Can Wal-Mart Beat Amazon at Its Own Game?
A Q&A on Wal-Mart

With John Del Vecchio (TMF Fuz)
March 14, 2000

How is retailing giant Wal-Mart coping with the tight labor market, rising oil prices, and increased competition from online e-tailers? Fool analyst John Del Vecchio answers these questions and more.

Q: What is Wal-Mart's (NYSE: WMT) strategy against online merchants like Amazon (Nasdaq: AMZN) and Value America (Nasdaq: VUSA)? How will the company go about growing its "dot-com" site while protecting its bread-and-butter retail stores?

A: In the fall of 1999, Wal-Mart announced partnerships with major online players like AOL (NYSE: AOL) and Books-A-Million (Nasdaq: BAMM), and revamped its website. Furthermore, Wal-Mart announced a deal with Accel Partners, a Silicon Valley VC firm, and plans to spin off The deal makes sense. Wal-Mart can concentrate on what it does best -- deliver "everyday low prices" and superior customer service, while the venture capitalists can exploit their Internet expertise. Recently, the announcements have died down, and the revamped website is nothing spectacular.

A long time ago, way back in 1995, a lot of people thought that the Internet would thrash bricks-and-mortar retailers. But Wal-Mart has several advantages over competitors that can transfer to the e-tailing space. First, Wal-Mart has customers. Over 100 million people shop at Wal-Mart each week. Acquiring customers is very expensive. In addition, Wal-Mart has an effective distribution system and leverage over suppliers. The big e-tailers are finding out now that they must make large expenditures to build a distribution system, and fulfillment has been suspect. Just ask all the parents who did not get their Pokemon toys on time for Christmas. As a result of Wal-Mart's dominance in the bricks-and-mortar world, it can deliver low prices and provide quality customer service online.

The Internet can be used to complement the product offerings of a business or provide another sales channel. It does not necessarily have to cannibalize its existing business.

Q: Where do you see Wal-Mart's online operations five years from now?

A: I don't know. Where will be five years from now? Wal-Mart has just scratched the surface in the online space. Unlike many investors, I think time will work for Wal-Mart, not against it if it addresses e-tailing over the next year. I do think that management should appease investors and at least address its general online strategy. The spin-off could create some valuable currency to build a powerful online brand. However, my best guess is that Wal-Mart is still in a wait-and-see mode. Rather than lose $26 on every customer, management is probably trying to figure out how to allocate capital effectively for the online operation, or dare I say, make money.

Q: It seems that Wal-Mart is quickly reaching its saturation point domestically. There simply aren't that many markets available that Wal-Mart hasn't already tapped. Where will the company see its future growth come from?

A: Future growth comes from several areas. Domestically, Wal-Mart is growing through its Superstores. The company plans another 165 Superstore openings during FY 2001. Through the Superstore, Wal-Mart will attack a piece of the $460 billion grocery business. Traditionally, this business is a very low-margin space, but with Wal-Mart's competitive advantages in distribution and leverage over suppliers, they can make it a big winner.

Wal-Mart is also gradually rolling out the Neighborhood Market concept. This fills a niche in the smaller, convenience-type market. With about 20,000 items and 40,000 square feet, it certainly isn't a Superstore. But Wal-Mart can build them faster, and expand in to markets that may not be fully able to support a 180,000-foot Superstore.

International expansion has been robust and will continue to be an important part of Wal-Mart's future growth opportunities. Certainly the Internet provides a growth avenue as well. The company has been slow to put the full court press on the e-tailing industry, but their strategy should become clearer over the next 6-12 months.

I really think that the growth opportunities for Wal-Mart are just beginning. Any company that can grow revenues 20% to $165 billion should make you do a double take. I personally feel that a trillion dollars in sales is not unreasonable.

Q: How is Wal-Mart's global expansion coming along?

A: The world is not enough! Wal-Mart's global expansion began in earnest about a decade ago under the leadership of former-CEO David D. Glass. Over the past few years, Wal-Mart has made some major acquisitions on the international front. The recent acquisition of Asda in the United Kingdom for example, gives Wal-Mart over 230 stores there.

Wal-Mart is building a diversified portfolio of international operations, and the growth rates have been significant. International operations now account for almost 14% of Wal-Mart's $165 billion in sales. Mexico and Puerto Rico have been strong areas, as well as Canada. Even though Latin America has had some weaknesses, the overall mix has been impressive. I would expect to see some further expansion into Asian markets beyond the six stores in China and five in Korea.

Q: Can Wal-Mart cut costs any further? Will margins rise in the future?

A: In the past, management has been vigilant about cutting costs. Wal-Mart invests heavily to maximize the efficiency of its asset management. The result has been fewer markdowns, increased roll-backs, better inventory management, and increased inventory financing by suppliers. This has led to reduced expenses and increased margins. In the short-term, costs should rise, but I don't believe management has achieved the maximum level of efficiency possible. Hence, I think they will continue to focus on inventories to control costs and improve margins.

On the cost-containment front, I would expect Wal-Mart to be a big B2B player sooner rather than later. They have already announced a deal with Oracle (Nasdaq: ORCL) and Chevron (NYSE: CHV) through its McLane's division. This is probably a test to see what type of return on investment can be achieved in the B2B e-commerce retail space.

Margins will likely be squeezed in the short-term. Management feels that increased labor costs and the price of oil may have adverse effects on profit margins in the next quarter, at least. However, factors such as these affect many competitors, and Wal-Mart is better able to sustain short-term bumps in the road than its weaker competitors.

Q: How has Wal-Mart handled the tight labor market?

A: The tight labor market is causing expenses to increase. In addition, Wal-Mart has had problems on the labor front with the recent vote in Jacksonville, Texas, to unionize the meat department. A greater movement to unionize would most likely lead to further increases in labor costs. Of course, only handful of people voted in the movement to unionize. The company claims that had the whole store been allowed to vote, the result would have been different.

Wal-Mart has fought this movement hard, and there could be public backlash against one of America's most admired companies if it is perceived as not providing the best conditions for its workers. Somewhere, there exists a balance between the needs of employees and the ability of the firm to compete. That balance needs to be found before things spin out of control.

Q: I thought I saw Sam Walton as a greeter at my local Wal-Mart last week. Am I nuts?

A: Um�yeah, you probably are.

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