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SMALL BUSINESS & THE BIG BOX ERA
Asian Imports & Minimum Wage Jobs

The “Big Box” movement, with their warehouse superstores, took root in the late 1980 decade and accelerated in the 1990 decade. The inherent low-cost, high-volume, no frills, bare bones theme caught on mainly due to the attractive prices and good selection. It radically reshaped the US economic landscape. One is hard-pressed to identify the first niche player to employ the big box with specialty in sales theme. The advantages are enormous. The shopper convenience is clear. It ain't sexy, in fact it is often drab. Nor can customer service necessarily touch the Mom & Pop personal touch. The high finance open road to Wall Street funds enables a leg up in competition. The small business retailers have never recovered. Even when resisted, expansion is relentless and almost unstoppable. The highly surprising phenomenon is that over the past decade, as a group they have enjoyed more growth and produced more profits than a great many technology companies, by harnessing information systems and executing a solid business plan to sell ordinary retail items. Their foundation, apart from IT systems, is built upon cheap Asian supply of products, and low-paying jobs at their stores. Much criticism leveled at Wal-Mart is justified, but the same also applies to the other Big Box superstores.

A survey is helpful to grasp the sheer magnitude and scope of the burgeoning irreversible model. Department stores have long dotted the urban and suburban centers of our nation. Sears, Woolworth, K-Mart (offshoot of Kresge), Wal-Mart, JCPenny, Marshall Fields, Federated, May, Lord & Taylor, Ames, Marshalls, and a slew of regional (e.g. Lazarus, Jordan Marsh) and upscale (e.g. Nordstrom, Neiman Marcus) department stores have a long history. Some died, but they seem to return restructured and ready to go again. Some department store specialization has long been present in furniture retail stores. Newer entries include Target and the upscale Nordstrom. This large group of department stores offered the niche players a guideline to emulate in their specialty. The model had emerged in a sneaky quiet way years ago. An early entry was Toys’R’Us, which separated a long time ago from a conglomerate bankruptcy, and might have established the specialty niche model, followed in name style recently with Babies’R’Us. As for the identity of the original ground breaker, leave it to historians. A listing by niche group is impressive to behold. By no means is the list complete. Only the first group requires membership and an upfront annual fee.

Most remarkable is the evolution of Wal-Mart. What started out as a department store has extended to a major pharmacy, and now a major food grocer. In isolated locations, they even sell gasoline, supplied by Russian Lukos. They have embarked on a massive vertical integration pathway, as 150 mfg plants are owned and produce wares in China, to earn it the dubious label of “ChinaMart.” Wal-Mart gets the attention for Chinese supply, but find one major retailer that is immune. All through the shelves of K-Mart, Staples, and Home Depot are Chinese manufactured goods. Wal-Mart receives so much focus due to its size. If a sovereign nation, it would boast of the 9-th or 10-th biggest economy in the world.

THE PLAYERS

Numerous obscure and miscellaneous niche players have added to the Big Box list, such as for  big & tall clothing, maternity clothing, mattresses, golf, pet supplies (PetsMart), coffee (Starbucks), movie rentals (Blockbuster, West Coast Video). Not to be left out, the entire movie industry has been transformed. Large mega-complexes dominate the movie scene, as many small theatres have been pushed into the avant garde and chic niche.

CUSTOMER TRADEOFFS

For customers who expect to explain their problem to a retail doctor, have it diagnosed, discuss alternative plans thoroughly, then be handed a recommendation for purchase, fahgeddaboutit!! Those days are not entirely behind us, as my experience can testify at Staples, CompUSA, Barnes & Noble, and Home Depot. As a Mr Fixit on the roof or in the bathroom or remodeling a family room, my needs have frequently been met with the helpful employees in Home Depot stores. Ditto at B&N years ago, once upon a time when novels were the main fare. Another superstore with personal experience for me has been CompUSA, where the young staff is exceptionally well informed and helpful. What seems missing is the consistent availability of service help at the superstores, since at times one will experience a lost feeling or encounter difficulty getting informed advice. Floor staff is typically kept to a minimum. When found, it seems to be helpful.

The Big Box superstore seems to force the customer to take more responsibility to know what is needed, to understand the design involved, and to come prepared. The alternative is to hire a professional for work to do on the home (construction repair or interior decoration), computer, office, or car. The Mom & Pop hardware store operator will slowly become a dinosaur, a thing of the past, except in very small towns. They surely helped me plenty when younger, but they were drained in time despite the joy they appeared to derive in dealing with their customers. You can observe the same joy among some service help, but it is clearly different now.

The customer is forced to accept a trade-off. Customers benefit from lower cost merchandise, but at times must search in what seems a vast warehouse. The membership warehouse clubs tend to offer few product choices but great deals, especially at bulk. The other superstores have far more product choices, even an avalanche of choices. You want some screws at Home Depot?  “Can we show you 80 types?” The quality of their lumber can be at times poor, with warped stacks of a variety of products, evidence of corner cutting. Some who have accompanied me display wide eyes in being overwhelmed by the size and scope inherent to the Big Box. Some object to the impersonal atmosphere of the warehouse. Search though, and a personal touch can be found among store personnel. On one side the nimble can save money on a project, but on the other side customers can tend to throw their hands up and hire a professional at a higher cost.

SUPPLY COST ADVANTAGE

The small business owner/ operator has been under absolute assault, as the retail industry has undergone a near total transformation. What happened to the neighborhood food grocer many years ago is now happening to the small specialized retailer. The grocer was knocked out by the supermarket, on lower price and greater choice variety, even as the specialized retailer is being knocked out by the Big Box specialty stores.

My job experience at Staples HQ enabled me to understand the breadth and depth of the supply side price competition. A couple key friends in discount superstore firms exposed me to other key factors. Small retailers are at a huge disadvantage. The Big Box vendor can approach the suppliers with offers of staggering volume. Suppliers benefit from economies of scale, can ramp up, can overcome fixed costs, and profit from the volume. It is a win-win situation. The big vendor wants a cost cut to render their discount retail business an advantage. Whether electrical receptacles and 4-by-4 lumber posts at Home Depot, or bestsellers and scattered paperbacks at Barnes & Noble, or spiral notebooks and business software at Staples, or Campbell Soups and sox at Sam’s Club, the sheer volume of inventory supply replenishment offers the Big Box vendors a strong bargaining position to win a lower cost structure across the board for their business. With size and power can come abuse. Sporadic reports hint of occasional intimidation of suppliers to reduce prices in return for locked long-term contracts. Suppliers are encouraged, and at times coerced, to share a more complete integration of their entire chain with the major vendor, to merge warehouses and order replenishment. Reference extends both to Wal-Mart and beyond to the specialty superstores.

On an increasing basis, Asian imports stock the shelves of many of the large discount retailers. This is the case for office supplies, consumer electronics, and home fashions, in much the same manner (but less publicized) as Wal-Mart. An interesting but brief project for me was to advise on formal financial hedging for Staples, in order to neutralize Asian currency exposure for large imported supplies to cover the risk of time lag (between inventory order and final sale). The experience enabled me to learn of the large volumes involved on Asian imports. Countries involved were far more than China and Japan, but also Taiwan, Korea, and Thailand. Without heavy reliance upon cheap Asian imported products, many such Big Box discounters could not execute on their business plan and exploit a price advantage.

The Big Box retailers make money in other clever ways also. The clubs like Sam’s (subsidiary of Wal-Mart) earn annual membership fees. Higher volumes lead to enormous cash flows, from which they can play the “delay game” with suppliers and essentially earn interest between supply payments. Since a warehouse type store needs large tracts of land, they purchase remote property. After development, the nearby parcels can be leased at a handsome profit. Traffic has been attracted, thereby raising the property values and lease potential. Superstores have become land developers and lease landlords as a result of their own growth and success. The small retailer has none of these advantages. They do, however, sometimes have the option to sell their urban land at huge multiples to office condo developers and other high potential ventures, as they sell out.

PRICING ADVANTAGE

The supply cost advantage translates into an immediate low product price advantage. In many instances the comparison with nearby smaller retailers comes to at least a 20% price difference. The Big Box makes money on volume and scant low profit margins. The usual suspects of loss-leader sales items get customers into the stores. Regularly scheduled sales promotions, pushed along by advertisements (run of press, newspaper inserts, television, radio, direct mail) enable the volume seller to inflict damage on the small retailer on a routine basis. Occasionally, surplus items must be moved out of inventory. Two instances come to mind. Staples received a bargain on paper shredders, like tens of thousands of them. So they offered a free shredder with any purchase of a higher margin furniture item for the home office. An accident occurred before the back-to-school season, whereby Staples was grossly overstocked with backpacks. They sold them at a ridiculous 50% discount. Nearby competitors for these two items could not compete, but the company did not even feel a speed bump.

During my days at the old firm, strange facts were collected. The top item for theft was the HP print cartridge, amounting to roughly $5 million annually. The total shrink rates were typical. Such losses were absorbed, like with any other business. The bigger the store, the bigger the theft, usually on a given percentage basis. Theft (and other shrink) actually hurts the discounter more, since their margins are lower. Truck and shipping damage is another common form of shrink; weather damage is another lesser factor.

If the nearby competitor owns a niche, like Best Buy competing with a camera shop, the large discounter can afford to lose money on a small portion of the overall business, and knock out that competitor. This pricing practice can be predatory in nature, and pre-meditated. Although illegal to sell below cost for the understood purpose to kill off a competitor, this practice is widespread. It is only obstructed by legal authorities when it done on a large scale and kills competitors in a very public manner, where lost jobs might be publicized.

ENTER WALL STREET HIGH FINANCE

The game is changed completely when the Big Box discounter firm is a publicly traded company, with stocks and bonds entering the mix. Any small competitive retailer must deal with a supercharged discounter which can knock them out with relative ease. Most of the specialty discounters listed above own a publicly traded stock. Some had huge growth prospects, and have realized the lion’s share (e.g. Home Depot, Staples, Best Buy, Circuit City) of that growth potential. In the growth years, the employer was able to keep labor costs low, in exchange for stock options. Most options went to management, but also high ranking analysts in the headquarters. Home Depot even granted stock options to floor personnel. Staples issued them to store managers and, of course, the HQ personnel. So Wall Street valuation premiums served as a wage subsidy for some discounters, who could further build on the profit margins in a way the small retailer could not. In my five years at Staples, the chain grew from 270 stores to 1050 stores. The stock appreciated between 600% and 700%. Many regarded their “discounted salaries” and “discounted vacation time” to be augmented by hefty stock options.

Public companies have three methods to raise capital. The cheapest form is stock equity secondary issuances, i.e. printing shares. In the short-term, investors suffer a dilution, but with a near-term expectation of return on new capital quickly at work. The next cheapest form is bond issuance. Corporate bonds enable discounters to expand their business with a cheaper cost of money versus commercial lending institutions, which is the most expensive route. Small retailers can only resort to commercial borrowing, unless they sell an equity interest in their private companies, which is often done to take in a paid working partner, an unpaid inactive partner, or an eventual successor.

Secondary stock issuance and bond issuance are tremendous advantages for the superstore discount retailer. The fresh capital infusion can essentially subsidize a string of new stores, as they expand their chain. Over the course of the first 12 to 18 months, a new store can successfully knock out the higher priced competitors. Wall Street gives them both the money and the time to deliver the death blows. In other situations, a market is big enough for the discounter to establish a second beach head, to solidify its tight grip on that area. Competitors, regardless of standard priced or discounter, consequently find a prohibitively high threshold to cross. The expanding firm sacrificed from the entrenched store in the chain. We called it “cannibalizing” market share locally, but it resulted in competitors turning away totally from that area. The Barnes & Nobles growth story came before the stock IPO splash, and did not contribute materially to its growth.

If growth was a lock, and Wall Street had engrained expectations of good growth, which was delivered year after year, an additional device kept capital costs even lower. Convertible bonds offer slightly lower bond yields, with the opportunity down the road to convert to equity shares. The acted like a cross between a conservative bond and a risky option. Staples was able to offer 4% convertibles when the prevailing corporate bond yields were in the 6% to 7% range. Conversion back then took place often at a price double the original strike price. Cheap capital is never good news for competitors.

Being a large multi-billion dollar Wall Street company carries additional advantages on customer credit. They can often tap into cheap short-term funds from bond hedge strategies, or from expansive marketing budgets, so as to subsidize generous credit offers like zero percent for several months. Best Buy, Home Depot, and Lowe's, among others, extend the practice. A friend of mine received a Christmas gift of a nice video camcorder, now happily paid off before the six months passed. Best Buy made me an offer that could not be refused. Small retailers cannot touch such offers, which usually cut into any profit.

Abused credit or excessive available capital from the steroid-driven bond market can lead to oversupply among domestic Big Box chains. In my residential area, located near suburban mall complexes, one after the other, a new Barnes & Noble bookstore is under construction. A perfectly fine Borders is but one quarter mile away. Down the road, a Lowe's home supply center is under construction, only one mile from the handy Home Depot. Small retailers would never exercise such poor business judgment. To be honest, nor would my old Staples.

LOW WAGES

Even as low-priced Asian supplies fill the shelves of many Big Box stores, low-wage jobs fill the payrolls among workers. Executives, managers, and buying agents surely earn sizeable incomes, competitive in the labor market. One significant virtue of the Big Box business model is a large flat organization chart, one which contains few upper-level positions but countless lower posts in sprawling braches more subject to turnover. In some instances, such as Home Depot, floor personnel are granted stock options to augment income. The added sense of wealth and income only comes during the growth years. Some major new age retailers have begun to taper off such heavy growth, and their stocks are not complementing simple wages like they used to.

The rank and file among the Big Box retailers do not hold down professional jobs. Many are only one step above minimum wage, whose pay scales enable the retail chain to keep costs down. Wal-Mart again receives the majority of attention, but the problem is widespread among the entire specialty superstore class. Checkout register attendants, inventory replenishment, delivery, shipping, shelf stocking, these make up the bulk of the jobs in their flat org charts. Staff turnover is a natural cost of doing business within this business model. Low pay and few upper level positions encourage turnover, which is overcome with an ample supply of unskilled workers who require only minimal training. At Staples the floor sales turnover was around 40% annually.

How many jokes do we hear about becoming a Wal-Mart greeter? The Wal-Mart pay scale is often so low, with few if any fringe (health) benefits, that public controversy has erupted in some recent new locations, such as Inglewood in California. They employ many people, and have displaced other small businesses. Their full-time employees sometimes have to go on food stamps if they have a family to support.

CONCLUSION

The Second Economic Myth was endured in the 1990 decade. The myth, promoted as much by Wall Street as by the Fed cheerleader Chairman Greenspan and Treasury Secretary Rubin (author of the Strong Dollar), was that the technology boom, with diverse productivity gains, led to greater corporate profits. Nothing could be further from the truth, as profits went into a great decline from 1985 to 2000. The big beneficiary was the consumer. Nobody can dispute the advances of technology and the change to communications and lifestyle. Where monopolies or near monopolies existed (e.g. Microsoft, Cisco) or niche dominance prevailed (e.g. Amgen, Dell, EBay, Yahoo), colossal profits did flow. The answer to the conundrum is that technology was widely shared, was diversely employed across corporate structures, with backroom information system processing and networking available to all firms. The benefit filtered all the way down to low final product price, as industry supply grew in free markets and efficiency sprouted. The consumer was the ultimate beneficiary. It should be noted that corporate executives profited handsomely from the charade, at least those who sold their companies or sold overvalued stock options. For instance, Mark Cuban (Broadcast.com), Greg McCaw (McCaw Cellular), Geoffrey Winnick (Global Crossing) exited at the top. It is not illegal to sell at a premium price in a frenzied market. It does foment controversy.

The great secret to Wal-Mart success is their advanced information systems to manage replenishment and accounting of inventory. Asian low cost supply chain and low cost labor add to their potential to sell at a profit. Their vast and growing owned mfg base in China completes the picture. They might enjoy another quantum leap in efficiency by utilizing radio frequency (RF) inventory accounting. The great secret to Staples success is their advanced distribution system and new store location model. The mystery is why Staples, Home Depot, Best Buy, Circuit City, and some others are not as harshly criticized for selling Asian-built wares and offering low-paid jobs, just like Wal-Mart. The ChinaMart label applies widely.

What the Big Box retailers have in common is excellent management generally, but also tremendous exploitation of that same shared infotech machinery behind the scenes. Their stock share values grew enormously, not from any mythical hoax, but from real dynamic growth and good execution of a business plan, riding the back of the tech locomotive, exploiting it to the hilt. Their small headquarters produced the great majority of high paying professional jobs. Their stores did not. At one point, Staples employed 2500 people at the suburban Boston HQ, and had a market cap valued at roughly $13 billion. In no way do they as a group engage in intricate product development from design. These stories are all marriages of “dumb tech” with infotech. The Big Box was enabled by awesome progress in information technology to monitor, control, replenish, and analyze inventory and sales of ordinary items. The real irony is that these diverse warehouse superstore retailers benefited far more from the tech miracle than most tech firms themselves!!! The exceptions are the cutting edge innovators like in cell phones or data storage or supply chain software or fiber optics, who established innovative new niches.

NEWS TIDBITS

Google (GOOG), the world's #1 web search provider, said its highly anticipated initial public offering would be worth as much $3.3 billion and could have an initial market cap as high as $36.25 billion, making it an instant internet industry bellwether. Google disclosed that second quarter profits rose 24% from the first quarter. About 24.6 million shares would be sold in the IPO for between $108 and $135 apiece in a Dutch auction, according to an amended SEC filing. Mylan Laboratories, one of the world's biggest makers of generic drugs, has agreed to acquire King Pharmaceuticals in a stock swap worth about $4 billion. Spanish Banco Santander extended a $15 billion offer to acquire British bank Abbey National. Toyota Motor is recalling more than 128 thousand Camry sedans in the United States because of a potential problem with their side air bags. Improper factory assembly could cause incomplete air bag deployment in the event of a crash. Average gasoline prices fell one penny to $1.95 per gallon.

Existing home sales rose 2.1% to a seasonally adjusted annual rate of 6.95 million units in June from an upwardly revised 6.81 million unit pace in May. Freddie Mac said that it sold $2 billion of one-month reference bills due Aug. 24, 2004 at a lowest accepted rate of 1.31%, and $5 billion of three-month reference bills due Oct. 26, 2004 at a 1.552% stop-out rate. California began the new fiscal year without a budget Thursday despite hopes that Gov Schwarzenegger would use his political muscle to negotiate a timely agreement. The proposed $103 billion budget includes no new taxes and would protect key services, but it includes billions of dollars in borrowing and one-time savings that put the tough choices off into the future.

“Bourne Supremacy” (Matt Damon) took the top spot at the box office, with $53.5 million on its debut. Next were “I, Robot” (Will Smith) at $22.1M in its second week, and “Catwoman” (Halle Berry) at $17.2M on its debut.

Lance Armstrong won his unprecedented 6-th consecutive Tour de France bicycle race, a 2000-mile Odyssey, by a margin of over six minutes. Roadside viewers treated him to water, fruit juice, and their own expectorant mucous cocktail. His dominant story joins landmark teams such as the old Boston Celtics (pro basketball) and UCLA Bruins (college basketball), as well as individuals like Michael Jordan, Pete Sampras, Bjorn Borg, Jack Nicklaus, Roger Clemens, and Barry Bonds. He continues to sponsor ads for Bristol Myers Squibb, for the anti-cancer drugs which saved his life. The Miami Dolphins are left stranded at the running back position by the sudden retirement of former Heisman Trophy winner Ricky Williams. Suspected reasons are a desire to exit the public spotlight, to shun fame and the burden of stardom, and removal of drug usage restrictions. He was facing a 4-game pay fine of $600k for a marijuana violation. Two years ago, Miami paid New Orleans two #1 draft picks. Runners Eddie George, Antwan Smith, and Corey Dillon have each settled contracts with new teams. The dreadlocked Williams joins three other notable early retirements from past years, with Jim Brown, Barry Sanders, and Robert Smith. The Red Sox and Yankees enjoyed a baseball donnybrook, as the longhairs fought with the establishment. The fight might be symbolic of the upcoming political convention battles to emerge from their native Boston and New York, to be followed by a campaign climax.

TODAY’S MARKET

Today the Dow Jones Industrials wrapped up at 9962 (-0.3), S&P at 1084 (-2), Nasdaq at 1839 (-10). TENS yield 4.48% (+4.3 bpt). Currencies closed with Euro at 121.31 (+0.44), JYen at 91.17 (+0.14), Can$ at 75.07 (-0.56). Metals finished with gold at 391 (unch), silver at 624.5 (-10.5), copper at 125.00 (+0.20). Energy ended with crude oil at 41.44 (-0.32), natural gas at 599.6 (-19.1), unleaded gasoline at 124.43 (-2.57). Prices are at major futures contracts.

Jim Willie CB

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