Wal-Mart Learns About Cost... And Value

Wal-Mart is in a bit of a pickle.  Over the last decade they have focused incessantly on unit cost, ostensibly to provide reduced price and therefore perceived value to their customers.  And they've been successful... millions of people can now afford products they previously could not, and hundreds of thousands of people have jobs.  Maybe not the best jobs, and obviously other smaller companies have been hurt in the process, but that's the subject for a different debate.

The company's obsession with unit cost has forced suppliers to transition to offshore manufacturing where unit labor costs are lower.  Huge ships constantly ply the Pacific waters filled with container loads of bicycles, electronics, and clothing.  Wal-Mart knows that cash is being tied up in inventory, although perhaps that doesn't accurately enter into the unit cost equation, but the continual high volume movement of goods at even tiny margins creates a lot of cash.

Until the market burps.  Not even a demand quake... just a burp.  A small hiccup that throws a wrench into the finely-balanced cogs of Wal-Mart's business model.  The company that activists hysterically believe will take over the world suddenly pauses.

Wal-Mart's inventories jumped 10.3% in the fiscal first quarter, ended April 30, to $35.2 billion from a year earlier, driven by unsold apparel, home decor, and outdoor products.  About $2 billion of the increase represents unsold spring clothing and home goods that are expected to depress profit through the summer, analysts estimate. 

With transit times from offshored manufacturer to Wal-Mart's stores measured in weeks, the situation will get worse before it gets better.

Wal-Mart's chief financial officer says clearing out stocks of unsold clothing is going to be a chore and could pressure margins all summer.

Of course that time frame is premised on the assumption that they'll guess right on fall and winter demand, and based on how they did with spring and summer it's probably not the safest of bets.  It's hard to predict the nuances of fashion six to nine months in advance in order to get the factories humming to fill a global supply chain.

That $2 to $3 billion (a billion here, a billion there...) in increased inventory is inventory of products that are seasonable and fashion-related and therefore can be deemed perishable.  And depending on how you calculate it, it's worth a one-time bite of about a third of Wal-Mart's 3.2% profit margin.  So far.  Not even counting the impact on company and shareholder value when the stock goes on a ride.

I wonder what would have happened if Wal-Mart had instead perhaps paid a miniscule bit more, if even that, to a company like American Apparel.  A company that could manufacture much closer to Wal-Mart's distribution centers, that leverages lean methods to provide small lots with extremely quick cycle times.  A company that could react quickly when demand and fashion fluctuate.  And a company that pays a decent wage with decent benefits and respects its people.  Which is also why American Apparel may not even want to do business with Wal-Mart.

Writing off a couple billion in inventory has a nasty habit of offsetting a shipload of unit cost savings once it hits the bottom line.

Comments

[Bruce Jimison]

Did you see the article in the same WSJ on how shipping rates are moving higher? That will also offset a few pennies of supposedly cheaper labor.

[Mark Graban]

The WSJ article also said shipping costs were still a very small pct of total cost, coming from Asia.

"Shipping typically accounts for just 3% to 4% of the total cost of a container of garments or toys hauled from China to the U.S. or Europe. But major retailers and other shippers do their best to shave pennies off their rates to maximize their competitive position at home."

Not that I'm justifying shipping from China, far from it! But, I wanted to share that tidbit, the specific #. I was honestly surprised the pct was so low.

[Mark Graban]

The biggest issue is the time involved with shipping, not necessarily just the cost. Time leads to inventory and slow response, as Kevin puts it so well.

[CB]

What a tremendous waste in our country toward "perishable fashion oriented goods." The emphasis on cost to consumers also neglects value in something that will last and won't need to be replaced every season. You also could infer from this article that walmart in fact lost even more money because it produced too much of what customers didn't want and not enough of what they did what (assuming their fixed retail space).

Taiichi Ohno states that Toyota's overarching mission is always to shorten the timeline between when a customer places an order and when its delivered with as little waste as possible. Short time lines mean you can be responsive to unpredictable customer demand. That can only be achieved by locating your production/assembly as close to your customer as possible. It's amazing that Ford figured this out 100 years ago yet it remains lost on society today...

[david foster]

I wonder if the WMT buyers who make sourcing decisions are measured on a fully-costed basis, including cost of transportation and inventory as well as price paid per unit? (I'm guessing the answer is transportation yes, inventory no)

Indeed, I wonder how many retailers have systems in place that can create a SKU-specific financial statement including return on the capital tied up on behalf of that SKU?