Wal-Mart’s Growth Practices Remain Unsustainable

As Wal-Mart’s sales growth hovers just barely above the zero mark, BusinessWeek examines the company’s growth strategy. Among the company’s problems: poor customer service, reliance on low-margin items and market saturation. The company plans to remedy much of this by expanding overseas, but as the article points out, Wal-Mart’s usual strategy of “cheap stuff and lots of it” doesn’t always work in foreign markets. More broadly, Wal-Mart still struggles with alternate formats. The retailer still has problems with apparel sales, and “people are still going in there to “save money” on basics, but going elsewhere for the ‘live better’ part of the equation.”

Wal-Mart: Fashioning a New Growth Track [BusinessWeek]

On Feb. 19, the world’s largest retailer, Wal-Mart Stores, reported sales of $374.5 billion—more than a third of a trillion dollars—for its fiscal year ending Jan. 31, 2008. It’s a stunning number. But a closer look at Wal-Mart’s prospects shows the larger question for the discount giant is whether it can avoid having store-sales growth turn negative in the coming year, for the first time ever.

The numbers the behemoth has reported for its latest fiscal year already reveal evidence of a slowdown. Its Wal-Mart stores division eked out a sales increase of 1% in stores open at least one year, the smallest sales gain in company history. That follows a 1.9% gain in 2006. (Total revenue increased 8.4% for the latest quarter, to $107.4 billion; net income rose 4%, to $4.1 billion, or $1.02 a share.) At this pace, it’s obvious Wal-Mart will have to fight flat or negative same-store sales growth in the coming year.

Outperforming Retail Chains

Burt Flickinger III, managing director of New York retail consultant Strategic Resource Group, has been a Wal-Mart shareholder for three decades. He says the company’s sales growth rates aren’t keeping up with the three indicators every retailer should beat: the inflation rate, which is currently just under 3%; the 1% rate of population growth in the country, and the increase in square footage, which grew 8.4% last year at Wal-Mart. “It’s pathetic,” says Flickinger.

Customers are giving Wal-Mart lower marks these days, as well. A yearly survey of customer satisfaction by the University of Michigan, released on Feb. 19, shows the retailer scored the lowest among 10 large discount and department-store chains. Wal-Mart’s satisfaction rating this year was 68 on a scale of zero-to-100, down 5.6% from a year ago.

Granted, the company’s sales increases of 0.5% in January and 2.4% in December, however small, looked good compared with the bloodbath in the retail sector as a whole. Store chains are being hammered across the board with declining sales, from the upscale Nordstrom (JWN) to discount department store Kohl’s (KSS). And Wal-Mart’s fourth-quarter same-store sales rose 1.7%, which beat Target. No wonder investors have bid up Wal-Mart’s stock 6% since the beginning of the year, to more than 50.

The thinking on Wall Street is that Wal-Mart will outperform the rest of the industry because its low prices provide relief to Americans who are being pressured from higher credit-card bills, larger mortgage payments, and high energy costs at home and at the pump. And the big retailer is going all out to woo shoppers with low food prices, cheap drugs, and affordable electronics and staples. “Wal-Mart has continued its strategy of acquiring more margin dollars by selling more and higher-priced items like high-definition TVs,” says Walter Loeb, president of Loeb Associates, a retail consultant in New York.

The problem is that whatever sales momentum there is at Wal-Mart is coming from the lowest-margin items at its stores—staples like food and $4 drugs. Indeed, company executives have said in the past they would rather take a hit on profits from these items to attract a large amount of shoppers into its stores who will then stock up on higher-margin goods like apparel. But that’s not happening. Even gift cards, which are usually viewed as something people would use for goods to treat themselves, were being redeemed in January for basics like food. “Wal-Mart is the biggest food retailer, and people have to eat, which makes food noncyclical, so it tends to smooth their results,” says Stephen Hoch, professor of marketing at the Wharton School of the University of Pennsylvania.

Uncertain Growth Strategy

Harried consumers shopping Wal-Mart’s food aisles will help the company buy some time during this slowdown. But as the dust settles in the economy, will Wal-Mart be prepared to find new avenues for growth?

Figuring out a growth strategy has been a challenge. Almost all avenues, whether international or domestic, have run into roadblocks. Wal-Mart knows it has reached a saturation point in the U.S. market and that its fortunes lie abroad. The retailer plans to invest as much as $3.6 billion to open new stores overseas in the next two years, while at the same time paring its investment in building new U.S. stores to $5 billion from $7 billion.

The company plans to open 80% of its new international stores in Canada, Mexico, and China. “What’s new for us is that either we will win in every market or exit the market,” said Mike Duke, chief executive officer of Wal-Mart International at an analysts’ presentation a few months ago. The retailer currently operates about 7,000 stores worldwide, including 3,000 in 13 countries.

Overseas Misfires

But time and again, Wal-Mart has found that its formula for success—high volumes of cheap goods—doesn’t work everywhere. In 2006, it sold its stores in Germany and South Korea after failing to excite shoppers there with its deal-driven approach. And just last week, its Japanese unit, Seiyu, posted a loss of 20.9 billion yen, or $195.5 million, for the year ended Dec. 31. That’s twice the 10.5 billion yen loss the company had forecast.

Japanese shoppers initially rejected Seiyu’s cheap goods, equating low prices with low quality. Then they eschewed even the higher-end goods the store began offering later in the year. So Seiyu ended up discounting too much, which ate into profit margins. The store said one of its weakest areas was clothing.

Apparel has been a sore spot for Wal-Mart domestically, too. The share of sales from that category, plus home goods, has dropped from 20% in 1990 to less than 15%, or $56 billion, today. The company’s most recent foray into fashion ended as a huge embarrassment: Two years ago it bought multipage ad spreads in fashion bible Vogue and sponsored a fashion show at New York’s Times Square during Fashion Week. The chain tried to redefine its stores as a mecca for fashion, with narrow-leg jeans and trendy outfits sold under the Metro 7 label. Bewildered Wal-Mart shoppers completely rejected the items, and thousands of stores were left holding unsold apparel. As inventory piled up, Wal-Mart let go of Executive Vice-President Claire Watts, who had led the effort.

Apparel Strategies Hampered by Marketing Flaws

Despite all these problems, Wal-Mart is hell-bent on figuring out an apparel strategy. Just last month it revamped its clothing unit, laying off several people at its Bentonville (Ark.) headquarters and moving several of its employees to New York under Dottie Mattison, who last year replaced Watts as chief of apparel, shoes, and jewelry. In New York, the apparel group will be more aggressive about quickly getting trendy items into stores to better compete with other low-priced rivals like Target (TGT) and H&M. A much smaller group in Bentonville will be in charge of number-crunching tasks like making sure the right assortment of goods is sent out to locations nationwide and replenished on time.

Wal-Mart is attracted to apparel because, if done right, clothing can deliver gross profit margins of 45% to 50% or more, compared with the lower 20% margins that Wal-Mart ekes out from most of the household staples it sells, including consumer electronics, says David Abella, portfolio manager at Rochdale Investments, a fund with $2.5 billion in assets, including Wal-Mart shares. “Even a basic $5 T-shirt has as much as a 35% margin,” says Abella. But he says fashion apparel is a harder sell than, say, a big-screen TV because it comes with the baggage of snob appeal. “For the simple reason that even people on the low-income end don’t want to be out in public with something they got at Wal-Mart,” he says.

Other discount retailers have succeeded where Wal-Mart hasn’t. Target, for instance, is a destination for cheap chic clothing from top designers. Apparel makes up 22%, and home furnishings, 19% of Target’s overall sales. At Wal-Mart, apparel makes up only an estimated 10% of sales, say some retail experts. They believe the giant could double that with a smarter approach. Flickinger believes that besides spending more on marketing, the company should look for celebrities who better connect with today’s consumers. “With the right choices of assortment, Wal-Mart can add as much as $75 billion in sales,” he says.

But Wal-Mart hasn’t been willing to invest heavily in such a marketing effort, especially since apparel is much harder to position in the market than staples like Tide or Bounty. Patricia Edwards, managing director and portfolio manager at Seattle money manager Wentworth Hauser & Volich, which has $7.9 billion in assets, says: “Wal-Mart executives are very good at the science of retailing but fall short when it comes to the art of retail.” At Target, for instance, there is a laser focus on marketing an image, to the point where even the chain’s topmost executives, including the CEO, get involved in what goes into Target advertising. By contrast, Wal-Mart CEO H. Lee Scott famously told BusinessWeek editors last March: “I’m not a big fan of marketing.” (BusinessWeek.com, 3/30/07).

In fact, retail experts agree that Target’s snazzy advertising is what makes the discount retailer look like an über-cool destination. Customers have learned they can find the latest trends in everything, such as home goods (a teapot designed by Michael Graves) or clothing from some of the edgiest designers like Proenza Schouler of New York and Luella Bartley of London. And while Target’s ads have been relentless for almost two decades now, Wal-Mart’s apparel-focused ad campaign was a flash in the pan whose few pages in Vogue and a handful of other women’s magazines barely lasted a few months before being pulled. “Wal-Mart is full of penurious people who want a quick fix, and an apparel strategy cannot be achieved overnight,” says Flickinger.

The behemoth’s ability to deliver in this key area is central to its domestic growth strategy, but everyone agrees this is the toughest challenge for the retailer to crack. “It’s similar to a strategy where Hyundai starts producing a luxury car—would people believe in that brand? I don’t think so,” says Robert Passikoff, president of New York brand consulting firm Brand Keys. Wal-Mart has changed its advertising tagline from “Always low prices” to “Save Money. Live Better.” The problem is, people are still going in there to “save money” on basics, but going elsewhere for the “live better” part of the equation.

Posted by Alex Goldschmidt on Tuesday, February 19, 2008

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