Food is Walmart's Toughest CHallenge

Food is the final frontier for Walmart. And it's turning out to be one of the toughest the company has ever encountered.

Walmart already is the biggest U.S. grocer, with sales of $274.5 billion in the last fiscal year. Grocery has been forming an increasing portion of Walmart's sales, rising from about 20 percent of net sales 10 years ago to 55 percent in the last fiscal year. Despite that, it hasn't been a panacea for the company.

Sales have been seesawing in recent years, with U.S. same-store sales declining in the last two quarters. Walmart has also been plagued by criticism–always present, but lately intensified–of its labor and other business practices.

Walmart doesn't break out its profits by category. But food's status as a growing, and now majority, share of total sales is a sign that Walmart sees grocery as its future. How long it will do so, and how far it can go, is an open question.

"They're still very strong there, [but] there has been obviously more price competition than I think they've ever faced before," says Neal Stern, senior partner with McMillanDoolittle.

Walmart's appeal as a grocer is and always has been the same as its appeal as a general retailer: low prices. And to date, it's enjoyed some striking success. According to some estimates, it accounts for half or more of the grocery sales in at least three dozen metropolitan areas.

RECESSION INSURANCE

Expansion into food has helped insulate Walmart against the recession. When consumers stop or reduce their purchases of things like electronics or apparel, the advantage of being the low-cost provider dissipates, but people always need to eat. Some observers even attribute the spate of consolidation in grocery retailing, at least in part, to Walmart's influence and pressure on prices.

Maintaining attractive displays of fresh produce is seen as one of Walmart's ongoing challenges.

However, the food sector is presenting Walmart with some challenges that just don't exist for durable goods. When it comes to low grocery prices, Walmart faces competition from both established players, like Aldi, and new ones like dollar stores. And there are factors besides price that most consumers find equally important for food–or, at least, more important for food than for other products.

"The bigger question for Walmart is, how do they get good enough and competitive enough in the other areas that matter for food shopping?" Stern says. Those other areas include quality, service and convenience, he says: "In an ideal world for Walmart, they need to hold on to that price reputation while improving their reputation in those other areas."

QUALITY AND FRESHNESS

Quality has been a particular challenge. In grocery retailing, one of the most important indicators of "quality" is the freshness, variety and visual appeal of perishable goods. Establishing and maintaining this kind of quality is cost- and labor-intensive, which complicates the mission of low prices.

Walmart's Facebook page has attracted complaints from some shoppers about being either unable to find the kind of produce they wanted, or finding it unappetizingly past its prime.

"It's one of the top issues they face," Gary Giblen, a retail industry consultant, told CNBC. "You only get one time at bat with perishables."

To burnish its reputation in this regard, Walmart recently announced a money-back guarantee for its produce. Customers who are dissatisfied with their fruit or vegetables once they get home can bring back the receipt–without the actual goods–for a refund with no questions asked.

Service, like quality for perishable goods, is a question of labor. Delivering better and more attentive service requires more workers, which seemingly works against cutting costs and lowering prices. Walmart has been plagued by labor-related accusations and lawsuits over the past decade, and its staunch anti-union position is well known.

SIZE AND CONVENIENCE

Convenience is another factor where Walmart faces daunting competition in the grocery sector. The basic question is whether the size and scope of a typical Walmart store is good or bad for grocery shopping. Customers can get many things besides food at Walmart, but they have to walk farther to get anything.

"I think historically that notion of a one-stop shop, the ability to get food and non-food in one trip, was an advantage to them, but it's becoming less so as you look in the future," Stern says. "Customers have many more options to get their shopping done conveniently."

The lowest-price strategy has propelled Walmart to the No. 1 spot among U.S. grocers.

That's why Walmart is extending beyond the Supercenter into smaller formats that will presumably make shopping more convenient–and confer other benefits.

Walmart has experimented with Walmart Neighborhood Market stores for about five years, and Walmart Express stores starting in 2011. These two store types, at 38,000 and 15,000 square feet respectively, are significantly smaller than the Supercenter average of 182,000 square feet. At a presentation to the Goldman Sachs Annual Global Retailing Conference in October, Walmart U.S. CEO Bill Simon unveiled plans to aggressively expand in both formats, establishing what he called "a market ecosystem" to compete more effectively with alternative CPG channels like drug stores and convenience stores.

Walmart currently has about 300 Neighborhood Markets and about 20 Express stores. Simon said at the Goldman conference that the company plans to increase the number of Neighborhood Markets to 500 within the next 18 months.

ALTERNATIVE SUPPLY SYSTEM

The smaller stores, in theory, will provide Walmart customers with a quicker, easier shopping experience. But the potential benefits extend beyond that. Part of the "ecosystem" that Simon described involves the potential use of Supercenters as alternative supply centers for surrounding smaller stores.

"This ecosystem will make the supply chain more efficient," Simon told the Goldman conference. "We'll continue to send those 53-foot trailers loaded with merchandise to the supercenters, but we'll add to that the pallets that the smaller stores need down the line. And then we use the supercenters' across-dock operation to supply the nearby small stores, eliminating those unprofitable and unproductive 53-foot trailer runs with just a couple of pallets to the small stores, big saving available there."

In addition, the smaller formats may allow Walmart to penetrate locations where it has been stymied up to now. This includes both urban areas, where the high cost of real estate has been a barrier, and, paradoxically, the remote, rural regions where the company got its start. Those remote areas have been harder to supply with food because of logistical problems, especially for produce and meat. The thinking is that the logistical efficiencies of the Supercenter-to-Neighborhood-Market "ecosystem" will alleviate this problem.

The "ecosystem" might come into play in another front on the grocery wars: online-based store delivery. Walmart has been test-marketing WalmartToGo.com in the San Francisco/San Jose, Calif., area since April 2011, and started a second test in the Denver area in October.

In this regard, Walmart is going head-to-head with Amazon, which is testing online grocery delivery in Seattle and San Francisco. It's mostly uncharted waters. Stern notes that online delivery accounts for some 0.3 percent of all U.S. grocery sales. (By contrast, it has about a 30 percent share of consumer electronics.)

Presumably, Walmart will have an advantage in being able to supply delivery trucks from its brick-and-mortar stores, while Amazon is faced with building or remodeling warehouses to accommodate the storage and delivery of perishable goods. But it may not be that simple, Stern notes.

"Walmart being the fabulous logistics company that they are, they're really good at moving pallet loads from distribution centers to back of store," he says. "But they're really not expert in moving single items from one place to another."