Walmart Express

Wal-Mart is closing all of its Walmart Express stores this month. Image source: Wal-Mart.

In 2011, retail giant Wal-Mart (NYSE:WMT) began testing a new small-format concept called Walmart Express. These stores average about 12,000 square feet, putting them in competition with dollar stores like Dollar General (NYSE:DG) and Dollar Tree (NASDAQ:DLTR). The goal was to capitalize on consumers looking for more convenient shopping experiences.

Last week, Wal-Mart announced that it will close all 102 of its Walmart Express stores. It will instead try to satisfy the demand for convenience by opening more supermarket-sized Neighborhood Markets, growing its e-commerce operations, and rolling out new pickup and delivery options.

Encroaching on the dollar stores
Just a few years ago, Walmart Express seemed like an extremely promising concept. While the total opportunity was significantly smaller than the $585 billion market that Wal-Mart identified for its traditional superstores, at $155 billion it was nothing to sneeze at.

G

Walmart Express was designed for quick trips. Image source: Wal-Mart.

In October 2013, Wal-Mart reported that the initial group of 20 Walmart Express stores had produced double-digit comparable-store sales growth in the first half of that fiscal year. Based on this strong momentum, the company accelerated the Walmart Express concept's growth in 2014.

Naturally, this seemed like very bad news for dollar stores. Dollar General and Dollar Tree are large businesses -- following the latter's merger with Family Dollar, both companies have annual sales of about $20 billion. Nevertheless, they don't have nearly the scale and purchasing power of Wal-Mart, which is approaching $500 billion in global revenue.

Plans go awry
The first sign of trouble for the Walmart Express concept came a year after the expansion plan was announced, in October 2014. First, Wal-Mart announced plans to rebrand the Express stores under the better-known Walmart Neighborhood Market banner, which would then cover all of Wal-Mart's stores in the 12,000 square foot-66,000 square foot range.

Second, Wal-Mart mentioned that it had discarded its "tethering" supply chain concept for Neighborhood Market and Express stores. The idea had been to use Walmart Supercenters as mini-distribution centers for nearby small-format stores. Large trucks would deliver items to the supercenter. Smaller trucks would then move goods from the supercenter to local Walmart Express and Walmart Neighborhood Market stores.

Images

Wal-Mart's tethering plan could have given it a competitive advantage over dollar stores. Photo: The Motley Fool

In theory, the tethering plan would have given Wal-Mart a huge advantage over dollar stores by creating a more efficient supply chain. Instead, it created chaos. The supercenters acting as mini-distribution centers couldn't keep up with the volume of goods moving through the back room.

It's impossible to say for sure whether the failed tethering test led directly to the demise of the smallest Walmart stores. But it did eliminate one of Wal-Mart's key potential advantages over competitors like Dollar General and Dollar Tree.

If nothing else, it seems clear that the rapid sales growth Wal-Mart achieved at its smallest stores was not profitable growth. That's the only reasonable explanation for the company's sudden decision to shut all of its 12,000 square foot prototype stores.

Dollar stores can breathe a sigh of relief
Given Wal-Mart's massive scale and nearly unlimited financial resources, a broad rollout of the Walmart Express format could have severely disrupted business at Dollar General and Dollar Tree. Not surprisingly, shares of both companies avoided the steep declines that the rest of the market suffered on Friday.

Wal-Mart isn't completely abandoning its small-format growth. It will continue to expand the Walmart Neighborhood Market concept, with plans to open 85 to 95 new stores in the coming year (compared to 23 that are closing this month). That puts traditional supermarkets in its crosshairs -- while dollar stores have dodged a bullet.

Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.