As we enter another round of quarterly earnings “surprises” on the upside for American corporations, one company continues to stand out from the crowd – Wal-Mart. The distinction is not one that Sam Walton would ever have wanted or expected: Wal-Mart has endured eight straight quarters of declining sales in stores opened for at least one year. This is the most important measure of success in retailing, because it strips out the distortions in revenue that come from adding new stores. Consider in particular how difficult it is for a retailer like Wal-Mart to achieve even one quarter of declining same-store sales; Wal-Mart’s two high-volume products are gasoline and food, both of which have experienced percentage price increases in the double digits. It should be easy for the company to achieve substantial revenue growth just on inflation alone, which means something has gone seriously wrong with the business model of the company that is a poster child for globalization.
The core of the problem rests with Wal-Mart’s customer base – middle class and poor Americans. This is a huge and growing segment of the American population, since wealth in the US is increasingly being concentrated in a small segment of the population which certainly doesn’t shop at Wal-Mart. Furthermore, within Wal-Mart’s customer base, there has been a shrinkage of the middle class and an expansion of the poor class since the depression hit in 2008. Depression is the right word to use for Wal-Mart’s customers, over one-third of whom are on food stamps. Mike Duke, the CEO of Wal-Mart, describes his customers as “broke” at the end of every month, when they cease to shop at his stores even for essentials until their next government support check comes in. These are “average” Americans, which means they have $10,000 or less in savings to their name, they clearly live paycheck to paycheck, they are burdened with debt, they have absorbed the bulk of the enormous job losses that have occurred in this depression, and if they have a job they haven’t see a real pay increase in over a decade.
Besides the fact that their customers stop shopping during the fourth week of every month, Wal-Mart sees some other patterns. Sales pick-up noticeably on days when government unemployment and social security checks go out, which says customers flock to the stores the minute federal “stimulus” arrives in their mailbox. There is a once-a-year windfall that also affects sales in the winter, and that is the federal tax refund that these consumers count on as their equivalent of an executive bonus. Of course, it is not really a bonus, but is the consumer’s own money resulting from allowing Internal Revenue to take too much in taxes out of their weekly paycheck. This is really the only form of savings for most Americans, and it should really be considered a one year savings plan, since the money is spent instantly when it is received.
Another phenomenon Wal-Mart sees is that consumers are making fewer trips to their stores. They are combining trips in order to conserve gasoline. When they arrive at the store, they do all their deferred food shopping, and they fill up the car with gas. They don’t bother to browse in the clothing or electronics sections, where all the high margin goods are located, so Wal-Mart not only is hurt on the revenue side, they are hurt on the net income side when all they can sell these days is low-margin goods.
If they were to shop in the high margin sections, these customers would be in for a shock. Anything Wal-Mart purchases from China, which is almost all goods other than food and gas, is subject to substantial price increases, because Chinese manufacturers are coping with devastating inflationary rises in the cost of raw materials and labor. They are passing as much of this as they can to their purchasers, and so much of global manufacturing is done in China that Wal-Mart cannot easily find replacement manufacturers in places like India, Thailand, or poorer countries like Bangladesh.
There is yet another category of customers who are problematic for Wal-Mart: the customers who used to shop there, but now take their business elsewhere. This problem is squeezing Wal-Mart at both ends of the price spectrum. First, customers who are still middle class and can afford high-margin goods are taking their business to rivals such as Target and Costco. These are warehouse retailers just like Wal-Mart, and their prices may even be higher on some products, but the shopping experience is much better. The stores are better lit, the aisles are wider, and in the case at least of Costco, the staff are friendlier.
Costco’s approach to the employee is noticeably different from Wal-Mart’s. Employees are universally given health insurance, which is a highly-prized benefit in America these days. Their pay is somewhat higher from the start, advancement opportunities are greater, and there are none of the widespread abuses used at Wal-Mart, which for example has been routinely accused of locking employees in the stores overnight if they are required to come in for inventory control. A job at Costco is hard to get because the employees rarely quit. People who work at Wal-Mart, on the other hand, take no pride in their work, and refuse for example to pick up goods like clothing that shoppers leave on the floor. Many of these employees openly disparage the company in front of consumers. These aren’t just anecdotal occurrences; Wal-Mart is well aware of the problem and has campaigns underway to improve the image of their stores and the attitude of their employees. Unfortunately, these plans do not include providing decent wages, health benefits, and career opportunities.
The squeeze on the other end of the price spectrum comes from stores like Dollar General, which sells goods in the $1 to $5 range. Often this includes marred or imperfect merchandize which other retailers have rejected. There are no brand names to be found on the shelves, and the food that is offered are snack items like chips, sodas, cookies, etc. This is the best that poor people can do. Immigrants who have recently arrived from places like Mexico or the Caribbean islands feel right at home here.
What Wal-Mart is experiencing is a globalization business model that is beginning to reach its logical conclusion. Wal-Mart’s motto is “Always Low Prices”, but it might as well be “Always Low Wages”. Wal-Mart’s average pay is a little over $11/hour, which is considered below the poverty level in America. Their medical benefits package is blatantly obvious – they don’t offer any benefits unless you have worked there for years and been promoted. Otherwise you are expected to visit hospital emergency rooms for your family colds, which means Wal-Mart workers are a burden on the taxpayers.
Because Wal-Mart is one of the largest employers in the United States, with over two million workers, it is a significant savings to the company if it can get the US government to pay for the health care of its workers. You would think, then, that along with its relentless pursuit of low-price merchandise in its stores, it would have the perfect business model for success as a growth company. It did for awhile, in the 1990s, but for at least the past decade its stock has languished in the $50/share range. What has gone wrong with its business model?
What has really happened is that its model was too successful. Too many retailers copied the Wal-Mart approach: JC Penney, Sears, K-Mart, and thousands of small boutique retailers that fill stores in malls across America now find their goods in third world countries. It is so rare for these companies to buy any product in the US, that Wal-Mart even has a small section in its stores where it touts its “Made in America” products. The selection there consists of pitiful knick-knacks of the sort China used to sell twenty years ago before it became a manufacturing colossus. There are certainly no electronics or appliances that are made in America, and if Wal-Mart does carry something up-scale from an American company, it hides the country of origin. When you get home and open your product, you still find “Made in China” stamped on the product.
Manufacturers, of course, have been pursuing the exact same approach, shifting plants overseas to places with low labor costs like Mexico and China. There aren’t a whole lot of factory workers anymore in the US making $25/hour; they too are earning $10/hour for the lucky few who still have jobs in manufacturing. The wage scale of most jobs in the US has sunk, or at best managed to hold steady for the past decade, very much like Wal-Mart’s stock. Even for those white-collar office workers who have seen their wages stagnate, the picture is bleaker, because bonuses have disappeared and benefits have been eliminated, forcing workers to spend more of their take-home pay on things like medical care and health insurance. Throw into this picture one other factor – a general increase in the cost of some essential goods like food and energy due to inflation – and you have a labor force that has experienced a significant decline in its standard of living.
The grand irony is that Wal-Mart’s business model has led to the impoverishment of the very customers that used to make it a profitable and growing business. Wal-Mart did more than transplant its product sourcing to third world countries, it transplanted its entirely [sic] business to a third world country, by bringing third world wages and salaries to its American customer base. Wal-Mart might just as well move its headquarters to Mexico or China and list its stock on a local exchange in a third world country, because those are the conditions it has created for itself.
This explains why Wal-Mart’s stock has gone nowhere in ten years; investors on Wall Street aren’t interested in putting their money into third world retailing companies because these are not growth companies. Even retailers in fast-growing economies like China and Brazil are suspect investments, because growth is usually highly dependent on large amounts of government spending (the government is by far the biggest employer in the country), there is hardly any regulation over these companies (you never know when the company you invested in accidentally poisons thousands of customers with tainted food), and the accounting and financial records are opaque if not altogether fraudulent (see the dozens of accounting frauds now plaguing Chinese IPOs which have been sold by Wall Street in the past few years).
But wait a minute. Doesn’t this increasingly sound like America itself? The government is not only the biggest employer in the US, it is the provider of an unprecedented 20% of all disposable income for American adults. In one business sector after another, regulation of business has been deliberately dismantled. Accounting standards have been weakened, and the increase in accounting fraud in the US is profoundly increasing the risks of investing here. Combine this with a concentration of wealth in the hands of a few fortunate families, and you have a third world economic environment that makes even Mexico or Brazil look like a stable, industrialized society.
What Wal-Mart ought to do is change its corporate colors to canary yellow, because the company is the proverbial canary in the coal mine. It is pointing the way for most other American companies which have pursued the globalization route. As living standards in the industrialized west compress and approach those of third world economies, companies are going to find that there is no place to go anymore that is not a less secure business environment. Wal-Mart is the first major company to experience this because its business model is so lopsided; it buys from China and largely sells to American consumers. Other companies, especially manufacturers like Ford and Caterpillar, have aggressively pursued sales in China. These companies have managed to benefit from the government-fed recovery of the past three years, but their sales growth has come almost entirely from China and some other emerging markets.
Ford, Caterpillar, Coca-Cola and such like companies talk as if this is a temporary emphasis, while they wait for the day when their traditional customer base in the United States or Europe recovers. The fact is, their traditional customer base is never going to recover to its former living standards of the 1990s. It is more likely that living standards in the west are going to continue to regress, especially since most consumers are able to shop either because they are living off the government dole, or they are living off their savings. Both of these sources are disappearing quickly. What these companies need to realize is that their new customer base is permanently in China, Brazil, India and other manufacturing centers, and that sales growth in these countries is just as heavily tied to government spending as it is in the west. In China it is even more dependent, and since local government spending in particular in China is out of control, leading to the inflation that is already seeping onto Wal-Mart’s store shelves, a day of reckoning is overdue. When that day comes, Ford Motors auto sales in China (to give an example) are going to dry up overnight, leaving them with hardly any substantial source of revenue.
This is a long, drawn-out process, but the road we are on in our well-connected global economy is not one in which third world living standards rise up to meet first world living standards. It is one in which everyone’s living standards meet at some happy middle ground – happy, at least, for those in poor countries that are on their way up. The process is playing out this way precisely because wage compression is capping the amount that China and other manufacturers can sell to the west. Moreover, the western countries have just completed an experiment of trying to keep up living standards with a massive consumer borrowing program, and it has failed spectacularly. The west is simply no longer able to borrow in order to buy cheap Chinese goods. Therefore, if annual wages for Chinese workers are $3,000/yr, and for American workers about $25,000/yr, they are going to meet up eventually at around $15,000/yr. In this sort of world, auto manufacturers are going to sell more cars to the Chinese, but fewer cars, and at far lower cost, to Americans and Europeans, who are going to be too poor to afford today’s average car costing $35,000. On balance, there are going to be growth opportunities with so many more Chinese, Indians, Brazilians and others able to buy cars, but few people are going to buy $35,000 cars ten years from now.
Unfortunately, GM and Ford and other manufacturers are geared up as companies to sell $35,000 cars. Their shareholders expect generous returns on equity based on such sales, and they are inevitably going to be disappointed. Sales revenue at major western companies is just beginning to undergo the compression process that wages and salaries have experienced at the consumer level. This is the cold, hard reality that is the end result of globalization: multinationals that brought this process about, particularly through labor arbitrage, are ultimately going to be victims as well. The consistent high returns on equity they achieved as western-based corporations are slowly disappearing along with the earnings power of western consumers.
Don’t expect to hear anything about this during earnings season. Earnings season is all about quarterly results. Companies talk about the future, but they look out only a quarter or two, and even then complain often about “poor visibility”. No CEO is going to tell you about their dismal earnings prospects for the next five, ten, or twenty years - they aren’t even thinking about it. They are instead going to be touting their genius at earning record profits, and at least in the US, garnering a record portion of GDP, at the expense of the consumer. They don’t see they have extracted the maximum amount of benefit out of globalization, and that they are now operating at the peak of the curve, after which revenue and margin growth are going to start reversing, and for some companies wind up negative. Most of them will pity poor Wal-Mart, whose customers are “broke”, never imagining that the same thing is going to happen to them.
