Wal-Mart Stores, Inc. (NYSE:WMT) recently adapted a new business model to take on head to head Apple Inc. (NASDAQ:AAPL) in the video and streaming sector.
Wal-Mart is teaming up with five Hollywood studios in an effort to stem the continuing decline in DVD sales. The idea is to try to encourage customers to own, rather than rent, movies by making them accessible on the Internet after they are purchased. The company plans to charge $2 more for this option.
Wal-Mart, is currently the country’s largest seller of DVDs. The Company plans to allow grant customers viewing rights in the so-called UltraViolet online library. Customers will afterwords gain access to UltraViolet via Wal-Mart’s Vudu website.
Apple operates on a different model. It does not use the Ultraviolet platform, which Wal-Mart plans on using. Apple instead makes purchase movies on Apple’s website view it on their product, iTunes. So far this model has been a success for Apple.
This is an area of heavy competition. Amazon Inc. (NASDAQ:AMZN), Netflix, Inc. (NASDAQ:NFLX) and Apple already dominate this industry. Wal-Mart has previously been successful by not taking on stiff competition, but rather by dominating their local markets. In the 1970s and 1980s, Wal-Mart did not try to penetrate Kmart’s areas, but rather to focus on the areas near its base in Arkansas, where Kmart was not located. This was the time period of Wal-Mart’s greatest growth.
While this current idea might work for Wal-Mart, the company appears to be grasping for straws. After decades of record growth due in large part to local economies of scale (as explained below), the company is trying out anything to increase revenue and the bottom line. The company has tried to open up branches in Germany, and tried to purchase Massmart, South Africa’s largest retailer.
The truth is that we believe there is Wal-Mart has seen its best days. The retailer originally was successful due to local economies of scale. It was able to overtake Kmart, by expanding slowly from its small headquarters based out of Bentonville, Arkansas, due to the lower costs of advertising, shipping, and even management fees.
In 1985 despite operating nearly 1,000 stores, 80% of Wal-Mart’s stores were located in Arkansas, and adjacent states. By contrast Kmart was much more spread out, despite having its own area of concentration in the Midwest. This helped Wal-Mart spend less money on bringing goods to its warehouses, and distributing the goods to distribution centers. Wal-Mart used its own trucks to transport merchandise, and since the distance between the distribution centers were close, Wal-Mart’s costs were lower.
Wal-Mart used the local economies of scale to get more bang for its buck. As Greenwald states, “a thirty-second spot in Nashville charges the same whether there are three Wal-Mart stores in the area or thirty”. This would apply whether the ad was on TV, in the newspaper, or in a circular. When Wal-Mart advertised it was able to reach a larger number of potential customers, despite paying the same price as competitors would.
We believe Wal-Mart has seen its best days. Retailing is a low margin, super competitive business. Wal-Mart has a large market cap, but unlike Apple is unable to penetrate overseas markets due to the reasons stated.
Bruce Greenwald predicted Wal-Mart’s stuggles 12 years ago. The company pursued exactly the strategy he advised against. In the past 12 years the stock has barely moved. Some famous value investors have bought Wal-Mart due to the increasingly low valuation. However, many of these investors are managing billions of dollars and can only invest in large cap companies. Additionally, even the greatest investors are sometimes wrong.
Wal-Mart might be in business for another 100 years. It could provide decent shareholder returns, in the form of capital gains and dividends. However, whether or not the new DVD model takes off, Wal-Mart will likely remain a struggling giant retailer.
(The author of this article has no position in any companies mentioned).