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Wal-Mart Rolls Back The Middleman

NEW YORK - Wal-Mart is famous for its everyday low prices, and just as infamous for maintaining those low prices by negotiating tough deals with suppliers. Its steep, sudden discounts, or "rollbacks," topped $12.5 billion last year, roughly $3 billion less than Gap generates in total revenue.


But now doubts are beginning to surface about Wal-Mart's (nyse: WMT - news - people ) ability to maintain its gross margins in the face of such continual deflation. So far no perceptible strains are showing. Gross profit has held steady at 21% to 24% of sales each quarter for the past three years. But the issue will only get more acute as commodity prices increase and the juggernaut spreads further into higher-cost regions such as the Northeastern United States and California.

Wal-Mart will only get so far by hammering suppliers such as Procter & Gamble (nyse: PG - news - people ), Gillette (nyse: G - news - people ) and Newell Rubbermaid (nyse: NWL - news - people ). And raising prices will never be a viable option. Archrival Target (nyse: TGT - news - people ), known more for its merchandising flair than rock-bottom deals, has been steadily closing the price gap. The Memphis-area Super Target store now sells a basket of common household items for 0.8% less than the nearby Wal-Mart Supercenter, according to a recent A.G. Edwards analyst report.

So, to fight margin erosion and keep to its goal of 13% to 15% shareholder return, Wal-Mart is increasingly buying direct from factories. It's a hallowed practice for department store chains such as Federated Department Stores (nyse: FD - news - people ) and J.C. Penney (nyse: JCP - news - people ) but, surprisingly, Wal-Mart does very little of it. Only 10% of its purchases are sourced directly from factories. By bypassing a middleman such as a P&G, no-name U.S. importer or Hong Kong-based sales agent, Wal-Mart can add as much as 800 basis points to gross margin, passing some on to the customer and keeping the rest....