Like Dell, Wal-Mart has been a judicious user of technology. This has been a
significant key to its market dominance. While the Third Law of Techonomics
predicts that organization size will shrink as transaction costs reduce, Wal-Mart has
grown rapidly by any measurement over the last 20 years.
This seems to defy the
Third Law, unless you consider the means of expansion: franchise. Wal-Mart found
a model that worked and then replicated it massively, all the while putting in place
systems that allowed smaller work forces to accomplish more. Wal-Mart is constantly
increasing the productivity of its operations via continuous improvements, many
based on technological innovations.
Using twenty-first-century data management systems, Wal-Mart places the
inventory control responsibility for their shelves into the hands of their suppliers.
Suppliers are allocated shelf space based on Wal-Mart’s projections. Suppliers are
responsible for keeping that shelf space full of viable products, and they carry the
cost of this inventory, often for months after the product is sold. Suppliers are left
with the responsibility for unsold merchandise at season’s end if they happened to
overstock Wal-Mart. The key to this system’s success is an electronic data network
linking vendors with inventory information from Wal-Mart central distribution centers,
retail store shelves, and store cash register transactions. Ideally, vendors have
“perfect information” in terms of their company’s collaboration with Wal-Mart (but
they do not get information about Wal-Mart’s other vendors; that is shielded). They
always know how many of their own products are on what shelves at what stores
and how fast they are selling each day.
It is the supplier’s responsibility to have the
right product quantity available at the distribution centers to meet the needs of
the store network.
In this operating model, Wal-Mart looks like a giant consignment shop. Vendors
place products on borrowed shelf space and are paid for only those products that
sell, with payment terms that are favorable to Wal-Mart. It is a very challenging
environment for vendors, but the volume of the opportunity is also very enticing.
The story of one man who said no to Wal-Mart, Jim Wier, then the CEO of Simplicity,
makes interesting points about how the specter of Wal-Mart changes the economics
of competition, even if a company chooses to say no to being a supplier to them.
Wal-Mart minimizes risk by giving inventory responsibility to the vendor. They also
maximize positive cash float by negotiating payment terms that extend beyond the
period of the anticipated cash sale to the customer.
Here is a simple example of the process to illuminate the model. Suppose a
publisher is seeking to sell a book through Wal-Mart. The publisher approaches Wal-
Mart with a proposal to garner the coveted shelf space. After some challenging
negotiations, Wal-Mart agrees to take 10,000 books for 90 days, with an additional
90-day payment term. The books sell for $30 and the publisher is to receive $20 of
that price for all books sold during the 90-day sales period. Everybody is happy.
The publisher now has a potential $200,000 book-selling contract with Wal-Mart.
On day one, the publisher ships 10,000 books to the Wal-Mart distribution center.
They sell well and on day 89, Wal-Mart collects all remaining stock from all stores
(say 1,000 books) and ships them back to the publisher. No payment yet; the terms
were 90-days after the sales period. On day 91, Wal-Mart reorders another 10,000
books to begin selling again, and the cycle repeats. Still no cash in hand for the
publisher, who is now out printing costs for 20,000 books and has 1,000 of them
on hand with Wal-Mart stickers on them! They must be sold for ten cents on the
dollar to a “seconds” dealer. Day 180 comes, and the publisher receives a check for
$180,000 ($20 x 9,000 sold in the first three months). By now, Wal-Mart has sold
the second 9,000 (returning again 1,000 not sold) and has received cash revenue of
$540,000 with a gross profit (profit before operating and overhead costs are deducted)
of $180,000 (18,000 x $10 per book sold). This cash management discipline eliminates
all inventory risk at the expense of a small increase in transportation logistics.
The Wal-Mart logistics system is already in place though, so the incremental cost
of shipping the extra product back to the publisher is minimal.
The gross markup of about 35% is typical of a retailing industry, but Wal-Mart’s
positive cash float results from a system of data management (technology), automated
distribution (technology), and savvy contract negotiation (economics) that
fuels the growth of a highly successful twenty-first-century enterprise. Meanwhile,
Wal-Mart’s suppliers and their competitors both languish while they try to understand
the dynamics of this arrangement. Like them or not, Wal-Mart must be admired for
their systematic approach to maximum efficiency, passing on many cost savings to
the customer and thereby making their competitive position even more substantial.
The success flywheel moves faster and faster, and the inertia of the 1,000 things
Wal-Mart did to get into a dominant position creates a crushing push against competitor
entry. Massive buying power allows negotiation of favorable terms, both cost
and payment cycle. The rolling warehouse network, backed by the automated distribution
system, reduces inventory costs and puts the right products on the shelves
in the right season. The combination of these advantages has made Wal-Mart a very
tough competitor in many sectors. The company systematically enters new markets
with a goal to obtain a market position in excess of 30% of the entire market segment,
placing it in the top two retailers in any given category.
Rank upon rank of companies have been transformed or displaced by the Wal-
Mart juggernaut.
When Wal-Mart enters a small U.S. community, the first to feel
the crush of competition are the “mom and pop” establishments. With limited buying
power and operating hours, they are no match for the diversity of goods or the
competitive pricing of Wal-Mart. Most of these small operations last no more than
two to five years on goodwill, perseverance, and savings. The second rank to fall is
direct competitors. Sears, K-Mart, and Service Merchandise have either ceased business or faded to mere shadows of their former operations. Target and Costco
are the remaining direct competitors. Now Wal-Mart is aggressively entering the
grocery market. Winn-Dixie has recently declared bankruptcy, and long-standing
chains like Kroger and Albertsons are battling for customer loyalty.
Wal-Mart’s success is now causing the competitive restructuring of major product
manufacturers. Proctor and Gamble has merged with Gillette, combining two
companies that had previously been formidable competitors. The first reason listed
in information to shareholders was the necessity of putting the combined corporation
into a better bargaining position with Wal-Mart. The recently hired CEO of Sara
Lee said her company would return to making baked goods, where there was a
reasonable margin, and sell off its clothing lines, because there was no margin
remaining in clothes sold through Wal-Mart’s channels, which had accounted for
over one third of their clothing sales.
The coming impact of Wal-Mart’s dominance may well shift the international
trade balance. For some time, Wal-Mart’s buyers have been commissioned to find
the right product at the best price anywhere in the world. Global sourcing has
been the techonomically logical direction for filling its huge distribution channel.
Low-cost Chinese labor, guided by focused product specifications from Wal-Mart
and interconnected by the global digital network, has caused a massive shift in
global consumer goods manufacturing over the past decade (from Japan and the
U.S. to China). International product collaboration, manufacturing inventory management,
and logistics (technology) have combined with the timeless natural
selector of lowest-cost labor pool (economy) to drive these production trends.
Wal-Mart is nearing “nation” status in its size, negotiating ability, and influence
in the world economy. Figure 6.4 shows the ranking of Wal-Mart as a country if its
revenues were considered a gross national product (in 2003).
If Wal-Mart were a
country its “revenues as GNP” would place it as the 18
th
largest economy in the
world
,
right behind Taiwan and in front of Switzerland.
Even more impressive from a trend standpoint, Wal-Mart and China are the only
two on the list growing at double-digit rates. Within 5 years, China would project
to have the world’s third largest GNP, and Wal-Mart would be nearing the top twelve
(if it were a country). Wal-Mart has almost single-handedly created a massive
distribution channel for Chinese goods in the U.S. over the past decade. The nearterm
result for U.S. consumers has been a slowing of inflation as consumer goods
have remained inexpensive. The long-term result may be that competition for the
world’s basic natural resources (energy sources like petroleum, building supplies
like steel, and raw materials like asphalt) will increase, causing prices to escalate.
The techonomic metric that measures the distance between Wal-Mart and its
competitors is the direct item price comparison. Wal-Mart has traditionally positioned
itself as the low-price provider, satisfied with a 35% retail markup on the
goods it sells. If it can drive a provider to a lower cost with the same payment terms,
then Wal-Mart will pass on the savings to its customers. Its competitors, with a more
costly distribution system, less favorable payment terms with suppliers, and less
purchasing power to drive down supplier costs, are left to price their offerings as
best they can while still making a profit.
The techonomic metric for competition margin measures the performance difference
between Wal-Mart and its challengers in any market. This metric relates the
shelf price for a product from a competitor to the Wal-Mart supplier cost and retailing cost for the same product. Retailing markup is traditionally 35%, which includes
the retailer’s selling costs. As the retailing and supplier costs are reduced in the Wal-
Mart system, the competitive margin increases. If the metric is less than one (1.00),
Wal-Mart loses money on the transaction. An increasing value for the metric beyond
1.35 reveals opportunities for pricing approaches that undercut vulnerable competition.
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