Wal-Mart, likely the nation’s most popular discounter, entered the market at the right time, when the barriers to entry were low. Benefiting from first mover advantage, Wal-Mart moved into markets that were not already served by competitors and was able to set higher prices in these areas (6). Conversely, to compensate for low margins in areas heavily congested with competition, it cut costs (1). With an aim to offer low prices, the Company soon learned that it needed to trim its expenses and establish itself as a lean organization, eventually leading to profitability and strong competitive advantage. Refer to Exhibit 1 for Wal-Mart’s successful performance, compared to the rest of the industry, as well as the sections below for an explanation by expense item.
Cost of Goods Sold
Inventory logistics were positive. Turnover exceeded 4.5 in the mid-1980s, well above that of competitors and trucks were 60% full on backhauls (4). In addition, getting in the forefront of technology allowed for lower overhead costs. The use of UPC scanning increased: from 25 stores in 1983 to 91 stores in 1984 and 235 stores in 1985 (5). Even though the Company catered to a vast market, offering 36 merchandise departments across 70,000 SKUs, it was able to remain highly organized with a computerized system to track inventory, which set itself apart from its peers, as well as a central computer at headquarters, which was updated on a weekly basis (5), the accuracy of which led to efficiencies.
The Company shopped around with its vendors, using around 3,000 of them, taking “no more than a fifth of its volume from any one vendor” (3). In 1984, the cost of inbound logistics was 50% that of the industry at 2.8% of sales (4). Still, Wal-Mart’s cost of goods sold was almost 2% higher than the industry average of 71.9%. Given the lack of distributors who would be able to offer competitive pricing, Wal-Mart built its own warehouse in 1970. By the mid-1980s, Wal-Mart’s five distribution centers served the rapidly expanding number of stores – over 850 stores, meanwhile racking on steep upfront expenditures.
The Company was able to minimize employee costs by paying low wages (7), meanwhile keeping employees happy, in hopes of avoiding turnover costs. In 1984, Wal-Mart’s salary expense was approximately 1% lower than that of the industry. Unlike its competitors, the Company’s 12 regional VPs all lived in surrounding areas, enabling intimate visibility over a relatively smaller geographic network, which ultimately saved the Company about 2% of sales by not having to set up regional offices. However, contrary to intuition, this decrease in expenses did not adversely impact anyone at the Company. Instead, the offsetting increase in costs resulted in a company-wide benefit as Wal-Mart offered profit sharing, employee stock purchase plans, bonuses, and rewards for low shrinkage.
With its “people-focused” initiatives, Wal-Mart was able to use intrinsic and extrinsic motivation to show employees how much they were appreciated. There was a huge emphasis on communication as management strived to be as transparent as possible with lower level staff. For example, executives came into the office for meetings on Saturdays, then disseminated the latest updates downward, starting with the regional managers, district managers, store managers, and so forth. With its personable CEO, who “kept a pledge to put on a grass skirt and dance hula on Wall Street to celebrate the achievement,” Wal-Mart was able to distinguish itself and was named one of the 100 best companies to work for in the United States (7-8).
Refer to Exhibit 1 for a high level summary, as well as Exhibit 2 for a more detailed breakdown, of the Company’s advertising expense compared to the higher industry average. Marketers placed a heavy emphasis on low prices with tag lines such as “we sell for less” (5) or “everyday low prices” (6). As expected, the cost of advertising was directly correlated with the launch of new stores (6), as well as the location of those stores (i.e. cosmopolitan areas would be more costly): after entering a new area and establishing itself, Wal-Mart would then scale back advertising in that area. Branded merchandise, which made up the bulk of the inventory, was mostly nationally advertised (5), thus quickly building brand awareness among consumers.
Rental expense at Wal-Mart was 0.3% lower than that of the industry. A large part of this was attributable to the fact that Wal-Mart did not permanently lock itself down to a certain location; of the 859 stores in the mid-1980s, 812 were leased. With the flexibility to move during flourishing times, the size of an average Wal-Mart store went from 42,000 square feet in 1975 to 57,000+ square feet in 1985 (3). In addition, the Company made a smart decision to stay out of locations that could not be expanded, again showing the Company’s long-term, instead of short-term, mindset.
After further analysis of Wal-Mart’s costs in 1984, we encountered findings in the data that was counter-intuitive to the costs that we would expect to see from the most successful discount retailer of its time. Naturally, the area in which we would expect Wal-Mart to exhibit higher than average cost savings compared to the industry average would be in Cost of Goods Sold. However in 1984, Wal-Mart’s COGS at 73.8% was almost 2% higher than the industry average. As mentioned above, Wal-Mart’s system contained over 70,000 SKUs, a number larger than most other discount retailers which would lead one to believe that a high volume discounter like Wal-Mart would achieve economies of scale to produce a COGS lower than the industry average.
Next, due to Wal-Mart’s efficient distribution network, inventory did not back up in storage as quickly as other retailers. Wal-Mart boasted inventory turn 4.5 times in the mid-1980s, which was higher than the industry average. With reduced inventory levels due to the speed at which Wal-Mart was selling its inventory, this would lead one to believe that there would be a smaller amount of ending inventory to subtract from beginning and purchased inventory.
“Being the first warehouse club to solicit and introduce the concept in a market can be a major competitive advantage” (9). As a result of the distinctive features mentioned above, Wal-Mart was able to set itself apart from its peers and rise to the top of the industry. In 1984, it started to diversify by starting three new ventures, the most notable of which was Sam’s, a warehouse club. The Company expanded from three stores in 1983 to 11 stores in 1984 and 23 stores in 1985. It took what it learned from the Wal-Mart venture and applied it to Sam’s accordingly.
Over the years, Wal-Mart’s success grew and it distinguished itself from its competitors, thus enabling the Company to expand its operations and diversify into the warehouse club market with the now-renown Sam’s Club. David Glass (later Wal-Mart’s president and chief operating officer) summarized the Company’s history best when he said: “ ‘We are always pushing from the inside out.
We never jump and then backfill.’ ” (3) Instead of becoming greedy and aggressively dominating the market, the Company did so steadily over time; by not taking on more than it could handle, the Company was able to strategically position itself. In the years to follow, Wal-Mart’s market value was twice that of its competitor, K mart, even though it was a third as large.