Wal-Mart is in a bit of a pickle. Over the last decade they have focused incessantly on unit cost, ostensibly to provide reduced price and therefore perceived value to their customers. And they’ve been successful… millions of people can now afford products they previously could not, and hundreds of thousands of people have jobs. Maybe not the best jobs, and obviously other smaller companies have been hurt in the process, but that’s the subject for a different debate.
The company’s obsession with unit cost has forced suppliers to transition to offshore manufacturing where unit labor costs are lower. Huge ships constantly ply the Pacific waters filled with container loads of bicycles, electronics, and clothing. Wal-Mart knows that cash is being tied up in inventory, although perhaps that doesn’t accurately enter into the unit cost equation, but the continual high volume movement of goods at even tiny margins creates a lot of cash.
Until the market burps. Not even a demand quake… just a burp. A small hiccup that throws a wrench into the finely-balanced cogs of Wal-Mart’s business model. The company that activists hysterically believe will take over the world suddenly pauses.
Wal-Mart’s inventories jumped 10.3% in the fiscal first quarter, ended April 30, to $35.2 billion from a year earlier, driven by unsold apparel, home decor, and outdoor products. About $2 billion of the increase represents unsold spring clothing and home goods that are expected to depress profit through the summer, analysts estimate.
With transit times from offshored manufacturer to Wal-Mart’s stores measured in weeks, the situation will get worse before it gets better.
Wal-Mart’s chief financial officer says clearing out stocks of unsold clothing is going to be a chore and could pressure margins all summer.
Of course that time frame is premised on the assumption that they’ll guess right on fall and winter demand, and based on how they did with spring and summer it’s probably not the safest of bets. It’s hard to predict the nuances of fashion six to nine months in advance in order to get the factories humming to fill a global supply chain.
That $2 to $3 billion (a billion here, a billion there…) in increased inventory is inventory of products that are seasonable and fashion-related and therefore can be deemed perishable. And depending on how you calculate it, it’s worth a one-time bite of about a third of Wal-Mart’s 3.2% profit margin. So far. Not even counting the impact on company and shareholder value when the stock goes on a ride.
I wonder what would have happened if Wal-Mart had instead perhaps paid a miniscule bit more, if even that, to a company like American Apparel. A company that could manufacture much closer to Wal-Mart’s distribution centers, that leverages lean methods to provide small lots with extremely quick cycle times. A company that could react quickly when demand and fashion fluctuate. And a company that pays a decent wage with decent benefits and respects its people. Which is also why American Apparel may not even want to do business with Wal-Mart.
Writing off a couple billion in inventory has a nasty habit of offsetting a shipload of unit cost savings once it hits the bottom line.