The Supply Side: Analysts assess Wal-Mart supplier contract changes

There is potentially a $7 billion reason execs with Wal-Mart are leaning on their 10,000 suppliers with tighter price negotiations and payment terms tied to sale rates.

Wal-Mart began in June to notify suppliers of contract changes. Some of the changes include extended payment terms on items that don’t sell quickly, Wal-Mart getting an additional 1% cash discount for paying early, and Wal-Mart charging suppliers a handling fee for products that go through the retailer’s distribution centers.

Budd Bugatch, a retail analyst for Raymond James & Associates, researched Wal-Mart’s history of inventory and payables. His work finds Wal-Mart’s payables percentage to inventory grew steadily during the first 10 years of this century, peaking at 93% in fiscal 2010. That ratio has since retreated to a mid-80% level, he said. 

“Net owned inventory now is nearly $7 billion, which is the amount of capital that would be unlocked if payables were equal to inventory,” Bugatch said. 

THE INVENTORY ISSUE
He said the unrealized profit center is at the heart of Wal-Mart’s recent communication with its suppliers, especially in requesting payment terms that reflect the sales rate of the merchandise. Bugatch said Wal-Mart’s size – 11,000 stores around the globe, serving 245 million customers weekly – entitles the retailer the expectation of getting the lowest possible prices from suppliers that also invest in inventory capital. To support this position, Bugatch and his research team also assessed the year-over-year growth rates for ending inventory and fiscal year sales at Wal-Mart.

“For as long as we can remember, Walmart’s leadership voiced the goal of growing inventory at half (and at sometimes at less than half) of the growth in sales. During the last 15 years, the company met its annual goal only five times. Over that time, sales grew from $165 billion to $482 billion (compound annual growth rate of 7.4%), and reported inventories grew from just less than $20 billion at the end of fiscal
2000 to $45 billion (compound annual growth rate of 5.7%) at the end of FY15.”

Accordingly, Wal-Mart’s executive management has acknowledged that despite the progress in fiscal 2015 and so far in fiscal 2016, “working capital is still an opportunity for us to generate stronger free cash flow.” Bugatch also found that if Wal-Mart had achieved its inventory growth rate at 50% of sales, they could have reaped nearly $11 billion in lower inventory costs in fiscal 2015 alone.

“Combining the impact of matching payables to days of inventory on hand with the goal of ultimately reaching and keeping inventory growth at 50% of sales growth, we peg the visible capital recoupment opportunity, conservatively we would argue, at $10-$15 billion,” he said.

WAL-MART RESPONSE
Wal-Mart’s explanation of the changing payment terms with its suppliers were characterized as part of Sam’s Walton’s founding goal of operating at the lowest possible cost in order to save customers money — the business model used by the retailer for more than 50 years.

“We are getting back to a place where we focused on ‘everyday low cost’ and ‘everyday low price’ in an effort to best serve our customers,” said Deisha Barnett, corporate spokeswoman for Walmart U.S.

“Walmart’s business model is simple – operate at everyday low costs to provide customers with everyday low prices. It was Sam Walton’s plan more than 50 years ago, and it’s the plan for our company today. Operating under this model affects all we do at Walmart, including how we negotiate with our suppliers, how we advertise and how we go to market with price,” Barnett told The City Wire in June.

OUTSIDE OPINIONS
Carol Spieckerman, CEO of Spieckerman Retail, also supported the retailer’s contract changes.

“Most of the suppliers I work with consider Walmart to be their cleanest business, devoid of the games and punitive practices that plague their other retail relationships,” Spieckerman recently told The City Wire.

She characterized the requested contract changes as a modest discount move and said suppliers will still find Wal-Mart easier to do business with than other retailers.

“These types of charges certainly aren't unprecedented in retail yet no doubt many will portray Walmart's ask as a slippery slope that runs counter to its everyday low price proposition. In reality, Walmart is cleaning up its policies and applying them more uniformly across its supplier base,” Spieckerman said.

Other retail experts say Wal-Mart’s tech spending and the $1 billion investment in store worker wages announced earlier this year are the primary reasons Wal-Mart is amending contract terms.

“Honestly the increase in pay will eventually just go toward the cost of goods because suppliers will have to address the impact to their bottom line. It will be a challenge to absorb for many. Cash is king and the flow must be in sync with agreements that were already in place before this change,” said Jami Dennis, a local supplier consultant.

A WEIGHTED PARTNERSHIP
The July 1 response date imposed by Wal-Mart has now long passed and market watchers believe that not all of the estimated 10,000 suppliers have willingly agreed to the new terms.

“No supplier will happily accept less payment and/or longer payment terms so we suspect there has been a significant number and level of prolonged discussions between suppliers, their merchandising counterpart and Walmart’s supplier administration including senior leadership,” Bugatch noted.

He also said Wal-Mart and its suppliers have a somewhat unequally weighted partnership.

“Wal-Mart is clearly the senior partner,” he said.

He said many suppliers also had their 2015 budgets in place when the changes were requested, noting that such amendments could threaten compensation and bonuses, which is likely why the press was tipped off to what is normally non-public information. However, Bugatch and his team agree with Wal-Mart’s two specific goals at the heart of the contract changes with its suppliers.
• Returning to its legacy practice for invoice allowances for new stores, new distribution centers and for products that get to stores using Wal-Mart’s internal supply chain.

• Creating a program to match payment terms for each individual sales rates. 

He said perhaps a more subtle result of the new requirements is suppliers will be somewhat more sensitive to selling Wal-Mart products that will sell faster, and not keep product in the the Wal-Mart distribution centers and stores that do not have more rapid rates of sale. For instance, if days-on-hand inventory drop, then when the next round of negotiations takes place, a specific supplier may have a stronger case for expecting faster payment. 

Likewise, Bugatch said if days-on-hand inventory drop, the stores become less cluttered, shrink (product loss) likely falls, and store employees’ time facing customers may rise. All of these would be welcome developments based on the urgent items being addressed by Walmart U.S. CEO Greg Foran.