SCDigest editorial staff

The News: The research analysts at Bank of America’s Equity Research group say the focus on Wal-Mart’s Remix program and the short-term hit to sales at some consumer goods companies isn’t the whole story. Changes in SKU counts and global sourcing also present long-term sales risk.

The Impact: While consumer goods companies digest the impact to sales right now from decelerating inventory levels at Wal-Mart and some other retailers, they need also to look at other changes that could have more permanent impact.

The Story: As Supply Chain Digest has noted, a number of consumer goods companies and even some transportation carriers have cited inventory cutbacks at Wal-Mart as impacting Q1 2006 sales and profit levels, and projects for the remainder of the year.

Many have seen this as having only a short-term impact, as there is a one-time inventory “reset” to a different level of inventory versus sales, after which sales to Wal-Mart will return to normal levels, albeit with some different order patterns. Analysis from Bank of America, however, shows there are other dynamics to worry about.

The changes at Wal-Mart reflect its goal to reduce the growth of its inventory versus its sales growth. In recent years, as illustrated in the BOA chart below, inventory levels have surged above historic ratios, which for many years was as low as 50% inventory growth.

Source: Bank of America Equity Research Report

Wal-Mart has said it wants to reduce its inventory growth going forward to half its sales growth. It will do that in part through the Remix program, which will speed the flow of high volume products to store shelves, with more frequent ordering and delivery. Wal-Mart has not confirmed other reports that it wants to take down its current levels of inventory to about $6 billion, or 20% of its average recent levels.

But the BOA report notes Wal-Mart’s inventory program is broader than just Remix and the short-term slow down in sales by consumer companies as inventories adjust to new levels. Two related initiatives can have a more serious and longer term impact on Wal-Mart suppliers:

• A reduction/rationalization of the overall SKU count, which will impact some vendors, especially smaller ones.
• Wal-Mart’s goal of tripling its offshore sourcing/private label, which will eat into sales of current branded supplier products.

The BOA analysts state that “we believe the market is focused on the one-time reset and not the broader implications to shelf-space due to SKU rationalization and increased private label penetration. Extent of impact is unclear, but directionally, companies dominated by number 1 and number 2 brands with positive share trajectory and little impact from private label (e.g. Procter & Gamble) should feel the least impact, while companies with some exposure to tertiary brands that are losing share have the most to lose.”

SKU Rationalization

The report says that Wal-Mart is taking a SKU by SKU approach to see understand the productivity of items and inventory. It notes that Wal-Mart’s continued aggressiveness in private labeling changes the dynamics, as SKUs are not only measured on their own merits but again potential replacement by a private labeled items.

The report says that the most risk for suppliers in naturally for “tertiary, underperforming brands.”

While those companies, brands and individual SKUs may well shelf space and sales, it could be great news for the leading companies and brands. Those that remain should gain shelf space and share of the spend at Wal-Mart, and potentially benefit from improved overall sales at Wal-Mart.

“The customer will notice a cleaner store that is easier to navigate, the company will be able to add new product lines as well as new categories to the mix, all of which should help top line sales,” the report states.

Private Label Growth

The growth of private label brands at Wal-Mart can impact many more suppliers, it appears.

The report says that Wal-Mart intends to triple its level of global sourcing in the next few years, which the authors estimate will double it current level of 10% of all cost of goods sold being sourced internationally to 20% in 3-5 years.

The reports notes that “We believe that as Wal-Mart looks more closely at private label and opportunities to increase margin from that strategy, they are able to uptick the pressure on the current vendor base. Of course in this instance, not all vendors are created equal,” in terms of their importance to Wal-Mart and consumer preference.

Still, it seems inevitable that tripling its direct sourcing levels will impact some significant numbers of current suppliers. The report cites the specific example of a rumored Wal-Mart private label entry into the “organic foods” category as potentially having a big impact on some food company providers, as growing  market demand for organics may be filled directly by Wal-Mart and not its traditional food-related vendors.

Silver Lining

As noted above, Wal-Mart’s Remix and SKU rationalization programs should actually drive increased sales for leading brands.

The report also notes that “on the positive side, we also believe that Wal-Mart and vendors believe that this could be a way for Wal-Mart to reduce out of stocks due to more frequent delivery. Vendors, Procter & Gamble for example (and others) are hoping this could ultimately drive better sales through the Wal-Mart channel, especially for impulse purchase via better in stocks. It also likely speeds innovation to shelf and reduces costs of damaged goods and obsolescence.”

But part of all this may involve pushing inventory holding costs and maybe increased transportation costs back on suppliers. How will that shake out in terms of cost and pricing?

“Both WMT and the vendors should in theory benefit from Wal-Mart’s improved asset productivity in the form of higher sales or increased orders,” the report states. “But if Wal-Mart is switching to smaller but more frequent shipments, and forcing more inventory ownership to the vendors, will Wal-Mart eventually have to accept price increases from the vendors? This is another question we look to explore as these initiatives unfold.”

What do you think the risks are for Wal-Mart suppliers in its changing inventory and sourcing strategies? Should suppliers look at this as a good thing or not? Will this all work as Wal-Mart intends? Let us know your thoughts.