Thursday, July 28, 2011

Walmart (WMT): Part Three - Benefits of Parsimony, the Right Premise & Indoctrination

Walmart possesses a culture that rallies around a simple "low cost + low price = more customers + higher volume" theme. The idea, initially a retail experiment by Sam Walton, represents the premise that drives Walmart's entire business. The idea is simple, the execution is tremendously complex. But the simple idea carries with it the benefit of parsimony (or, KISS...keep it simple stupid!), reducing the amount of deliberation required to make those difficult or confusing decisions that pop-up each and every day in business. 

In an environment of complex choices leading to uncertain outcomes, humans often fall victim to either "CYA Syndrome" (cover your ass by making choices you believe will offend others the least rather than those that might lead to greater benefit) or Paralysis by Analysis. The latter tends to manifest itself in one of two forms. 

First, decision-makers err on the side of more information and more analysis in a belief this will help them make the ideal choice. They hold meeting after meeting, soliciting input from an expanding ring of people, crunching more numbers, and generating a long paper trail of memos. The process takes a lot of time and, by virtue of involving more people, creates a "complicity cover" (i.e., the more people you involve in the decision, the more you can spread blame if the outcome is bad). 

Second, would-be decision-makers use analysis to suffocate the very act of making a decision. They hide behind it, biding their time (yet acting very busy) until the issue loses any sense of urgency and just quietly dissolves into the periphery.   

But when the principle of parsimony comes into play, guided by an easy-to-understand premise (or raison d'ĂȘtre), complex matters can be quickly reduced to their lowest common denominator and the potential decisions re-framed in terms of how they help the organization abide by the premise.  Default one becomes "do something simple instead of something difficult." And, for Walmart at least, default two becomes "make the decision that lowers costs, thereby lowering prices, thereby bringing more customers in the doors, thereby increasing volume, thereby increasing returns."

Sam Walton was not the first retailer to champion this philosophy. A recent book by Marc Levinson, The Great A&P and the Struggle for Small Business in America, provides insight into what may have been the earliest implementation of what became the Walmart way. This quote, from the book, is attributed to John A. Hartford, part of the brother duo running A&P.
"We would rather sell 200 pounds of butter at 1 cent profit than 100 pounds of butter at 2 cents profit."
The sentiment is hardly different an example in Walton's tome, Sam Walton: Made in America:
"Here's the simple lesson we learned...say I bought an item for 80 cents. I found that by pricing it at $1.00 I could sell three times more of it than by pricing it at $1.20. I might make only half the profit per item, but because I was selling three times as many,  the overall profit was much greater...In retailer language, you can lower your markup but earn more because of increased volume."
He wasn't the first to understand the power of low prices and high volume. In fact, it didn't take genius level retail IQ to latch onto that insight and turn it into the basic premise of the entire Walmart operation. Good ideas...even some of the best ideas...are worth nothing unless the person or the organization has the ability to execute on them. And this particular premise has been difficult to execute in a live-fire business setting. Why?

My first suggestion is that it's not such a simple task to get a group of people lined up behind a common purpose. But Walton was unrelenting. He screened new employees based on how well they seemed to buy into the Walmart premise. One can imagine he was ruthless in pruning out executives who attempted to stray from the idea. He became cheerleader extraordinaire for the cause, championing the Walmart premise throughout the organization. He instituted a company cheer, still in place today, that culminates with associates responding to "Who's number one?" with "The customer! Always!" Walton was, ultimately, a master at indoctrination.

Consider the following account by an early Walmart manager (from Charles Fishman's bestseller The Wal-Mart Effect):
"We would sit around a big table, and Sam would talk to us like a Dutch uncle. He would say, 'You see this pen? We're selling it for 88 cents. It's a good pen. We're paying 60 cents for it. We could write an order for this at 60 cents and sell it at 97 cents. But we don't. We want to sell a good product at the best price. And make sure we've always got it.'"
My second suggestion is that the temptation is always high for retailers to stray from low-cost + low-price.   When it was founded in 1962, Walmart was not the only company attempting to get into the discount store game. Indeed, Walmart, Target, and K-Mart all came out that same year trying to make similar jumps from their variety formats into discounting. Each was dedicated to growing through volume, using the power of bigger stores in more markets to extract better pricing from suppliers.

Writing an early post-mortem on the competition, Walton penned the following words in the early-90s. From his book:
"What happened was that they didn't really commit to discounting. They held on to their old variety store concepts too long. They were so accustomed to getting their 45 percent markup, they never let go. It was hard for them to take a blouse they'd been selling for $8.00, and sell it for $5.00, and only make 30 percent. With our low costs, our low expense structures, and our low prices, we were ending an era in the heartland. We shut the door on variety store thinking."

Bumping up margins by bumping up prices has always been a siren's song for retailers. It's easier to let prices creep up a penny here or a penny there, feeding higher gross margins, providing a comfortable cushion to pay for your overhead expenses. It's easier than cutting expenses, firing people, reducing salaries, forgoing the nice headquarters building, etc. Surely the customer won't notice just a little increase in prices, right?

Walton understood the slippery slope of that thinking, and so he worked tirelessly to imbue his Walmart culture with a sense of repugnance for higher costs and higher prices. Again, from the Fishman book:
"'Sam valued every penny,' says Ron Loveless, another of Sam's early, legendary store managers...'People say Wal-Mart is making $10 billion a year, or whatever. But that's not how the people inside the company think of it. If you spent a dollar, the question was, How many dollars of merchandise do you have to sell to make that $1? For us, it was $35. So, if you're going to do something that's going to cost Wal-Mart $1 million, you have to sell $35 million in merchandise to make that million.'"
We'll allow that idea to close this line of thought. I've meant to convey a rather simple point, but that gets tangled easily in all this writing. Perhaps it boils down to this: 1. Parsimony is better than complexity when it comes to helping people sort through their myriad daily decisions; 2. The right premise - steeped, of course, in parsimony - helps ease the decision making process while avoiding problems like paralysis by analysis; and 3. If you have the right premise, you will benefit from indoctrinating your people and making sure it becomes an enduring part of your culture.

This, I believe, defines the successful low-cost, low-price culture of Walmart. And if we're studying Walmart only to marvel at its culture, we can stop our analysis there. We are, however, evaluating the company as an investment opportunity and must segue into our next series of questions, starting with...Has its strength become its weakness?

Now, looking to the future...If the company can only build so many more supercenters before saturating its markets and cannibalizing its sales...if the company is battling reduced buying from penny-pinched customers...if same store sales are what kind of predicament does Walmart find itself if it wants to continue to grow revenue but refuses to raise prices?

Has the simple premise that has worked so remarkably for 50 years become more of an anchor, slowing the momentum of the Walmart ship, than an engine driving it?

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