Sunday, May 28, 2006

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.]

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