By Brian Kilcourse, Managing Partner
6/2/2009
The local Sunday paper screamed the headline, “CLASH of the discount titans”[i], as if announcing the next big heavyweight grudge match, let alone something that consumers haven’t been well aware of for the past year. The storyline is simple (according to the newspaper report): Walmart is pummeling Target. The world’s largest retailer continues its relentless low price message while Target finds itself disadvantaged by the brand image it has carefully built (“Tar-jhey,” the store for fashion-at-a-bargain suburban shoppers who wouldn’t be seen in a Walmart).
The news story reminded me of something one retail CEO-friend was fond of saying: “Being the low price leader just means you don’t have anything else to offer.” Walmart of course is the exception that proves that rule. With their world class supply chain, they are able to consistently deliver a great low price to consumers, as we all know. The real danger for other retailers is getting pulled into the ring with them. As the CEO-friend also used to say to explain his company’s strategy, “We watch what Walmart does very carefully, and then go and do the other thing.” We at RSR have been preaching that getting into a fight to be the low price leader is a really low percentage strategy. A better one is not to let price become a negative in the eyes of consumers- in other words, don’t let high-price become a problem. The fact of the matter is that channel-master Walmart has raised the “low-price leader” bar so high that it’s unlikely that any other retailer will win at that game any time in the forseeable future. So the question for other retailers is, if you can’t win at their game, why not play a different one? During the good times, Target was doing just exactly that, but in the face of the recession and noise from the investment community, has made the mistake of getting into the ring with Walmart.
Wall Street analysts are critical of Target’s slow response to the recession, and attention on the company has been heightened by complaints from high-profile activist shareholder William Ackman, who wanted to force changes with the Board of Directors. One might think that Walmart executives are enjoying the sideshow, but I suspect that they are far too focused on their own knitting to worry at all about a competitor that (after all) is only one-sixth the size of the Arkansas giant. In fact, if you look at the numbers, the magic of a strong business model and relentless execution come into clear focus.
Looking at the Walmart’s income statement for the last three fiscal years ending in January, the company’s consistency has been remarkable. The company has managed cost-of-goods (COG) and Sales, General, & administrative (SG&A) expenses compared to top-line revenue. COG measured 75.48% of revenue in the year ending 1/09 compared to 75.64% in ’08 and 75.76% in ’07, while the SG&A ratio was 18.9%, 18.56%, and 18.36% in the same three years. The net after-tax result has been equally consistent: 3.30% went to stockholders in ’09, 3.36% in ’08, and 3.24% in ’07. In these rocky times for investors, no wonder Wall Street likes Walmart again!
Taking the same look at Target reveals the impact of getting into the ring with Walmart. For example, it is easy to see the impact of competing with Bentonville on price: Target’s COG as a percentage of revenue rose sharply in the year ending 01/09 to 67.99%, compared to 66.11% in ’08 and 66.23% in ’07. Barring the unlikely explanation of a massive supply chain breakdown, this can only mean that the company got aggressive on prices (round one to the heavyweight champion Walmart). To make up the difference, Target has been putting the screws on operational expenses, most likely at store-level. As a result, their SG&A has dropped from 22.95% of revenue in ’08 to 22.47% in ’09. No more Tar-jhey levels of service! (round two to the champion). As the predictable result, Target’s after tax earnings dropped in ’09 to 3.41% of revenue (note that this is still higher than Walmart’s!), down from 4.59% in ’08 and 4.68% in ’07 (round three to the current and probable future heavyweight champ, and now Wall Street spectators are jeering the contender).
The result of these maneuvers is depressingly predictable. The retail roadside is littered with the wreckage of companies that lost focus on their model and unsuccessfully attempted to play a competitor’s game. What the Walmart story shows is that belief in your model and relentless execution to that model are vital to long term success. It wasn’t that long ago that the geniuses on Wall Street were complaining that Walmart’s best days were behind it. Now the same clamor is being heard about Target. Although Walmart may have been tempted (remember the company’s ill advised attempt to go up-market with fashion?), they believed in their model and didn’t lose focus. They didn’t beat themselves. Target should pay attention to that lesson.
[i] Contra Costa Times, Sunday, 5/31/09
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