Wal-Mart’s Cost Leadership

Wal-Mart’s Cost Advantages

(Article by Michelle Chong Xui Ing)

Wal-Mart has always been focused on achieving the lowest possible costs. As the firm began to expand
and grow, there were two main sources of cost advantage: 1) a growth pattern of rural locations
surrounding distribution centers, and 2) information technology.

Wal-Mart’s careful selection of rural locations created cost advantages because of relatively cheap land
and very efficient distribution through its distribution centers. Stores were typically located along
interstate highways and/or heavily traveled crossroads. There was usually very low demand for the land
purchased for these locations because other retailers were uninterested in rural locations. However,
these stores had incredible drawing power. People flocked to the stores in search of low prices and a
wide product offering. Distribution was also relatively inexpensive because Wal-Mart’s trucks could easily
get to these locations from interstate highways. One large distribution center could efficiently handle all
the stores within a day’s drive.

These location advantages were coupled with Wal-Mart’s information technology which was always state-
of-the-art. Highly efficient inventory management, facilitated by IT systems, allowed Wal-Mart to achieve
costs significantly lower than its competitors. Wal-Mart knew which items were selling and which were
not. It knew how much of which products were needed and where they were needed. And, it could
distribute these products quickly and efficiently.

Wal-Mart has heavily advertised low prices. People tend to associate Wal-Mart with low prices.
However, careful shoppers in some markets have realized that competitors sometimes offer lower prices,
especially on food items. Thus, it would appear that Wal-Mart is in the enviable position of having low
costs but not having to charge the lowest prices on all products all the time.

This pricing advantage can be very frustrating for competitors. Wal-Mart has a policy of beating
competitors’ prices whenever a customer points out that a competitor has a lower price. If a competitor
attempts to compete vigorously on price, Wal-Mart will simply lower its price and it can better afford to do
so.

One store manager from a competing food retailer stated his frustration this way: “People just assume
that Wal-Mart has the lowest prices on everything, but they don’t. I have sent professional shoppers to
compare prices and we have better prices on many items. But, if I advertise lower prices on any specific
item, Wal-Mart will beat my price and I’m worse off.”

Wal-Mart is able to offer low prices and still make a profit because of its low costs. One remarkable
aspect of Wal-Mart’s success is that it has operated in a business that is highly competitive. Wal-Mart
appears to have achieved competitive advantage with its cost leadership strategy.

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 Wal-Mart’s Cost Leadership

How Did Wal-Mart Attain a Cost-Leadership Position?

(Blog of Dr. Miland Brown, an academic from North America)

Recently, I wrote a post about The Penney Idea and Wal-Mart. Continuing in this direction, I am posting
today on some reasons I think Wal-Mart achieved success. This post is heavy on business ideas and
deals with a contemporary issue. However, my post here is looking at recent history which I think will be
studied extensively in the future by historians.

Wal-Mart has pursued many strategies over the decades to achieve and then maintain a cost-leadership
position. Some have failed but the majority have been successful. Of these, six are: 1. innovative
warehousing system, 2. emphasis on everyday low prices, 3. basing store design on consumer studies, 4.
effective use of superstores, 5. using size to negotiate for the best price on brand-name items, and 6.
industry leading inventory control system.

One of the biggest innovations that Wal-Mart has introduced was in having a flexible regional warehouse
system. Most Wal-Mart stores are within a six hour drive of a Wal-Mart warehouse. Camerius (2004)
wrote, “Wal-Mart built the distribution center first and then spotted stores around it, pooling advertising
and distribution overhead.”

The use of new distribution centers continues to be a part of Wal-Mart growth. Scheraga (2005) wrote,
“The locations of the facilities indicate Wal-Mart’s expansion plans. They also illustrate an ongoing
challenge the retailer faces in choosing DC locations: Wal-Mart is adding stores at such a pace that new
DCs must be planned five years in advance of the store expansion they are designed to support. The
first step in the DC site-selection process is identifying the centroid or the point most central to the
locations the DC is meant to support.”

This has been a sound policy for Wal-Mart. All stores need to be restocked frequently. As such,
warehouses are a necessity. To make the most money, the business should have the fewest number of
warehouses supporting the most number of stores for efficiency. Further, to be responsive to store
needs, each warehouse should be as close as possible to the actual stores. Getting the contrast
between a lower number of warehouses coupled with short distances can be hard. However, Wal-Mart
solved this problem early on and continues to benefit from it. The warehouse system reduces overhead
for Wal-Mart significantly reducing production costs. This then has been translated into lower prices for
consumers.

A second strategy that Wal-Mart has pursued has been everyday low costs for customers. While many
businesses have attempted to make this claim, few have delivered like Wal-Mart. Rather than have a few
loss leaders on sale every week, Wal-Mart attempts to keep all items in the store cheaper than
competitors. This then allows Wal-Mart to avoid costly weekly advertising in newspapers. Customers
know that all Wal-Mart items are always on sale.

Anonymous (1995) wrote of the Wal-Mart approach, “There are only two ways to lower prices: Lower the
cost of goods sold through improved supplier relationships while holding gross margin percentage
constant, or, lower the retail prices. Increasing the range of merchandise requires either increasing
merchandise intensity per square foot, or, increasing store size. Wal-Mart has been pushing both these

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initiatives relentlessly over the past 10 years. By lowering gross margins and reducing costs of goods
sold, Wal-Mart has been able to strengthen its price and value image.”

Clearly, this has been an effective strategy for Wal-Mart. Consumers think of Wal-Mart as a low cost
product provider. This is central to Wal-Mart’s image. The smiley face dancing around slashing prices on
TV commercials resonates with the public. This has a drawback with a backlash by some social activists
who deride the low costs as harmful to society. However, in American capitalistic society, it has been
almost uniformly positive for Wal-Mart business plan.

A third area that Wal-Mart has used to maintain a cost leadership has been designing stores based on
consumer studies. Looking at consumer research, Wal-Mart has built stores with wide aisles, warm
colored carpeting, and smiley faced store displays. The stores are known for having friendly greeters.
Further, Wal-Mart uses brown papers bags rather than plastic bags in some instances. All of these store
designs have resulted from Wal-Mart heeding consumer studies.

This is important as these store features have been identified with Wal-Mart by customers. This has
translated into higher sales. Hence, the good use of research has helped Wal-Mart attain and keep their
cost leadership position. As Camerius (2004) noted, “Consumer studies determined that the chain was
particularly adept at striking the delicate balance needed to convince costumers its prices were low
without making people feel that its stores were too cheap.”

A fourth strategy that Wal-Mart has pursued has been building superstores. Wal-Mart is not alone in this
approach (K-Mart, Home Depot for example) but has been successful in doing it. The large 100,000 to
300,000 square feet buildings merge the general merchandise sales approach with a warehouse model.
This allows for a reduction in operating expenses which then translates into further price reductions for
consumers. It also has allowed Wal-Mart to branch into the grocery business.

This model closely matches the first strategy of warehouses discussed earlier. This in many ways
strengthens the warehouse approach. In addition to having warehouses close to store, many stores also
now have a larger inventory of goods to sell on hand. As Wal-Mart knows what items sell in large
quantities, they can have them at hand reducing transportation costs and making more sales if there is a
run on an item. At the same time, there is a warehouse close by if they need to have additional
merchandise delivered.

This appears to have been a successful model for Wal-Mart. Customers seem to appreciate having a
large number of items in one place. This includes having low cost grocery items. Many customers can
buy new clothes, pick up a new appliance, and buy their groceries in one shopping trip. This has been a
winning idea and has broadened the number and types of items that Wal-Mart can offer consumers.

The fifth strategy that this post will discuss is perhaps Wal-Mart’s most controversial way of maintaining a
cost-leadership position. Wal-Mart has used both its large size and geographical diversity to directly
bargain with brand-name product producers. This saving could be passed on to Wal-Mart customers.
Camerius (2004) wrote, “As the nation’s largest retailer and in many geographic areas the dominant
distributor, it exerted considerable influence in negotiation for the best price. Delivery terms, promotion
allowances, and continuity of supply. Many of these benefits could be passed on to consumers.”

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Few retail chains have the ability to negotiate the same low prices that Wal-Mart has been able to do.
This has been a huge advantage for Wal-Mart. It makes it virtually impossible for retailers to compete
with Wal-Mart on many items. The public realizes this and patronizes Wal-Mart. However, it has also
created a backlash from consumer advocates claiming that Wal-Mart drives smaller competitors out of
business with predatory pricing. This has not impacted the success of Wal-Mart as a cost-leader.
However, it has created a PR backlash which may threaten its future.

As such, the ability to negotiate with the power of size and regional distribution capability has been a
huge winner for Wal-Mart. The company has become synonymous with low prices. Customers
appreciate this. This has been a successful strategy. However, it has also planted the seeds for what
could be an eventual downfall politically or economically if the public turns against this concept and
blames Wal-Mart as one of the primary boogie man of the working class.

The final strategy this post will examine is the Wal-Mart inventory system. A computer network connects
all of the stores to Wal-Mart headquarters. Every product is recorded as it is scanned when purchased.
When a particular product is selling well, Wal-Mart headquarters can send a message to a warehouse to
immediately ship the product to a store. In this way, Wal-Mart never runs out of a product which is selling
well. Wal-Mart can respond to consumer demand almost immediately. How can most local businesses
and even other national chains compete with this? In most cases, they cannot and Wal-Mart has
benefited.

An anonymously written Chain Store Age article from 1999 reported an interesting quote from a small
business owner (Charles Weinacker) who worked with Wal-Mart.

“There is no excuse for being out of stock if you are a vendor with Wal-Mart using Retail Link. I know
where I am every day with Wal-Mart,” Weinacker says. “That’s where they are kicking butt. They are
never out of stock. Their biggest concern today is people aren’t using the system,” Weinacker says.

Is this a good strategy for maintaining cost-leadership? As other retailers are rushing to copy this system,
the answer would seem to be yes. This is a good strategy. Many recent news items have not only
acknowledged this but addressed how Wal-Mart is pushing this further by introducing RFIDs for every
item that a producer ships to Wal-Mart.

There could be strategies that have not been reported here which could even be more important than
these six. However, this is a representational sampling of the ideas which have led to the success of
Wal-Mart.

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