In a conversation following the shareholders' meeting in June, Bill Simon (CEO of Walmart U.S.) took Q&A from Wall Street analysts. U.S. stores had endured something like seven consecutive quarters of comparable sales declines. With over 60 percent of revenue coming from Simon's division, these declines have become the crux of the debate about whether Walmart can continue as a growing enterprise or if it's approaching saturation and decline.
With this in mind, Simon took the stage under the glare of the analyst klieg lights. Here is a slightly edited transcript between Simon and one participant:
Analyst: "Are your current operating margins sustainable? Is there opportunity for further improvement, or do you think you should give up margin to get the top line going further and faster?"
Simon: "In the long run I'd like to see our gross margins come down and our operating margins go up."
Analyst (incredulous at Simon's response): "Uh, how do you do that?"
Simon (unflinching): "Work really hard. Lower your costs. Sell more."
Analyst: "Um, I think that's what Walmart has done for 20 years and it looks like your operating margin is sort of steady where it is right now...So you don't think your operating margin is an impediment to sales growth?"
Simon: "I think the gross margin could be an impediment to sales growth."
Translation of Simon's stance: I want to charge even less for products than I do today, and I want to grow operating margin - irrespective of whether I finally increase revenue by getting existing stores selling more goods - by continuing to take expenses out of our operations.
In no uncertain terms, Simon is telling Wall Street that Walmart is going to keep dancing with the girl that got them to the party.
*****
But Bill Simon has his job because Walmart did make a pass at more popular girl.
Expectations were high during the initial stages of the so-called Great Recession. This is the ideal environment for Walmart, so went conventional wisdom, because consumers will flock to its low-price offering. But the company seemed to stumble, initially attempting to grab and keep fat-wallet customers stepping out on Target (that "more popular girl" if I can keep torturing this metaphor) by redesigning Supercenters, focusing more on chic products, and reducing overall selection to reduce the clutter feel. It was a departure, no matter how slight it felt at the time, from the EDLP theme.
And it didn't work. Rather than retain Target shoppers (it did not), Walmart managed to chase its core base of customers into the waiting arms of convenient dollar stores. The mistake generated two straight years of declining same store sales in the U.S., cost Eduardo Castro-Wright his job, made for a disenchanted investor constituency, and forced the c-suite to confess that it wandered from the tried-and-true.
Bill Simon's job has been to put Walmart US stores back on track, and he's doing it with a firm and public commitment to the old theme: "lower cost + lower price = more customers + higher volume."
The investment community should be overjoyed at this, right? Well, this is where the old yarn kicks in...that one about success having many fathers but failure is an orphan. EDLC-EDLP converted plenty of non-believers when it was the driving force behind making Walmart the fasting growing retailer in history (up to that point at least) with few signs suggesting that expansion would stop anytime soon. It was driving double-digit growth through existing stores and finding plenty of opportunities to open new ones at a blistering pace.
But that sort of growth is behind us now. No matter your views on Walmart's current ability to expand its store base, it's hard to argue that even the most optimistic scenario has that growth at low single digits. It's just the reality of a business getting large and testing the limits of its market size. So here's the challenge if there are fewer opportunities to grow Walmart's earnings through increasing its store count...where does growth come from?
There are three major sources:
First is international expansion, and it's a good one. In fact, it has been the driver of most of Walmart's overall growth since domestic sales slowed down. But international growth does not come easy, seems to carry a higher base of expenses (and therefore less profit), and runs up against a lot of entrenched retail competition.
Second is the internet. Walmart has to compete here, but it's going to have to find out its unique way of doing so. It will not work in a pure head-to-head battle royale versus amazon.com. The company is doing a lot of good work to figure out how the internet can complement its physical retail business, but when looking for growth on top of its existing $420 billion sales...well, it would have to match the business amazon has spent 17 years growing to $40 billion to move the needle. Amazon is in a dominant position and has the resources to compete ferociously to keep it that way. Walmart has to play in this arena if only to avoid ceding more territory to amazon.
Finally, there's domestic same store sales growth ("comps"). The US market continues providing the lion's share of Walmart's revenue and profits. If this market is truly saturated or (worse) the Walmart model is no longer attractive to American consumers, then Walmart is probably a business that has peaked without realizing it.
This is where the EDLC-EDLP model comes under heavy scrutiny and earns the kind of skepticism Bill Simon encountered in his analyst conversation from above. Traditional retail can grow comp sales through 1. pushing more volume through existing stores; or 2. raising the price on your stuff and earning higher margins.
Walmart's model mandates that it do everything it possibly can to avoid raising prices. (Indeed, former CEO David Glass has been quoted saying, "We want everybody to be selling the same stuff, and we want to compete on a price basis, and they will go broke five percent before we will.") This avenue is effectively cut off to it. So, that leaves us with increasing volume in the current store base. And that's the exact place Walmart has stumbled these past two years.
Expectations were high during the initial stages of the so-called Great Recession. This is the ideal environment for Walmart, so went conventional wisdom, because consumers will flock to its low-price offering. But the company seemed to stumble, initially attempting to grab and keep fat-wallet customers stepping out on Target (that "more popular girl" if I can keep torturing this metaphor) by redesigning Supercenters, focusing more on chic products, and reducing overall selection to reduce the clutter feel. It was a departure, no matter how slight it felt at the time, from the EDLP theme.
And it didn't work. Rather than retain Target shoppers (it did not), Walmart managed to chase its core base of customers into the waiting arms of convenient dollar stores. The mistake generated two straight years of declining same store sales in the U.S., cost Eduardo Castro-Wright his job, made for a disenchanted investor constituency, and forced the c-suite to confess that it wandered from the tried-and-true.
Bill Simon's job has been to put Walmart US stores back on track, and he's doing it with a firm and public commitment to the old theme: "lower cost + lower price = more customers + higher volume."
The investment community should be overjoyed at this, right? Well, this is where the old yarn kicks in...that one about success having many fathers but failure is an orphan. EDLC-EDLP converted plenty of non-believers when it was the driving force behind making Walmart the fasting growing retailer in history (up to that point at least) with few signs suggesting that expansion would stop anytime soon. It was driving double-digit growth through existing stores and finding plenty of opportunities to open new ones at a blistering pace.
But that sort of growth is behind us now. No matter your views on Walmart's current ability to expand its store base, it's hard to argue that even the most optimistic scenario has that growth at low single digits. It's just the reality of a business getting large and testing the limits of its market size. So here's the challenge if there are fewer opportunities to grow Walmart's earnings through increasing its store count...where does growth come from?
There are three major sources:
First is international expansion, and it's a good one. In fact, it has been the driver of most of Walmart's overall growth since domestic sales slowed down. But international growth does not come easy, seems to carry a higher base of expenses (and therefore less profit), and runs up against a lot of entrenched retail competition.
Second is the internet. Walmart has to compete here, but it's going to have to find out its unique way of doing so. It will not work in a pure head-to-head battle royale versus amazon.com. The company is doing a lot of good work to figure out how the internet can complement its physical retail business, but when looking for growth on top of its existing $420 billion sales...well, it would have to match the business amazon has spent 17 years growing to $40 billion to move the needle. Amazon is in a dominant position and has the resources to compete ferociously to keep it that way. Walmart has to play in this arena if only to avoid ceding more territory to amazon.
Finally, there's domestic same store sales growth ("comps"). The US market continues providing the lion's share of Walmart's revenue and profits. If this market is truly saturated or (worse) the Walmart model is no longer attractive to American consumers, then Walmart is probably a business that has peaked without realizing it.
This is where the EDLC-EDLP model comes under heavy scrutiny and earns the kind of skepticism Bill Simon encountered in his analyst conversation from above. Traditional retail can grow comp sales through 1. pushing more volume through existing stores; or 2. raising the price on your stuff and earning higher margins.
Walmart's model mandates that it do everything it possibly can to avoid raising prices. (Indeed, former CEO David Glass has been quoted saying, "We want everybody to be selling the same stuff, and we want to compete on a price basis, and they will go broke five percent before we will.") This avenue is effectively cut off to it. So, that leaves us with increasing volume in the current store base. And that's the exact place Walmart has stumbled these past two years.
*****
And so we revisit the question: Is EDLC-EDLP a strength or a weakness?
Before answering that, let me confess something. When I shop at a discount store, I shop at Target. This despite my admiration for the Walmart model and despite the fact that I am a Walmart investor. I explain it this way...
First, Target is in a much more convenient location to my home, and I am foremost a minion of convenience. It's a five minute drive away and happens to be in the same shopping center as my gym.
Second, I rarely have to fight for a close parking space, maneuver through aisles crowded with competing patrons, or wait more than a minute or two in a check-out lane.
And third, I'm relatively price insensitive to the items I normally purchase at a discount store and so am willing to pay a premium for the two set of conveniences noted above. And from my unscientific observations, Target sticks me with mark-ups on anything it knows I'll buy there rather than venture out on another shopping trip to a competitor. (For example, on a recent trip, I believe I got a fine deal on their diapers but also had to buy a bottle scrubber. I'm quite certain this item would cost $3 or $4 at Walmart. Target had three options for me, the cheapest of which was $11.)
My patronage must suggest Walmart's theme is flawed, right? Quite the opposite. To begin with, I'm not exactly Walmart's demographic. Looking at consumers today (and thinking about demographics of population growth), I believe people are getting more price sensitive, not less.
But more importantly, what might my observations suggest about Target versus Walmart? One, Target pays a premium to fit itself into an upscale shopping space near my neighborhood. It must cover that higher overhead. Two, the convenience I appreciate only occurs because this Target location drives far less customer traffic and so leaves open more parking spaces, generates fewer patrons in the aisles, and therefore doesn't have clogged check-out aisles.
When I do visit my local Walmart, it's further away, the price always seems low, and it's ALWAYS crowded. I have to wait in line for several minutes for check-out. As a customer, I dislike this. As an investor, I love it. Although anecdotal, it suggests to me Walmart maintains capital discipline...choosing to maximize traffic through its less expensive real estate before investing more to "fill-in" locations in more convenient locations.
How does Walmart get its customers to drive further, park further away, and wait longer in check-out lines?
EDLC-EDLP. Customers are price sensitive. As true as it was 10, 20, 30...50 years ago, there remains a draw to stores that offer the right selection at lower prices.
As long as Walmart maintains its edge, that ability to do EDLC-EDLP better than other traditional retailers (e.g., dollar stores, discount stores, consumer electronic stores, and grocery stores), offers consumable goods like groceries that bring customer in week-in, week-out (so they won't bring their other purchases to amazon.com), and provides selection beyond what a warehouse club can offer at bulk...as long as Walmart can execute this hard to replicate model, it will grow same store sales over the long run.
That being said, next we must consider how/why Walmart is a reasonably priced investment opportunity...
No comments:
Post a Comment