe the wages of unskilled labor should be lower than they actually are, and employees feel as though they have the right to higher wages so that they may live affordably.
Looking at the graph, we can see that at the current minimum wage of $7.25 an hour, the number of laborers employed is 100. This is because of the quantity demanded, or the number of workers that business owners are willing to hire, is 100. Contrastingly, the number of workers unemployed is 100 (quantity supplied minus quantity demanded at the intersection points of the minimum wage rate). If the national minimum wage were to rise, what would happen? According to the graph, the quantity of labor demanded would actually decrease to 30 and the quantity of labor supplied would increase to 300 (just think about it, a lot more people would now be searching for jobs if they discovered the new minimum wage to be $10.10). As a result, the number of those unemployed is more than double the unemployment value at $7.25.
Imagine yourself as a small business owner and think about the consequences of such a spike in wages. At a higher minimum wage price, you would have to allocate more funds for paying your employees. Where does this money come from, you ask? It could be taken from the wages of your veteran workers, which means they would be taking pay-cuts to help fund the pay of new, lower-level employees (not to mention their incentive to work efficiently and productively is probably gone). The money could also come from the manufacturing budget, which results in less production. If the company is producing fewer goods and services, the firm does not need as many employees, which, or course, leads to people being laid-off and increasing the levels of unemployment. Moreover, the most important facet of your company that could lose money is your profits! I’m certain this would not fly with you considering you opened the business to make money.
For sake of argument, let’s say the minimum wage appreciated and stimulated the economy, like some economists believe would happen. If you read my last post , you understand that stimulation would increase the number of jobs available. The issue that may arise through this theory though, is the law of diminishing returns. This law states that in all productive processes, such as the work of a frier at McDonald’s or of a shelf-stocker at a grocery store, adding more of one factor of production (an employee) will eventually yield lower per unit returns. In plainer terms, this suggests that adding more and more employees results in decreased marginal production. Why reduce this factor of production when firms could maximize production until marginal benefit equals marginal cost?
Lastly, it is feasible that by raising the minimum wage we reduce the chances of unskilled laborers (e.g. people who did not finish high school or people who only have a high school diploma/GED) receiving job offers. The graph already indicates a shortage of 270 jobs at a wage rate of $10.10, so when firms do hire people they are probably choosing the best possible applicants who have the best chance of improving their skills, making it that much more difficult for unskilled workers to find jobs.
I’m personally not sure if a spike in the national minimum wage floor is a good idea for the U.S., for there are factors on both sides of the argument that are swaying me in every direction. From a purely financial lens, it seems like raising wages does not bode well for a firm. At the same time though, I do not think its acceptable for some of our nation’s hardest workers to live below the poverty line. Especially when thinking about out larger corporations, like Wal-Mart and McDonald’s, I do not think it would be an extreme burden or great loss of profit to pay their employees above the minimum wage. Not only would their employees be able to live more comfortably, but the corporations would probably see increased production due to the whole efficiency wage principle…just a thought. This issue is so intriguing because economic theory is not the end-all-be-all. People across the country will be affected by whatever decision is made regardless of an appreciation. Emotions, rationalities, and the viewpoints of business owners throughout our nation are involved. I’m not sure we even know exactly what would happen with a wage increase, but hopefully this post made the topic clearer so you can arrive at your own conclusions.