SN: Is Wal-Mart losing its low-price image, and if so, what is it doing about it?
Mushkin: It's always frowned upon to say Wal-Mart can do whatever it wants, but Wal-Mart exerts enormous pressures on the industry — and there are enormous pressures on Wal-Mart as well now that its consumables volume has gone negative. We believe that's the first time that's ever happened to Wal-Mart.
Mushkin: Wal-Mart may be caught between a rock and a hard place. If it invests in price, it will really hurt earnings and the company may never get enough incremental sales to justify the lower prices — and if it doesn't invest, it looks like it will continue to bleed share.
Wolf: What Wal-Mart is doing now is reloading on consumables inventories, and now the front end, which used to be clean, is full of Little Debbie types of merchandise. And it is going after the dollar stores with dollar items all over the place, especially in food and consumables. Wal-Mart has not been happy seeing its low-end customers going to dollar stores.
Adler: Personally, I don't think there's anything Wal-Mart can do right now, certainly on price, to fix the situation because I think the problem is the shopping experience. No matter how many dollar items you put in a 180,000-square-foot store, you're not going to duplicate the experience of an 8,000-square-foot store.
Giblen: That's why Wal-Mart could go nuclear and invest much more deeply and broadly in price — maybe not tomorrow, but within a six-month period.
Heinbockel: But it won't get a lot more aggressive because it won't get a good payoff investing in price. Whole Foods got a payoff by investing in price because that had been its Achilles' heel. But Wal-Mart won't get the same kind of bang for its buck investing in price because that is already its strength. Wal-Mart has to invest in the service experience — that's its Achilles' heel. At the end of the day Wal-Mart can get a lot more aggressive and just drop prices across the board and it will hurt everybody else, but I don't think it will solve Wal-Mart's problems.
Wiltamuth: I think you're right, because if you look at the core Wal-Mart customer, it's someone whose annual income is in the low-$40,000 range, and unemployment in that population is twice the national average, so that customer is not really in a position to spend more. As a result, even if you give him the price cut, he's not going to respond. But at the same time, that's still the same customer who's saying he doesn't think Wal-Mart's prices are low enough.
Wolf: That's why Wal-Mart is putting dollar price points all over the floor. As for the crossover shopper who's shopping at multiple stores, he's in Wal-Mart thinking, “Well, I'll get this yahoo for a buck.”
Adler: But what makes them crossover shoppers? This is one of Wal-Mart's Achilles' heels. Assuming shoppers have some conventional operators available to them, people are taking the ads and comparing. And of course, Wal-Mart doesn't have an ad.
Wolf: It has an “ad match” program now.
Adler: Which is really stupid for three reasons. First, what better way to say you do not have the lowest prices than by saying you'll match the lowest? Second, I don't think customers will feel comfortable getting into an argument with the checkout clerk who's going to read the ad from the competitor to see when it expires. And that leads right into the third reason, which is that it's going to kill productivity if people seriously take them up on that offer.
Wiltamuth: It's a stop-gap measure for Wal-Mart. It's just putting that out there until it's actually able to get prices down.
Adler: I think there are a lot of temptations at a Wal-Mart store, and if you can afford to buy only 10 items because you're buying for the next two days, why would you go to a store that big?
Giblen: You'd go if you're convinced the prices are already back to being the lowest.
Adler: I don't think Wal-Mart can set its prices as low as conventional chains' advertised prices. Everyday low price cannot match an advertised price — not unless you want to absolutely destroy earnings.
Giblen: My sense is that Wal-Mart perceives it is close to solving the out-of-stock and apparel mis-assortment issues and that it will dial down pricing big time once it feels the store offering is right. That way, the traffic generated is exposed to the new, improved Wal-Mart experience.
Cerankosky: When you talk to Wal-Mart's suppliers, they tell you Wal-Mart wants a lower price, not higher quality, and that's how it's trying to get to that shelf price in certain categories — with smaller sizes or taking quality out so it hits a price painlessly.
The interesting thing about Whole Foods is it gets the value equation right with great quality, whereas Wal-Mart doesn't want to focus on quality — it wants reduced costs.
SN: So can Wal-Mart get comps back to positive territory by the end of the year as it has promised?
Heinbockel: I think it can do it in consumables, simply because of inflation.
Wolf: And by selling more product. Its consumables inventory, at least from what I'm seeing, is way up. Remember, it took everything away from the front end, which wasn't always food, and it took out the whole Action Alley, and now both are full of food.
Adler: Then how come the comps have gotten sequentially worse?
Wiltamuth: One of the other problems for Wal-Mart is, if you look at sales of consumables that are clearly comping negative in the mid-single-digit range and some in the double digits, those categories are more dependent on the lowest-income shopper. So Wal-Mart is going to have a hard time turning that part of the store around, and the consumables are going to have their own problems, given the inflation issue. So I think the company is still going to comp negative through the end of the year.
Mushkin: So it seems like we're all feeling Wal-Mart is in a bit of a box, and — unless it pursues the nuclear option and cuts prices dramatically, which I agree would not make sense from a financial perspective — Kroger is the beneficiary because it competes with Wal-Mart more than any other retailer. Also, the dollar stores just keep picking up sales.
So for Kroger, it becomes a fairly virtuous cycle because strong volume growth of 3%, plus 2% inflation, yields a 5% comp that lets it leverage expenses quite well. Our research shows that this dynamic is letting Kroger drag its heels a bit on price at retail, and, of course, that yields further share.
Giblen: Ironically, that was Steve Burd's original strategy during his first years with Safeway.
Adler: I think his strategy was to cut costs.
Giblen: Well, to cut costs but in a constructive way and lower prices from that point. But then he got sidetracked in delusions of grandeur about the superiority of the Safeway store experience, and he over-did it on acquisitions in the belief he could Safeway-ize everything and achieve vast improvements.
Adler: If Wal-Mart were to begin lowering prices, would it do it selectively, as opposed to trying to do it everywhere?
Heinbockel: Geographically, no. By category, perhaps. But I challenge all these guys on whether they understand price elasticity. Kroger will tell you as it tests strategies and works with Dunnhumby that it can get elasticities pretty much right. But I think a lot of companies struggle with that — that if they make a price investment, what's the consumer reaction and return on investment going to be? I think they all overestimate elasticity.
Adler: Of course, you want to be able to measure elasticity based on a whole lot of historical data, but I am not sure things stay the same.
Giblen: Kroger has the best tools in the industry, but it's very execution-sensitive and walking an execution tightrope that it could fall off of at any time.
Mushkin: It all depends on what the competition does. If you look at Houston, H-E-B, Kroger and Wal-Mart are all priced within 3% or 4% of each other. Houston is doing fine, and the effect of price increases on the economy is different. But it's hard to be the low-price leader when you're not the low-price leader. It's almost impossible. Therein lies Wal-Mart's challenge, but it might be a challenge for the industry.
Adler: I think Wal-Mart is stuck in a box — a very small box — and it's made of iron, which makes it hard to get out.
Cerankosky: What makes the elasticity calculation more difficult is, what's the economy going to do, given that people are trading down?
Wolf: I agree with John on Dunnhumby. It has a lot of economists and math wizards, and clearly it's probably noticing what's going on with the economy and any potential effect on elasticity, even if it is history-sensitive. Kroger is investing efficiently, and it deserves a lot of credit for it. It's one of the things that makes Kroger an interesting stock.
Wiltamuth: I think something that's going to be interesting to watch with Wal-Mart over the next few years is, what is it doing with small stores? It has decided that returns at Walmart Market — the former Neighborhood Market — are equal to the returns of a supercenter, and now it's testing the 15,000-square-foot Walmart Express.
To open enough Walmart Markets to really move the dial, it would have to do 150 to 200 stores a year to get to a penny a share of earnings impact. So it doesn't seem like the plan is to move the dial. But Wal-Mart is interested in getting these out there, which will put competition from Wal-Mart a little more in the backyard of conventional grocers.
Cerankosky: I think the reason Wal-Mart got the returns up at the Neighborhood Markets is because it raised the price of consumables enough, so instead of having higher consumable prices at the Neighborhood Market and lower ones at the supercenters, it has them both at the same higher level, so now the math works without the merchandise subsidy.
Wiltamuth: I think Wal-Mart has also been experimenting with its labor cost model, and it's learned from its international markets where it has some of these smaller stores that it can have a more flexible labor model.
Wolf: I think the smaller Wal-Mart store is definitely the big risk for the industry, even more than pricing. I've heard that in the Seattle area Wal-Mart was trying to get approval for a 200,000-square-foot parcel and the locals said no, so now it's going in with a 40,000-square-foot store and the locals are very comfortable with that. That's going to be a productive store. And if Wal-Mart opens 200 of those a year …
Cerankosky: The problem with counting on that store format to make a big impact on the conventional guys is that Wal-Mart will still be very weak in perishables.
Adler: Wal-Mart did well with supercenters because they were really differentiated, especially on price. Now those stores don't have the best price image, nor the in-store specials, nor the kinds of bells and whistles you find at a Kroger. It's usually very hard to enter a new market with a conventional format where one conventional chain is already dominant, and I think that's going to be challenging for Walmart Markets. I think real estate is going to be a huge challenge as well.
What about acquisitions? Do you think Wal-Mart would ever buy the Great Atlantic and Pacific Tea Co.?
Wiltamuth: I think Wal-Mart wants to avoid anti-trust review, so I think it will continue to grow organically.
Cerankosky: And it doesn't want a union.
Heinbockel: I'd be surprised if it took anything unionized. Even if it was a very loose sweetheart contract. I think that's a non-starter.
Wiltamuth: That's the beauty of the small stores — you can get into all sorts of areas, including the New York metro area — and at 15,000 to 40,000 square feet, there are plenty of opportunities out there.
Adler: But is Wal-Mart going to open 200 of those a year?
Wolf: It was doing 300 supercenters a year, so why not 200 smaller ones?
Adler: That was a long time ago, and it was different geography.
Wiltamuth: Drug stores aren't growing like they used to, so there are sites out there that are available.
Adler: It's not so much the size of the box — it's the parking. You're not going to take a drug store pad and put a 40,000-square-foot Wal-Mart there.
Heinbockel: Wal-Mart couldn't afford the rent that a drug store could because the margins are that much higher at a drug store, particularly the front end.