Monday, November 22, 2004

The Great Wal-Mart Of China, Part I

The recent acquisition of Sears, Roebuck & Company by fellow retailing giant Kmart may be a cause of some concern for our economy. While this aspect of the story did not receive much attention, I think that China was secretly delighted with the turn of events - for reasons that I will explain in the rest of this series. The newly formed retailing behemoth will still only be 3rd on the retail totem poll, trailing #2 Home Depot, and the overall leader Wal-Mart - the company that Kmart/Sears is trying to compete with by joining forces. The move by Kmart/Sears is indicative of the evolving landscape of the retail industry in America, and the impetus that the corporate practices of Wal-Mart and others have given to the mission of other retailers to galvanize, coordinate and expand. The New York Times described the prevailing conventional wisdom:

In the world of retailing, there is no such thing as "too big to fail," as investors have often learned to their sorrow.
The New Bosses

The basic premise of the merger, and the underlying economic imperative, is that large retail chains are the power brokers in today's global economy, and as such they have had a direct impact on the decline of manufacturing in America and the rise of manufacturing in other developing nations - primarily China.

A recent edition of
Frontline, the PBS new program, which dealt with the Wal-Mart phenomenon, drew on opinions from both sides of the debate over the significance of the emergence of the new paradigm of the "buyer-driven" global economy. Despite the many differences, there was agreement as to the tectonic shift in power.

Nelson Lichtenstein, an economic historian at the University of California, Santa Barbara, draws a colorful analogy to medieval times: "The power of Wal-Mart is such, it's reversed a hundred-year history in which the manufacturer was powerful and the retailer was sort of the vassal," he says. "It's changed that. It turned that around entirely. Now the retailer, the mass global retailer, is the center, the power, and the manufacturer becomes the serf, the vassal, the underling, who has to do the bidding of the retailer. That's a new thing."

Brink Lindsey, an economist at the Cato Institute, a libertarian Washington think tank, agrees. "We've definitely seen a shift in the balance of bargaining power between manufacturers and retailers," Lindsey says. "Back in the old days, manufacturing was a high-productivity endeavor; retailing and distribution was fairly low-productivity. And manufacturing was big and consolidated; retailing was small-scale and decentralized. And so manufacturers called the shots.

"Now, things are very different. You have large-scale retailing that's very high-productivity, that has a lot of bargaining power. And they can go to smaller manufacturers and call the shots and say, 'If you want to be on our shelves, you have to do it our way'...Wal-Mart -- they're very demanding, and they've got a lot of bargaining clout to back up their demands."
To understand just how persuasive Wal-Mart can be, you have to look at the magnitude of their influence. As of today, although the numbers seem to be growing by the minute, many manufacturers sell "20-30 percent of their output to just one big box retailer -- Wal-Mart, which represents the consolidated buying power of 100 million customers who shop in its 3,500 stores every week."

But it's not just one group of manufacturers or producers who are finding their list of customers dwindle as Wal-Mart assumes an ever prominent role. UCLA Sociology Professor Edna Bonacich described Wal-Mart's status as a "monopsony" a condition in which a single buyer controls substantial portions, if not dominant positions, in many different markets. For example:

They don't control 100 percent of the market, but they may control 38 percent of the market for [several] goods. They are the largest toy seller. They are the largest grocer. So there are large products that they control. And then the manufacturers are basically stuck having to sell to them. If they don't sell to [Wal-Mart], then they're in deep trouble. So there's a big volume effect.
According to Gary Gereffi, a Duke University professor who studies global supply chains:

Wal-Mart has life-or-death decision over [almost] all the consumer goods industries that exist in the United States, because it is the number one supplier-retailer of most of our consumer goods -- not just clothes, shoes, toys, but home appliances, electronic products, sporting goods, bicycles, groceries, food.
And Wal-Mart has used this leverage to enormous, some would say, ruthless advantage. Part of the success is owed to a technological innovation. Wal-Mart led the charge for the retail trade to adopt the universal barcode, as opposed to other less centralized labeling. Wal-Mart then designed a computer system and remote scanners that it could use to tap into the vast information bonanza contained within the lines and numbers of the bar code. Now, Wal-Mart had a way of maintaining real time sales data on all of the products it offered.

Former Wal-Mart store manager Jon Lehman described the minor revolution thusly:

It really took it from sort of an archaic or old-build way of just maybe communicating with a vendor every 52 weeks out of the year to communicating every day, every hour, every minute," he says. According to Professor Bonacich, this created a power shift from the manufacturer to the retailer, because Wal-Mart "knows what is being sold...[and] what prices are popular, so they are able to say, 'We want to sell this at a certain price. You make it at a certain price, or we're not going to work with you.'"
And that is exactly what Wal-Mart began to do. Armed with reams of data, Wal-Mart representatives went about aggressively pushing the manufacturers to lower their costs in order to comport with consumer habits. But they did not rely on this data alone. They took the additional step of prying into the business models of the manufacturers themselves. According to Lehman, buyers for Wal-Mart:

...visit these factories; they visit the manufacturers. They want to look in their books; they want to look at the cost of manufacturing, the cost of packaging, the cost of shipping, the cost of production. All of those things are factored in, and Wal-Mart wants to see all that. ...

Wal-Mart puts the pressure on these manufacturers to: "Come in here and sell me the same merchandise you sold me last year, but sell it at a reduced cost. And we know you can sell it to us at a reduced cost, because we've been to your factory. We've seen your books. We've seen your cost of product, cost of shipping," so on and so forth, "your wage cost." They look at all that, and they call it "partnership."
The manufacturers are thrust out in the open, naked in a sense, with all information known by Wal-Mart before the bargaining process begins. There is no back and forth, just a unilateral dictation of terms. Take it or leave it. For many, it was the death knell of their operations. An offer they had to refuse, but couldn't at the same time.

New Model

Aside from the aggressive intrusion into the supply chain that Wal-Mart has embarked on, there is a basic business model that informs its labor policies. I think they are best summed up by this quote from founder Sam Walton:

I pay low wages. I can take advantage of that. We're going to be successful, but the basis is a very low-wage, low-benefit model of employment.
In this respect, Wal-Mart caught their competitors by surprise. Companies like Sears, Woolworth's, Kmart and Costco were operating under the premise that it would be too costly and inefficient to maintain a minimum wage workforce, which has a 50 or 75 percent turnover. The costs of re-training, they thought, would outweigh the upside of lower salaries and benefits.

Nelson Lichtenstein describes the Wal-Mart revelation:

But Wal-Mart, I think, showed that they could do that. And partly you can have a workforce which rapidly turns over if you have the technology there, which means you can just slot one person into the job with no training and no sort of background. And that's what's happened. Wal-Mart has to hire something on the order of half a million workers every year just to maintain its current workforce. And they understood that. And that's been true, not just at Wal-Mart, of course, [but in] the whole fast-food world, the whole world of contingent workers. I mean, this is sort of a new American model for labor, for workforce, and Wal-Mart has been right there at the forefront of that, partly forging the way, partly being a vanguard firm, but partly just taking advantage of that.
It didn't take long for Wal-Mart's competitors to catch on. Kmart/Sears has been paying close attention, and will follow Wal-Mart's lead in ushering in a new era of low wage disposable workers.

But clearly Wal-Mart, the largest and, according to Fortune, the most emulated and respected firm in the nation today, is setting a new standard that other firms have to follow if they hope to compete. And more than just other firms, it's setting standards for the nation as a whole. It's almost legislating social policy, not in terms of votes and lobbying, but when it does something, it's so large, it's so influential, others follow it. ....

We can see that right now in terms of Wal-Mart's employment policy, which is the de facto employment policy of vast ranges of people in America ... who don't work for the firm, but their employer sets their wage standards, their benefits standards according to the standard that Wal-Mart has put in place.
Gone is the old "GM model" that was based on establishing employee loyalty during the course of lifetime employment. The skilled worker who is valued for his or her knowledge and ability is being phased out, in favor of workers with less training, that also represent less investment by the employer, and are thus easier to undervalue. In addition, Wal-Mart's aggressive anti-union measures have insured that their workforce has remained unorganized, and as such, without any bargaining power to demand an increase in any of these areas.

Edna Bonacich discusses the dilemma:

On the one hand, you can say that poor people need cheaper goods, and this is a tremendous service for the United States. But on the other hand, that is ignoring that people are not just consumers, but they also are workers, and they are citizens, and they have other interests besides being a consumer. But the United States can focus entirely on the consumer role and ignore, to a large extent, the worker role. And Wal-Mart, in its promise to lower consumer costs, is ignoring the fact that at the same time it's participating in the lowering of worker standards; that the very people who buy their goods are, in fact, being pushed into a lower earnings [category].

There's a kind of cyclical process of poorer workers needing cheaper goods, needing poorer workers to produce those goods, in a kind of ratcheting down of standards. What happens is that inequality is increasing in the United States. The middle class is kind of being hollowed out, and there are more and more workers who find that it's hard to earn a living wage. They don't make enough in order to live. The distinction between the earnings of workers and the earnings of management, that division has grown huge. It used to be something like 60-1, [what] the highest executives made versus their workers. Now it's something like 600-1.
There is no doubt that Wal-Mart's revolutionary product tracking system has helped efficiency by streamlining the supply chain from the warehouse to the store's shelves, which in turn creates savings for the company. Certain aspects of this method are praiseworthy, and deserving of imitation. Other sides of this story are slightly more controversial. While prices have been lowered for consumers, many of the manufacturers targeted in the process have been priced out of business, which in turn has led to the loss of thousands of jobs. When Wal-Mart forces competitive bidding down to cost, some consumers benefit in incremental ways, but for others, who lose manufacturing jobs that they have built their entire lives around, the results are catastrophic. Furthermore, Wal-Mart's own labor policies have nudged the market, in terms of salary and benefits for employees, downward even further, dragging along competitors and non-related industries. On the one hand, their practices are leading to unemployment, and on a second front, they are driving the very nature of "employment" down by their own dedication to the low wage model.

With K-Mart/Sears primed to enter the market as a newly formed mega-retailer, I expect them to pattern their business model on that of Wal-Mart's. This will further impact domestic manufacturers and suppliers, sending ripples through an already troubled sector of our economy. On the bright side, K-Mart/Sears might also be hiring new workers at lower wages with fewer benefits.

Profits and Savings

The argument in favor of Wal-Mart's practices in regard to manufacturers, employees, and otherwise, is that in the end, the consumer wins out as savings are passed on to the shopper (as was pointed out above, however, this can be an illusory benefit when the full impact of Wal-Mart's corporate practices are factored in). More than just savings, some argue, Wal-Mart is successful because of its other innovations like technological advancements, and the concept of the superstore itself. To some degree this is true, as their is no doubt that Wal-Mart has contributed to the advancement in technology industry wide. In addition, the comprehensive nature of the offerings is truly staggering. Wal-Mart offers everything from food and clothing to appliances and video games. It is the location for one-stop shopping - a convenience oriented society's happy hunting grounds, and a clever strategy.

But it all goes back to the low prices. Although convenience is a factor, consumer loyalty is built around the affordability of the products, and that has been the engine by which Wal-Mart has charged to the forefront of the US retail market. It was the message behind the ubiquitous Wal-Mart slogan, "Always the low price." But in the world of discount items, all that glitters is not even cubic zirconia.

According to insiders and industry watchdogs, Wal-Mart is actually engaged in an elaborate form of a bait and switch campaign designed to ensnare unwitting shoppers. They lure in consumers with highly advertised, and prominently displayed, low priced items relying on the fact that once in the store consumers will opt for higher priced products from the rest of the store's offerings. The corporate policy is built around the concept of the "opening price point" as explained by Jon Lehman:

OK, it's lawn-and-garden time. Your grass is getting high. Your lawn mower is broken from last year, or you need a new lawn mower. You're going to go to Wal-Mart. So you go to Wal-Mart, and you're looking for a lawn mower, and to your delight, you walk in, and you see this $99 lawn mower. You may not want a cheap, basic lawn mower, but you see that price point on an end cap or a big display stack base, and you say, "Wow, what a great price." And it draws you in. It lures you into the department, and you form the perception immediately that "Hey, Wal-Mart's got the lowest prices in town. Look at this item right here. How could they sell it for $99?"...

But as you walk into the department and look for that $269 power-drive lawn mower that you really are after, they're not losing money on that item. And it may not be the lowest price in town. Wal-Mart used to advertise "Always the low price." They don't do that anymore.
As Lehman recalled, Wal-Mart was actually sued for false advertising by several competitors after industry studies revealed the truth that Wal-Mart is quite frequently not the lowest price in town. But this was a strategy conceived of in the days when Wal-Mart was little more than founder Sam Walton's start-up company, and despite the lack of that exact language in advertising slogans, the opening price point method is still a crucial aspect of Wal-Mart's pricing strategy. Informed by their repository of sales data on all things from last year's sales and customer requests, to this year's hot new items and emerging trends, Wal-Mart carefully selects opening price point products to attract consumers, and sell them on the higher priced items that surround them in the stores. Lehman recounts Walton's influence on the practice:

That was his idea, yeah: Let's get the hottest item that we can find within a category, the item that customers, they're going to look at that, and they're going to equate that to the lowest price in town. They're going to see that, and they're going to say, "Wow," and they'll form an opinion that this is the best place to shop. And Wal-Mart doesn't run too many sales, as you probably know, but "I can come here every day and find the items that I want at the lowest price in town." But they're duped.
In addition, it is important to point out, that the savings from "efficient" business practices are not always passed on to the consumer for other more or less obvious business reasons. First, Wal-Mart is very well attuned to profits, and as such, is keen on keeping margins high, which means that lower costs don't always correlate to lower prices - just more profits. Second, Wal-Mart is in the business of expansion. What started out as a small cluster of stores in mostly rural areas has transformed into a retailing empire that has a presence in all corners of the globe, and a foothold in every region of this country. There is a reason Wal-Mart is number one in a competitive industry. Such growth requires reinvestment of capital and, as such, lower costs don't necessarily translate into cheaper prices.

Gazing Eastward

While Wal-Mart has been tirelessly paring away at costs and overhead by dragging manufacturers down to bare subsistence levels, capitalizing on their dominant position in the supply chain, and remaining faithful to a corporate policy of low wages, they have been running out of room to make progress on the domestic front. There is only so far that US manufacturers and laborers can go, constrained by the mandates of labor law - such as the minimum wage, mandatory work week and overtime rules. So, in pursuit of ever greener pastures, Wal-Mart has been moving Eastward, seduced by the receptive shores of the emerging manufacturing Mecca that is China. In Part II of this series, I will explore the intricacies of the unique symbiotic relationship that Wal-Mart and China have formed over the past decade, and examine how this strange marriage may impact our economic stability and strength in the future.

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