The Bully of Bentonville

by Anthony Bianco

  Sok Hong, managing director of the family-owned Kong Hong Garment Co. in Cambodia, admitted to being as worried as any American company about his customers shifting orders elsewhere if they think they can save a penny or two on each unit. “They just care about the price. If you have a cheaper price, they will buy from you,” said Sok, whose company exports as many as 30,000 pairs of jeans a month to the United States, nearly three-fourths of them to Wal-Mart. “We don’t have child labor at this factory…. [But] the buyer doesn’t care how good you are.”

  Where will it end? Wal-Mart says that it is simply acting as an agent of its customers, who want more for less. It insists it is “giving a raise” to poor people lucky enough to have a Wal-Mart nearby; it is helping people out of work make ends meet—even if those customers are poor and jobless because of the practices that deliver those “Every Day Low Prices.” Besides, Wal-Mart claims, if it doesn’t deliver DVD players for $38.76 or SpongeBob SquarePants T-shirts for $6.44 or any of the other bargains it has every day, someone else will. And if the process of delivering these bargains requires terminating millions of middle-class jobs in Ohio and North Carolina and elsewhere, creating new jobs with poverty-level wages, and putting the United States in hock to China, so be it. More than a few economists agree, as do some of the millions of people who shop at Wal-Mart every day—at least those who bother to wonder how on earth Wal-Mart can make a profit selling Mr. Coffee machines for $19.94.

  Others, however, are beginning to question the wisdom of this race to the bottom. “People ask, ‘How can it be bad for things to come into the United States cheaply? How can it be bad to have a bargain at Wal-Mart?’ Sure, it’s held inflation down, and it’s great to have bargains,” says Steve Dobbins, president and CEO of Carolina Mills, whose business of making thread and yarn for clothes sold at Wal-Mart is continually being nibbled away by lower-cost Chinese competitors. “But you can’t buy anything if you’re not employed. We are shopping ourselves out of jobs.” 39

  THE ANTI–WAL-MART

  Discount retailing is a tough business that requires obsessive attention to labor costs, the largest single category of expense for Wal-Mart and its competitors. Even Wal-Mart, that paragon of cost efficiency, makes just three cents of profit on every dollar of sales. “Last year we earned $10 billion in profits, so our critics argue that we should pay more to our associates. But I ask anyone to do the math,” CEO Lee Scott said in late 2005. “Even slight overall adjustments to wages eliminate our thin profit margins.” 1

  To which the most persuasive rejoinder is: What about Costco?

  It’s not hard to figure out how Costco Warehouse supplanted Wal-Mart as the big-box employer of choice. Its average wage of $15.97 an hour is 33 percent more than that of Sam’s Club, its closest competitor, and 65 percent higher than Wal-Mart Stores’. Costco spends an additional $5,735 a year in health benefits per worker to Sam’s Club’s $3,500, and it provides coverage to 82 percent of its workforce, compared with Sam’s 47 percent. 2 What is surprising—astounding even—is that Costco also is more profitable than Sam’s Club. In 2004, Costco reported $13,647 in net profit per employee to Sam’s $11,039 per employee. How, in Sam’s name, is such a thing possible?

  In pioneering its distinctive low-price, high-wage business model, Costco didn’t so much beat Wal-Mart at its own game as change the game—or at least its mathematics. The key to Costco’s new math of discount retailing is an annual turnover rate of just 23 percent, half of Wal-Mart’s. “Taking care of your employees and turning inventory faster than your people is good business,” said James Sinegal, Costco’s founder and chief executive in what clearly was a swipe at his giant Bentonville rival. 3

  Based just outside of Seattle in Issaquah, Washington, Costco is America’s largest warehouse club chain, and its fifth-largest retailer overall. Costco is descended from Price Club, the San Diego chain that Walton had aped in founding Sam’s Club. Sol Price, the left-leaning maverick discounter who founded Price Club and who took such delight in baiting Walton over dinner, schooled a talented protégé named Jim Sinegal. In 1983, Sinegal left Price Club and moved up the coast to found Costco with a local partner just as Wal-Mart was launching Sam’s Club. In 1993, Price sold Price Club to Costco. “We were good at innovating,” Price explained, “but when it came to expanding and controlling, we weren’t so good.” 4

  Sinegal was good at all of it. A gruffly charming man who resembles the late Quaker Oats pitchman Wilford Brimley, Sinegal is a blue-state Sam Walton, if such a thing is possible. “Here’s the difference between Sam’s and Costco,” said Charlie Munger, who is a Costco director as well as super-investor Warren Buffett’s favorite sidekick. “We have a live Sam Walton who’s still there, and Wal-Mart doesn’t.” 5

  Sinegal shared Walton’s visceral belief in the primacy of low prices, right down to the insistence that no item ever be marked up more than 14 percent to 15 percent. “The traditional retailer will say: ‘I’m selling this for $10. I wonder whether I can get $10.50 or $11,’” Sinegal said. “We say: ‘We’re selling it for $9. How do we get it down to $8?’” 6 Sinegal, too, could slice fat from crisp dollar bills when it came to operating expenses, and he also brought a barely controlled ferocity to his negotiations with suppliers. Like Walton, Costco’s chief traveled compulsively, visiting each of his stores at least twice a year and maintaining a preternatural supply of energy into his sixties by playing racquetball every day, or about as often as Walton played tennis on the court in his yard.

  Like Walton, Sinegal kept his office door open to all comers and managed to be demanding without being intimidating. “To walk with Sinegal from his headquarters building to the Costco next door is to hear a nonstop chorus of ‘Hi, Jim…Hi, Jim…Hi, Jim,’” one visitor recalled. “He returns the greetings by using first names, without appearing to consult nametags.” 7 Sinegal wasn’t any more enamored of unions than Walton had been, but wasn’t doctrinaire about it. When Costco opened a store, it modeled its wages-and-benefits package on the contracts of unionized grocery stores in the area. In absorbing Price Club, Costco picked up unionized stores that now employ about 14,000 of the company’s 113,000 employees. The current contract with the Teamsters guarantees employees a minimum of 25 hours of work per week and requires that at least half of a store’s workers be full-time. 8

  Costco surpassed Sam’s Club in sales a few years ago and now controls about 49 percent of the $104 billion warehouse club market in the United States to Sam’s 40 percent. Its performance is all the more impressive considering that it operates only 457 stores, about 100 fewer than its archrival. Costco and Sam’s both sell pallets of goods out of no-frills stores, but by narrowing its selection to 4,000 items at any one time and skewing its merchandise mix toward high-end goods, Costco attracts a much more affluent clientele than Sam’s. “Our customers don’t drive 15 miles to save on a jar of peanut butter,” Sinegal said. “They come for the treasure hunt.” 9

  One could also argue—Sinegal certainly does—that another reason the average Costco store outsells the typical Sam’s Club is that it employs a happier, more productive workforce that actually deserves the premium wages it makes. Paying up also serves the cause of customer loyalty by absolving shoppers of any guilt they might be inclined to feel if their savings were coming at the expense of workers.

  Wall Street analysts periodically pillory Sinegal for what they consider his excessive benevolence to employees, but it’s hard to argue with the numbers that Costco has been racking up. Surprisingly, Costco’s labor costs add up to just 9.8 percent of sales, compared with 17 percent at Wal-Mart. (Bentonville does not break out a figure for Sam’s Club.) This is a huge differential that speaks not only to the superior salesmanship of Costco’s workforce, but also to its longevity. Of the employees who’ve been with Costco at least a year, a scant 6 percent leave annually, compared with 21 percent at Sam’s Club.

  In the last few years, Bentonville has experimented with adding more high-end, fashiona
ble merchandise to Sam’s Club and Wal-Mart stores alike to compete not only with Costco but also with Target. Mostly, though, Wal-Mart has reacted to the Costco phenomenon in the same way it has always responded to a competitive threat: by trying to muscle its rival on price. To be fair, Sam’s Club long was hamstrung by its quasi-independent status in that it was unable to avail itself of its parent’s superior buying power or its distribution system, and it wasn’t able to compete all out with Wal-Mart discount stores for business. In 2003, Scott bolstered Sam’s Club’s underlying economics by folding it into Wal-Mart. The warehouse club division promptly cut its prices across the board, and Costco responded in kind. The price war cut into Costco’s profit margins, but it managed to maintain its market share and even posted a 22 percent earnings gain in 2004. For Sam’s Club, it’s time to go to Plan B.

  Would Walton have seen in Costco’s humbling of Sam’s Club a refutation of the business model that undergirds Wal-Mart and its warehouse club unit alike? It’s hard to say, but certainly he would have pondered the implications long and hard. Walton’s genius lay in disproving conventional wisdom with common sense. Of course country folk were as keen for a bargain as city dwellers, but it took Walton to prove it. The consensus in retailing today—as epitomized by Wal-Mart—is that holding hourly wages to a bare minimum is essential to success, if not survival. Costco’s workers are cogs in a big hyperefficient machine, too, but they are well greased and buffed to a bright shine. The ultimate moral of the Costco story may be as commonsensical as any of Walton’s old-fashioned maxims: With employees, like most everything else in life, you get what you pay for.

  CHAPTER EIGHT

  WILL THE LAST INDEPENDENT GROCER IN AMERICA PLEASE TURN OFF THE MONORAIL?

  Wal-Mart has been a relentless, unstoppable force across the landscape of America. Yet from 2000 through 2005, the company quietly closed nearly 900 stores, far more outlets than Kmart shuttered during its long slide into bankruptcy reorganization in 2003. The fact is that the Wal-Mart discount store—Sam Walton’s signature creation—is dying a slow death. The reason? Over the last decade a fearsome new competitor has emerged, against which the traditional Wal-Mart is essentially helpless. Bentonville couldn’t be happier about this turn of events, because that competitor is the Wal-Mart Supercenter. Virtually all of the discount stores that Wal-Mart has closed have been reborn in larger and more lucrative form as Supercenters. In 2004, for the first time, Wal-Mart Supercenters outnumbered Wal-Mart discount stores, 1,713 to 1,353; by 2007 the margin is expected to increase to two-to-one.

  The triumph of the Supercenter already has enthroned Wal-Mart as America’s largest food retailer by far—and Bentonville is just getting started. In 2005, it opened some 250 more Supercenters (160 of which were conversions). Wal-Mart originally thought it had to locate Supercenters at least fifteen miles apart along the fringes of large and midsized cities to avoid internecine competition. In the last few years, though, it has convinced itself that Supercenters can thrive just three to four miles apart in the biggest markets. “In the U.S. alone, we estimate there is room for almost 4,000 more Supercenters,” Lee Scott recently told Wal-Mart shareholders. 1

  The great Supercenter expansion augurs an escalation of what already is the biggest food fight in history. America is chockablock with warehouse clubs, supermarkets, convenience stores, drugstores, and corner grocers selling the same stuff Wal-Mart sells, though generally at much higher prices. In most locales, the market for mass consumables is growing at no more than a few percentage points a year. This means that almost every dollar rung up by a new Wal-Mart Supercenter is a dollar that it has taken away from a rival grocer or pharmacy. “Wal-Mart’s growing domination of consumers’ grocery and drug spending will devastate the competition,” Retail Forward Inc. predicts, estimating that two supermarkets will shut down for every Supercenter that opens from 2003 to 2007. 2 This adds up to 2,000 supermarkets, not to mention untold corner grocers and convenience stores.

  Wal-Mart’s killer business model puts even the largest supermarket chains at a competitive disadvantage in every facet of their business. For a start, the company uses its size to provide brand-name merchandise at the best possible wholesale price. Wal-Mart is able to roll back prices because of the new efficiencies continuously being created by its high-tech distribution system, which minutely tracks everything from power tools to pretzels as they travel from supplier to distribution center to store at a pace no other retailer can match. The effect is not only to lower costs but also to boost sales, since hot-selling items are quickly restocked. Wal-Mart locates stores on the outskirts of a city and brings down its land costs even further by squeezing subsidies out of local government to cover the cost of roads and other improvements. Most important, Wal-Mart’s labor cost advantage looms especially large in the grocery trade, where most big chains are locked into contracts assuring even their lowest-paid workers about 20 percent to 30 percent more than their counterparts make at Wal-Mart.

  If there is not a Supercenter within a short drive from your home today, one is assuredly on its way. It might take a while, though, for Wal-Mart is Supercentering America in the same way that an invading army conquers enemy territory: city by city. It builds a mammoth distribution center in a market adjacent to one that it dominates, and then methodically fills in the territory defined by the DC with stores.

  Oklahoma City was one of the first large metropolitan areas that Wal-Mart thoroughly Supercentered, and it serves as a model of what Bentonville wants to do to every sizable city, with the possible exception of New York City. In 1997, Wal-Mart operated three Supercenters in Oklahoma City and controlled just 6 percent of the grocery market. Today, the company has eight Supercenters and ten Wal-Mart Neighborhood Markets blanketing Oklahoma’s largest city, giving Wal-Mart a 35 percent share. (The Neighborhood Market is Wal-Mart’s version of a conventional supermarket and is one-quarter the size of a Supercenter; Bentonville introduced the format in 1998 as a more convenient alternative to its flagship store.) Wal-Mart’s assault brought down food prices for consumers by a hefty 15 percent, but it has also made making a living in the grocery business a whole lot tougher. Some thirty supermarkets in the area shut down. What had been the number-one supermarket chain, Fleming/Baker’s, saw its market share shrivel to 5 percent from 16 percent, despite big cuts in prices and in the wages paid to its workers. 3

  Wal-Mart’s financial muscle is unmatched, and its ambition is limitless. Yet in places, the Supercenter juggernaut has been less than inexorable. At times, the company has bypassed a particularly well-fortified city in its path, encircled it, and returned to fight another day from a position of enhanced strength. The most telling example is Cincinnati. By the time the first Supercenter opened in Cincinnati in October 2004, Wal-Mart was well on its way to Super-saturating each of the major metropolitan centers that ring the Queen City: Louisville, Lexington, Indianapolis, Dayton, Columbus, Memphis, and Nashville. Why not Cincinnati, too?

  With two million inhabitants, Cincinnati is the twenty-fourth-largest metropolitan area in the United States. The city lies on the northern bank of the Ohio River, which forms the boundary between Ohio and Kentucky. However, culturally it is a Southern city, famously conservative and almost willfully provincial—just like a certain company headquartered in the Ozarks. “When the end of the world comes, I want to be in Cincinnati because it’s always 20 years behind the times,” Mark Twain supposedly quipped. 4

  In the grocery trade, though, Cincinnati is no backwater. For one thing, it was home to the first U.S. hypermarket. In 1984, the French supermarket company Euromarché had joined with a U.S. partner to form Bigg’s, which attracted national attention by opening a 200,000-square-foot hypermart in Cincinnati. Utterly confounded by American shopping habits, the French investors behind Bigg’s soon sold out to Supervalu, a big U.S. food wholesaler and supermarket operator. Supervalu scrapped Bigg’s plans to build stores in thirty other cities in order to concentrate on Cincinnati, adding
ten more stores over the years. 5 Cincinnati was all Bigg’s had; it could not afford to cede ground to Wal-Mart (or anyone else) and survive.

  Cincinnati also is an important hub for Meijer, the Michigan-based chain that introduced the superstore format to the Midwest in the early 1960s. Meijer, which also operates ten stores in greater Cincinnati, is widely respected in the business as a disciplined, meticulous operator. With $12 billion in revenues, the privately held, family-run company ranks a distant eleventh on the list of America’s largest grocers, but it already has proven that it was not afraid to mix it up with Wal-Mart. In 1993, complaints filed by Meijer with authorities in its home state of Michigan had forced Wal-Mart to promise in court to stop making misleading price comparisons, adding to a regulatory backlash that eventually persuaded the company to alter its advertising tagline from “Always the low price. Always” to the less assertive “Always low prices. Always.” 6

  First and foremost, though, Cincinnati is Kroger country. Founded in Cincinnati in 1883 by Barney Kroger, The Kroger Co. had outlasted its archrival—The Great Atlantic and Pacific Tea Co., better known as A&P—in classic tortoise versus hare fashion to finally become the nation’s largest grocery chain in the 1990s. Today, Kroger owns 2,500 supermarkets, which it operates under two dozen different banners, including Kroger, Fred Meyer, Ralph’s, Smith’s, Dillon’s, King Sooper’s, and Fry’s. In 2004, Kroger pulled in $56 billion in revenue, ranking twenty-first among all U.S. corporations.