A Typical View of Wal-Mart’s Advantages. Again!

If you have an important point to make, don’t try to be subtle or clever. Use a pile driver. Hit the point once. Then come back and hit it again. Then hit it a third time – a tremendous whack. –Winston Churchill
We will discuss Wal-Mart in the next few posts before moving on to the Coors case study.  Think of reviewing these cases as you develop more experience with analyzing competitive advantages. In fact, do not be afraid to read the cases again! Think of these guys: http://www.youtube.com/watch?v=T9AajQn7b18

Now give me fifty push ups! Does power corrupt?

A Typical View of Wal-Mart’s Advantages

http://www.thefreemanonline.org/headline/the-limits-of-the-local/

The Limits of the Local by Steven Horwitz

Critics of the market often point to the increased globalization of production and consumption as one of the problems that economic freedom can generate. This criticism has a number of elements. One is that multinational firms like Wal-Mart or McDonald’s turn the United States, as well as the rest of the world, into one commercial culture, destroying the local stores that provided a distinct identity to small towns and cities across the globe.

Large chain stores and franchises do affect local businesses, especially in small towns, but note that it’s mostly a shift rather than destruction: Some businesses find ways to compete effectively by filling niches that the larger stores can’t fill, particularly with respect to distinctly local products, such as restaurant food.

However, larger chains have at least two big advantages worth discussing.

First and perhaps most obviously, their size normally gives them the ability to buy in larger quantities, keeping their costs and prices down. Wal-mart grew to the size it did through highly effective inventory management; it pressured suppliers to keep their input prices low and passed those low prices on to consumers.* Low prices are a big part of what lures people to shop there rather than at the smaller boutique stores. Chains like McDonald’s work in similar ways; a burger, fries, and drink there is usually no more expensive (especially if you count the lack of a tip) than the diner up the road.

Known Commodity

The second advantage is less commented on. The very similarity of chain stores and franchises nationwide, and even worldwide, is a big attraction to many customers because they are a known commodity. If you’re hungry in a strange town, you know that you can always go to a national fast-food chain and get a meal of nearly identical quality to what you’re used to at the chain’s restaurant at home — and for a good price. If you are sufficiently risk-averse, the consistency of a national brand is very valuable. In an economy where national chains were more difficult to operate, we would be far more at the mercy of the unknown.

And it’s not just about food. On a recent trip I forgot to pack dress socks. Thankfully, in a strange town 2,500 miles from home there was a Wal-Mart five minutes up the road. I happen to like Walmart’s in-house Faded Glory cotton dress socks, so I was able to buy several pairs of exactly the socks I like and usually wear (for less than $2 per pair). In a “local only” economy, not only would I have had to spend more time searching for a store that carried dress socks (and was open at 8:30 a.m.!), I would also have faced uncertainty over whether those socks would be the kind I like. And I probably would have paid considerably more. A highly local economy constantly puts strangers in a similar position to the traveler with car trouble who knows he is at the mercy of a mechanic he’ll never see again. Chain stores and franchises bring reputation and repeated dealing into the equation, removing uncertainty and reducing the seller’s power over the buyer.

Freedom of Choice

One final advantage of a global economy is that it still permits people to “buy local” if that’s what they prefer. I love living in a small town with a Wal-Mart ten minutes away and a farmer’s market during the summer and a top-notch restaurant that serves lots of local beef and produce. In a world where everything is local, those of us who want to “buy global” presumably would be prohibited from doing so — in the name of preserving the local character. Just as markets allow pockets of voluntary socialism, but socialism cannot abide capitalist acts between consenting adults, so a global economy has room for the local, while mandatory localism cannot meet the needs of those who prefer to buy global.

Whether it’s food or socks or pretty much anything else, the freedom of the marketplace allows for firms of varying size and composition to meet the equally varied wants of consumers.

*Has the writer accurately assessed the competitive advantages of Wal-Mart—the source of Wal-Mart’s cost advantage? Will going global help or hurt Wal-Mart’s profitability? How? (See 2003 Wal-Mart Case Study for help).  And if the writer is correct, then why do Sears, Kmart and other large retailers struggle? What does this article illustrate about most business writers or analysts? Lessons?

5 responses to “A Typical View of Wal-Mart’s Advantages. Again!

  1. Has the writer accurately assessed the competitive advantages of Wal-Mart—the source of Wal-Mart’s cost advantage?

    No. As we learned from the case study on WMT, the company’s structural competitive advantage in 1985 was based on regional economies of scale with limited customer captivity. WMT’s advantage was not based on higher inventory turns or pressuring suppliers for better deals. In fact, we saw in the numbers that WMT’s COGS were actually higher than a competitor such as KMART. WMT could not pressure consumer branded companies for better deals than competitors. I would say that the relationship was more symbiotic–the consumer branded companies drive traffic to WMT stores.

    Regarding pressuring suppliers, I have a question. I’m reading the Little Book That Builds Wealth. The author states on page 108, “In the United states, the rise of big-box retailers like Target, Wal-Mart, and other has permanently changed the economics of many consumer-products comjpanies for the worse. Although a number of factors have contributed to decreased pricing power for firms like Clorox and Newell Rubbermaid, the increased buying power of a concentrated group of customers certainly tops the list.”

    Do you agree or disagree with the author? In the 2003 Wal-Mart case study it discusses how Wal-Mart introduced Sam’s American Choice detergent at roughly half the price of PG’s Tide, but PG officials said “this in no way strains our relationship.” Tide still commnaded 4X the shelf space. Again, this is this evidence that the relationship is more symbiotic and Wal-Mart is not trying to get the lowest possible price from its vendors?

    Will going global help or hurt Wal-Mart’s profitability?

    Going global will most likely hurt Wal-Mart’s profitability. The company has two options in new markets, buy or build. If WMT can purchase a small chain with regional EOS in a country such as Brazil, the price paid and potential growth opportunities (within the Regional EOS) would likely determine whether growth would be profitable. It is highly likely that Wal-Mart would be entering new markets against more established competitors (who might perhaps already benefit from REOS+CC), therefore they would need to invest large sums of money to establish their stores and store network AND take customers from established competitors. Even though Wal-Mart is larger in absolute terms, these smaller foreign companies might be far larger in their regional/local markets.

    If you look at the numbers, WMT’s international operations are much less profitable than the core U.S. Discount and Supercenters, with pre-tax operating margins of 9% and 6.6% respectively. International only has 4.9% pre-tax margins. The lower pre-tax margin for Supercenters might be due to the higher sale of food (would need to look into this more). ROA for core US operations is 48% while international is 6.6%!! International accounts for only 15% of pre-tax profits but 32% of assets.

    My questions: Are Wal-Mart’s international operations profitable? Is growth profitable? It would be helpful it they broke out profitability by region, country, etc. How would you go about assessing whether growth is profitable is the company does not break out their international segment? This is like a retailer not breaking out MROIC for international stores. Also, I’ve spoken to management teams that say “we target a 15% return on capital,” especially large grocery chains… but that 15% DOES NOT show up in their numbers (nationals, not counting smaller regionals).

    Lessons:
    1. Look at the numbers for yourself.
    2. Think like a strategic business analyst. What are the structural competitive advantages of the business? Are there any?
    3. Question all “experts.”

    The analysis above shows a lack of logic and analysis. No numbers were presented as factual evidence to back up the statements. Only broad generalizations presented.

    Thanks.

    • Great post Logan.

      No I don’t agree with the author. Perhaps Wal-mart gets a price discount but probably with costs savings shared with the branded product producer. Wal-Mart needs the brands to bring in customers. Why no Wal-Mart Cola?

      Where is the author’s proof? Show me the $%^&! money through lower cost of goods sales.

      PS I added a post later to this discussion down below.

      • I have kept thinking about store brands vs. branded products. If you go to Whole Foods or Costco their “Store” brands seem to be doing well. In fact, I actually like some store brand products better.

        If a store like Whole Foods builds a relationship of quality with their customers then for certain products they could have significant negotiating power over competitors branded products. Good question.

  2. Question all experts! I like that attitude–excellent write-up. But thank God we can sometimes gain an edge by digging deeper while thinking with strategic logic.

    Let me read that passage in context and return with my reply.

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