Wal-Mart eyes Amazon in potentially costly e-commerce battle

Wal-Mart Stores said that it would take a different approach to online growth than Amazon.com Inc by using its large network of stores as distribution points.

But if the world’s largest bricks-and-mortar retailer is serious about competing more directly with Amazon - as it has suggested by testing a free shipping club - then it may have to spend well beyond a previously announced investment target on big distribution centers and other costs for its plan. Wal-Mart’s sluggish quarterly results that were released highlighted the importance of growing its online business.

Online revenues grew 17 percent globally in the first quarter ended April 30, against a slight drop in overall sales. However, investments in e-commerce shaved 2 cents off the retailer’s earnings per share, equal to the cost impact in the quarter of its move to raise wages for entry level workers across the U.S.

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Because of the high growth rates, most analysts see merit in investing aggressively in e-commerce. But as Wal-Mart prepares to test a free shipping program aimed at undercutting Amazon on price, the prospect of competing with a rival that spends heavily on investments has raised some concerns. “They continue to try to grow e-commerce which is good because it is growing. But it comes at a cost,” said Brian Yarbrough, retail analyst at Edward Jones.

Wal-Mart has said it would invest $1.2 billion to $1.5 billion on e-commerce this year. It plans to open four large dedicated fulfillment centers - adding to 11 facilities in operation already, and the dozens of conventional distribution centers refitted to help in the online push.

But for Wal-Mart the biggest plus in its plan is a network of 4,500 stores. It already uses more than 80 for distribution, accounting for a fifth of its online deliveries on a unit basis. Wal-Mart booked $12 billion in online revenues last year.

“We feel like that’s a great advantage that we can leverage,” Wal-Mart Chief Financial Officer Charles Holley said, when asked about competition with Amazon. He said his response was not particular to Amazon. Converting conventional distribution centers to handle e-commerce probably costs $20 million to $40 million dollars each, while building a large-scale fulfillment facility from scratch can cost $150 million, estimates Steven Osburn, director at Kurt Salmon specializing in supply chain.

Given that, any attempt to catch up with Amazon could run into the billions of dollars, Osburn said. “However, finding ways to use their existing infrastructure better is a much cheaper way to go about it.” Even then, Wal-Mart would likely need at least 5 to 10 more dedicated fulfillment centers, Osburn said: “You are still probably talking a billion dollars plus in investment if this catches on.”

Shipping costs are another concern. Forrester Research analyst Sucharita Mulpuru estimates Amazon could be losing $2 billion a year on shipments to members of its Prime program, which offers free shipping on most items for a $99 annual fee. Wal-Mart’s pilot program is offering free shipping within three days for a fee of $50, half the cost of Prime. While Mulpuru believes Wal-Mart would find it difficult to put a big dent in Amazon’s market share, she reckons it could make gains by capitalizing on its strengths, such as its strong relationships with packaged goods makers and in groceries.

David Cheesewright, head of Wal-Mart’s international division, pointed to the company’s strong position in online groceries in Britain as know-how that could be leveraged elsewhere.

“I think particularly in the area of grocery, where product knowledge, understanding of the fresh supply chain, operational excellence, is going to be a key part of being successful in that space,” Cheesewright said on the media call after the release of its earnings.

Reuters