What Wal-Mart's latest earnings downgrade means for the retail industry

Earlier this week Wal-Mart, still by far the world's largest retailer by sales if not by market value (it was recently overtaken by Amazon), announced disappointing second quarter results, with operating profit in the US down 8%. The full-year earnings outlook was cut by 7%. Wal-Mart's share price has fallen nearly 5% since the Q2 announcement, taking the year-to-date decline to 20%, compared to Amazon's 66% rise. Aside from currency headwinds and weakness in international markets, the two main factors behind Wal-Mart's falling earnings are higher labour costs, following management's decision to raise wages in February, and greater investment in e-commerce. 

Watch out - these two factors are set to become an increasing issue for all mainstream retailers in the US and Europe.

Donald Trump aside, there is increasing support for higher minimum wages in the US, with Los Angeles having raised its level from $9 in February this year to $20 by 2020 and New York tabling a rise for fast-food workers from $8.75 to $15 by 2018 at the city level and by mid-2021 statewide. In July, the UK's Tory government announced the introduction of a new national living wage of £7.20 an hour, rising to £9 in 2020, compared to the current minimum wage level of £6.50. In Germany too, employers are bracing for real wage hikes after decades of stagnation despite productivity improvements.

Although retailers tend to pay their front-line staff slightly more than the minimum wage, it is very likely there will be a knock-on effect. Higher labour costs will inevitably reduce profits, unless offset by increased productivity. While a pay rise is always appreciated, it is unlikely to be sufficient per se to drive a sufficient increase in sales per employee, especially if companies give in to the temptation to try to increase productivity by cutting labour hours or staff numbers. 

Meanwhile, it is an unfortunate fact of life for many general merchandise retailers and all mainstream grocers that e-commerce adds more incremental cost and complexity than sales. The problem for grocers is exacerbated by dis-economies of scale in order fulfillment, which to avoid congestion above a certain threshold (around 10% of store sales in the UK) has to be moved out of stores to dedicated picking centres. This adds incremental capex and opex and deleverages stores' fixed costs.  

In light of the above, it is time for retailers to think about new ways of improving productivity. The old way - reducing input (people, hours) in the hope of maintaining output (sales) - has reached its limit and will only serve to further narrow any competitive edge mainstream grocers have against limited assortment discounters and the movement online. It is however also possible to increase productivity by raising input so as to drive an even greater rise in sales. The best way to do this in increased investment in training - for proof look only to Wegmans, Trader Joes or Costco.

At Strategic Food Retail we have devised a program to teach all customer-facing staff the basics of how to choose, use and preserve food. This will stimulate, empower and engage staff and customers alike, thus more than justifying higher wages and transforming grocers into value-added service providers instead of resellers of commodities.