Wal-Mart and Economies of Density

Today’s a-ha moment is brought to us by Thomas J. Holmes, professor of economics at the University of Minnesota. In an interview about his paper “The Diffusion of Wal-Mart and Economies of Density,“ he says:

Holmes: Briefly, Wal-Mart has an incentive to keep its stores close to each other so it can economize on shipping. For example, to make this simple, just think about a delivery truck: If Wal-Mart stores are relatively close together, one truck can make numerous shipments; however, if the stores are spread out, you wouldn’t have that benefit. So, I think that the main thing Wal-Mart is getting by having a dense network of stores is to facilitate the logistics of deliveries.

There are other benefits, too. Opening new stores near existing stores makes it easier to transfer experienced managers and other personnel to the new stores. The company routinely emphasizes the importance of instilling in its workers the “Wal-Mart culture.” It would be hard to do this from scratch, opening up a new store 500 miles from any existing stores....

For the sake of this discussion, let’s say that Wal-Mart’s most desirable location, or “sweet spot,” when it was starting its business was a town the size of 20,000. One strategy Wal-Mart could have pursued would have been to go around the country opening stores in its sweet spot locations and then later go back and “fill in” less desirable locations. With this alternate strategy, the first store in Minnesota would have opened a lot sooner than it actually did, as there certainly are locations in Minnesota right in Wal-Mart’s sweet spot. But with this strategy, stores would initially have been much more spread out. Wal-Mart would have lost the gains from having a dense network of stores.

Instead, Wal-Mart waited to get to the plum locations until it could build out its store network to reach them. It never gave up on density.

[Interviewer]: And when you see what it’s done, with the benefit of hindsight, it seems like the right thing to do, almost the obvious thing to do. But that would suggest that other retailers would have also recognized the benefits of density and should have engaged in the same behavior. Did Wal-Mart invent, if you will, this retailing idea?

Holmes: It is useful to contrast Wal-Mart with Kmart, as both opened their first stores in 1962. Wal-Mart, from the very beginning, was different from Kmart. Wal-Mart built up its store network gradually from the center out; Kmart (and Target, for that matter) began by scattering stores all over the country. Early on, Wal-Mart focused on logistics, with things like daily deliveries from its distribution centers, early adoption of advanced communication technology and so forth. Kmart did not do these things. A customer going into these two stores might not be able to see much of a difference between the two stores. But underneath, in the way that merchandise was getting on the shelves, these stores were very different.

And for a visual kicker, see this 26-second video, plotting the locations of Wal-Mart stores from 1962 to 2004.

[I found the references to the interview and video at Marginal Revolution. There are working versions of Holmes’ paper online, but since the URLs have a non-permanent feel about them, I suggest you just search for the paper’s title in your favorite search engine.]

GM Gets Shifty With Numbers

General Motors (GM) gets shifty with numbers in a recent print ad titled “Change is in the air.” I saw it on page 53 of The Economist magazine’s U.S. edition dated May 13-19, 2006.

The ad begins:

We’re changing a lot of things at GM these days. Even people’s minds. Take the environment. Today we lead the industry in the number of models that get an EPA estimated 30 mpg or better on the highway. More than Toyota or Honda.

The ad does not mention that GM also leads the industry in the number of models that get an EPA estimated 29 miles per gallon or less. What? It turns out GM can win either side of this issue because GM has significantly more models than any other car company. In other words, “We have the most models above 30 mpg! We have the most models below 30 mpg! How? Because we have, by far, the most models!”

To make a more meaningful comparison, let’s look at the percentage of each car company’s models that get 30 mpg or better on the highway. Using the Environmental Protection Agency’s data for model-year 2006 cars, we find that 14.1% of GM’s models get 30 miles per gallon or better on the highway. That’s less than half the 30-mpg+ percentage of either Toyota (36.7%) or Honda (36.4%). It’s also less than the average 30-mpg+ percentage across all car models in the database (17.3%).

Thus, GM’s “leadership” doesn’t look so good from this, more meaningful angle. (For those who remember the Arizona State University ad that claimed superiority over Stanford and several Ivy League schools in the number of freshmen who were top-10% high schoolers, this GM ad is abusing numbers in a similar way.)

For the record, below is a ranking of car brands by the percentage of models that get 30 mpg or better on the highway. You can create this analysis from the 2006 EPA data file using an Excel PivotTable. The original data represents each GM brand separately, but I have added a line at the end that totals the GM brands listed in the ad (Buick, Cadillac, Chevrolet, GMC, Hummer, Pontiac, Saab, and Saturn).

Rosum: A Down-to-Earth Version of GPS

At a recent event, I met someone from Rosum, a company with a new twist on Global Positioning System (GPS) technology. I know nothing about the company’s business outlook, but their technology is a great example of elegant design.

A little background: GPS is the satellite system that allows a receiver to pinpoint his or her position anywhere on Earth. The receiver locates itself by knowing the position of at least three satellites and the time it takes a signal to reach the receiver from each satellite. This page’s section on “2-D Trilateration” has a good explanation of the general concept, which is easier to understand as a two-dimensional example than the GPS system’s 3D version.

GPS works best when a relatively unobstructed path exists from the receiver to the satellites. Thus, reception in areas with hills or high buildings can be problematic, as is reception inside buildings.

Rosum’s plan is to run a GPS-like system using over-the-air television signals, from television broadcast towers. I like the plan because of its elegance at multiple levels:

• There are already enough broadcast towers around most urban areas, saving a huge amount of time and money that would otherwise go to creating infrastructure.
• Television signals already include precise synchronization information, which is important for enabling the trilateration.
• Compared to GPS signals, over-the-air television signals are higher-power and lower-frequency, both of which improve reception indoors and amid uneven terrain.
• Television towers don’t move, as satellites do; over-the-air television signals’ relatively short path to the receiver are subject to less distortion than satellite signals from space. These factors reduce system complexity.

Of course, Rosum’s “GPS-TV” concept has its own challenges—the company has been around since 2000 working on them. But, like hearing glasses, this is one of those ideas that deserves mention just for its cleverness.

The company plans to make money from a variety of applications, which you can view here. The technology is currently in field testing.

Dave Ibsen, Webby Winner

Congratulations to my friend Dave Ibsen, whose 5 Blogs Before Lunch won “Best Business Blog” in the 2006 Webby awards.

Dave’s blog primarily covers marketing, advertising, and branding topics. It’s a companion to his consulting practice, which I recommend to those in need of technology- or consumer-marketing insight.

Given who else won Webby awards this year, Dave seems to be in good company.

Ormerod’s Why Most Things Fail and Schelling’s Segregation Models

I recently read Paul Ormerod’s Why Most Things Fail. Focusing on the frequent failure of companies and government policies, Ormerod argues that the environment in which these entities exist is so complex and unpredictable that even the best laid plans cannot reflect what will really happen. Between this complexity and the competition of many players’ laying plans, the ones that succeed often get there by luck. And once successful, the only viable strategy for long-term survival is constant adaptation via trial and error.

For a review of the book, I’ll just agree with this Financial Times review’s mixed bag of praise and criticism. However, I will highlight one of the book’s better examples.

Economist Thomas Schelling created a model of how racial segregation happens. First, he posited a large grid, like a chessboard but much larger. Each square either has a red person’s house, a green person’s house, or nothing. A person will move if a certain number of his immediate surrounding neighbors are a different color—the number is fixed across all people, representing a societal level of tolerance for different-race neighbors.

It’s a complex system because a single person’s move can have cascading effects on the former and new neighbors, which in turn can have cascading effects. Thus, the results are not obvious from the initial conditions.

Northwestern University has a Schelling-inspired segregation simulator, where I generated this before-and-after combination.

Those familiar with cellular automata (CA) may have already expected that the few rules would give rise to order from randomness, but the nature of the order is surprising. For my model, I assumed that each person wanted at least 40% of neighbors to be the same race, yet the system ended up 85% segregated. Due to the system’s interconnections, the relatively weak individual preferences, upon interaction, led to a strongly segregated society, a result typical of Schelling segregation models.

This type of result—where a societal outcome emerges nonlinearly from complex interactions—is what Ormerod sees everywhere, albiet in yet more complex form than this model.

And finally, if you’re thinking that the Schelling model has its own kind of predictability, it does at an aggregate level. Ormerod does not give this point enough weight with regard to Schelling’s work, but elsewhere in the book he describes how company failures are predictable in the aggregate by a power law distribution similar to that of biological species extinctions. However, these high-level patterns won’t tell us when particular companies will fail or, in a real-world city, which people will move exactly where.

Back to the Land: Earthbound Farm Tours

If you have an organic farm, you can skip this. Everyone else, if you want an interesting perspective shift, take a tour at Earthbound Farms’ Farm Stand in Carmel Valley, California.

It’s a chance to see your food from the point of earthly production. You get a tour of the fields, including the ability to fill a basket with whatever you want to pick.

Being in the clear air, amid the literal cornucopia of vegetables and herbs—it’s a good way to reconnect with some fundamental things.

Although the Farm Stand is open daily, farm tours only happen on a handful of Saturdays each year. On the Farm Stand’s calendar of events, look for the days/times with either a Farm Walk or Chef’s Walk.

[The picture is from Earthbound Farms, taken at the Farm Stand.]