I recently reviewed Bruce Greenwald’s book Competition Demystified in this article. In the article I purposely omitted the best chapter of the book as I wanted to write a separate summary of the chapter. Chapter number five is titled Big Where It Counts: Local Economies of Scale.
The first part of the chapter starts with a small retailer in Arkansas that started in 1945. The company went public in 1970 with thirty stores located in Arkansas, Missouri, and Oklahoma. In 1985 the company had 859 stores in 22 states. By 2010 the company had over $400 billion in revenue, operated over 3,000 stores in every state, and employed 2.1 million people. This is the story of Wal-Mart.
So how did Wal-Mart grow from a single branch in Arkansas to the largest retailer in the world? Wal-Mart is one of the most unbelievable growth stories ever. Yet, it accomplished this feat in the most competitive market with no patents, government licenses, or massive amounts of R&D.
There are many myths about how Wal-Mart achieved its growth. Some of these myths include; putting pressure on vendors, having a monopoly in small towns, better management, and that products are cheaper in the south. Instead of focusing on the myths which Greenwald does a reasonable job of disproving, I want to focus on the facts of how Wal-Mart truly achieved its dominance.
The best time period to evaluate is the mid 1980s. This is when Wal-Mart was at its peak, and Kmart was declining. In 1985, Wal-Mart had far higher operating margins, and returns on capital than Kmart. So what made Wal-Mart excel, while Kmart falter? The answer lies in the powerful moat called economies of scale.
In 1985 despite operating nearly 1,000 stores, 80% of Wal-Mart’s stores were located in Arkansas, and adjacent states. By contrast Kmart was much more spread out, despite having its own area of concentration in the Midwest. This helped Wal-Mart spend less money on bringing goods to its warehouses, and distributing the goods to distribution centers. Wal-Mart used its own trucks to transport merchandise, and since the distance between the distribution centers were close, Wal-Mart’s costs were lower.
Wal-Mart used the local economies of scale to get more bang for its buck. As Greenwald states, “a thirty-second spot in Nashville charges the same whether there are three Wal-Mart stores in the area or thirty”. This would apply whether the ad was on TV, in the newspaper, or in a circular. When Wal-Mart advertised it was able to reach a larger number of potential customers, despite paying the same price as competitors would.
The final advantage Wal-Mart had was due to the structure of its management. Executives, and store Managers would pay close attention to the local branches under their supervision. Since the stores were close traveling time was decreased, and managers could spend more time effectively managing their stores. This territorial advantage allowed Wal-Mart to hire fewer managers. To supervise the same number of stores, a Kmart executive would have to cover territory four times as large. Greenwald estimates this expense may have cost Kmart 2% in additional expenses. This extra 2% is a massive difference when operating margins only hovered around 6%.
All the advantages Wal-Mart enjoyed were due to local economies of scale. Even though Kmart’s revenues were three times the size of Wal-Mart’s revenues in 1985, Wal-Mart was able to operate much more efficiently.
After 1985, Wal-Mart’s operating margins, and return on capital started to decline. This is not surprising as Wal-Mart had nowhere else locally to expand. Wal-Mart started to open chains in California where it competed with Target. Wal-Mart also expanded to the Midwest facing competition from Kmart, and Northeast where it faced Caldor. Wal-Mart no longer had a monopoly as it did in the areas surrounding Arkansas.
What does the future hold for Wal-Mart? It does not look promising. Wal-Mart no longer has the advantages of local economies of scale. Furthermore, Wal-Mart is trying to expand overseas where it definitely does not have this advantage. Wal-Mart’s expansion into places like Germany has been largely unsuccessful. If one takes Greenwald’s view, the best option for the company would be expansion into Canada, and Mexico however Wal-Mart will likely never have the returns that it used to have.
Disclosure: none
The first part of the chapter starts with a small retailer in Arkansas that started in 1945. The company went public in 1970 with thirty stores located in Arkansas, Missouri, and Oklahoma. In 1985 the company had 859 stores in 22 states. By 2010 the company had over $400 billion in revenue, operated over 3,000 stores in every state, and employed 2.1 million people. This is the story of Wal-Mart.
So how did Wal-Mart grow from a single branch in Arkansas to the largest retailer in the world? Wal-Mart is one of the most unbelievable growth stories ever. Yet, it accomplished this feat in the most competitive market with no patents, government licenses, or massive amounts of R&D.
There are many myths about how Wal-Mart achieved its growth. Some of these myths include; putting pressure on vendors, having a monopoly in small towns, better management, and that products are cheaper in the south. Instead of focusing on the myths which Greenwald does a reasonable job of disproving, I want to focus on the facts of how Wal-Mart truly achieved its dominance.
The best time period to evaluate is the mid 1980s. This is when Wal-Mart was at its peak, and Kmart was declining. In 1985, Wal-Mart had far higher operating margins, and returns on capital than Kmart. So what made Wal-Mart excel, while Kmart falter? The answer lies in the powerful moat called economies of scale.
In 1985 despite operating nearly 1,000 stores, 80% of Wal-Mart’s stores were located in Arkansas, and adjacent states. By contrast Kmart was much more spread out, despite having its own area of concentration in the Midwest. This helped Wal-Mart spend less money on bringing goods to its warehouses, and distributing the goods to distribution centers. Wal-Mart used its own trucks to transport merchandise, and since the distance between the distribution centers were close, Wal-Mart’s costs were lower.
Wal-Mart used the local economies of scale to get more bang for its buck. As Greenwald states, “a thirty-second spot in Nashville charges the same whether there are three Wal-Mart stores in the area or thirty”. This would apply whether the ad was on TV, in the newspaper, or in a circular. When Wal-Mart advertised it was able to reach a larger number of potential customers, despite paying the same price as competitors would.
The final advantage Wal-Mart had was due to the structure of its management. Executives, and store Managers would pay close attention to the local branches under their supervision. Since the stores were close traveling time was decreased, and managers could spend more time effectively managing their stores. This territorial advantage allowed Wal-Mart to hire fewer managers. To supervise the same number of stores, a Kmart executive would have to cover territory four times as large. Greenwald estimates this expense may have cost Kmart 2% in additional expenses. This extra 2% is a massive difference when operating margins only hovered around 6%.
All the advantages Wal-Mart enjoyed were due to local economies of scale. Even though Kmart’s revenues were three times the size of Wal-Mart’s revenues in 1985, Wal-Mart was able to operate much more efficiently.
After 1985, Wal-Mart’s operating margins, and return on capital started to decline. This is not surprising as Wal-Mart had nowhere else locally to expand. Wal-Mart started to open chains in California where it competed with Target. Wal-Mart also expanded to the Midwest facing competition from Kmart, and Northeast where it faced Caldor. Wal-Mart no longer had a monopoly as it did in the areas surrounding Arkansas.
What does the future hold for Wal-Mart? It does not look promising. Wal-Mart no longer has the advantages of local economies of scale. Furthermore, Wal-Mart is trying to expand overseas where it definitely does not have this advantage. Wal-Mart’s expansion into places like Germany has been largely unsuccessful. If one takes Greenwald’s view, the best option for the company would be expansion into Canada, and Mexico however Wal-Mart will likely never have the returns that it used to have.
Disclosure: none
