Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Commentary

Walmart and the Limits of Discounting

Walmart Stores Inc. (NYSE: WMT) might be demonstrating that there are serious limits to the business of discounting. Historically, it has been assumed that discounters are capable of unlimited growth as long as they can keep lowering their prices.

That’s certainly been the case at Walmart, which operated around 5,249 stores in the United States on August 31, 2015. Those locations included 3,445 supercenters, 455 discount stores, 656 Neighborhood Markets, 41 small format stores and 652 Sam’s Clubs. When Sam’s Club is taken out of the mix, the company operated 4,597 stores under the Walmart brand in the United States.

In contrast, Costco Wholesale (NASDAQ: COST) only operates around 474 of its club stores in the United States, while Kroger Co. (NYSE: KR) operated around 2,625 supermarkets and supercenters and 782 convenience stores in 2014.

In the past, Walmart’s size and constant expansion paid off. It reported revenues of $485.62 billion on July 31, 2015. The problem is that those revenues have actually started to shrink. Walmart reported revenues of $485.65 in January 2015 and $485.52 billion in April 2015. Basically, the mega retailer’s revenue has suddenly stalled, a situation that is unprecedented and new.


In July 2013 Walmart reported revenues of $472.48 billion that grew to $480.48 billion in July 2014. Walmart went from adding $8 billion in revenue in a year to dealing with a modest loss. What is going on here? Has Walmart reached the limits of its growth, and can that affect the entire retail industry?

Has Walmart Reached the Limits of Growth?

For decades Walmart seemed to operate as if it was capable of unlimited revenue growth. It just kept expanding and expanding in anticipation of increased revenue from an increased footprint, yet that does not seem to be happening anymore. Why?

The most likely reason is that Walmart has far more competition than ever before, led by (NASDAQ: AMZN). Amazon’s revenue has been growing at an incredible rate; it topped the $100 billion mark for the first time on Sept. 30, 2015, when the Everything Store reported a TTM revenue of $100.59 billion.


The rate of Amazon’s growth is rather feverish; it reported a TTM revenue of $95.81 billion in June 2015, meaning that its revenue grew by nearly $5 billion in the third quarter of 2015. If that was not enough, Amazon reported a TTM revenue of $85.25 billion in September 2014, meaning that it its revenues increased by $15.14 billion in a year.

What this seems to indicate is not that Amazon is stealing business from Walmart but instead it is stealing revenue growth. Basically, the additional revenue in the economy that would have normally flowed to Walmart and other big box retailers seems to be flowing to Amazon.

If this keeps up, Amazon could surpass Kroger as America’s third largest retailer within the next six months. The online retailer will have larger revenues than the nation’s largest grocer.

This would seem to indicate that the economy has changed; the factors that were propelling Walmart’s growth are no longer there or no longer working. One major difference in today’s economy is that people are making a lot of the purchases they used to make at Walmart at various online outlets such as Amazon. Obviously, the free shipping deals that companies like Target (NYSE: TGT) offer, which offers free shipping on all orders over $25, could be cutting into Walmart’s business.


How Walmart Profited from Income Inequality

Another interesting factor here is that the biggest years of Walmart’s growth in the 1990s and 2000s coincided with the stagnation and contraction of middle- and working-class wages in the United States. The Washington Post reported that the average family’s income has not grown for 25 years and average incomes in 81% of American counties were lower in 2014 than in 1999.


The American middle class’s wages stagnated and in many cases shrunk over the last 25 years, while Walmart’s business boomed. One reason why Walmart’s business boomed was that people had less money to spend so they were most likely to shop at discount stores. It was during that period that Walmart supplanted the firmly middle-class Sears as America’s number one retailer.

One has to wonder if middle-class shrinkage has reached its limits or, worse, if wage contraction has gotten so bad that many people can longer afford to shop at Walmart. Small box discounters or dollar stores have become some of the fastest-growing retailers in America; between July 2014 and July 2015 Dollar General (NYSE: DG) saw its revenues grow from $18.12 billion to $19.68 billion.

A major reason why dollar stores have been growing so fast is that they are the only places that some Americans can afford to shop. In February 2014 Walmart itself admitted that a $5 billion cut in the nation’s food stamp program would affect its financial performance.

That cutback, which began in November 2013, coincided with the explosive growth at Dollar General and the start of Walmart’s present woes. The practical effects of the food stamp changes were to cut family benefits by around $90 a month (or one trip to Walmart for a working-class family).

Do We Have Too Many Discount Stores?

Dollar General now operates around 12,198 stores in the United States, and it has plans to open several hundred more. Another dollar store operator, Five Below (NASDAQ: FIVE), has expanded to 400 stores in recent years and is now in 25 states. If that was not enough, Dollar Tree Stores (NASDAQ: DLTR), which recently absorbed Family Dollar, could have as many as 13,600 stores in the United States and Canada.

Add these numbers to Walmart’s, Kroger’s and Target’s 1,799 stores and you see the problem. There could simply be too many discount stores in the United States today. The situation is made worse by modern retailers’ tendency to move into each other’s spheres; for example, Walmart’s opening of Neighborhood Markets and Kroger’s entry into the supercenter arena.


This massive expansion comes at a time when the actual market for discount stores could be shrinking because of the rise of aggressive online discounters such as Amazon and the erosion of middle- and working-class wages. One potential result of this could be massive drops in revenue like those we have seen at McDonald’s (NYSE: MCD) and Sears Holdings (NASDAQ: SHLD).

My prediction is that we will see the collapse of at least one major discount chain in the next few years. We already saw the near demise of Family Dollar last year; I have to wonder if Dollar General or Dollar Tree might not share its fate. Also tottering could be Target, which simply lacks the resources available to Kroger, Costco and Walmart.

Target reported a TTM revenue of $72.71 billion and a net income of -$900 million on July 31, 2015. Dollar Tree reported a TTM revenue of $9.759 billion, and Dollar Three reported $19.69 billion on the same day. That means all it would take is one really lousy Christmas season to send one of these chains spinning straight into the kind of death spiral we have seen at Sears.

The death spiral occurs when a retailer’s expenses exceed its revenues, which causes the company to start cannibalizing itself to keep the doors open. A classic example of his behavior is Eddie Lampert’s real estate deals at Sears, in which he is selling off properties to raise money to finance operations. Another is mindless closing of stores in an attempt to cut expenses.

Another Limit of Walmart

Walmart can easily avoid this kind of death spiral because of the resources it has. What can be more constraining to Walmart are what we might call the political and social limits facing the company.

Historically, Walmart’s business model has been based upon low wages for both its direct employees in the United States and the workers of its overseas suppliers, mostly in China. That situation is changing as the political, economic and social climates in both nations have become far less tolerant of low wages.

Walmart was forced to raise wages for over 100,000 workers in June 2, 2015, partially out of fears of labor unrest and efforts to raise the minimum wage. Another potential cause, which is poorly understood, is the cuts in food stamps upon which a large percentage of Walmart employees depend for part of their income.
Rising wages and growing labor unrest in China are increasing the cost of doing business in the People’s Republic. That could raise the price of Chinese-made goods at some point.

This means Walmart could lose even more of its competitive advantage because sooner or later it will have to pass the increased product and labor costs on to the customers in the form of higher prices. Historically, Walmart’s success has been based on its ability to deep discount. In recent years it has lost its edge as companies like Kroger and Costco have managed to imitate that ability, and Amazon has even been able to undercut Walmart on prices.

That puts Walmart in a difficult position because it lacks the kind of customer loyalty that Costco and Target have. Target has an advantage here because it sells more premium, higher-value goods, while Costco has legions of loyal membership holders and the revenue that their subscriptions produce. The only reason people shop at Walmart is the low price; take that away and many Americans will avoid Walmart like the plague.

One has to wonder if Walmart can survive the limits of discounting or not. Will this great American institution crash and burn like Sears or manage to reinvent itself like Kroger did? Only time will tell, but there is an obvious certainty here: The limits of discounting mean that Walmart is no longer the surefire moneymaker it once was.

Disclosure your brilliant blogger owns shares of Kroger (NYSE: KR) that he has no plans to sell any time soon.