With all the discussions of Walmart over the past several years, one topic that has been overlooked is the prospects for the company in the future. All successful companies go though a life cycle. First they start small, then they figure out a unique business plan and start to prosper. At some point they reach a point where they just “click” and experience very rapid growth. At this point they become media personalities and all their successes and failings are examined. Once they reach a certain size, however, the dynamics changes. The rate of growth slows down and investors who bought in because of the rapid expansion become disinterested. At this point the company starts to get worried and a period of new business ideas is tried to hold on to the “magic”. Eventually, even this fails to excite and the company is see as “mature”.

Wall Street values a company not by its rate of return, or by its growth rate, but by the rate of increase in its growth rate. What in mathematics is called the second derivative. The stock is evaluated on how much bigger the company will be in the future. Obviously the larger the company the harder it is to sustain a given percent growth increase. A company grossing $1,000,000 a year needs to add another $1,000,000 to have 100% growth, but a company grossing $1 billion needs to add another $1 billion, a much more difficult task.

An examination of Walmart’s stock price over the past several decades will show this effect. After a long period of relative stability it went through a rapid increase which stopped around 2000. Since then it has essentially moved sideways. This reflects Wall Street’s belief that the best growth years are behind it. Walmart has been trying to disguise its growth deceleration by buying other companies and expanding into regions that it did not favor before. This means trying to move into cities, for example.

The expansion into urban areas does not follow their original business plan. Store costs are higher as is land and transportation. Warehousing is less efficient, and labor and customer competition is more prevalent. In addition the addition of another big box store is not as important to the local economy and doesn’t get the kind of favorable treatment from local government that they aim for. So, in general, it’s harder to do business.

By expanding and acquisition Walmart is able to claim a growth rate in 2004 of about 11%. Closer examination of their annual report reveals that on the real measure of operations, (sales in existing stores), the growth rate was about 4%. This is just about the rate of inflation plus population increase. In effect this means sales are flat. This is not something that investors take kindly to.

On the other side of the ledger, Walmart has made great efforts to lower costs. The most discussed one is outsourcing production to China and other developing countries. This process has now been completed with some estimates of up to 90% of Walmart’s non-food items being imports. The prospects for further cost savings in this direction thus seem limited. Walmart recognizes this and is developing a more efficient supply chain to lower costs. The adoption of new technologies like RFID (radio scannable bar tags) will help them track items from the point of manufacture all the way to the store shelf. So anxious are they for the implied cost savings of this that they have been pushing suppliers to adopt it even before the RFID developers have a fully usable product to offer.

Finally, another part of Walmart’s business plan has matured as well. They have shifted from a purveyor of offered goods to a chooser of products to sell. This is called the pull model as opposed to the older push model. So what they offer as a company is market research and item selection, supply chain management and retail distribution. It is the model for the modern corporation. The plant and equipment investment is a small part of their overall costs. Most expenses are transaction costs like shipping and labor. This leaves them open to a variety of new challenges. Here is a single example.

Let’s start with a hypothetical example. Suppose Walmart decides to sell a widget for $2. Let’s also assume it pays its supplier $1 and then it has costs of 50 cents. So its gross profit is also 50 cents. From this it has to pay taxes of about 35% leaving an after tax profit of $0.325. (In reality the profit margin is much smaller). Now it pays its Chinese supplier only $1 and he starts to have profit issues of his own. Being at the mercy of his customer he has limited options. If he complains Walmart will find another supplier and he will lose the business. This is what caused the US makers to move production abroad, originally. There is, however, no place for the Chinese business to go. He is the bottom of the labor pool. Now suppose a group of these suppliers band together and form a consortium along with the government to invest in US businesses. One of the things that might occur to them is to buy up Walmart. It’s true that this would costs, perhaps, hundreds of billions of dollars, but China has just this type of US funds available from years of their trade surplus with the US.

Let’s suppose the deal goes through and the manufactures now (at least indirectly) own Walmart. They change the business model. The $2 retail widget stays at the same cost, but the maker charges $1.49 for it. Walmart still has 50 cents of internal costs so its gross profit is now only one cent. The consumer doesn’t notice the difference. There is even a net savings to the company since they are only paying tax on one cent instead of fifty cents. The suppliers are happy because they are making a decent return on their investments. Even the Chinese government is happy because it has turned its captive US treasuries into a revenue source. The only ones who would seem to be the losers are the Walmart stock holders who will no longer be getting a dividend. But, they were all eliminated when the Chinese holding company bought up the company and made it a wholly owned subsidiary.

Lest you think this is far fetched, similar things have been done for decades. One of the favorite tricks is to “move” a company to a foreign tax shelter like Bermuda and then arrange for the profits to be realized there instead of in the US. One of the most notable examples of this was the Stanley Tool Works move of a couple of years ago. Another trick is to make a product in a cheap country then “sell” it to a subsidiary in a tax shelter and then have this subsidiary add some valuable “intellectual property” right like a logo which allows for a high markup. So a pair of sneakers from Indonesia gets sold to the subsidiary in Bermuda for $5. They then add the swish and claim that added $50 to the value and sell it to their US branch for $55. The US branch sells to the stores for $60 thus sheltering 90% of the profit from US taxes.

Given Walmart’s growth problems, its labor problems and lack of Wall Street appeal there is an extremely good chance that investors will start to demand major structural changes to the way the company is run within this decade. As to whether this will change their current local business and labor practices remains to be seen.

So is Walmart over? Perhaps sooner than you think.

This entry was posted on Friday, December 9th, 2005 at 1107 by Robert Feinman and is filed under Business, Walmart. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.