Bigger is not always better why Amazon is worth more than Walmart


This week an important event happened on Wall Street. The value of Amazon (about $248 billion) exceeded the value of Walmart (about $233 billion). Given that Walmart is the world's largest retailer, it is pretty amazing that a company launched as an online book seller by a former banker only 21 years ago could now exceed what has long been retailing's juggernaut.

WalMart redefined retail. Prior to Sam Walton's dynasty, retailing was an industry of department stores and independent retailers. Retailing was a lot of small operators, primarily highly regional. Most retailers specialised, and shoppers would visit several stores to obtain things they needed.


But WalMart changed that. Sam Walton had a vision of consolidating products into larger stores, and opening these larger stores in every town across America. He set out to create scale advantages in purchasing everything from goods for resale to materials for store construction. And with those advantages he offered customers lower prices, to lure them away from the small retailers they formerly visited.

And customers were lured. Today there are very few independent retailers. WalMart has about $488 billion in annual revenues. That is more than four times the size of #2 in USA CostCo, or #1 in France (#3 in world) Carrefour, or #1 in Germany (#4 in world) Schwarz, or #1 in U.K. (#5 in world) Tesco. Walmart directly employes about five per cent of the entire US population (about one in every 200 people work for Walmart). It is a given that nobody living in America is unaware of Walmart, and very, very few have never shopped there.

But, Walmart has stopped growing. Since 2011, its revenues have grown unevenly, and on average less than four per cent a year. Worse, it's profits have grown only one per cent/year. Walmart generates about $220,000 in revenue per employee, while Costco achieves about $595,000. Thus, it need to keep wages and benefits low, and chronically hammer on suppliers for lower prices as it strives to improve margins.


Worse, the market is shifting away from WalMart's huge, plentiful stores toward online shopping. This could have devastating consequences for WalMart, due to what economists call "marginal economics".

As a retailer, Walmart spends 75 cents out of every $1 revenue on the stuff it sells (cost of goods sold) That leaves it a gross margin of 25 cents – or 25 per cent. But, all those stores, distribution centers and trucks create a huge fixed cost, representing 20 per cent of revenue. Thus, the net profit margin before taxes is a mere five per cent (Walmart today makes about five cents on every $1 revenue)

But, as sales go from brick-and-mortar to online, this threatens that revenue base. At Sears, for example, revenues per store have been declining for over four years. Suppose that starts to happen at Walmart- a slow decline in revenues. If revenues drop by 10 per cent then every $100 of revenue shrinks to $90. And the gross margin (25 per cent) declines to $22.50. But those pesky store costs remain stubbornly fixed at $20. Now profits to $2.50 – a 50 per cent decline from what they were before.


A relatively small decline in revenue (10 per cent) has a 5x impact on the bottom line (50 per cent decline) The "marginal revenue", is that last 10 per cent. What the company achieves "on the margin." It has enormous impact on profits. And now you know why retailers are open seven days a week, and 18 to 24 hours per day. They all desperately want those last few "marginal revenues" because they are what makes – or breaks "their profitability.

All those scale advantages Sam Walton created go into reverse if revenues decline. Now the big centralised purchasing, the huge distribution centers, and all those big stores suddenly become a cost Walmart cannot avoid. Without growing revenues, Walmart, like has happened at Sears, could go into a terrible profit tailspin.

And that is what Amazon is trying to do. Amazon is changing the way Americans shop. From stores to online. And the key to understanding why this is deadly to Walmart and other big traditional retailers is understanding that all Amazon (and its brethren online) need to do is chip away at a few percentage points of the market. They don't have to obtain half of retail. By stealing just 5-10 per cent they put many retailers, the ones who are weak, right out of business. Like Radio Shack and Circuit City. They suck the profits out of others like Sears and Best Buy. And they pose a serious threat to WalMart.


Amazon is succeeding. It has grown at almost 30 per cent/year since 2010. That growth has not been due to market growth, it has been created by stealing sales from traditional retailers. And Amazon achieves $621,000 revenue per employee, while having a far less fixed cost footprint.

What the marketplace looks for is that point at which the shift to online is dramatic enough, when online retailers have enough share, that suddenly the fixed cost heavy traditional retail business model is no longer supportable. When brick-and-mortar retailers lose just enough share that their profits start the big slide backward toward losses. Simultaneously, the profits of online retailers will start to gain significant upward momentum.

This week, the marketplace started saying that the time could be quite near. Amazon had a small profit, surprising many analysts. It's revenues are now almost as big as Costco, Tesco – and bigger than Target and Home Depot. If it's pace of growth continues, then the value which was once captured in Walmart stock will shift, along with the marketplace, to Amazon.


In May, 2010 Apple's value eclipsed Microsoft. Five years later, Apple is now worth double Microsoft – even though its earnings multiple (stock Price/Earnings) is only half (AAPL P/E = 14.4, MSFT = 31.) And Apple's revenues are double of Microsoft's. Apple's revenues/employee stands at $2.4 million, three times that of Microsoft's $731,000.

While Microsoft has almost doubled in value since the valuation pinnacle transferred to Apple, investors would have done better holding Apple stock as it has more than tripled. Again, if the multiple equalises between the companies (Apple's goes up, or Microsoft's goes down), Apple investors will be six times better off than Microsoft's.

Market shifts are a bit like earthquakes. Lots of pressure builds up over a long time. There are small tremors, but for the most part nobody notices much change. The land may actually have risen or fallen a few feet, but it is not noticeable due to small changes over a long time. But then, things pop. And the world quickly changes.


This week investors have started telling us that the time for a big change could be happening very soon in retail. If it does, Walmart's size will be more of a disadvantage than benefit.

(Adam Hartung is the managing director at Spark Partners. He blogs here.)

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