No Stopping Wal-Mart In Its Quest for Uber-Efficiency

March 15, 2006

There's no denying that Wal-Mart is a juggernaut. Just look at the numbers. Net sales for the fiscal year ending Jan. 31, 2006, were $312.4 billion. To put that amount in perspective, consider that the current CIA World Factbook estimates Australia's gross domestic product at a little more than double Wal-Mart's sales: $649.9 billion. In fact, a recent Wall Street Journal article noted that Wal-Mart alone "generates 2 percent of the gross domestic product" in the United States.


What's more, Wal-Mart's sales continue to rise. Using January year-over-year figures, in 2004, sales jumped 9.5 percent. The year before, they had climbed 11.3 percent. Can the mighty retailer continue to grow at this pace? 


According to a group of supply-chain experts at the W. P. Carey School of Business, overseas expansion will help Wal-Mart continue its current growth rate. However, the company also needs to capture more customers in its domestic market, and the retailer plans to do so by building another 1,500 stores in the U.S. Many of these stores will be its new Wal-Mart Neighborhood Markets, which are smaller, 42,000- to 55,000-square-foot outlets that offer 28,000 items for sale 24 hours per day.


In addition, the company -- already legendary for supply-chain genius -- must refine processes even further if it is to continue to grow at its current clip. "Wal-Mart must gain even greater control over its supply chain; increase visibility of the movement of product through its supply chain and become more effective in terms of product availability and promotional execution," says Mark Barratt, assistant professor of supply chain management at the W. P. Carey School. To do so, Wal-Mart is pushing various initiatives designed to cut costs, increase efficiency and improve purchasing decisions.


Supply-side economics, Wal-Mart's way


Wal-Mart has been tremendously successful in negotiating bargain prices from suppliers, notes Elliot Rabinovich, assistant professor of supply chain management at the W. P. Carey School of Business. Moving those products to the right place at the right time for consumers to buy them also has been one of Wal-Mart's claims to fame.


Along with purchasing power, Wal-Mart has the industry's best information system -- Retail Link -- that allows the merchandiser to share masses of data on a nearly real-time basis with its suppliers, Barratt says. According to Wal-Mart's 2005 Annual Report, the company's data center tracks more than 60,000 stock-keeping units or SKUs every week and maintains a data warehouse consuming more than 570 terabytes of digital storage. When that 2005 annual report was written, Wal-Mart's data warehouse was "larger than all of the fixed pages on the Internet," the report states.


Wal-Mart uses its data to track demand and set inventory targets for specific products, Rabinovich says, but the company also correlates purchasing data with "factors that contribute to increasing demand for a particular product." Weather is one such factor, he notes, and not necessarily in obvious ways. You might expect to sell more bottled water, tarps, flashlights, batteries and food basics like milk and eggs with a storm on the way. However, last year's annual report mentions that Wal-Mart's IT gurus were able to correctly predict how the approach of Hurricane Ivan would dramatically boost demand for strawberry Pop-Tarts in the Florida panhandle.


"Most retailers have such capabilities, but not at the level of Wal-Mart," Rabinovich continues. With more storefronts, "the sheer size of the systems they handle is unmatched in the industry," he says.


Other winning Wal-Mart supply tactics include customized pallets, enabling Wal-Mart to work with vendors to achieve just the right mix of product on the pallets that wind up at stores. "For example, instead of having Kellogg's deliver a pallet of cornflakes, they put together different types of cereals, different SKUs, allowing Wal-Mart to move the pallet through the distribution center directly to a particular store," Rabinovich explains.


In addition, Rabinovich points to Wal-Mart's constantly moving supply chain as a winning strategy. "Products get unloaded at a distribution center, then get loaded back onto a truck to go to a store," he says. Rabinovich adds that the retailer has distinguished itself for effective, cross-docking warehousing. Still, Wal-Mart managers have new distribution center plans.


Faster, faster


The 1.2-million-square-foot distribution centers Wal-Mart has traditionally used for Supercenters and discount stores generally serve around 100 stores each and do so efficiently with high levels of mechanization, says Arnold Maltz, an associate professor of supply chain management at the W. P. Carey School. But, "the issue with those big facilities is that they were never designed to be food distribution centers," Maltz says. The centers lacked necessary temperature controls and food-handling equipment, so Wal-Mart set up a separate network for food operations.


Food distribution centers, he notes, are generally smaller and use less automation. Merchandisers don't need automation and conveyor-belt action for moving full pallets around, as they do to handle items that quickly fly off store shelves. Consequently, Wal-Mart is starting to transfer quick-selling merchandise to food DCs, Maltz says. "Presumably, that will make the high-volume, high-velocity stuff move more economically," and allow Wal-Mart to "put the mechanization to better use."


One area where Wal-Mart is adding mechanization is in inventory tracking, and the company has diligently tested radio frequency identification, or RFID, technology.


RFID isn't new. It's the same technology that lets drivers whiz past an electronic tollbooth and veterinarians discover the name of a pet's owner simply by scanning the radio frequency transponder lodged under the skin behind the animal's ear.


In 2003, Wal-Mart asked its 100 top suppliers to put RFID chips embedded with product information on pallets and cases and, so far, 37 other suppliers have volunteered to do the same, says supply-chain expert Barratt. The goal is to increase stock visibility as it moves in trucks and through distribution centers and on to the stores. This allows Wal-Mart to track promotion effectiveness within the stores while cutting out-of-stock sales losses and overstock expense.


Watch closely now


"One of the issues that Wal-Mart faces is that it does not know whether products sold through the checkouts have come from shelves, end-of-aisle displays or the front of store displays," Barratt says. If RFID could help the retailer know where items came from, he adds, it would "be a huge win in terms of how effective in-store promotions are. Promotional effectiveness and execution are a key issue."


So is shelf stocking, a process Wal-Mart generally does with "picklists" that are compiled by associates who visually inspect the sales floor for what's missing or by associates in the backroom who use barcode scanners and an automated system to determine if a case of some product will fit on the available shelf space. "Both methods of creating picklists are laborious and rely on the accuracy of the system," note researchers from the University of Arkansas in a paper titled, "Does RFID Reduce Out of Stocks?"


How can RFID tags on pallet and cases reduce stock-outs? Wal-Mart places the RFID tag readers in several parts of the store: at the dock where merchandise comes in, throughout the backroom, at the door from the stockroom to the sales floor, and in the box-crushing area where empty cases eventually wind up. With those readers in place, picklists can be generated automatically by combining RFID-supplied data showing what is in the backroom and what is on the sales floor with data showing what has passed through the point-of-sale barcode readers.


Such automatically generated picklists are what the Arkansas research team evaluated in select Wal-Mart stores in Texas. Compared to control stores with no RFID readers in place, the automated picklists did cut out-of-stock inventory dramatically.


Spectral sales sabotage


According to 2003 research published in The International Journal of Retail & Distribution Management, about 25 percent of out-of-stock inventory in the U.S. isn't really out-of-stock. It may be in the backroom, and no one knows about it. The same paper -- partially titled "Desperately Seeking Shelf Availability" -- notes that nationwide, around 8 percent of merchandise is out of stock at any given time. And, if consumers can't find it, they can't buy it, so stock-outs can easily translate into lost sales.


A primary cause of stock-outs is "phantom inventory."


"An associate may try to place products on a shelf, only to find that there is not enough space to fit all of the case," Barratt says. The associate might return the items to the storeroom or misplace them somewhere on the sales floor itself. "What this tends to cause is a situation where the system says one thing about stock levels and the reality is different," he explains.


Barratt goes on to explain that when the system shows a positive balance of stock, no orders are generated. And, because few question the verisimilitude of computer-generated reports, no orders are likely to be placed for quite some time. "This impacts future forecasts, which show diminishing demand for a product that does not actually exist on the shelf," Barratt adds.


Conversely, if the store computer shows a negative balance when, actually, plenty of stock exists, unnecessary orders are generated. This leads to excess stock, Barratt says.


Made to order


In the study performed by University of Arkansas researchers, Wal-Mart stores with RFID show 26 percent fewer stock-outs on the 4,554 RFID-tagged products that were tested. Stock-outs also decreased in the control group of stores -- perhaps because of the "Hawthorne Effect," which maintains that people who are being watched change their behavior. Still, the RFID stores had 63 percent fewer stock-outs than the control stores without electronically generated picklists. That's a net improvement of 16 percent.


"This is not an illusion," says Maltz. He maintains that the research indicates RFID will "increase on-shelf availability and shave supply costs."


While out-of-stock merchandise doesn't automatically mean lost sales, it is a contributing factor. And, it won't take much of a bump in sales to make the RFID technology pay off.


"Wal-Mart is running about $300 billion a year in sales at this point," Maltz reminds us. "Even a 1 percent improvement is worth $3 billion. A tenth of a percent equals $300 million."


This good news for Wal-Mart may be a challenge for smaller suppliers. "Wal-Mart is expecting suppliers to pick up the tab for tagging products with RFID," Barratt explains. "In an industry where most products are relatively low-priced, the addition of a tag that costs 17 cents represents a significant increase in costs" that could erode profit margins. "This limits the number of suppliers that Wal-Mart can cajole into tagging products," he adds. "However, the writing is on the wall, and Wal-Mart has been briefing its entire supply base to expect to be tagging products within the next few years."