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January 25th, 2022

Insight

Walmart is already planning for a post-inflation world

Tara Lachapelle

By Tara Lachapelle Bloomberg View

Published November 29, 2021

Inflation is so 2021. Walmart has already been preparing quietly for the day prices drop so that it can beat rivals to the punch and hold on to all the customers it has gained during the pandemic. Other retailers should take notice.

"We're out there asking suppliers even now, 'Do any of you want to get aggressive and swim upstream and take prices down - while prices are going up - to gain share?'" John Furner, the head of Walmart's U.S. business, said on the company's third-quarter earnings call Tuesday morning. In the meantime, the retailer's traffic has benefited from not passing along all of its higher supply-chain costs to customers, said Walmart Chief Executive Officer Doug McMillon. He added: "And in a deflationary environment we can lead down. We can take advantage of both situations."

That forward-looking stance seemed to throw off investors. Shares of Walmart slid about 3% after the earnings report, even though it led with mostly good news. Same-store sales for the U.S. Walmart chain easily beat analysts' average forecast, climbing 9.2%, excluding fuel sales, in the 13 weeks ended Oct. 29, compared with figures in the period a year earlier. But shareholders zeroed in on the 12 basis point decrease in gross margin, a measure of a company's pricing power. That's a shortsighted way to look at how Walmart is navigating this period of higher costs.

"Our cost inflation is higher than our retail inflation, and that's what we would want," McMillon said. "We would care a little bit less about how the gross margin and [selling, general and administrative expenses] balance out as we would what the net looks like."

It might feel a bit early to even mention deflation - almost no other consumer-facing businesses did this earnings season, instead emphasizing their ability to keep raising prices to maintain profit margins. And certainly Walmart isn't about to bring back its catchy "rolling rolling rolling" commercial from the 1990s, when a cowboy-hat-wearing smiley face bounced around the store cracking a whip at price tags.

Walmart's results also echoed Commerce Department data showing that U.S. retail sales rose in October for a third consecutive month, more evidence that spending is holding up in the face of the fastest consumer price increases in 30 years.

But rather than look at this moment in a vacuum, McMillon and Furner are thinking ahead to how price decisions can affect loyalty to Walmart down the road and how it can capitalize on competitors' missteps. Walmart's "everyday low cost" sales pitch is so foundational to the brand that it shorthands the phrase to EDLC in its filings.

Even so, it could join the crowd in juicing its gross margin if it wanted to. The larger concern is that as consumer sentiment drops and inflation erodes wage gains, companies risk being too cavalier about raising prices just to avoid a few quarters of earnings pressure. It might not be worth it.

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Investors are also underestimating how the new Walmart+ subscription might factor into this strategy. They're skeptical, given that Walmart hasn't disclosed how many people have signed up for its $98-a-year version of Amazon.com Inc.'s Prime shipping perks. That said, one of the biggest benefits of Walmart+ may take some time to play out: luring customers who wouldn't otherwise go to its stores and slowly shifting some of their spending from Amazon to Walmart.

While Walmart is known as a discounter, it has an opportunity to draw shoppers with more disposable income through convenience and store avoidance. The reputation of Walmart stores varies by state. In some areas, they are clean and sprawling megastores. In parts of the Northeast, though, they can be rundown and uninviting. Walmart+ gives households that want to avoid its crowded locations the chance to still take advantage of its prices. And to anyone who's ever been sent a fraudulent or defective personal-care item from Amazon, there's an added appeal to use Walmart for grocery orders.

The slightly shrunken gross margin that Walmart reported is a blip that will be forgotten a year from now. But by then, its careful price considerations could start to look quite shrewd.

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Tara Lachapelle is a Bloomberg Opinion columnist covering the business of entertainment and telecommunications, as well as broader deals.

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