Externalizing the Costs; Internalizing the Profits

A Commentary by William C. Shelton

(Editor’s note: The views and opinions expressed in The Somerville News’ commentary section, belong solely to the authors of the articles and do not neccessarily reflect the views of The Somerville News.)

The company that wants to build an Assembly Square furniture store the size of six DeMoulas markets has achieved extraordinary business success with a strategy that is as innovative as its product design.  Readers may be interested in knowing how, with only 160 stores worldwide, IKEA has annual sales conservatively estimated at 13 billion dollars.  Or how the company‚Äôs owner replaced Bill Gates as the richest man in the world.

IKEA‚Äôs genius has been to take the business strategy known as ‚Äúcost leadership‚Äù to a new level‚Äîcost externalization.  Its customers, people who are unable or unwilling to pay high prices, include students, newly weds, and other people starting a household.  Before Ikea, this market segment relied on second-hand furniture, low-quality products, or did without. 

IKEA invested in design talent.  It offers products that are more stylish, attractive, and innovative than those of its competitors. Demand for these low-cost, well-designed home furnishings is enormous.  This alone would be a significant accomplishment, but Ikea has developed a strategy by which others absorb much of its costs, while the company absorbs the enormous resulting profit.

The basic idea of ‚Äúcost leadership‚Äù is to offer a product for which there is so much demand that you can get volume discounts on everything that you need‚Äîdesign talent, raw materials, freight, manufacturing, third-world labor, advertising, and so on.  You offer low prices, but your sales volumes and low costs more than make up for them.

IKEA takes this a step further.  It begins with externalizing raw materials and basic production costs to workers and rural peoples in countries with less-than-scrupulous labor and environmental regulation.  Sensitive to its image, Ikea did agree to stop chewing up ancient forests deemed intact by the Forest Stewardship Council, and to eliminate toxic fumes produced by its particle board binder and inhaled by workers and customers.  It continues to gobble up trees that will not be replaced for generations.

By shipping its furniture as flat-packed particle board, IKEA externalizes transport costs to customers, who also cover manufacturing and delivery costs when they retrieve these flat packs from the warehouse and then load, pay for, transport and assemble them. 

Ikea externalizes its facilities costs by locating one showroom/warehouse within a 200-mile trade radius, as opposed to say, Jordan‚Äôs Furniture, which has four stores and a warehouse within a 30-mile radius.  This creates costs that are much higher than those of local stores, but are paid for by IKEA customers, tax payers, and breathers.

Thousands of people drive pickups, trailers, and SUV‚Äôs as much as 200 miles each way to haul off their particle board.  You can get a sense of their collective impact by looking at customer vehicle trips projected in the Somerville IKEA‚Äôs environmental impact report.  Even though these trip projections are understated, they would require customers to drive 68 million miles per year to get here, burn 3.4 million gallons of fuel, and pump 67 million pounds of carbon dioxide into the atmosphere.

Local officials often don‚Äôt understand IKEA‚Äôs traffic impacts until it‚Äôs too late.  New Jersey had to pay $200 million to fix the Turnpike mess caused in large part by the Elizabeth IKEA‚Äôs traffic.  California had to build an $80 million dollar new lane on I-880 to reduce IKEA‚Äôs congestion in Emeryville. 

This is why Britain‚Äôs Deputy Prime Minister halted the construction of any new IKEAs, even though that country accounts for 12% of the company‚Äôs worldwide sales.  (U.S. sales represent 13%.)  New Rochelle, New York had the wisdom to listen to citizen groups.  City officials told IKEA that it could build a store there if it agreed to pay for any road improvements needed to accommodate its future traffic.  IKEA left.

Victims of the world‚Äôs growing incidence of hurricanes, tornados, floods, and droughts may also be counted as payers of IKEA‚Äôs business costs.  As would Somerville breathers, who already enjoy the highest excess heart attack and lung cancer deaths per square mile in Massachusetts.

Yet, IKEA‚Äôs real estate development personnel are unfailingly friendly and courteous.  They have gone through every regulatory process required of them.  This is in stark contrast to the mall-site developers who deceived state regulators and persuaded Somerville officials to gut Assembly Square‚Äôs health and zoning protections so that they could make $30 million without building anything.

Indeed, within the American economic system, IKEA‚Äôs responsibility is to generate as much profit as possible for its owners.  It has fulfilled that responsibility admirably.  Our responsibility is to elect officials who are not so ignorant, unaware, or venal as to harm our interests, health and wellbeing.  How do you think we‚Äôre doing?