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How Walmart Model Wins With "Everyday Low Prices"

Author: Ethan Harris

Walmart's (WMT) success is the stuff of legend.But there is no mystique at the core of its mammoth success. WalMart 's ability to provide customers with "everyday low prices" and its presence as an economic and political force of gigantic size and influence, is the result of a process that was built on some core principles and procedures. Looking at Walmart's history and present operations helps investors understand the methodology that enables this sizeable chain to do what it's known to do best – sell cheap. (For a background on retail operations, see: The Industry Handbook: The Retailing Industry.)

Walmart operates over 10,000 retail units under scores of banners in an increasing number of countries, and has e-commerce websites in several more. It employs millions of associates around the world, with over a million of these residing in the U.S. It reportedly grossed 476 billion dollars in the fiscal year ending January 2014, which was up from 408 billion in the fiscal year of 2010. It's also been noted that Walmart's revenue constitutes 81% of what the National Restaurant Association says the entire U.S. restaurant industry made in 2013. In fact, the author of the Walmart Effect, Mr. Charles Fishman, has noted that the company is 2% of the United States economy, all by itself. (For related reading, see: How Wal-Mart Makes Its Money.)

Foundation Philosophy and First Moves

As staggering as it is, Walmart's standing can be attributed to the way it started -- the approach taken by its founder Sam Walton, who opened his first five-and-dime store in 1950 with a business model that was focused on keeping prices as low as possible. That strategy of offering low prices hinged on another key cornerstone on which so much of Walmart's advantage is built: scale/volume. Walton was aware that even if his margins were slimmer than his competitors, he could make up for that through the volume of his sales. In time that volume would permit economies of scale, and a level of bargaining power that would enable Walmart to remake the supply sector and the retail landscape, to suit its own schemes. (See: Explaining Economies of Scale.)

The third principle on which Walton based his operation is the minimization of operating costs. Walton kept a tight fist, and pinched his pennies. It's been noted that he continued to drive an old pickup truck and to share budget hotel rooms on business trips even after he had acquired great wealth due to Walmart's success.

What's worth noting, though, is that this model – built on low prices, on a large scale, at minimal cost – was never changed, but instead gained momentum, building on each success, resulting in an ever-wider spread of operations and constantly increasing leverage for this retail entity, which would in turn use the power gained to acquire even more clout and to provide even lower prices, at an even larger scale, at even less cost to itself. The result would seem to be a magnificent retail mountain to some, and a merciless mercenary monster to others.

Walmart's Modern Operations: Strategies and Systems Built Onto the Original Model

Walmart continues to offer very low prices, and this is possible due to (1) its huge volume of sales that's possible due to the spread of its operation and its wide customer base, (2) a supply chain management system that maximizes efficiencies and reduces outlays, (3) minimization of overhead and operational costs, and (4) leveraging of its bargaining power to force suppliers to lower prices:

1. Sales volume, scope of operation and wide customer base: Walmart has been able to capture a huge market share by selling almost everything, and being almost everywhere. It has endeavored to meet the demand of various segments of the market, and to present a huge swath of buying opportunities, compressed into single locations. It actually has a multiple-store format that extends its market reach, and it sells goods through four types of stores: discount stores, Walmart Supercenters, Sam's Club warehouses (which sell bulk items), and neighborhood markets.

It's also worth noting that, as observed by Charles Fishman, 90% of Americans live within 15 miles of a Walmart store. There is an omnipresence to the WalMart store that allows it to increase its penetration in customers' lives and increase the probability of a purchase.

Its large volume of sales enables it to make substantial profits, even in instances where individual margins on single items may be slimmer than those of its competitors.

2. Supply chain management based on electronic product information, vendor role in distribution, and layout of warehouses: Walmart has a supply chain system that is regarded in multiple quarters as one of the most technologically advanced and efficient. Whether in the case of barcodes or RFID tags (radio frequency identification technology), WalMart was a pioneer in getting detailed product information electronically attached to products so that such information could be relayed to its database and could inform its inventory management system. The goal, according to one commentator, was to master the art of knowing what it needed, how much was needed, and when it needed it. During the first 8 months of 2005, Walmart reportedly experienced a 16 percent drop in its out-of-stock merchandise at its RFID-equipped stores.

Another key strategy by Walmart has been its move in the 1980's to deal directly with manufacturers. Suppliers at that time became responsible for managing inventory in its warehouses. This shift in responsibility for inventory management from Walmart to the suppliers, which constituted a vendor-managed inventory system, was said to have created a smoother flow of inventory, with less irregularities, and helped ensure that products requested by customers have always been available on the shelves. All of this has resulted in a more cost-effective process, with these savings being translated as well into lower prices in the Walmart stores. (See article: Measuring Company Efficiency.)

Information such as point-of-sales data, as well as warehouse inventory and real-time sales are all sent to, and stored in, a centralized database that is shared with suppliers who know when to ship more products. Walmart also, according to CIO online, has the largest private satellite system that enables the easy transfer of this information among all participants in its supply chain process and allows voice and data communication among all units and offices of the company in various locations.

Also key to the cost-effectiveness of Walmart's supply chain strategy and distribution network is the positioning of its nearly 160 distribution centers, which cover almost 120 million square feet and are all within 130 miles of the stores they supply. (Regional distribution centers have been placed at locations that offer lower labor and transportation costs.) They have thus been able to carry out cross-docking at their warehouses, a process in which products are taken from a truck upon its arrival and packed in a truck headed to a store without spending time in the warehouse. This in turn has resulted in reduced costs for inventory storage and has lowered transportation costs.

What amplifies the effectiveness of all of this is that in its early years Walmart followed a backward expansion strategy, opening stores in small, rural towns first before entering metropolitan areas. This resulted in lower operating expenses, and ensured that all stores' locations were within just over a hundred miles of their distribution centers. It became cost-prohibitive for competitors which had focused on large towns to enter regions Walmart had already saturated later on. This constituted a barrier to entry.

Walmart also uses its own trucking fleet and drivers, who are required to have three years and 250,000 miles of driving experience. The impact of all these supply chain mechanisms on Walmart's bottom line and its ability to offer lower prices is pronounced. By 1989, its distribution costs were 1.7% of its sales, or less than half of Kmart's costs, and just under a third of what Sears (SHLD) was spending-- according to Arkansas Business.

3. Minimization of overhead and operational costs: Continuing the model Walton established for a low-cost operation, Walmart still keeps its overhead low. Its executives reportedly fly coach and share hotel rooms with colleagues. Its meager wages and low-benefit healthcare plans which are offered to rank-and-file employees have been publicized and protested against. (See: Employee Benefits: How To Know What To Choose.) The company has even been accused of demanding that hourly workers put in overtime without pay. Researchers at some policy institutes have speculated that each Walmart associate does the job of 1.5 to 1.75 employees of a rival. It has also been said that Walmart staff are expected to keep costs at a minimum, even for heating and cooling of the buildings.

4. Leveraging of Its bargaining power to force suppliers to lower prices: Many well-known companies rely on Walmart for more than 20% of their revenue. Walmart, as the number one supplier-retailer of most of our consumer goods, wields considerable power over their bottom line and in fact wields this power over almost all the consumer goods industries in the U.S. In adhering to a strategy of keeping prices low (experts estimate that Walmart saves shoppers at least 15% on a typical cart of groceries), Walmart is constantly pushing its suppliers to cut prices. In the Walmart Effect, author Charles Fishman discusses how the price of a four-pack of GE light bulbs decreased from $2.19 to 88 cents during a 5-year period.

The pressure on suppliers to lower prices has resulted in layoffs at certain factories, changes in manufacturing inputs and processes, and even the transfer of manufacturing processes to foreign countries like China where labor is cheap. (For related articles see: Alternatives To Layoffs and 4 Ways Outsourcing Damages Industry. )

A clear example of the results of the application of such pressure is Lakewood Engineering & Manufacturing Company, a fan manufacturer in Chicago. In the early 1990s the cost of a 20-inch fan was $20. After Walmart pushed for the lowering of the price, Lakewood automated its production process, which resulted in the layoff of workers. It also put pressure on its own suppliers to slash the prices of parts, and it opened a factory in China where workers earned 25 cents an hour. By 2003, the price of a fan in Walmart had dropped to $10.

The Bottom Line

The latter two strategies have somewhat tarnished Walmart's image in the public eye, and have surely impacted some consumers' purchasing choices, but the question is whether consumers' quest for a product that is backed by a conscientious process overrides their desire for good prices.

It could be said that consumers with more disposable income are more inclined to make purchasing choices that reflect social responsibility. For other consumers, though, being able to stretch a small paycheck is the goal, and in such instances, Walmart's low-pricing strategy wins. There are also other questions. Is the size of the middle class, that portion of the Walmart market segment with more disposable income and more willingness to demand conscientious policies, shrinking?

What is clear is that Sam Walton, according to Mr. Charles Fishman, believed that Americans will change their behavior to save a bit of money, and Walmart's supply chain mechanism, business model and supplier negotiations bank on this being true.

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