How Gap's wage hike will boost its bottom line

February 20, 2014: 3:01 PM ET

MIT operations expert Zeynep Ton argues that the clothing retailer's pledge to increase worker pay is about much more than good PR.


FORTUNE -- When Gap Inc. (GPSannounced that it would raise the minimum wage it pays retail associates to $10 per hour by 2015, it was impossible for observers not to consider the move politically motivated.

After all, Washington is mired in a debate over raising the federal minimum wage to roughly the same amount ($10.10) Gap is promising to pay its workers. Even President Obama made a point to praise Gap's move, saying, "I applaud Gap Inc. for announcing that they intend to raise wages for their employees beginning this year."

But the change at Gap was anything but political, and it should be taken as a sign that if the traditional retail industry is smart, it will invest much more in its employees as it competes with low-cost online retailers.

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For years, the brick-and-mortar retail industry has at least claimed to understand that the key to survival is to leverage their store base and give customers what online retailers can't: great face-to-face service and in-store experiences. Companies like Best Buy (BBY), Macy's (M), and Wal-Mart (WMT) are racing to build out a so-called omni-channel shopping experience where customers can seamlessly switch from shopping online to shopping in-store. That means using stores as distribution centers for an online retail operation, and creating an in-store shopping experience in which shoppers can get expert advice on products they want.

Of course, the omni-channel shopping experience requires significant investment in technology and, above all else, workers. Zeynep Ton, a professor of operations management at MIT and author of the recently published The Good Jobs Strategy, argues that Gap Inc.'s recent move is an acknowledgment of that fact. "It's ironic that as the retail industry has become more complex, investment in employees has gone down," she says. "More complexity requires workers who are able to cope with this complexity."

And an able workforce needs to be well paid, trained, and offered predictable scheduling so that they are sufficiently motivated to help a complex retail operation succeed. Ton's book looks specifically at four retailers -- Trader Joe's, Spanish-based grocer Mercadona, Costco (COST), and QuickTrip -- that have successfully adopted the "good jobs strategy" by heavily investing in worker pay and training.

Ton says companies like Trader Joe's pay their employees well so that they are motivated to provide good customer service, and these workers are trained so that they can perform a variety of tasks. Finally, her model retailers hire more workers than their competitors, operating with labor "slack" so that they can offer employees more predictable hours and customers as much service as they want.

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It makes sense that most retailers have avoided this strategy. Ton writes:

Retailers view store labor as a cost driver, not a profit driver. And labor is not just any cost. After the cost of goods sold, labor is the largest cost for most retailers. Perhaps more important, labor is the largest controllable cost. In a pinch, retailers cannot quickly cut other large expenses such as the cost of the products they sell or their retail costs, but they can quickly and fairly easily reduce what they spend on training, benefits ... or the total number of employee hours.

Retail executives have failed to view labor as an investment rather than an expense. Of course, creating a state-of-the-industry operations management department isn't easy. Firms must have a clear strategy for growing their businesses through investing in employees. But the rise of e-commerce has made it an appealing option for many traditional retailers. If you can't beat Amazon (AMZN) on cost, you'd better find another way to keep your customers happy. "It's a step in the right direction," says Ton of Gap's pledge to pay its workers more. "Just paying people more isn't enough, though. You really have to overhaul your operations so that your employees can drive returns."

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