How the Discounters Hurt Themselves
BATAVIA, Ohio (AdAge.com) -- If one thing defined the marketing landscape of the 1990s, it was the power of cheap.
Wal-Mart Stores, Southwest Airlines and Dell Computer reshaped their industries with low-cost models that forced competitors to adapt or die. Each of the power discounters thrived heading into the 21st century as their competitors often struggled.
But each is now facing a much tougher battle for growth. Wal-Mart's top line has continued to weaken; both its revenue and comparable-store sales -- excluding grocery -- grew slower than Macy's last quarter. Southwest is cutting expansion plans and revamping its service model. And Dell returned to founder Michael Dell as CEO to reinvigorate growth.
Their struggles might suggest consumers care less about price. But don't bet on it, particularly with a recession always looming seemingly around the next corner. Instead, the power discounters are paying the price for their own success. They have reached the end of the frontier for easy growth and made their rivals stronger. Now they are all trying, with varying degrees of success, to adapt their marketing and business models to the new, tougher competitive landscape they've helped spawn.
Wal-Mart scales back
"These discounters start from a very low-cost platform, so no one is going to try to challenge them until they've proved their concept," said Frank Luby, partner at the Boston-based consulting firm Simon-Kucher & Partners, which specializes in pricing issues. Eventually, however, incumbents adapt by lowering prices and sharpening their branding to include something else, he said, while new low-cost competitors emerge too.
Wal-Mart has scaled back new-store expansion plans twice in the past year and plans to open only half the new supercenters (140) two years from now that it opened last year. Southwest and JetBlue also have pulled back on expansion plans or routes. And Dell acknowledged the limits of its mass-customization model by starting to offer products through fellow discounter Wal-Mart.
It's not that discounting as a concept is waning. It's never been stronger, said Michael Silverstein, principal with the Boston Consulting Group, as the percentage of goods sold at full seasonal markup continues to decline, as it has for years.
But, he said, "the traditional discounter has played out phase one of their growth plans. Stores are within easy access for most consumers. Phase two is trickier. It requires discounting with an eye to merchandising. ... It requires a different set of skills."
More than discounts
Unfortunately for the big discounters, they may have been better in developing those skills in competitors than in themselves. Each helped drive several of their weaker competitors out of business, into bankruptcy or into one another's arms. But many of their remaining competitors have learned how to chip away at price gaps while offering something beyond price -- be it style, convenience, quality or service.
"It's tough to compete on price alone," said Ralph Blessing, principal with the consulting firm Arbor Strategy Group in Chicago. "Our surveys show people increasingly are unwilling to sacrifice quality in the shopping experience or in customer service just for the sake of price. They expect you to do both."
The same challenges the big discounters face, he said, are mirrored in value package-goods products such as Unilever's Suave or Alberto-Culver's VO5, each of which has been focused lately on higher-priced midrange products.
|*Through first three quarters
Source: Southwest financial filings
Wal-Mart long has struggled against Target and Costco offering prices close to its own alongside either a flair for design (Target) or treasure-hunt merchandising and a more-upscale product assortment (Costco).
More recently, Wal-Mart has faced a reinvigorated Kroger Co. that's cut its price gap to between 7% and 8% this year from more than 20% five years ago, according to pricing analyses by Banc of America and Citigroup. Kroger made those gaps appear smaller still by using direct mail to target deep discounts on items its loyalty data show matter most to profitable customers.
All those factors have helped steadily cut the revenue growth rate of Wal-Mart's U.S. stores by half in five years, to 6.4% through the first three quarters of this fiscal year from 12.9% in 2003.
Wal-Mart is still gaining share in grocery, Eduardo Castro-Wright, CEO of the unit, pointed out on an earnings conference call last month. Comparable-store grocery sales rose 5.3% while overall grocery sales rose 13%, well ahead of the division's overall growth rates.
Trouble is, Wal-Mart has started losing share across the aisle, where margins are better. Based on numbers disclosed by Mr. Castro-Wright, Wal-Mart's revenue last quarter -- excluding grocery and pharmacy -- rose only about 0.1%. Same-store sales outside grocery and pharmacy declined about 2.3%. Macy's, while disappointing Wall Street, actually beat Wal-Mart's nongrocery business on the top line last quarter, with overall sales up 0.3% and comps down 0.8%.
"Even scaled back, our sales growth and new-store openings are still bigger annually than some competitors' whole business," a Wal-Mart spokesman said. But he termed the slower store growth part of a program to balance growth with earnings.
Learning from mistakes
Beaten-down competitors are also rising up against Dell and the discount airlines. Two rivals Dell chastened in years past -- Hewlett-Packard and Compaq -- combined and regained share leadership in recent years with hipper designs and youth-oriented marketing. The discount airlines now face legacy carriers such as Delta, Northwest and United that slashed their costs through bankruptcy.
|*For Wal-Mart Stores U.S. division, fiscal years ended Jan. 31
**For third quarter of fiscal year ending Jan. 31, 2008. Source: Wal-Mart financial reports and statements
But the discounters also have spawned scrappier new discount competitors, too. Wal-Mart has had to fend off dollar stores, usually located closer to low-income consumers -- a big plus as gas prices spiked.
Meanwhile, some of those mall stores Wal-Mart helped drive away created cheap space for sportswear retailer Steve & Barry's to grow, adding 70 stores to its existing 200 this year. The chain offers storewide price points below $8, like a dollar store for clothes only in stores that are festive, not discount-style dark and dismal.
On the airline front, Southwest and JetBlue face the likes of Skybus, which sells seats for as little as $10 to flyers willing to pay separately for everything from water to blankets. Instead of JetBlue's DirecTV, Skybus passengers get to watch something like QVC as flight attendants hawk trinkets.
While Dell sells non-customized merchandise cheap at Wal-Mart, the retailer has been offering Linux laptops from Everex even cheaper -- for $200.
Limits of discounts
Yet Wal-Mart, like Southwest and Dell, has had trouble pushing its own costs ever lower -- though the retailer's third-quarter slashing of inventory helped reverse a trend of creeping costs in recent years. Its program to track inventory using radio-frequency-identification chips has moved much slower than originally planned, leading to doubts it will ever roll out fully.
Former Continental CEO Gordon Bethune once said discount airlines' advantage over legacy carriers stemmed mainly from younger, cheaper labor and newer, easier-to-maintain aircraft. Now, both the workers and the aircraft have aged at the discounters as the legacy carriers have used Chapter 11 to cut labor costs and fleets. And Mr. Bethune? He's advising a hedge fund pushing United to merge with Delta -- which could drive their costs still lower.
"Our cost challenges are there. They are well-known," said Southwest CEO Gary Kelly in a conference call with analysts last month, sounding a lot like Mr. Bethune might have years ago. Southwest has instituted early-retirement incentives to help combat labor costs, but maintenance costs soared 26.5% last quarter. Mr. Kelly said the airline had slowed its plans for capacity growth, much as Wal-Mart has.
|Net new supercenters for Wal-Mart Stores U.S. for fiscal years ending Jan. 31.
Source: Wal-Mart Stores.
JetBlue faces additional challenges to growth, such as the overcrowded facilities at New York's JFK airport that exacerbated its customer-service meltdown in February and make its everyday customer experience less pleasant.
Even private labels -- the discount bogeymen that forced waves of restructuring on package-goods marketers in the 1990s -- appear to be contained, in part because Wal-Mart's program has been losing share.
Wal-Mart, already so big and surrounded by so many discount alternatives, may have the toughest time adapting, Mr. Luby said, while Southwest seems to be adapting best. The airline earlier this month broke new ads from Omnicom Group's GSD&M Idea City, Austin, Texas, featuring a major change in its service model -- allowing business travelers to pay extra for pre-assigned seats.
"They can still grow," Mr. Luby said, "by reaching out to people who were turned off by the experience before."