In theory, cheap labor is good for investors. All other things being equal, the less you have to pay to produce, transport, and sell goods, the better it is for the company's bottom line.
But all other things aren't equal.
Low wages and minimal staff can compromise job performance and cost businesses more down the road. Recent labor woes at Walmart (WMT) prove just how costly it can be to rely on cheap labor.
Walmart's Cheap Labor: Bad for Business, Bad for Shoppers
Walmart's Cheap Labor Is Costing It a Fortune
Last week, Walmart agreed to pay an $81.6 million settlement after pleading guilty to violating the Clean Water Act and other environmental laws in California and Missouri. It's not the first time Walmart has had to pay up for environmental violations, either. In 2012 the company paid a $27.6 million settlement to settle similar charges from California authorities.
Federal prosecutors claimed that poorly trained workers disposed of fertilizer, pesticides, and other toxic materials by dumping them into trash bins or pouring them into drains connected with the sewer system.
In other words, Walmart's reliance on employees lacking key training cost it nearly $110 million for these violations alone.
Granted, Walmart has updated its training programs to teach employees how to dispose of toxic materials. However, here are some reasons to believe this scandal is a symptom of a larger problem.
Consider the Huffington Post's analysis of an internal Walmart document leaked last year. A low-level worker at Sam's Club (a division of Walmart) who starts out making around $8 per can expect to make about $10.60 per hour after working at the company for six years if he is a "solid performer" and gets one promotion (the average rate). With wages like those, it's no surprise that the company's annual turnover rate was more than 37 percent in 2011.
Because it's not paying employees enough to stick around, Walmart has an incentive to invest as little as possible into training each employee, lest their investment simply give their employees the skills to obtain higher-paying work elsewhere.
Under its current labor model, the company certainly has reason to train its employees well enough to avoid a scandal -- but just well enough -- and sometimes skating along that edge turns out to be costly, as is the case when employees don't know how to properly deal with toxic waste.
According to Bloomberg, this workforce reduction has driven customers away due to the company's inability to keep its shelves stocked and keep checkout lines moving.
Clearly, these are known issues. Even a single out-of-stock item can significantly affect sales. Walmart went so far as to hire an outside firm -- Acosta -- to secretly audit the availability of certain items in its stores. Bloomberg quotes a 2012 study in which Erick Kritsky, Acosta's director of application development, said, "In a superstore, if we fix a void at the beginning of the month, one single SKU in oral care translates to about $360,000 in sales at the end of the month."
The high cost of cheap labor isn't just monetary. Cheap labor also brings risks of worker safety scandals, such as the recent building collapse in Bangladesh that killed more than 1,100 workers and a factory fire last year that killed 112 people. Both factory buildings contained evidence that the companies were doing business with Walmart.
While retailers like Walmart may be drawn to Bangladeshi factories because they are low-cost options, these discounts come at a cost to worker safety when factory owners fail to invest in safe working conditions to ensure they can offer the lowest possible prices.
In addition to creating bad PR, safety scandals can cause worker unrest and disrupt a business' supply chain. For example, after the building collapse, violent protests erupted in Bangladesh, in which workers set fire to at least two factories.
Some retailers show that low-cost labor is not the only alternative. For example, Trader Joe's has a rule that the minimum pay for all full-time workers must be at or above the median household income in their community. Also, Slate has reported that after less than five years at Costco (COST), employees will make about $19.50 per hour and receive a $2,000 bonus twice a year.
And the cost of such "generosity"? Forbes points out that Costco's most recent quarterly report showed 8 percent sales growth from last year, while Walmart offered only 1.2 percent sales growth.
Granted, Costco's relatively smaller size gives it better growth potential than the Bentonville Behemoth. However, its ability to operate on a higher-wage model suggests that cutting workers' pay to the bone isn't the only way to go.
It's a point investors should note as they look at mass-market retailers: There are investment opportunities that lack the risks associated with Walmart's cheap labor model.
Motley Fool Contributor M. Joy Hayes, Ph.D. is the Principal at ethics consulting firm Courageous Ethics. She has no position in any of the companies mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale.