International Business take-home exam

Wal-Mart

How big can it grow? Apr 15th 2004 | FRANKFURT, LONDON AND VALLEY OF THE SUN, ARIZONA From The Economist print edition

AP

The world's biggest retailer is defying its critics by continuing to grow

vigorously

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AT A recent retail-industry convention, Wal-Mart's boss, Lee Scott, was asked

whether his firm was trying to take over the world. “I don't think so,” Mr Scott replied with a smile on his face. “All we want to do is grow.”

How big can Wal-Mart grow? With $256 billion in sales in the year to January 31st,

the firm is already the world's biggest company by that measure. Its nearest

retailing rival, a French supermarket chain called Carrefour, is less than half Wal-

Mart's size. In America, Wal-Mart manages nearly 3,000 giant discount stores and

hypermarket “supercentres”. Abroad, it has ventured into Mexico, Britain, Japan,

Canada, Germany and China, as well as making smaller investments elsewhere.

Eight out of ten American households shop at Wal-Mart at least once a year.

Worldwide, more than 100m customers visit Wal-Mart stores every week.

Photographs circulated over the internet and purporting to come from the Exploration Rover show NASA's recent discovery of a Wal-Mart on Mars.

The mathematics of big numbers suggests that Wal-Mart's growth must slow.

Amazingly, the opposite appears to be happening. In America this year, Wal-Mart

intends to open some 50 new discount stores and more than 220 new supercentres,

some of which will be existing stores moving to new locations. Overseas, it plans

another 140 or so new stores, including relocations. This adds up to some 50m

square feet of new space—even more than many of its rivals operate in total.

As Mr Scott likes to points out, Wal-Mart still represents “only” 8% of total retail

sales in America. It is not unusual for dominant firms in mature industries to

command market shares of 30% or more. So, in theory at least, Wal-Mart could still get an awfully lot bigger.

Although the firm possesses undeniable momentum at the moment, its sustained

smooth expansion is by no means inevitable. Wal-Mart's success is sharpening the

acts of other retailers, some of whom are learning how to compete more effectively

against the “Beast of Bentonville” (Wal-Mart's headquarters are in Bentonville,

Arkansas). Legal and labour problems threaten the firm's decentralised,

entrepreneurial culture—a culture which, until now, Wal-Mart has zealously protected

against creeping corporate bureaucracy. Abroad, the firm's success remains in doubt,

as does its ability to make money out of new retail formats at home. Most important

of all is the likely future growth of its core domestic discount-store business, which

makes up 65% of the firm's sales and 87% of its profits. When will that begin to

slow?

One of the guiding principles of Sam Walton, the company's late founder, is to pass

on savings won from suppliers to consumers, which encourages more of them to

shop at the company's stores and to buy more things. Wal-Mart then profits from

higher sales, instead of simply putting the savings directly into its coffers. The

company is skilled at obtaining products cheaply, and the emergence of China as a

centre of low-cost production is playing to its strengths. Wal-Mart already buys $7.5

billion-worth of goods directly from China each year and another $7.5 billion via its

suppliers, with scope for more in future. Shoppers make such big savings that

economists credit Wal-Mart with driving down America's inflation rate.

This strategy of “Always Low Prices. Always” continues to surprise even Wal-Mart

with its success. When Tom Schoewe joined the firm as its chief financial officer four

years ago, Wal-Mart thought that its core discount-store business was about to slow,

he says. The company began looking for other sources of growth by investing more

heavily in different formats: smaller groceries, called neighbourhood markets, that

were meant to fill in the spaces between the larger discount stores and supercentres,

and a warehouse-style format, which Wal-Mart calls Sam's Club. But, says Mr

Schoewe, Wal-Mart then changed tack. It began to realise that America's suburbs can absorb many more supercentres than the company had previously supposed.

Glorious suburbia

If that seems fanciful, then spend the 45 minutes it takes to drive across Arizona's

Valley of the Sun from Scottsdale, a well-heeled suburb of Phoenix, to the city of

Surprise to the west. Between the strip malls, low-rise apartments and Whataburger

franchises that dot the route, Wal-Mart's name pops up again and again. On a single

20-mile stretch of road sit six giant Wal-Marts, all of them doing a reasonable

business on a recent rainy weekday. Shoppers have 14 more Wal-Marts to pick from

a few miles further south and east. The area, says Mr Schoewe, with obvious pride, “shows you what can happen.”

The valley's sprawl—the Phoenix area has annexed 400 square miles of desert in the

past 50 years—suits Wal-Mart perfectly. In other bits of America, the firm is finding

growth more difficult. Some communities (notably in California and the north-east)

oppose yet more supermarkets and edge-of-town hypermarkets. There are plenty of

Americans who accuse the so-called “big-box” retailers of driving local firms out of

business. In prickly California, Wal-Mart has tried to bypass planning committees by

appealing directly to voters, so far without success. On April 6th, 60% of voters in a

local referendum in Inglewood, a suburb of Los Angeles, turned down a proposal for a giant new Wal-Mart.

Some of Wal-Mart's new supercentres, which can range up to 220,000 square feet in

size, are now being designed to be just a fraction smaller than the 100,000 square-

foot limits on retail units that have been imposed in some parts of America. For instance, Wal-Mart recently opened a 99,000 square-foot outlet in Florida.

In states with strong trade unions, such as New Jersey, Illinois and California, Wal-

Mart has faced what has been called an “invisible picket line”: obstruction and

boycotts, sometimes only on an individual basis, by people who object to its strong

anti-union stance. Naturally, Wal-Mart has grown fastest where it has been easiest to

build its big boxes. Per head of population, there are between five and ten times as

many stores in Arkansas, Oklahoma, Mississippi and Missouri as there are in New

Jersey, California and New York.

Wal-Mart is buying up land at an astonishing rate. The monthly real-estate meeting

in Bentonville approves more than $1 billion-worth of land purchases every time it

gathers, says Mr Schoewe. Yet as Wal-Mart makes more of those purchases in the

less-served, but more difficult states, growth will inevitably slow. It can take the

company two or even three times as long to open an outlet in California than in

Arizona, for instance. All the same, Michael Silverstein of the Boston Consulting

Group (BCG), thinks Wal-Mart's core business has three years of decent growth left

in it. Darrell Rigby of Bain, another consultancy, thinks there is “plenty of room at least through 2010.”

That growth alone would result in a firm with annual sales of somewhere between

$350 billion and $450 billion. On top of this, investors must weigh the likely success

of Wal-Mart's expansion overseas where, in the longer term, the firm will have to

find the bulk of its growth. Traditionally, retailers are not very good at going abroad.

Wal-Mart is no exception. It has done well in America's border countries. It has been

successful in Canada, for instance, and in Mexico, where Wal-Mart is the biggest

private employer.

But in Germany, Wal-Mart ended up with egg on its face. Even Mr Scott has admitted

that the company's arrival was “somewhat embarrassing”, although the situation is

improving. Wal-Mart entered Germany, the third-biggest retail market after America

and Japan, in 1997-98 by buying two local retail chains, Wertkauf and Interspar, for

$1.6 billion. Whereas Wertkauf was well-known and profitable, Interspar was weak

and operated mostly run-down stores. Wal-Mart has lost money in Germany ever

since. Problems have included price controls, which prevent below-cost selling, rigid

labour laws and tough zoning regulations, which make it extremely difficult to build big stores.

Wal-Mart also faced well-established rivals in Germany, like Metro, and hard

discounters such as Aldi and Lidl, already comfortable with razor-thin profit margins.

Many retailers in Germany are owned by wealthy families whose business priorities

are not always the maximisation of shareholder value.

But there was more to it than that. Wal-Mart's entry was “nothing short of a fiasco”,

according to the authors of a study at the University of Bremen. At first, Wal-Mart's

expatriate managers suffered from a massive clash of cultures, which was not helped

by their refusal to learn to speak German. The company has come to be seen as an

unattractive one to work for, adds the study. In part this is because of relatively low pay and an ultra-frugal policy on managers' business expenses.

This contrasts with Wal-Mart's much smoother expansion into Britain, where it

bought Asda for $10.7 billion in 1999. Asda already had a strong business competing

on price, and it has since overtaken struggling J. Sainsbury to become the second-

biggest supermarket chain after Tesco. But that may say more about Sainsbury's

difficulties in overcoming its problems than Asda's successes. Unlike Tesco, under its

boss Sir Terry Leahy, Sainsbury was slow in responding to Wal-Mart's expected

arrival in the British market. In particular, it was late in expanding into non-food

goods, the source of much of Tesco's growth. Tesco, which now has half its retail space overseas, also competes with Wal-Mart in other countries.

A force for good?

In the popular imagination, Wal-Mart ruthlessly exterminates the competition,

especially local mom-and-pop retailers. Yet as Bain's Mr Rigby argues, Wal-Mart is

more than just a destructive force. “Wal-Mart is good for retailing in the same way

that any good predator is good for an ecology,” says Mr Rigby. “Life works through struggle, and many retailers are better today because of Wal-Mart.”

A number of retailers in America have gone up against Wal-Mart and survived—even

thrived. They have deliberately avoided trying to do the same thing as Wal-Mart.

Hence Target, based in Minneapolis, competes as a sort of “upmarket” Wal-Mart with

low prices, but a more edited selection of goods. It also employs its own designers to

create exclusive ranges. Costco, based in Issaquah, Washington state, operates a

chain of membership discount-warehouses, which rival Wal-Mart's Sam's Club chain.

Costco carries international brands and is particularly noted for its wines and

surprises: it recently had $52,000 diamond rings for sale. Costco also has a

reputation for paying its staff well above the average union rates.

Then there is HEB, a 100-year-old retailer operating supermarkets in Texas and

Mexico. It looked to be doomed when Wal-Mart rode into town. But it was re-

invigorated into an award-winning grocer that impresses many in the industry. “They

looked to where they had an advantage,” says Mr Rigby. “They are, like Wal-Mart, an

everyday low-price grocer. But you don't have to match prices on everything.” One

of HEB's features is a concept called “Central Market” which provides a wide variety

of fresh and prepared foods within its stores, including on-site chefs who show how

to prepare the evening meal.

All three of these retailers offer something similar: low prices, with something extra

on top, be it a nicer shopping experience or luxury goods. Conceivably, this might

hint at a more threatening market change: that shoppers might begin to tire of the

attractions of rock-bottom prices alone. BCG's Mr Silverstein has written a book*

describing how American shoppers are becoming increasingly sophisticated in the

way they discriminate between “trading up” to those goods they think of as luxury

items, and “trading down” to the rest. “Costco does trading up and trading down

under one roof,” says Mr Silverstein. “Wal-Mart just does trading down. At some

point, that will have played out.”

AP

Growing up with Wal-Mart

Alternatively, the everyday-low-price pull may lessen as prices stop falling so

quickly. Mr Schoewe says that, because Wal-Mart has already gained most of the

advantages of importing goods from China, deflation in the Wal-Mart economy

should slow down in coming years. He maintains that this will be a source of future

financial growth for the company. But perhaps slowing deflation will work in the

opposite direction, as consumers no longer stampede with such relish through Wal- Mart's stores in search of the DVD player that has dropped from $49 to $28.

Perhaps Wal-Mart might even begin to suffer upward pressure on prices as it

struggles to hold down costs. A.T. Kearney, a consultancy, recently examined the

perception that Wal-Mart uses its huge size to clobber its suppliers into providing

lower prices, but concluded that this is “not a significant source of cost advantage”.

Indeed, in many cases manufacturers actually make more money selling through

Wal-Mart than through other retailers. Wal-Mart is not easy to work for, but some

suppliers say the experience has made them leaner and fitter. One of the latest

companies to conclude that it would be better off supplying Wal-Mart is Levi Strauss.

It has been struggling to boost sales through traditional department stores, but has

now produced a range of jeans, called Levi Strauss Signature, for sale through Wal-

Mart and other discount stores. Some are selling in Arizona for $9 a pair. So far, the

decision seems to be paying off. This week Levi reported a better-than-expected 9.7% increase in first-quarter sales.

According to A.T. Kearney, Wal-Mart's three-biggest sources of cost advantage are

low corporate overheads, the efficiencies of its supply-chain and, above all, its low

labour costs. A newly hired “associate”, as Wal-Mart calls its employees, could earn

as little as $8 an hour, some 20-30% less than unionised workers at rival

supermarkets. Union members might also have benefits, such as health-care

insurance.

There are several reasons to suppose that this labour-cost advantage might begin to

erode. One is falling costs elsewhere as Wal-Mart squeezes its competition. In

February, for instance, unionised grocery-store workers in southern California agreed

to wage and benefit reductions following a five-month-long strike. This strike began

after local supermarkets proposed to cut wages and benefits in preparation for Wal- Mart's entry into the market.

A second reason might be slowing staff turnover at Wal-Mart itself, as the firm

struggles to renew its 1.4m-strong workforce. In recent years, staff turnover at Wal-

Mart has fallen from over 60% to 44%, close to industry averages. Yet even with a

turnover rate of 44%, the firm has to hire an astonishing 600,000 people every year

simply to stay at its current size. As the company grows and employs yet more

people, that task will become even more difficult, suggesting that Wal-Mart will want

to push turnover lower still. That might put pressure on costs, as workers gain tenure, pay rises and better benefits.

Another force working to slow Wal-Mart down is the company's mounting legal and

labour-compliance problems. At any moment, Wal-Mart faces about 8,000 lawsuits.

The vast majority of these are personal-injury claims from employees. More

material, given the sheer numbers of people that Wal-Mart employs, are employee

suits seeking class-action status. Among other suits, Wal-Mart's most recent annual

report lists 33 putative class-action suits alleging violations of the Fair Labour

Standards Act, including forcing employees to work “off the clock” and failing to

provide work breaks; eight further putative suits alleging that the firm failed to pay

overtime; and a suit that could prove costly alleging discrimination against its female employees. The potential size of this class alone is 1.5m plaintiffs.

Cleaning up its act

An investigation is also continuing into allegations over whether Wal-Mart knew that

a subcontractor was using illegal workers. Last year, federal agents raided a number

of stores and took documents from the company's headquarters. Wal-Mart has denied doing anything wrong.

In response to a comment by Mr Scott that “my mornings start with reading sales,

followed by a visit from our general counsel,” Forrester, a research company,

predicted that “Wal-Mart will spend more legal energy than other retailers as it

battles a barrage of lawsuits and struggles to not get distracted by any more legal

issues in 2004.” The company is recruiting more legal help: in January, it hired Tom

Gean, a former United States attorney, to work with its “operation compliance

groups”, which have been set up to assist store managers keep within laws and

regulations.

That points to a broader worry for the company: that its cherished entrepreneurial

culture might become choked by expanding human-resources, public relations and

legal departments. Wal-Mart has fought hard to preserve its entrepreneurial culture,

which pushes responsibility out to the company's powerful store managers and

endeavours to check central, bureaucratic growth. But being big makes companies a

magnet for social issues. And freedom among the firm's store managers to set

policies which they think will make their outlets as profitable as possible also

provides room for abuse.

With so many eyes watching it, Wal-Mart may have decided that it has to sacrifice a

bit of its entrepreneurialism to reduce its legal risks. It recently set up a “reputation

taskforce”, introduced new personnel procedures, hired extra lobbyists in

Washington, DC, created an “office of diversity”, and launched new public-relations

and advertising initiatives, dubbed “good jobs” and “good works”, featuring lots of

beaming associates. These are not the actions of a company intending to get smaller. Wal-Mart, already huge, is preparing to get a whole lot bigger.

*"Trading Up: The New American Luxury", by Michael Silverstein and Neil Fiske. Portfolio Press, 2003.

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