Copying Dollar Stores Is Not The Answer To Wal-Mart's Woes

The dollar store market may not provide Wal-Mart with the opportunities that some analysts are looking for.

Feb 28, 2014 at 6:00PM

There was good news and bad news for Wal-Mart Stores (NYSE:WMT) investors in the retail giant's Feb. 20 conference call. The good news is that Wal-Mart isn't planning to follow analyst Michael Exstein's advice and buy Family Dollar Stores. The bad news is that Wal-Mart is going to launch about 700 new dollar stores in an effort to boost revenue.

Expanding its dollar store business is the wrong strategy for Wal-Mart at this time. Opening small box stores will be a waste of money and resources that will distract Wal-Mart from far greater opportunities in the online retail market. Here are a few reasons why expanding its dollar store operations is a bad idea for Wal-Mart:

The dollar store market is already saturated, as I've argued elsewhere. A SWOT analysis last year indicated that the U.S. retail market could support around 15,000 additional dollar stores. Two major dollar store players, Family Dollar Stores and Dollar General, plan to open 18,600 new stores in the next few years. Add the 700 stores that Wal-Mart plans to add, and that's 4,000 more stores than the market can support. That sounds like a bubble that could quickly collapse.

Dollar stores are heavily dependent on food stamps and other government benefits for a portion of their revenues. Wal-Mart is already heavily dependent on food stamps -- one out of five of its customers rely on them, according to Reuters. With Congress cutting $14 billion from food stamps over the next few years, it would be a good idea for Wal-Mart to move away from them. Yet Wal-Mart is moving into an arena that's heavily dependent on food stamps; around 70% of Family Dollar's sales come from grocery store items.

Dollar store additions distract Wal-Mart from its online business, which generated around $10 billion last year. Wal-Mart needs to go online and compete with because that's where the middle- and upper-class customers with the money are. Dollar stores are where the cash-strapped poor shop. The company's Wal-Mart to Go delivery service is a good start and a potential cash cow.

How dollar stores could help Wal-Mart

The flip side of this argument is that dollar stores wouldn't cost Wal-Mart that much to build -- around $600 million. That's a drop in the bucket for a company that reported a trailing annual revenue figure of $475.11 billion on Oct. 31, 2013. The dollar store experiment won't cost that much for Wal-Mart, and there are some potential benefits:

Small box stores would be easier to open in urban areas, older suburbs, and other regions that Wal-Mart has had a hard time penetrating. There would be far less resistance to a Wal-Mart small box location in a strip mall than there would be for a supercenter.The massive number of stores owned by other companies which will close, which includes 500 Radio Shacks, will provide lots of locations that Wal-Mart can pick up cheap.

Wal-Mart's dollar stores would be very competitive because they would offer a wide variety of merchandise Family Dollar, Dollar Tree, and Dollar General do not carry, such as fresh vegetables, meats, and better selections of clothing, electronics, and tools. The small box stores would be excellent outlets for Wal-Mart's financial-services products, such as the Bluebird card it offers with American Express, check cashing, and money orders. None of the other major dollar store operators offer these products.

The small boxes would be excellent locations for pharmacies. Other dollar store operators don't offer pharmacies. With Obamacare expanding the number of Americans who have health insurance, this could be an opportunity.

Wal-Mart's logistics capabilities could allow it to tailor dollar stores to each market, for example by offering specific products that sell better in specific areas, such as tacos in heavily Latino neighborhoods.

 The small boxes would fit in nicely with the Wal-Mart to Go online operation. They could serve as pickup points for Wal-Mart to Go merchandise.Middle class customers and urban dwellers who refuse to go to a Wal-Mart supercenter might shop at the small box Wal-Mart locations.

 One thing is clear from both sides of this argument: Wal-Mart is still a very good company with a very bright future. It knows how to react quickly to a changing market and take advantage of opportunities. Even if the dollar store experiment doesn't work out, Wal-Mart is still in a position to dominate American retail for decades to come.

Daniel Jennings has no position in any stocks mentioned. The Motley Fool recommends and American Express. The Motley Fool owns shares of Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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