The Bleeding Beast of Bentonville

Why Wal-Mart is struggling.

This is supposed to be the most wonderful time of the year—for Wal-Mart. During the frenzied Christmas shopping season, the world’s largest retailer’s low prices and logistical might ought to crush the competition. Not this Yuletide. Last Saturday, Wal-Mart shocked the public and investors by announcing that because of a poor early Christmas, same-stores sales for November would rise by only 0.7 percent, instead of the 2 percent to 4 percent forecast.

At first blush, the disappointing report from the nation’s largest retailer would seem to be bad news for the whole economy. After all, Wal-Mart’s touchpoints with the Consuming Nation include 1,383 stores, 1,625 Supercenters, 543 Sam’s Clubs, and 76 Neighborhood Markets in the United States alone. To a degree, as goes Wal-Mart, so go the retail sector and the U.S. economy.

But this year, Wal-Mart’s pain might be others’ gains. ShopperTrak found that overall retail sales for last Friday and Saturday were up 3.5 percent from the same two days the year before. This Thanksgiving-weekend roundup found that “big chains including J.C. Penney Co. Inc. and Sears, Roebuck and Co. were pleased with their sales.” The Beast of Bentonville seems suddenly vulnerable—from rivals, from the economy, from its own missteps.

The stock market unexpectedly cheered the Nov. 17 Sears-Kmart merger. For years, the two legacy chains had been seen by financial and retailing cognoscenti as hopeless laggards that would inevitably succumb to Wal-Mart’s superior strategy and execution. But even before the merger announcement, the shares of both Sears and Kmart were walloping Wal-Mart. The initial pre-merger conventional wisdom that Sears and Kmart shares were rising because of the value of their real estate quickly morphed into a postmerger conventional wisdom: United under the smart management of Eddie Lampert, a resurgent Sears and Kmart could become a more effective challenger to Wal-Mart.

Of course, Wal-Mart still dwarfs the combined entity in sales and profitability. And few predict that Kmart and Sears can realize the same kinds of efficiencies that Wal-Mart does. But in retail, distribution and low prices only take you so far. At some point, merchandising—selecting the right product mix at the right price at the right time—makes a difference. And in a development that would have seemed heretical a few months ago, serious people have started to question Wal-Mart’s retail smarts. James Cramer of today dissed Wal-Mart: “The stores are dowdy. The aisles are ugly. There’s nothing exciting or different or even colorful at Wal-Mart. It feels almost Soviet in its selection and presentation.”

Ouch. The larger issue for Wal-Mart investors and management isn’t simply decor. It’s existential. Could it be that Wal-Mart has reached the limits of its cheapness? The company’s raison d’etre is to function as pass-through between (increasingly foreign) manufacturers and lower- and middle-income consumers. Acting as an agent for its vast customer base, Wal-Mart delivers low prices. But there’s a limit to how low the company can go. Wal-Mart’s sales didn’t grow more rapidly last month in part because it didn’t cut prices on promotional items aggressively. At long last, the weaker dollar and higher costs for commodities, raw materials, food, and energy are working their way even into Wal-Mart’s ruthlessly efficient supply chain. Ultimately, the higher costs would either have to hit Wal-Mart’s shareholders, in the form of lower profits, or Wal-Mart’s customers, in the form of less-cheap prices. So far this Christmas season, Wal-Mart has sided with its investors. The same higher costs affect other stores, too. But more so than Target, Sears, or pretty any other retailer, Wal-Mart competes on price, not brands, hipness, quality, or shopping experience. Wal-Mart’s customer base is more price sensitive than that of most other big retailers.

The company may also be bumping up against limits to profitable growth. Faced with a dearth of appealing locations and occasional opposition to its presence, Wal-Mart has domestic growth plans for 2005 that call for the number of Wal-Mart U.S. outlets to grow by about 4.5 percent in 2005, slightly below the pace of recent years. The company is growing more rapidly outside the United States, where it plans to open more than 150 units next year—an addition of about 10 percent to its current total. But overseas, too, the giant retailer seems strangely constrained. Wal-Mart has ferociously (and so far successfully) resisted unions in the United States. Last week it meekly agreed to accept unions in China, where it has 39 stores.

“Wal-Mart Vulnerable” could be just the latest evanescent trend story. After all, the business press (Moneybox included) is a prisoner of the rise-and-fall narrative. Sure as night follows day, Fortune’sUnstoppable Triumphant Krispy Kreme” cover story of June 2003 was followed by the “How Krispy Kreme Lost Its Way” story of June 2004. After so many years of being painted as an invincible Ozarks retail steamroller, Wal-Mart was bound to be on the receiving end of a bad run of press. But with the trends that have contributed to its weakness only gathering strength, it could be years before the “Great Wal-Mart Comeback” stories are assigned.