When the Pundit was just a boy, we remember the Pundit Poppa investing in the high-yield securities — in other words junk bonds — of many retailers. Hallowed names like W.T. Grant and McCrory’s are gone now but were the subject of avid attention at the Prevor dinner table.
So we’ve been studying the way retailers announce their sales and earnings for a long time and, although different retailers do different things at different times, for the most part we find retail explanations highly self-serving.
It seems that if people don’t shop at stores, it is often bad weather that gets the blame, and that seems to make sense as, after all, who wants to go out through the sleet and snow to get to a store? Of course, if sales are down and the weather is good, retailers sometimes blame good weather for poor results and that, also, makes sense — after all, who wants to go shopping when they can be at the beach?
After enough years of listening to this stuff, you realize that with a few exceptions, these reports are often ex post facto attempts to explain things in any possible way except to blame management.
One got that feeling in the recent Wal-Mart conference call covering first quarter earnings of 2010.
Once again, Wal-Mart’s United States same store sales were down while profits were up. Last time, we wrote about this phenomenon in a piece titled Wal-Mart Reports Strong Earnings — Is It Creating A Pricing Umbrella For Aldi?
The explanations didn’t really make much sense.
Eduardo Castro-Wright, President and CEO of Wal-Mart Stores, Inc. USA, said the proximate cause was that customer traffic was down since basket size was up. Fair enough.
He pointed to two problems: The first was unemployment and fear of unemployment, although, one would think that even if existing Wal-Mart shoppers have lost buying power or fear losing buying power, and so are buying conservatively, other consumers would compensate for this dynamic by “trading down” to Wal-Mart. It is curious this isn’t happening and no explanation was given.
Eduardo Castro-Wright’s second claim was that visits were down because of high gas prices as Wal-Mart shoppers consolidated their trips to Wal-Mart in order to save on gas.
We are sure some consumers did this but visits to Wal-Mart Supercenters historically go UP with rising fuel costs, as a Supercenter concept provides one-stop shopping, thus eliminating trips to multiple stores. This historically saves both time and money.
For every Wal-Mart consumer who might reduce his or her visit frequency to Wal-Mart because of high gas prices, there should be ten who decide to increase their Wal-Mart visits and decrease visits to other venues because they can save on gas by getting everything they need at Wal-Mart.
Since economic distress and high gas prices are actually dynamics that should favor Wal-Mart and did not, an honest search for explanation has to go deeper.
We found three hints in the financials, press release and conference call:
1) Wal-Mart has been on a binge of reducing SKUs. This has never made sense to us. Yes, offering a limited assortment is a key way ALDI can keep costs low — but Aldi does not have 200,000-square-foot stores to fill. The whole point of a supercenter is that one can get everything one wants there. Cutting low volume SKUs seems like a no-brainer — eliminate slow selling items and reduce costs — but very often those slow selling items are the exact reason people select that store for their shopping. They love that brand, that size, that flavor profile — and can’t get it elsewhere. If you drop the SKU, you lose the customer or at least the frequency of visit. Which is a better explanation for why visits are down than gas prices or unemployment.
One suspects Wal-Mart knows this as they mentioned in the call that they were restoring 300 items to grocery that they had just taken out — in other words they had to restore items because they were losing customers or, at least, frequency. Which shows Wal-Mart doesn’t have a good system for knowing what customers really value — which is not the same as simply what they buy. They may buy 90% Coke and Diet Coke but choose the store because it is the one that sells Dr. Brown’s Cel-Ray Tonic.
2) A related insight as to what is depressing visits is in the explanation of where sales were strong and where they were weak. Areas such as produce, seafood and deli were up, but grocery was down. Note that rising sales of fresh products makes no sense in the context of a decline of shopping frequency caused by high gas prices. It also makes no sense if the decline of shopping frequency is due to high unemployment and fear of unemployment, since such concerns lead to the purchase of items that won’t go bad and potentially be wasted.
What would explain this is that in addition to reducing SKU count, Wal-Mart has been pushing a private label initiative. This reduces further the likelihood that a consumer will find the brand and size they want on Wal-Mart’s shelves.
But the private label roll-out has not been uniform across the store; it is far more advanced in grocery than in perishables.
So we are now coming to see a reasonable explanation on what has been happening. Consumers who come to Wal-Mart can’t find the products they want because SKU count is reduced and branded product is replaced by private label, so the consumers come less frequently because Wal-Mart is forcing them to go to other stores to find the products they want.
3) Finally, one other hint of a problem was the incessant attention to Wal-Mart’s “rollback” program on prices, which is, in fact, just a gimmick. The important numbers are that Wal-Mart’s profits have been rising faster than its sales.
Yes, we know all about the greater efficiencies Wal-Mart is claiming to realize. What it should do is pass on those savings to consumers. This is what encourages a virtuous circle of lower costs, leading to uniformly lower prices, which leads to high volume, which leads to lower costs.
The rollback strategy — which is the same thing as telling consumers “we used to overcharge you… now we won’t” — is actually damaging Wal-Mart’s reputation for always having the right price. This is a precious asset because it means consumers won’t feel the need to price-compare. What Wal-Mart is teaching its customers now is that they better price-check other stores because although Wal-Mart has rolled back certain prices, it is not promoting on other items — but, perhaps, some competitor is.
With gas prices high, and consumer budgets stressed, Wal-Mart management is creating a promotional — as opposed to EDLP — environment that encourages consumers to check around. That is likely why Wal-Mart visits are down. Don’t hold your breath waiting for that analysis on a conference call.