Thursday, September 21, 2006

How Did Wal-Mart Attain a Cost-Leadership Position?

Recently, I wrote a post about The Penney Idea and Wal-Mart. Continuing in this direction, I am posting today on some reasons I think Wal-Mart achieved success. This post is heavy on business ideas and deals with a contemporary issue. However, my post here is looking at recent history which I think will be studied extensively in the future by historians.

Wal-Mart has pursued many strategies over the decades to achieve and then maintain a cost-leadership position. Some have failed but the majority have been successful. Of these, six are of note. These include 1. an innovative warehousing system, 2. an emphasis on everyday low prices, 3. basing store design on consumer studies, 4. effective use of superstores, 5. using size to negotiate for the best price on brand-name items, and 6. an industry leading inventory control system.

One of the biggest innovations that Wal-Mart has introduced was in having a flexible regional warehouse system. Most Wal-Mart stores are within a six hour drive of a Wal-Mart warehouse. Wrote Camerius (2004), "Wal-Mart built the distribution center first and then spotted stores around it, pooling advertising and distribution overhead" (p. C377).

The use of new distribution centers continues to be a part of Wal-Mart growth. Scheraga (2005) wrote, "The locations of the facilities indicate Wal-Mart's expansion plans. They also illustrate an ongoing challenge the retailer faces in choosing DC locations: Wal-Mart is adding stores at such a pace that new DCs must be planned five years in advance of the store expansion they are designed to support. The first step in the DC site-selection process is identifying the centroid or the point most central to the locations the DC is meant to support" (p. 68)

This has been a sound policy for Wal-Mart. All stores need to be restocked frequently. As such, warehouses are a necessity. To make the most money, the business should have the fewest number of warehouses supporting the most number of stores for efficiency. Further, to be responsive to store needs, each warehouse should be as close as possible to the actual stores. Getting the contrast between a lower number of warehouses coupled with short distances can be hard. However, Wal-Mart solved this problem early on and continues to benefit from it. The warehouse system reduces overhead for Wal-Mart significantly reducing production costs. This then has been translated into lower prices for consumers.

A second strategy that Wal-Mart has pursued has been everyday low costs for customers. While many businesses have attempted to make this claim, few have delivered like Wal-Mart. Rather than have a few loss leaders on sale every week, Wal-Mart attempts to keep all items in the store cheaper than competitors. This then allows Wal-Mart to avoid costly weekly advertising in newspapers. Customers know that all Wal-Mart items are always on sale.

Anonymous (1995) wrote of the Wal-Mart approach, "There are only two ways to lower prices: Lower the cost of goods sold through improved supplier relationships while holding gross margin percentage constant, or, lower the retail prices. Increasing the range of merchandise requires either: increasing merchandise intensity per square foot, or, increasing store size. Wal-Mart has been pushing both these initiatives relentlessly over the past 10 years. By lowering gross margins and reducing costs of goods sold, Wal-Mart has been able to strengthen its price and value image" (p. 46).

Clearly, this has been an effective strategy for Wal-Mart. Consumers think of Wal-Mart as a low cost product provider. This is central to Wal-Mart's image. The smiley face dancing around slashing prices on TV commercials resonates with the public. This has a drawback with a backlash by some social activists who deride the low costs as harmful to society. However, in the American capitalistic society, it has been almost uniformly positive for the Wal-Mart business plan.

A third area that Wal-Mart has used to maintain a cost leadership has been designing stores based on consumer studies. Looking at consumer research, Wal-Mart has built stores with wide aisles, warm colored carpeting, and smiley faced store displays. The stores are known for having friendly greeters. Further, Wal-Mart uses brown papers bags rather than plastic bags in some instances. All of these store designs have resulted from Wal-Mart heeding consumer studies.

This is important as these store features have been identified with Wal-Mart by customers. This has translated into higher sales. Hence, the good use of research has helped Wal-Mart attain and keep their cost leadership position. As Camerius (2004) noted, "Consumer studies determined that the chain was particularly adept at striking the delicate balance needed to convince costumers its prices were low without making people feel that its stores were too cheap" (p. C377).

A fourth strategy that Wal-Mart has pursued has been building superstores. Wal-Mart is not alone in this approach (K-Mart, Home Depot for example) but has been successful in doing it. The large 100,000 to 300,000 square feet buildings merge the general merchandise sales approach with a warehouse model. This allows for a reduction in operating expenses which then translates into further price reductions for consumers. It also has allowed Wal-Mart to branch into the grocery business.

This model closely matches first the strategy of warehouses discussed earlier. This in many strengthens the warehouse approach. In addition to having warehouses close to store, many stores also now have a larger inventory of goods to sell on hand. As Wal-Mart knows what items sell in large quantities, they can have them at hand reducing transportation costs and making more sales if there is a run on an item. At the same time, there is a warehouse close by if they need to have additional merchandise delivered.

This appears to have been a successful model for Wal-Mart. Customers seem to appreciate having a large number of items on one place. This includes having low cost grocery items. Many customers can buy new clothes, pick up a new appliance, and buy their groceries in one shopping trip. This has been a winning idea and has broadened the number and types of items that Wal-Mart can offer consumers.

The fifth strategy that this post will discuss is perhaps Wal-Mart's most controversial way of maintaining a cost-leadership position. Wal-Mart has used both its large size and geographical diversity to directly bargain with brand-name product producers. This saving could be passed on to Wal-Mart customers. Camerius (2004) wrote, "As the nation's largest retailer and in many geographic areas the dominant distributor, it exerted considerable influence in negotiation for the best price. Delivery terms, promotion allowances, and continuity of supply. Many of these benefits could be passed on to consumers" (p. C382).

Few retail chains have the ability to negotiate the same low prices that Wal-Mart has been able to do. This has been a huge advantage for Wal-Mart. It makes it virtually impossible for retailers to compete with Wal-Mart on many items. The public realizes this and patronizes Wal-Mart. However, it has also created a backlash from consumer advocates claiming that Wal-Mart drives smaller competitors out of business with predatory pricing. This has not impacted the success of Wal-Mart as a cost-leader. However, it has created a PR backlash which may threaten its future.

As such, the ability to negotiate with the power of size and regional distribution capability has been a huge winner for Wal-Mart. The company has become synonymous with low prices. Customers appreciate this. This has been a successful strategy. However, it has also planted the seeds for what could be an eventual downfall politically or economically if the public turns against this concept and blames Wal-Mart as one of the primary boogie man of the working class.

The final strategy this post will examine is the Wal-Mart inventory system. A computer network connects all of the stores to Wal-Mart headquarters. Every product is recorded as it is scanned when purchased. When a particular product is selling well, Wal-Mart headquarters can send a message to a warehouse to immediately ship the product to a store. In this way, Wal-Mart never runs out of a product which is selling well. Wal-Mart can respond to consumer demand almost immediately. How can most local businesses and even other national chains compete with this? In most cases, they can not and Wal-Mart has benefited.

An anonymously written Chain Store Age article from 1999 reported an interesting quote from a small business owner (Charles Weinacker) who worked with Wal-Mart.

"There is no excuse for being out of stock if you are a vendor with Wal-Mart using Retail Link. I know where I am every day with Wal-Mart," Weinacker says. "That's where they are kicking butt. They are never out of stock. Their biggest concern today is people aren't using the system," Weinacker says (p. 92).

Is this a good strategy for maintaining cost-leadership? As other retailers are rushing to copy this system, the answer would seem to be yes. This is a good strategy. Many recent news items have not only acknowledged this but addressed how Wal-Mart is pushing this further by introducing RFIDs for every item that a producer ships to Wal-Mart.

Wal-Mart has more than six strategies for how it achieved and is maintaining a cost-leadership position. Thee could be strategies that have not been reported here which could even be more important than these six. However, this is a representational sampling of the ideas which have lead to the success of Wal-Mart.

References

Anonymous. (1995). The profit wedge: Key to successful retailing. Chain store with executive with shopping center age, 71 (January), 46-48.

Anonymous. (1999). Vendor challenge: Vendors armed with data to meet the future. Chain store age, 75(13), 92, 93.

Berman, R. (2006). Behind the Wal-Mart bill. Chain store age, 82(3), 48.

Camerius, J.W. (2004). Wal-Mart Stores, Inc.: Strategies for dominance in the new millennium. In C. Hill & G. Jones (Eds.), Strategic management: An integrated approach (C374-C385). Boston, MA: Houghton Mifflin Company.

Scheraga, D. (2005). Wal-Mart's muscle. Chain store age, 81(6), 64-66.

2 comments:

Ahistoricality said...

allows Wal-Mart to avoid costly weekly advertising in newspapers
Then why do I get MallWart circulars on a weekly basis?

For that matter, I've never seen paper bags or carpeting in one of those stores. Is Anonymous reliable?

Miland said...

The anonymous article from 1995 is from a reputable trade magazine. However, it is eleven years old now which is OK for me as I was looking over several decades just not current.

Wal-Mart may be using circulars now but it has not always been part of their business plan. They could probably drop circulars and feel the impact the least compared to their competitors.

My local Wal-Mart has carpeting and gives me paper bags. I am sure there are some regional differences even though all the stores have the same parent company.