Public Sector Procurement and the Walmart Effect

UPDATE March 4th, 2013: According to an article in FCW, President Barack Obama is slated Monday morning to tap Walmart Foundation President Sylvia Mathews Burwell as the next head of the Office of Budget and Management. Reuters first reported the news, citing sources familiar with the issues.

Given Walmart’s history in terms of “dealing” with suppliers, one can only hope that Burwell doesn’t bring a Similar mindset to the Office of Budget and Management.  The following July 2007 post reminds us why suppliers might want to take notice.

In Part 4 of my Changing Face of Procurement conference series titled Winning Strategies for Vendor Engagement I ask attendees the question; “is your current e-procurement initiative a threat or a benefit to your supply base?”

While the answer is of course important, what is of greater significance is whether or not your organization has even considered the impact its current strategy is having on these important external stakeholders.

An important question worth asking!

In June 2005 I had the opportunity to address 200 senior executives from the supply side of the automotive industry.  Even though the focus was on reverse auctions, when I asked for feedback in terms of how they as suppliers felt about the tool’s increasing utilization by their customers, the responses quickly extended to e-procurement technology in general.

While I expected that there would be a degree of resistance to the introduction of technology into the procurement process, I did not expect the level of anti-technology to be so intense and wide spread.  Approximately 95% of all company representatives were not just against technology, they believed that it represented a serious and direct threat to the financial health of their organizations.

This position was accentuated by comments ranging from “the product is commoditized under an e-procurement program . . . we will do everything to resist participating,” to “we spend too much time working on RFQ’s . . . the RFQ process chews up dollars and time for something that is going to bring us no return.”  One executive went so far as to suggest that they should “charge the customer (RFQ issuer) to respond to a request.”

Given this feedback, I could not help but wonder if the expressed supplier sentiment was truly known and fully understood by the buying-side of the market.  For the balance of 2005 and well into 2006 I made a point of researching this subject in greater detail which included soliciting feedback from Changing Face conference attendees.

The results of this exercise was surprising in that the level of supplier resistance was only surpassed by the paucity of buying organizations that even questioned trading partner satisfaction let alone quantify its degree.  In short, you have two individual stakeholders who instead of coming together are heading in diametrically opposite directions.  (This is one of the main reasons that the recent ISM, CAPS and AT Kearney report’s position that “technology is the key in the supply chain organization of the future” is troubling.)

If we have learned anything from past challenges it is that technology no matter how advanced or heralded, in and of itself has little impact on the ultimate success of an e-procurement initiative.

The automotive industry’s failed Covisint program should be a shining beacon to all regarding the veracity of the above statement.  Think about it for a moment.  With Covisint, you had a consortium of automotive industry heavyweights such as Ford, General Motors, DaimlerChrysler and Nissan team-up with software vendor CommerceOne in 2000 to create an online marketplace involving more than 800,000 suppliers and billions of dollars in overall spend.

Even with what many still consider to be one of the greatest examples of collaborative industry expertise (which was backed by seemingly unlimited funding and immeasurable buying clout), could not prevent the Covisint program from being abandoned as an outright failure in 2003.  While buyer resistance cannot be discounted as an important contributing factor, it was ultimately the unwillingness on the part of suppliers to participate that the decisive blow was dealt.

Public Sector Omnipotence

Even though it is essential for all organizations in both the private and public sectors to monitor and gauge the mindset of their supply base on a regular basis, I am going to focus on the public sector.  The reason for this is that public sector organizations are more widely perceived by suppliers as sharing the same aura of “omnipotence” as the Covisint consortium (at least at the State, Provincial and Federal levels).  Specifically, we are big, we have money, and we buy a lot!  Add into the equation the demands for greater spend transparency, and heightened political sensitivities that frequently manifests itself in the form of conspicuous front page stories, and the importance of effective supplier engagement is magnified exponentially.

And since there is no longer a Covisint from which we can draw a current day comparison, I thought that I would make use of my research on another behemoth . . . Wal-Mart and select that organization as the parallel case study for this posting.

The Walmart Effect and public sector procurement practice?

In his book of the same name, Charles Fishman asks and answers the questions; what is Walmart doing for America?  What is Walmart doing to America?

And while his assertion that “Walmart is now so large, it has created its own business ecosystem,” makes for interesting reading, I wanted to limit my scope of interest to supplier impact.  Combined with research material from other sources, I think that you will find the parallels with public sector procurement interesting, if not worthy of further serious discussion.

To begin, multiple sources indicated that Walmart suppliers are in a Catch 22 situation in which their choices are limited to: 

1. Selling their products to Walmart at a below profit level
2. Reducing the quality of their products, or
3. Employ people to manufacture Walmart products at poverty levels resulting in jobs lost to those overseas

Through a variety of engagements (including my position as chair of the 2006 Summit Roundtable on Federal Government procurement practices), I found that the majority of suppliers (especially within the SME community) actually share similar challenges, albeit confined to point 1 and to a lesser degree point 2 of the above referenced 3 choices.

What is worth noting from a foreign competition standpoint, especially taking into account currency strength at a given time, is how public sector procurement policy either stimulates or inhibits domestic supplier participation.  I will cover this in more detail in an upcoming post titled The Two Faces of Competition Advocacy in Public Sector Procurement Practice.  However it is worth noting that while I am not talking about offshore, low paying manufacturing jobs, given that we are living in an expanding period of globalization, the impact of foreign organizations competing for domestic public sector contracts has to be considered.

When Winning Means Losing!

Since the question of profitability is the most pressing for public sector suppliers, I wanted to pull comparative statistics from our Walmart case study.

One study reported that those companies “that sell more than a quarter of their product to Walmart generate half the profit made by those companies who have smaller or non-existent business relationships with the Arkansas giant.”

This prompted Walter Todd, a money manager at Greenwood Capital Management to make the ominous statement that “Walmart can be your best customer and your most difficult one at once.”

As a means of verifying the above findings, I referenced a study by Forbes.com in which they analyzed 2006 Sales Revenue across multiple industry sectors in an effort to determine the impact of a Walmart relationship on gross margins.  Here are the findings, which were posted under the heading Double-digit sales a red flag!

(Note: the survey involved 333 companies in six industry sectors that “sell heavily” to discounters and other retailers.  The six industry sectors represented were; apparel and accessories, consumer games and electronics, food and beverage, household accessories, personal care and leisure goods.)

Ø      On balance, firms that derive less than 10% of their sales through Walmart averaged 39.1% in gross margin, the percentage of profit realized before items such as fixed costs and interest expense are considered. For those falling between 10% and 20%, gross margin was 36.2%. Above 20%, and margin dipped a little bit more, to 35.4%.

Ø      This trend is most pronounced in the apparel-and-accessories category, where average gross margin drops from 48.7% for companies generating less than 10% of sales through Walmart to 28.7% for those selling 20% or more.  Food and beverage also shows a big disparity, where the same breakdown shows average gross margins dropping from 39% to 22%.

Ø      In all, only 25 of 333 companies managed to beat their sector gross-margin average while generating at least 10% of their revenue through Walmart.  Only 7 that sold more than 20% there did it.

Ø      The numbers show that company size has little to do with Walmart dependency at least once you get past the top handful.  The 10 companies that sell through Walmart in the highest percentages, a list that includes apparel maker Jaclyn and personal-care company CCA Industries average a relatively paltry $107 million in market cap (CCA is the only top 10 member whose gross margins beat its sector average).  Past the top 10 companies that generate at least 10% of their sales through Walmart carry an average market cap of $5.9 billion, more than the $4.9 billion average of those firms that sell less than 10% there.

Ø      While Walmart squeezes margins of suppliers of all sizes, it’s still true that smaller companies tend to feel a tighter pinch.  For example, beverage company Cott, even with a market cap in excess of $1.2 billion doesn’t have the brand strength of Coca-Cola or PepsiCo, whose products are in more demand at supermarkets, convenience stores and other outlets.  So Cott, whose primary business is producing and distributing company-brand carbonated soft drinks, turns to Walmart for 38% of its sales, compared with less than 10% for the two beverage titans.  The result?  Cott’s gross margin of 12.4% last year was about a third of the industry average, while Coke and Pepsi both registered more than 50%.

Interesting numbers, especially when you take into account the impact on smaller companies.  The Forbes report went on to say that even blue chip corporations are not exempt from repercussions in terms of “double digit” sales to Walmart suggesting that it raises a “red flag” with investors.

The above data should prompt a review of policy to determine if current procurement practices are having the same impact on public sector suppliers.  If suppliers (especially from the SME or Minority-Owned Business community) are being adversely affected, the consequences for both buyer and seller will be dire starting with a serious erosion of the overall supply base.  (Note: supply base erosion may already be a significant problem with most public sector organizations in that their number of “active” suppliers may represent only a small percentage of the overall potential supply base.  This can lead to creeping margins and a drop in the level of the quality of deliverables.)

The Vlasic Pickles Story

An article from Fast Company recounted what they referred to as the “sad story of Vlasic Pickles.”  Here are excerpts from that article.

“Young remembers begging Walmart for relief. “They said, ‘No way,’ ” says Young. “We said we’ll increase the price”–even $3.49 would have helped tremendously–“and they said, ‘If you do that, all the other products of yours we buy, we’ll stop buying.’ It was a clear threat.” Hunn recalls things a little differently, if just as ominously: “They said, ‘We want the $2.97 gallon of pickles. If you don’t do it, we’ll see if someone else might.’ I knew our competitors were saying to Walmart, ‘We’ll do the $2.97 gallons if you give us your other business.’ ” Walmart’s business was so indispensable to Vlasic, and the gallon so central to the Walmart relationship, that decisions about the future of the gallon were made at the CEO level.”

“The story is that Vlasic, a premium pickle brand, agreed to sell a gallon jar of pickles in Walmart for an absurdly cheap price. What happened is fairly predictable. Why would consumers buy a small jar for $3.00 when they could get a gallon for the same price? Yet the margin on the gallon jar was incredibly thin, so despite the increased volumes, the pickle maker took in less and less, especially when you factor in Walmart’s insistence (stated up front) that suppliers lower their prices each year.”

“Finally, Walmart let Vlasic up for air. “The Walmart guy’s response was classic,” Young recalls. “He said, ‘Well, we’ve done to pickles what we did to orange juice. We’ve killed it. We can back off.’ “Vlasic got to take it down to just over half a gallon of pickles, for $2.79. Not long after that, in January 2001, Vlasic filed for bankruptcy.”

My findings do not indicate (at least at this stage) that there are a disproportionate number of bankruptcies amongst suppliers whose business with public sector organizations exceed a certain dollar level.  However, it is an outward manifestation of a solipsistic purchasing strategy that fails to recognize and therefore understand the diverse needs of its key stakeholders.

Will negative procurement practices come full circle?

I want to emphasize that I am not suggesting that public sector procurement practice is generally flawed or inherently mean-spirited.  What I am saying is that the majority of public sector organizations has not effectively measured the impact of their strategy on their supply base and therefore do not have the necessary data to assess policy one way or the other.

Unfortunately an absence of understanding is no different than a predatory purchasing practice in that the end results will be for all intents and purposes the same.

One of the countless papers I have read asked a simple question, how great is the business risk to Walmart as a result of this negative publicity?  Even more importantly, is it too late for them to turn things around?  While a recent McKinsey study found that between 2 and 8% of consumers have “stopped pushing a Walmart cart because of the company’s practices,” there is little faith in the numbers as “consumers voting with their credit cards” do not have a favorable history in terms of influencing change.  However the article did go on to say that it doesn’t take much to “put a real blockage” on Walmart’s revenue stream, and that a tangible risk exists in a gradual erosion of shopping frequency.  Given Walmart’s razor-thin margins coupled with high “Wall Street demands,” many pundits believe that their procurement practices could prove devastating to the company both now and in the long run.

Walmart’s share price by the way is lower than at many points over the previous 5 year period (although growth and sales figures do remain strong).