IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
By Jacob Arfwedson
For global capitalism to reach optimal eclosion, there are several basic conditions:
> free trade: companies are allowed to sell wherever they sense a profitable opportunity;
> the tech revolution: production may take place anywhere, whereas selling may be done thousands of miles from the point of production;
> open communications: without a reasonably modern infrastructure – including telecoms, ports, airports etc – the network effects known as globalisation will not pay off;
> protection of intellectual property rights: platform companies like IKEA, Wal-Mart or Dell would be worthless without this provision;
> the right to be wrong, i.e. the right to fail which is inherent in and necessary to any entrepreneurial activity.
It is against this contrasted backdrop that platform companies (IKEA, Wal-Mart, Dell etc) reap rewards and prove their role as major catalysts of the increasingly fluid context of market globalisation. They move and thrash, cutting through established patterns of production and distribution, upsetting trade balances and government accounting in the process.
In 2012, IKEA had 338 stores in 40 countries. Sales rose to € 27.5 billion, whereas prices were reduced by 0.8 per cent (and by more than 20 per cent over the past decade). Sales are 72.5 % in Europe, 14.5 % in North America and 12% in Middle East/Asia/Australia. As IKEA is not a listed company, it does not publish profit figures. But it has total assets of 44 billion euros and 29 billion in capital.
A number of years ago, the Wall Street Journal published an editorial entitled “The IKEA Economy”: it argued that any country’s wage costs could be measured by the progressive expansion of IKEA stores on its territory. Indeed, the higher the payroll taxes, the more it makes sense for citizens to travel to the Swedish outlets in the middle of nowhere to do it themselves, rather than buying furniture from a high street store. At the very least, it is a surrogate measurement for the demand of decently priced, but attractive consumer goods.
When it was invented in 1953, the flat pack concept was revolutionary; but it was also a response to a much wider context. Before starting to design its own furniture, IKEA had been buying goods from other companies, mostly small regional manufacturers. As success lead to growth, the competition awakened and organised itself: “If you buy from IKEA, we won’t buy from you”, warned the largest trade association. The response was to found and use other companies without the IKEA name, appearing at trade fairs to sell the same products under a different label in order to bypass the boycotts. Demand was not the problem; dirty tricks from competitors were however multiplying, denying IKEA the right to put out price labels at trade fairs, for one. But this encouraged new responses by constantly finding new solutions to bring out cheaper goods, come what may. And two major strategies emerged from this desperate struggle, turning necessity into virtue.
First, complaints about transport damages were increasing, such as broken legs on tables. Then one fine day, one of Kamprad’s colleagues said, when packing up a table, “It takes too much space; let’s take off the legs and put them underneath.” (He was to become one of the major designers of IKEA, father of the ubiquitous best-seller Billy bookshelf, as well as a long-time author of the company catalogue.) And that was the birth of the flat pack and the do-it-yourself furniture which first appeared in IKEA’s catalogue in 1956.
Second, IKEA became a pioneer of outsourcing by finding a willing partner in Poland, almost thirty years before the fall of the Berlin Wall. The problem was simple: the number one IKEA article was the simple kitchen chair; but because of the sales boycott, half of the quantity required by customers could not be delivered. The solution: going to Poland for more sympathetic producers. Despite severe initial difficulties (including dealing with archaic production facilities and communist bureaucracy) IKEA managed to build up a functioning delivery operation. Conversely, the Polish producers benefited from technology transfers, long-term contracts and reliability in decision-making.
So may we conclude that the IKEA concept is a magnificent blend of global capitalism and Swedish Welfare State ideology, practised privately? What is certain is that Ingvar Kamprad stays true to his origins in Småland. Because of its history, this region epitomises hard work, thrift, inventiveness and penny-pinching.
This mentality has impregnated IKEA’s corporate culture and manifests itself in rules which may sometimes be perceived as inverted snobbery: nobody wears ties to work, nor travels business class. (And the author can testify that this applies to the founder himself whom I met on a flight in coach class, wearing clogs, no less.) But beyond the informal dress code, the “strength-through-joy” atmosphere which permeates staff policy, IKEA is equally a genuinely global business with a constant eye on cost-containment.
The staff also benefits from bonus schemes: starting at the Seattle, Washington, store, employees were given the entire sales proceeds of one Saturday per year (minus tax). Each employee receives a percentage of the sales, calculated on the number of years of employment. Interestingly, this was pioneered in a store which since 1994 is majority owned by the two managers by franchising This is method of rewarding veteran managers who have reached the top, and who would like to take on further responsibilities – an “intrapreneurship”, as Kamprad’s biographer calls the model.
The “hot dog concept"
In 1995, IKEA stores started selling hot dogs for SEK 5 (instead of SEK 10-15 at the street vendour). Kamprad initially had problems convincing his managers of the viability of yet another price-cutting strategy; indeed, it was his own idea, and most of the management wondered why IKEA should launch itself into selling hot dogs. Somebody objected that the cost of raw materials might exceed the retail price; wouldn’t that justify raising the price to SEK 6 or 7? In that case, Kamprad responded, we might as well forget about the whole thing. But as so often, he succeeded in turning round the skeptics, giving an admirably succinct demonstration in his memoirs:
“The hot dog remained priced at SEK 5, whatever the cost of raw materials. We are not losing in the business, we don’t earn much on each hot dog, but still something. And this is what counts in the end.”
This was the birth of the “hot dog” concept: each product line should contain what Kamprad calls “Oh my!” deals – a hot dog-like offer.
“Thus I wrote down my philosophy of the ten (now 20) hot dogs. We would quickly find ten products which passed the hot dog pricing test. The rule of thumb was 3+1+1. Meaning SEK 3 to the producer, SEK 1 to the tax man and SEK 1 for ourselves. Each time we cannot work out this equation, we should think again.” “[The economists] talk about ‘cash flow’, and I say I don’t know what ‘cash flow’ is; but I know what I have in my pocket.”
This remark is interesting, considering that IKEA’s expansion, being a non-listed company, has been financed almost exclusively on its cash-flow, in great part because the founder believes that the stock market is too expensive an option (and because he wants to retain family ownership).
For all its social concerns and money spent on charity, the core and inner sanctuary of the IKEA business model is heavily guarded. This is ensured through an intricate system of foundations, deliberately designed to keep the business concept and ownership protected:
1) the IKEA Group (the stores, production, development, distribution, retail) is owned by the INGKA foundation, based in the Netherlands
2) the IKANO Group (Habitat stores, financial services, real estate, insurance, banking) is owned by the Kamprad family
3) the INTER IKEA Group (the “concept” including franchising, trademarks, copyrights …) is owned by a holding company based in Luxembourg.
IKEA systems (which is part of the INTER IKEA) is the guardian of the temple: any franchiser who wishes to make a change in the concept must first receive its blessing, or face the ultimate threat of having deliveries stopped and the IKEA sign removed from the operation.
To close, this magnificent quote from the IKEA founder:
“Profit is a wonderful word! Let us once and for all de-dramatise the word profit. Politicians often use and abuse it. Profits give us resources. Resources can be had in two ways only, either through profits or through subsidies. All public subsidies come from government profit in some activity, or through taxation in some form, which you and I have to pay. Let us trust ourselves also when it comes to the creation of economic resources”.
Whereas eradicating poverty is consistently on the agenda of governments, NGOs, international organisations and professional philanthropists worldwide, their struggle to stifle global trade, wipe out intellectual property and penalise multinational corporations will produce the opposite result.
Outsourcing manufacturing industries is a fountainhead for better production and thus greater prosperity overall. Far from being a zero-sum game, globalisation adds value at every stage of the process, by constantly integrating new actors and contributors in the entrepreneurial game. The network effects are inherent in the opening of new markets and drivers of ever-increased innovation and growth.
International free trade and Schumpeterian growth are the best allies of the poor. In this respect, platform companies such as IKEA and others are truly champions for a better world. Let’s be grateful for this.