What does store design have to do with price increases?

In a WSJ interview  Wal-Mart’s chief of U.S operations says this about Wal-Mart’s attempt to re-design its stores,

WSJ: Is Wal-Mart as focused as it needs to be on offering the lowest possible prices?

Mr. Simon: A lot of things have distracted us from our pricing mission. We got enamored with presentation as an example. We walked people through our [remodeled] stores and they were gorgeous.

But they cost more. And if you spend more on your building, your prices can’t be as low as you want them to be.

“Every Day Low Price” can’t come from the supplier because they have to make money too. “Every Day Low Price” has to come from every day low cost, which means we have to operate for less.

Sustainability and some of these other initiatives can be distracting if they don’t add to every day low cost.

There are two claims made here that I believe the interviewer should have pushed Mr.Simon on but did not.

  1. If you spend more on your building, your prices can’t be as low as you want them to be.
  2. Sustainability and some of these other initiatives can be distracting if they don’t add to every day low cost.

I will discuss the first point in this article and defer the second for a future article.

Better design and presentation does not mean the sourcing costs (what Wal-Mart pays to suppliers) go up.  So why should the customers offset that cost in the form of higher prices?

If the design changes are already made and if there are no recurring costs to keep-up the design, the costs are sunk. So why do they matter?

Unless of course Mr.Simon is looking at an accountant’s definition of Cost Of Goods Sold (COGS) which includes in it a share of all fixed costs. To an accountant preparing the company’s financial statements, ever bar of soap and bottle of shampoo must be assigned its share of the building cost, employee cost, utility cost etc.

It is due to the quirky accounting rule of how costs are matched with inventories and how inventories are moved into expenses as Cost of Goods Sold.

But the accountants do not run businesses, set prices or make business decisions. They report on the business’ performance with just enough clarity and obfuscation at the same time.

A business cannot spend more on a building and expect to pass on the costs to customers in the form of price increases. Before spending money to improve the aisles, they should have estimated whether the improvements will nudge their customers’ willingness to pay higher and whether they can  generate enough profit to justify the costs.

Incremental profit need not come in the form of higher prices,  it can be in the form of increase in sales from new customers. Better design could bring in new customers who otherwise would not have stepped into the store.

To say, “If you spend more on your building, your prices can’t be as low as you want them to be” is neither true nor relevant here.

As an important side point, when a store spruces up and improves its design and shopping experience will the willingness to pay of its customers go up?

The answer will take us through the path set forth by Thaler on Mental Accounting and Consumer Choice.  It starts with the  story of you relaxing in beach and thirsty for an ice cold drink.

To be covered in a later article.

3 thoughts on “What does store design have to do with price increases?

  1. Max
    Mental accounting I refer to near the end of the article is about how customer Willingness to Pay is influenced by place they are buying.

    If Wal Mart has not spent money to improve a store and if their incremental profit calculations show that this is not worth the investment, that is different. They should have done that calculation before rolling it out.

    Margin you refer to is likely the net margin or operating margin – If I use margin here it would be contribution margin.

    If everyday low prices is their driver then they should not have raised prices.

    Like

  2. I’m having trouble seeing what this has to do with mental accounting.

    Wal-Mart has always been about low prices ever since Sam Walton first founded the company. So if you start with the set-in-stone premise of low prices, spending more or less on the building has everything to do with the prices of their products.

    The building and other refurbishments are fixed costs (not on the income statement accounting-wise, but fixed costs over time nonetheless). The specific redesigns for a single store may be “sunk costs” but they are representative of the ongoing capital expense. And the lower the fixed costs, the lower Wal-Mart can price their products and still make a profit. (Another retailer may keep prices the same and have higher margins, but again, Wal-Mart’s policy is lower prices and higher volume.)

    Assuming Wal-Mart does not want to lower their profit margins *and* they also want to have the lowest prices (lowest markup above cost), they can’t spend too much on the building. So the statement “If you spend more on your building, your prices can’t be as low as you want them to be” seems rational to me.

    Like

Comments are closed.