The lesson for Main Street from the Walmart, Target inventory failures

The retail battle narrative over the past few decades has cited one of two wars: Amazon and e-commerce against the big bricks-and-mortar retailers, and everybody big against small Main Street entrepreneurs. But in the current confusing economic environment — marked by inflation, supply chain bottlenecks and a volatile consumer changing spending patterns due to the high prices which followed Covid — small business experts say that Main Street should be more optimistic about the advantages of being small.

The inventory builds and subsequent markdowns from the biggest retailers, including Walmart and Target, show that even the best can get this consumer economy wrong. In fact, small business owners, being closer to relationships on both the supply and customer ends, may be able to more nimbly manage a fast-changing environment.

That's the advice from Nada Sanders, Northeastern University distinguished professor of supply chain management. She told CNBC's Small Business Playbook virtual summit on Wednesday that she has been "gloom and doom" in the past, but is now optimistic about Main Street's chances in the current economy.

"I actually see this as a tremendous opportunity. I really do. Especially for small businesses," Sanders said.

She cites three areas where entrepreneurs should be focused, and the first is directly related to the big box retailer woes: forecasting.

"The big companies are really struggling with that," Sanders, who is an academic expert on forecasting, said. "We see it, obviously, with the retailers. Walmart, Target."

Talk directly to customers to understand shifting consumer demand

Her opinion is that the biggest companies have become too reliant on inventory algorithms to forecast data, but in the current economy, which has defied many historical patterns, "historical data in this space right now isn't really good data. It's not clean data, it doesn't indicate the future that is very volatile," she said.

This gives small business owners who can connect directly with customers, to understand what their needs are, a potential advantage that can't be calculated by an algorithm.

Whether a small business is B2B or B2C, Sanders said direct communication is a "real answer" for them right now in dealing with changing consumer behavior.

"What I'm seeing with the big companies, they're trying to hire futurists and trying to figure out ways to actually predict demand. But every time we look at the numbers, the Consumer Price Index, all of it, we're looking backwards," Sanders said. "The fact of the matter is, we're in a very quickly changing landscape and I think we have to look forward. Small business owners really need to connect and use judgment to forecast and to understand what their customers need."

"As a small business owner on a tight budget ... you don't even need the really heavy duty AI, which I think a lot of small business owners, they get a little bit nervous. ... You can actually make a lot of gains with really simple solutions," Sanders said, "When you're a small business, you have an end-to-end control that a large business doesn't have. I see this as a really big opportunity," she added.

Main Street already thinks it's operating in a recession

It will be a leap for many entrepreneurs to come around to this view. Data shows that the current sentiment on Main Street is pessimistic. The latest CNBC|SurveyMonkey Small Business Survey for Q3 2022 showed that small business confidence hit an all-time low, with the largest percentage of small businesses citing inflation as their biggest risk.

In the Q3 survey, an increasing percentage of small businesses forecast a sales decline over the next 12 months as the economy, in their view, is already in a recession. The downbeat sales outlook was the biggest contributor to the all-time low in confidence being hit. And as small businesses face higher costs in inputs, labor, transportation and energy, few (only 13%) say now is a good time to pass along price increases to customers, according to the survey.

How to set pricing during inflation

But pricing is also an area where small businesses can effectively, and directly, communicate with their customers and find solutions.

Jeffrey Robinson, Rutgers Business School provost and executive vice-chancellor, and co-founder of the Center for Urban Entrepreneurship and Economic Development, said at the Small Business Playbook virtual summit that one big mistake business owners make is to not figure out pricing on new products until it is too late. At a time of high inflation, entrepreneurs need to be basing any pricing of new items on a detailed analysis of the costs that go into producing it. A traditional way that businesses set pricing — decide on the product and then once it is available look at what competitors are charging — is not the way to operate in this economy. Inflation requires that small business owners set price by, first and foremost, understanding their costs.

"All those prices along the supply chain have gone up," Robinson said. "The shipping costs ... anything that has any component of transportation involved, those costs have gone up. So assessing and valuing your product or service that you're providing along those costs, before you set the price, allows you to set the price at the right level," he said.

And then comes the hard part: explaining it to the customer. Robinson says the direct relationship that small businesses have with their customers should be seen as an advantage, too.

"We have relationships. Talk," he said. "Explore. You've got to explain to them that the costs have gone up for these components. 'In order for me to do this, I have to change some pricing,'" he said.

Helping customers understand the situation that a business is in related to supply chain inflation is going to help set prices in an appropriate way, he said. In the end, Robinson said it is really no different than a restaurant that has always shown the price of a fish on the menu to be "market price." That may be a simplified example, but it has reverberated in the current situation.

Some restaurants have put signs out front during the current inflationary period to be transparent with customers about pricing changes. Robinson didn't weigh in on that method specifically, but did say every business needs to have some form of conversation with customers and potential customers about the fact that the prices of two years ago are not going to be the prices of today. While the survey data shows that small business owners are wary of this conversation, Robinson said they shouldn't be.

"I believe a lot of consumers understand that, especially if you're a business-to-consumer type of business," he said. "It's about being transparent ... helping people understand that pricing is changing."

Map out the supply chain with key vendors

The conversation with suppliers is no less important, and Sanders said the data shows that, on average, 80% of a company's spend goes towards about 6% of their suppliers. Those are the business partners to focus on, and where to pick up the phone and call and build a relationship. "As a small company, this is really what it's going to be about," Sanders said. "What I think you need to do as a small company is really be able to map your supply chain for your key items, talk to your vendors, really build partnerships," she said.

Most big companies don't have great visibility below their tier one suppliers, according to Sanders, so many items become harder to track that are far back in the supply chain, "tier four, tier five," she said.

A small business can map out its supply chain and work with partners to visualize the entire chain and identify the risks. Right now, the inventory issues in retail might make small business owners more reluctant to stock up — even though it is the start of peak shopping season, with back-to-school and then the holidays. Sanders said she is firm believer in running a "lean" operation, but in the current economy, "we need to implement some caveats to the meaning of lean."

In certain cases, small businesses are going to have to store extra items, critical items with longer lead times, and where there are expected price increases. All businesses should also be taking a look at their production processes and whether alternatives exist that could lead to more cost-effective operations. Carrying extra inventories "flies in the face of lean," she said, but she added, "the advantage for a small business is really being able to manage at the same time, upstream and downstream, and coordinate those."

The biggest problem in the current economy is the mismatch between demand supply, and that's where Sanders comes back to the issues Walmart and Target have faced and why small businesses should take an opportunistic view of the situation, and be proactive about conversations on both the supply side and end customer side of their operations.

"Large companies are dinosaurs. ... They're very heavy, bureaucratic. As a small business, you're very limber," she said.

The key for small business owners is to not only look one way, either downstream (customer) or upstream (supplier). "But look at those at the same time, really marry those, watch them, and connect with customers, connect with all the vendors," Sanders said. "Large companies can't do that. They're stuck because they have huge silos. As a small business, you don't have that, so leverage that right now."