Why Wal-Mart’s Business Model Is Being Destroyed

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“Now, when it comes to Wal-Mart, there’s no two ways about it: I’m cheap,” wrote Wal-Mart founder Sam Walton in his 1992 memoir “Sam Walton: Made in America.”

If the notoriously cheap Walton were alive today, he would probably be surprised that his pioneering profit formula — keep costs low so that prices are as low as possible and customers buy more — is now virtually impossible to maintain. Full blame for that can be pinned on employees demanding higher wages and the rise of e-commerce giants such as Amazon , which are open 24 hours a day, seven days a week.

Perhaps the retail legend saw some of this on display from up above on what was a dark day in Wal-Mart’s history on Wednesday. Wal-Mart’s usually stable stock price tumbled 11% as the company said at its annual investor day that higher wages for associates will dent profits by about $1.5 billion in the 2017 fiscal year, following a $1.2 billion hit this fiscal year.

For years, Wal-Mart has had the upper hand with its employees, paying them state minimum wages, offering basic healthcare plans, and using computerized systems to control their hours. But with the rise of social media and the internetgiving employees a free platform to express views, and the rising cost of living causing state governments to push through higher minimum wages, Wal-Mart has had to change with the times.

As a result, it has lost a key element of its business model put in place by Walton that has supported the company’s profits since its founding. Further, rising employee costs are arriving as online shopping is also limiting the ability of Wal-Mart to raise prices at all to help deliver sustainable profit growth.

Wal-Mart added on Wednesday that it expects earnings per share to decline between 6% and 12% next year. Wrote Sterne Agee analyst Charles Grom in a note to clients on Wednesday : “What’s surprising to us is that the new outlook is incorporating roughly $20 billion in share buybacks in the next two years, which implies significant margin contraction along with modest sales growth,”

Employee costs aren’t the only line item on the income statement Wal-Mart is battling to control.

Wal-Mart’s investments in e-commerce and digital initiatives are expected to total about $1.1 billion in the 2017 fiscal year. This year, Wal-Mart is projected to shell out $1.2 billion to $1.5 billion on e-commerce and digital.

These investments are a necessary evil to stay competitive with Amazon, as well as with Best Buy and Target , which are continuing down their own paths to reduce prices, improve checkout speeds and offer a range of delivery options.

When Walton opened the first Wal-Mart store in Rogers, Arkansas in 1962, though, it’s unlikely he foresaw a day when a sweater could be purchased off a handheld device. Today it can be, however, and to make it happen seamlessly and at the lowest cost is proving to be a major profit headwind for the once mighty Wal-Mart.

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Source: The Street | Brian Sozzi

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