The Retail Game

The Retail Game

Great companies in attractive industries generate returns on invested capital that far exceed the cost of capital.

1. However, retail is generally a very low-return business with low or no barriers to entry.

Retail bellwethers Wal-Mart and Walgreen earn little ore than 3 cents profit for every dollar of sales, so store management is critical. The problem is that many retailers don't execute as flawlessly as these two and flame out as soon as trouble hits.

2. The sector is rampant with competition.

Think of all the specialty apparel shops that try to imitate Abercrombie & Fitch and Gap. A few succeed; most fail, but the point is that nothing exists to prevent new concepts and stores from being launched. There are few, if any, barriers to entry. Customers may be swayed to buy a cool $50 sweater, but they'll quickly go to the store next door if the same sweater can be had for $40.


3. The primary way a firm can build an economic moat in the sector is to be a low-cost leader.

Wal-Mart sells items that can be purchased just about anywhere, but it sells it all for less than the competition, and consumers keep coming back for the bargains. Others may try to imitate Wal-Mart's strategy in the short run but lack the economies of scale to remain profitable employing the strategy in the long run.