Walmart, which was founded in 1962, has been the bellwether of the retail industry for over 50 years. Apparently, they are not satisfied with the current traditional retail industry, because the company is planning to rely more on its e-commerce sector. In October 2016 the investors of Walmart were informed that the company would cut the number of new stores in this coming year and invest more on its online operations. Walmart is confident in competing with its strongest competitor in the e-commerce industry, Amazon, with its price advantage as well as its abundant inventory. This paper aims to analyze the investment strategy of Walmart using microeconomic theory, focusing on the allocation of inputs, conditions of uncertainty, new market equilibrium, and consumer preferences.
When Walmart changes its investment strategy, it alters its allocation of inputs. Theoretically, a firm’s production for a particular good is brought by its combination of two types of inputs, capital and labor (although Walmart doesn’t physically produce any products, it generates service that can be considered as a special class of product). In a general case, opening a retail store requires more labor than operating a shopping website. By changing its investment strategy toward e-commerce, Walmart reallocates its combination of inputs, thus eventually changing its service level as well as its total costs. Refocusing its production process from labor to capital, Walmart could capitalize on cost savings through automation in the long run.
Walmart is not the first retail company trying to keep production costs down by reallocating its resource. For example, Kroger, as the third largest U.S. retail company, began allowing customers in 2016 to choose their grocery items online; and pick them up in front of the store (Slater, 2016). If Kroger’s business model finally works out, it is expected that its demand for shopping guides or salesperson would drop markedly.
A profit-maximizing firm like Walmart tries to enlarge the gap between its total revenue and its total economic costs as much as possible. However, the heavy investment in e-commerce would dramatically increase the firm’s total cost in 2017, thus shrinking the total profit next year. Assuming shareholders are all risk-averse, they take the risk and make the bet that they would earn more profit in the next few years if they temporarily increase cost and reduce profit. The truth is, after Walmart announced its new investment plan on Oct. 6, 2016, the adjusted close of Walmart stock price immediately experienced a 6 percent decrease in the next five days, reaching its lowest level since May 5, 2016. On the announcement day, over 20 million shares of Walmart stocks were traded, 3.1 times compared to its usual level (Yahoo Finance, 2016).
This turbulence of Walmart’s stock market shows that internal executives and public shareholders of Walmart have different perspectives and expectations toward the new investment plan. Believing in e-commerce has brighter prospects than the traditional retail industry, the expected utilities of the internal executives from e-commerce are higher than their expected utilities from traditional retail, while the decreasing stock price tells us a different story of the public shareholders’.
Walmart’s largest competitor is Amazon. Today, about half of American households have an Amazon Prime account, and over 55 percent of the U.S. consumers consider Amazon as their first choice when they want to search for a product online (Pettypiece, 2016). Based on Amazon’s income statement for the second fiscal quarter of 2016, Amazon earned a profit of 857 million dollars. The opportunity of taking a share of this huge profit is the main motivation for Walmart to step in. Theoretically, new firms are lured into a market in which its economic profits are positive as long as there are no special costs of entering or exiting from an industry.
After Walmart enters the market, because there will be more competition in the market, indicators like consumer preferences would shift the market demand curve and create a new market equilibrium price. Under this circumstance, the two firms’ individual marginal cost curves would eventually decide how they are affected by the market price, thus generating different levels of profits. As mentioned in the introductory paragraph, Walmart considers its abundant physical inventory as a great advantage against Amazon. The ability to deliver products from retail stores all over the United States instead of one centralized warehouse would give Walmart chips to compete with Amazon’s powerful and experienced delivery chain.
The technological development in the past decade changes consumers’ life style as well as their preferences. Up to 2015, over 69 percent of U.S. adults, shop online at least monthly, with 33 percent shopping online weekly (Mintel, 2015). The latter was only 24 percent in 2014. American consumers enjoy the convenience of simply clicking the mouse instead of driving to the nearby retail store and pushing a shopping cart around. As the new generation becomes more economically independent, consumer preferences are expected to gear toward e-commerce more dramatically.
Walmart, as the leading company of the retail industry, which serves over 100 million of customers worldwide every week over the past decade (Brain, 2016), has realized that companies like Amazon have taken many potential market shares away from them. Although current income statements of Walmart seem healthy to its investors, Walmart has enough reason to believe that it is necessary for the company to make e-commerce an important part of its business in the long run.
Online Sales are still small currently, but no one could ignore its potentials in the future (Platform, 2015).
This paper aims to discuss the economic thinking behind Walmart’s new investment strategy. Walmart enters the e-commerce market by changing its allocation of inputs; this investment plan was made under the condition of uncertainty; we, as the consumers, would expect to see a new market equilibrium price through competition, thus changing our consumers’ preferences accordingly. The effect of Walmart’s new investment strategy may not be seen in a short period, but it follows a logical economic thinking based on the above discussion.
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