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Carnegie ConsultingStrategic Solutions for Business

Components Of Future Growth In TheDiscount Retail Industry

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______________________________________________________________________________Carnegie Consulting

425 N. College Ave. s Claremont, CA 91711-2-

Table of Contents

Executive Summary................................................................................... 3

Company History ....................................................................................... 3

Internal Rivalry........................................................................................... 5

Substitutes and Complements................................................................... 8

Entry .......................................................................................................... 9

Buyer and Supplier Power......................................................................... 9

Strengths, Weaknesses, Opportunities and Threats............................... 11

Financial Outlook..................................................................................... 14

Strategic Analysis: Components of Growth............................................. 17



Executive Summary

Wal-Mart faces the challenge of trying to maintain its historical growth patterns. First,Carnegie Consulting recommends that Wal-Mart must continue striving to achieveinternational growth, particularly in China, and to monitor closely its expansion in Japan.Second, Carnegie Consulting recommends that Wal-Mart continue its efforts to developnew U.S. growth by means of its Supercenter concept. Complementary to the concept,Carnegie Consulting also recommends that Wal-Mart further diversify into interrelatedservice and product industries. Wal-Mart’s dominant industry position will allow it to bethe leader in the development of interrelated industries and to obtain the advantages thatwill come with being the first mover.

Company History

The first Wal-Mart Discount Store, then called the Wal-Mart Discount City, was openedin Rogers, Arkansas in 1962. The owners, Sam Walton and his brother “Bud,” continuedto develop their department-sized discount stores in small midwestern towns withpopulations less than 25,000. By 1969, the number of Wal-Mart discount stores hadreached 18. Wal-Mart became incorporated in 1970, initially trading over the counter,raising $44 million in the IPO. In 1972, the Company was listed on the New York StockExchange. Four years later, the Waltons began to phase out their Ben Franklin stores.The stores were the initial basis of their self-owned, small discount business concept inthe 1950s. In the following year, Wal-Mart made its first significant purchase of one itsrivals with the acquisition of sixteen Mohr-Value stores in Missouri and Illinois. Thesame year Forbes ranked Wal-Mart the number one discount and variety store in theUnited States.i In 1978, one year later, Wal-Mart diversified its services by providing itsown pharmacy, auto service center, and jewelry divisions. By 1979, 276 discount storesexisted in 11 states and total sales had reached $1.25 billion.

In 1983, the Company opened its first three Sam’s Clubs, membership only cash andcarry discount warehouses, and began to expand into more populated markets. In 1987,18 Supersave Wholesale Clubs, later to become Sam’s Clubs, were acquired and Wal-Mart introduced its first Hypermart USA combining a grocery store, the traditionaldiscount store with its complementary services, restaurants, banking, videotape rental,and a playroom for children. In the same year, Wal-Mart was able to reduce prices asmuch as 40% below full retail level because of their buying power and ability to dealdirectly with vendors; sales volume averaged $1 million per week. Operating in nearlyevery state in the South and Midwest, Wal-Mart Inc. included 1,182 discount stores, 90Sam’s Clubs, and 2 Hypermart USAs by 1988. In the same year, Sam Walton steppeddown and David Glass was named president and CEO.

In 1990, Wal-Mart opened its first stores in California, Nevada, North Dakota, SouthDakota, Pennsylvania, and Utah. Four Sam’s Clubs opened with produce, meat, andbaked goods sections. Wal-Mart also acquired Western Merchandise, Inc., a supplier ofmusic, books, and videos, and McLane Co, Inc., a grocery and retail distributor, furtherstrengthening and consolidating the Company’s buying power from vendors. On April5th, 1992, founder Sam Walton died. That same year, Wal-Mart’s total discount storesreached 1,720 and total Sam’s Clubs reached 208. Wal-Mart also began aninternational joint venture with the Mexican company Cifra to create a price-club store



called Club Aurrera. Two years later, after announcing plans to expand in Argentina andBrazil, Wal-Mart signed a joint venture to open stores in Hong Kong and later planned toopen stores in China. In March of 1996, Wal-Mart announced a new prototype of itsSupercenter, a scaled down and evolved version of the Hypermart USA consisting of afull discount store with a grocery department, and began online operations. In thefollowing three years, Wal-Mart opened the new Supercenters as remodels of existingdiscount stores and became a significant player in the grocery industry. Continuing toexpand international operations, Wal-Mart purchased the ASDA Group, Inc., the thirdlargest food retailer in the United Kingdom, and obtained full ownership of 194 storesand 205 restaurants from Cifra becoming the largest retailer in Mexico, in 1999 and 2000respectively. Also in 1999, Wal-Mart was named one of the Most Admired Companiesby Fortune due to their shareholder returns, growth, and use of technology.ii

K-mart declared bankruptcy in January of 2002, signifying a fall of a once mightydiscount retail leader. In February of 2002, already the world’s largest retailer, Wal-Martsurpassed ExxonMobil to become the largest company in the United States by revenue.Currently, Wal-Mart operates a total of 1,736 Discount stores, 888 Supercenters, 475Sam’s Clubs, and 19 Neighborhood Markets, a grocery store with a small amount ofdiscount store items, in all 50 states and Puerto Rico and 8 foreign countries includingArgentina, Brazil, Canada, China, Germany, Korea, Mexico, and the United Kingdom.Wal-Mart Stores, Inc. employs more than 1.2 million workers making it the largest privateemployer in the world.

The success of Wal-Mart in the 1990s was somewhat tarnished by bad publicity. Wal-Mart came under criticism in the early 1990s for its impact on small town retailbusinesses. Evidence was made public that Wal-Mart was destroying an entire town’sretail base because it could supply everything cheaper and in one location. A backlashensued and towns began to refuse entry to Wal-Mart by passing restrictive zoning laws.In January of 1993, Dateline reported that children working for five cents an hour inBangladesh were producing merchandise for Wal-Mart. It also alleged that Wal-Martwas mislabeling these items as “Made in the USA.”iii

In 1996, Costco Co. overtook Sam’s Club as the largest domestic membership onlywarehouse club. Wal-Mart also saw its growth slow in the mid-1990s in its otherdivisions. The Company had seen growth of revenue at least 35% a year for 12 yearsprior to 1988; however net sales grew only 13%, 12%, and 12% for 1996, 1997, and1998 respectively. Wal-Mart began to feel the limitations for growth in the domesticmarket. This primarily fueled the reinvention of the Supercenter and the scaling back ofthe discount store. The number of Wal-Mart Discount stores peaked in 1998 with 1,995.Wal-Mart’s international operations first turned a profit in 1997, seven years afterbeginning international operations, but have yet to obtain the desired returns or evenbegin to approach the returns of their domestic stores to date.



Internal Rivalry

Exhibit 1Summary of Five-Forces Analysis of the Discount Retail Industry

Force Threat to Profits

Current Future

Internal Rivalry High High

Entry Low to Medium Low to Medium

Substitutes andComplements

Low Medium

Supplier Power Low Low

Buyer Power Low Low

Wal-Mart Stores, Inc. operates in the industry of variety discount retailers and grocers,supplying discount hardline and softline merchandise and complementary services.Hardline merchandise consists of electronics, appliances, home furnishings andequipment, office supplies, health and beauty supplies, automotive supplies, sportinggoods, toys, candy, tobacco, and seasonal/holiday goods. Softline merchandise iscomprised of apparel and accessories, sheets, towels, and other linens.Complementary services include pharmacies, photo development, and auto servicing.

The retailing market has expanded into other complementary industries to obtaineconomies of scope. For example, Wal-Mart first combined the ideas of a pharmacyand auto-service center with its discount store concept in 1978. In 1999, Wal-Mart triedto enter the banking industry but was met by stiff regulatory resistance by the Office ofThrift Supervision. Currently, all major competitors in the market operate at least one ofthe following services beyond discount retailing: pharmacies, photo processing, and autoservicing. The industry trend of diversifying into other industries will continue asdiscount retailers find new sources of profitable growth by leveraging their brand name,customer base, and scale. Entry into complementary service industries commonly isdone first by an industry leader and then closely followed by competitors. In the future,discount retailing may include service industries such as banking, insurance, utilitypayments, travel agencies, Internet access, automobile sales, and telecommunications.iv

The discount retailer’s product is one-stop, low-cost merchandising and servicing forcustomers shopping for a wide variety of goods. Currently, the product line includes amix of hardline and softline merchandise, groceries, and services including pharmacies,photo development, and auto servicing. The industry trend to combine interrelatedservices and industries is designed to increase the frequency that customers use theproduct.

The main competitors in the discount retailing industry are Wal-Mart, Target, Kmart,Target, and Costco. Close rivals include JC Penney and Sears-Roebuck and otherdepartment stores. The concentration ratios illustrate that the market is highlyconcentrated. But, the market is highly competitive given low profit margins relative to



sales demonstrating the presence of little oligopoly power. The ratios and thecorresponding Herfindahl-Hirschmann Index based on revenue are listed in Exhibit 2. Ifthe industry continues its current trend to expand into complementary markets, discountretailers will take on new competitors. For example, in the future Target may competewith AOL Time Warner as an ISP.

Notably, in local markets concentration ratios and the Herfindahl indexes are probablyslightly lower than those shown in Exhibit 2 due to the presence of numerous smallstores located in urban malls and in strip malls.

Exhibit 2C4 and C8 Ratios and HHI For the Retail (Discount & Department) Industry

Based on Revenue (TTM January, 2002)

Company Revenue($ mil)

Percentage

Wal-Mart 212,127 47.0%

Sears, Roebuck & Co. 41,078 9.1%

Target 38,975 8.6%

Costco Wholesalev 37,028 8.2%

Kmart 36,909 8.2%

J.C. Penny Company 32,035 7.1%

Federated Dept. Stores 17,444 3.9%

May Dept. Stores 14,532 3.2%

Coles Myer Ltd. 12,657 2.8%

Dillard’s Inc. 8,516 1.9%

C4 72.9%

C8 95.3%

HHI 2588Source: Market Guide, ProVestor Plus Company Report Wal-Mart, January 23rd, 2002

Wal-Mart operates the largest international division in the industry with sales totalingover $32 billion. In 1968, Kmart was the first to start international operations in Australia.Costco has succeeded in Japan, Korea, Mexico, Taiwan, and the United Kingdom.Foreign competitors include local, national and international chains in all segments of theretail industry.vi Kmart and Wal-Mart are the primary international operators of theindustry. Internationally, they compete with Carrefour the world’s second largest retailerbased on revenue, Metro AG based in Germany, Daiei Inc. based in Japan, and Tescobased in the United Kingdom. Metro AG and Daiei are the third and seventh largestretailers based on revenue.

The industry competitors are differentiated by price, location, merchandise and services,and style of store. Price is primarily a function of buying power and selling costs. Wal-Mart historically has been able to set lower prices than rivals due to its superior inventorymanagement and buying power. During the 1990s, the margin of discount has closed ascompetitors adopted the systems that made Wal-Mart the industry price leader. Target



has been able to match Wal-Mart’s inventory efficiency due mainly to investment insimilar computerized inventory tracking systems. Future improvements by Wal-Mart willbe marginalized more quickly because improvements will be smaller, such as thehandheld inventory tracking devices for employees, and significant comparativeadvantages in technology between companies are disappearing. Price will play asignificant role in the future of the industry as it branches out into new sectors. In thefuture, decisions to expand into new complementary services will be made mainly onprice advantages relative to existing competitors in the specific service industry. Theprice advantages are largely based on the ability to spread costs over the entire storeand the minimal marketing costs due to an established customer base found in discountretailing.

Geographic location of the discount retailers plays a significant role not only indifferentiation but also in customer market share. Discount retailers locate themselvesclose to their target consumer because travel costs offset price advantages. Mostdiscount retailers are concentrated in suburban and rural markets and not in urban areasbecause of economies of scale and scope. Sometimes competitors locate close to eachother, as in an urban mall, in order to achieve the externalities generated by reducingconsumer search costs. Another tactic to take market share from a less efficient rival isto minimize switching costs for the customer. One of Wal-Mart’s tactics against Kmart inthe 1990s was to open new discount stores almost across the street from where Kmartwas the only discount retailer. Kmart customers could costlessly switch to a superiorWal-Mart store.

Merchandise and services and style of store are designed to focus on different customerdemographics and brand imaging. For example, Target provides more expensivedesigner housewares and electronics to attract more affluent consumers. Target andCostco work to build a brand image of a low-priced treasure chest for the middle andupper-middle classes. Target also works on pushing its young, chic image by employingfashion designers to mimic the latest European fashion trends. If the industry trend ofcombining complementary services continues, differentiation based on merchandise willplay a more significant role moving ahead. In the future, discount retailers may begin tooffer a mix of merchandise and services that more specifically focus on a customer’sage, class, and life stage such as recent college graduates or retirees.vii

The discount retailing industry has become increasingly competitive during the 1990s.Competitors have differentiated themselves from rivals within the industry in order tobuild market share away from direct rivals as well as from substitute retailers. Thecurrent industry trend is to incorporate complementary industries into the discount storeconcept. Wal-Mart’s decision to combine the existing discount store format with agrocery store has proved successful. Target and Kmart have followed suit. Discountretailers can be expected to continue complementary services to provide a moreencompassing one-stop shopping experience for the customer.



Substitutes and Complements

Substitutes

Currently, the most direct substitutes for discount retail industry are defined by thecomplementary services the seller chooses to provide. Sporting goods stores,electronics stores, department stores, and home and garden stores are all substitutes onproduct but not price. The discount retailing industry has taken all of these products andmade them cheaper, simpler, and more efficient at the expense of substitute industries.

Groceries can be bought at a large chain grocery store, at a corner convenience store,or at a Wal-Mart Supercenter. Home lighting can be purchased at Target, the HomeDepot, or the local lighting specialty store. Cars can be serviced by the local mechanic,or at Jiffy Lube, Grease Monkey, an auto dealership, or at Costco. Discount retailersoffer private label brands to compete with the national brand merchandise they alreadysell. Wal-Mart sells products under its private labels, Ol’Roy® dog food, Great Value®grocery items, Equate® health products, Spring Valley® vitamins, Faded Glory® jeans,and American Value® food products sold at Sam’s Clubs. Clothing can be bought in anurban mall at Macy’s, Broadway, and Nordstrom or in a specialty shop; at TJMaxx in astrip mall; or at Wal-Mart.

Department stores like Sears, JC Penney, The Broadway, and Dayton’s, now known asMarshall Field’s, that once dominated many sectors of retailing are still important but arelosing market share to large discount retailers like WalMart and Home Depot and toniche stores.

Customers also use specialty retailers as substitutes. While specialty retailers cannotcompete directly with discount retailers with the same merchandise, they offer niche setof products not found at discounters. Tuesday Morning, Corp. is an example of aspecialty retailer selling upscale home closeout merchandise. While its revenue is only0.2% of the industry leader’s at $642 million, Tuesday Morning has found a positionselling upscale brands of luggage, bedding, and house wares not found in the discountstores, at closeout prices. Plus, they have room to grow. The Wall Street consensus isthat Tuesday Morning should achieve $1 billion in sales by 2004.

While specialty retailers provide a substitute for the discount retail industry, they do notcurrently pose a significant threat. The specialty retailers, like Tuesday Morning, havedifferentiated themselves through merchandise and price in order to survive—twoelements the industry does not find as profitable to adopt. Specialty merchandising, likeTuesday Morning, fills a small, niche demand and does not provide the efficiency orreturns found in the discount industry.

Complements

The future of the industry is based on adding products that were once complements tothe WalMart shopping experience and bringing them into the store. This reduces searchcosts and adds value to the shopping experience mainly in freed time for the consumer.Current examples include One Hour Photo Labs that can develop pictures while youshop, restaurants in the store, and grocery departments to combine two trips in one. Inthe near future, discounters may start adding utility payment stations, banks, insurance



departments, car dealerships, and travel services, as complements to the shoppingexperience and also for the built in value added of convenience that gives discountretailers an edge.

Entry

Entry into the chain discount retailing business requires significant start-up costs. Brickand mortar networks of distribution and sales are necessary to compete on scale withthe incumbents in the market. Wal-Mart’s property, plant and equipment assets totalover $40 billion. The retailing market is also considered a mature market where firmsgain market share mostly at the expense of other competitors. Carnegie Consultingbelieves there is no direct threat of entry to the chain discount retailing industry.

Significant barriers to exit exist in the chain discount retailing part of the industry due tothe huge fixed costs associated with operating a nationwide retailer. These barriersallow competitors to have fierce and prolonged price wars. Wal-Mart continuously tookKmart’s market share by offering lower prices and more efficient service in the samelocations until nearly thirty years later Kmart finally declared bankruptcy. Strong barriersto exit also provide large incentives to differentiate to fend off direct attack from marketleaders such as Wal-Mart. If the industry makes considerable strides to spread out intoother services the barriers to exit may decrease as industries with lower fixed costs andcomplementary costs such as travel services are encompassed. Nonetheless, largediscount retailers will have an advantage to entry and exit in new industries due in part totheir ability to leverage.viii

On the contrary, entry and exit by local niche players and online niche retailers intoretailing is very easy. Most local niche players only operate one store and sell uniquemerchandise to their customers specific in the local market. Online retailers operate witha lower sunk cost than traditional retailers. Local niche and online retailers do notcurrently pose a significant threat. Online retailing is estimated to contribute only 3% oftotal retailing in the United States.

Buyer and Supplier Power

Supplier Power

In the retail sector up-stream suppliers do not pose a threat to industry profits. Thesector is dominated by a few firms selling a wide variety of items, which makes it difficultfor any individual supplier to dramatically influence the large retail companies. As thechart below demonstrates, four multi-product categories contribute to almost 70% ofWal-Mart’s discount store and Supercenter sales. No one supplier dominates any ofcategories of products. Other large retailers such as Kmart, Target, and Costco havesimilar results.



Exhibit 3Wal-Mart Sales by Category in Discount Stores and Supercenters for 2001

Category Percentageof Sales

Hardgoods 21%Softgoods/domestics 19%Grocery, candy, tobacco 19%Pharmaceuticals 10%Electronics 8%Sporting goods and toys 7%Health and beauty aids 7%Stationary 3%Shoes 2%Jewelry 2%

One-hour Photo 2%Source: Wal-Mart Annual Report, 2001

Large discount retailers buy from many suppliers; however, the retailers offer a verylarge market for each individual supplier. This creates a situation where the retailershave buying power in the supply chain. The large retailer’s buying power can beexploited to shift some costs from the retailer to the supplier. For instance, Wal-Martworks with its suppliers to create self-contained displays (PDQs) that are pre-packagedby each supplier. These PDQs eliminate the labor-intensive task of stocking eachindividual shelf or hanger. PDQs often allow merchandise to go directly from thestockroom to the floor with little more than opening a box. For example, “Before PDQs,an Associate had to hang each battery pack by hand, which was labor intensive. Now,batteries come in packaged disposable trays and an Associate only has to removeplastic wrap and move it onto the sales floor.”ix Wal-Mart is able to shift the responsibilityof creating a display to the supplier so now the supplier bears the cost of packaging thedisplay instead of Wal-Mart.

Another facet of supplier power in retail industry is distribution. Discount retailcompanies have thousands of stores spread across the United States and distribution isan essential aspect of their business. Wal-Mart has a large percentage of its salesshipped from its own distribution centers. In 2001, approximately 84% of the discountstores’ and Supercenters’ purchases and 59% of Sam’s Club’s purchases were shippedfrom Wal-Mart distribution centers.x Wal-Mart also handles all of its grocery distribution.Target ships 91% of its sales from its own distribution centers but has outsourced itsgrocery distribution to third party vendors.xi Wal-Mart and Target’s upstream integrationinto distribution have effectively negated any advantage their suppliers could gain fromdistribution.



Buyer Power

Consumers do not have significant buying power from discount retailers and thereforedo not pose a threat to industry profits. The fact that rivals must compete for pricesensitive consumers is not a function of buying power but of the competitive nature ofthe industry. The competition, not buying power, keeps price-margins low in theindustry.

Strengths, Weaknesses, Opportunities and Threats

Strengths

Buyer Power

Wal-Mart’s buying power by volume is unmatched by any competitor in the industry.The Company’s cost of goods sold for fiscal year 2001 topped $150 billion. Wal-Martalso has consolidated buying power by self-distributing 84% of its discount store andSupercenter sales and 59% of its Sam’s Club sales. Wal-Mart also distributes all of itsgroceries to its Supercenters and Neighborhood markets. Through the Company’sbuying power, Wal-Mart is able to negotiate unique bulk pricing and pass stocking coststo suppliers in the form of PDQs. Wal-Mart and other close competitors haveadvantages over specialty retailers because of the buying power from the economies ofscale associated mass retailing. Wal-Mart, through its Retail Link system, allowssuppliers to monitor their own products’ inventory levels so that they can observe ordersin advance. The practice transfers the inventory risk Wal-Mart would normally retainonto the production cycle of the supplier.

Productivity

Wal-Mart has historically been revered as the productivity leader in the retail industry.Known for its massive computer system and Retail Link, second only in size to theUnited States Government computer system, and its inventory management, Wal-Martconsistently leads in the productivity indicator sales per square foot of store. Anothermore rigorous productivity measurement is sales per employee. This measures theoverall productivity of the entire firm versus its competitors. Again, Wal-Mart continuesto hold a hefty advantage over its rivals even as they have copied Wal-Mart’s practices(Chart 1 and Chart 2).



Chart 1Sales Per Retail Square Foot

0

50

100

150

200

250

300

350

400

1997 1998 1999 2000

Target Wal-Mart

Chart 2Sales Per Employee

020406080

100120140160180

1997 1998 1999 2000

Target Kmart Wal-Mart

Customer Base

Evidenced by Wal-Mart’s market share and its ranking as one of the top ten mostadmired companies in America, the Company has a very large and loyal customer base.Both the loyalty and size of the customer base allow Wal-Mart operate with lowmarketing costs. The strong customer base also gives Wal-Mart the ability to leveragethe Company by branching into interrelated industries.

Weaknesses

International Operations

Wal-Mart’s major weakness is its lower than expected international performance. TheCompany’s international ventures consist of partner ventures and acquisitions outside ofthe Canadian and Mexican markets. Wal-Mart has failed with ventures in Hong Kongand Indonesia because it was unable to adapt to local conditions. Chart 3 illustratesWal-Mart’s international operations growth. Before 1999, international operating incomeas a percentage of revenues was near zero. The acquisition of ASDA in the UnitedKingdom significantly propelled revenues and income. However, internationaloperations have been plagued by remodeling costs, startup costs related to distributionnetworks, and excess inventory and transition related expenses in the Company’sGerman units.xii Wal-Mart has also not realized U.S. type growth rates in Europe despitetheir price advantages compared to the domestic market. The anti-foreign sentiment inalready established markets such as Europe will take several years to overcome.International revenue is heavily weighted in United Kingdom, Mexico and Canada.Returns in Argentina will be minimal until the country recovers from its economicmalaise. Overall, international operations will be weaker in 2001 and 2002 as the worldeconomy absorbs the impact of the United States economic slowdown.



Chart 3Increase of International Stores by Year and International Revenues as a

Percentage of Total Sales

0%

20%

40%

60%

80%

100%

1996 1997 1998 1999 2000

Revenue as % of Sales Store % Increase

Opportunities

Kmart Bankruptcy

Kmart is closing 284 stores in 2002 and possibly more in 2004 under their Chapter 11bankruptcy protection. Wal-Mart and Target stand to gain significant market share asthe customers of these stores switch to competitors. Of the 284 closing stores, nearly allare situated within five miles of one of these two competitors indicating that customerswill probably switch rather than stay loyal and drive further to shop at Kmart. InCalifornia Kmart is closing 38 stores. All 38 stores have a Wal-Mart with ten miles of itslocation and 36 have a Wal-Mart within five miles. Conservative estimates have Wal-Mart and Target splitting the revenue from the closing Kmart stores under theassumption that most customers have already made the switch since the Christmasholiday. Wal-Mart stands to receive at least $1.5 billion boost in revenues for 2002.

Economies of Scope

Wal-Mart stands at a unique position as the leader in the discount retail industry.Historically, Wal-Mart has been a pioneer in the industry by first includingcomplementary services. Its Supercenter format has proved successful and moreprofitable than the current discount center format. As a result, Wal-Mart is transformingmore discount centers to Supercenters than its number of new stores. The Company’scustomer base and reputation will most likely allow it to extend its concept of addingeven more complementary services and products of other industries beyond just theSupercenter concept. Wal-Mart may be able to include businesses such as automobilesales, banking, insurance, Internet access, telecommunication services, travel agencies,and utility payments to boost same store revenue growth. The concept is discussedfurther in the Strategic Analysis section.

International Operations



As domestic sales growth flattens out, Wal-Mart has branched out internationally tomaintain growth. Wal-Mart has been recognized by the Chinese government as one ofthe major foreign retailing purchasers for Chinese manufactures and will be grantedmore freedom than other firms to expand operations in China, the world’s largestuntapped market. In the 2000 fiscal year, Wal-Mart’s acquisition of ASDA greatlyincreased its market share in Europe. Wal-Mart has also begun a joint venture in theJapanese grocery industry with Seiyu Ltd. This venture opens the second largesteconomy in the world to Wal-Mart’s discount concept. Wal-Mart has entered Japanslowly at first, only owning 6.7% share in Seiyu with an option to own 33% by yearend,to test the large, inefficient but fickle consumer market.xiii Current expansion in Asia isthe best opportunity for Wal-Mart because it is the largest untapped market.

Threats

Internal Rivalry and Regulation

Wal-Mart faces threats only from its other competitors and from regulation. Costco iscurrently the largest cash and carry warehouse retailer having eclipsed Sam’s Club in1997. Costco continues to outperform Sam’s Club and presents a serious challenge togrowth. Regulatory measures could also be used to impede growth. The recentdecision to block Wal-Mart’s bid to become a Savings and Loan Thrift is a goodexample. If Wal-Mart begins significant expansion across interrelated industries, thegovernment may come under pressure from effected industry lobbying groups toregulate Wal-Mart’s activities. This risk is limit to industries that are already regulated,such as banking.

Financial Outlook

For the fiscal year ended 1/31/02, revenues rose 14% to $219.81 billion. Net incomerose 6% to $6.67 billion. Revenues reflect higher international, McLane, Wal-Mart andSAM'S CLUB sales. Net income was partially offset by reduced gross margins and anincrease in utilities, employee medical benefits and insurance expenses and minorityinterest losses.xiv

Given Kmart’s lackluster earnings and financial problems, Wal-Mart and Target’s marginshould continue to benefit in 2002. Recent studies by Goldman Sachs analysts indicatethat the pricing gap between Kmart and its two competitors is expanding back to the 6%-8% historical levels.

Reuters reported that Wal-Mart has raised its earnings guidance for the fiscal yearended Jan. 2003 to a range of $1.74 to $1.76 a share, which is above its previousforecast for earnings of about $1.71 a share. This was a result of Wal-Mart’s salesexceeding expectations in 1Q 2002. The Company also said that it sees first quarterearnings of $0.35 to $0.36 a share and expects same-store sales growth of 5% to 7% inthe quarter. Wall Street analysts on average agree with the Company’s per shareexpectations and predict revenues of $54.7 billion in the same period.2



Wal-Mart Stock Data

Price (4/22/02) 57.5552 Week Price Range 42.00 - 63.94Market Capitalization (bn) 256.2Shares Outstanding (bn) 4.5

The retail sector as a whole has held up very well since September 11th due to easy Fedmonetary policy. From looking at the 3 charts below, it is obvious that Wal-Mart and theretail sector in general has outperformed the market, growing constantly since the 9/11lows. In fact, the retail sector has rebounded by better than 45% to levels last seen inApril of 2000. More importantly, in a global economy, bigness in the U.S. is not a limit onthe growth of companies, since they can grow abroad. Wal-Mart, which is now thenation’s largest company has great expectations for growth in China and Japan, where itsees its business model working extremely well. Such optimism seems to have furtherfueled market success for the Company thus far in 2002.

31-Jan-01 31-Jan-00 31-Jan-99

Income Statement Analysis

Total Revenue $193,295,000,000 $166,809,000,000 $139,208,000,000Cost Of Revenue $150,255,000,000 $129,664,000,000 $108,725,000,000Gross Profit $43,040,000,000 $37,145,000,000 $30,483,000,000Operating Expenses

Research And Development N/A N/A N/A

Selling General And AdministrativeExpenses $31,550,000,000 $27,040,000,000 $22,363,000,000 Non Recurring N/A N/A N/A Other Operating Expenses N/A N/A N/A

Operating Income $11,490,000,000 $10,105,000,000 $8,120,000,000Total Other Income And ExpensesNet N/A N/A N/AEarnings Before Interest And Taxes $11,490,000,000 $10,105,000,000 $8,120,000,000Interest Expense $1,374,000,000 $1,022,000,000 $797,000,000Income Before Tax $10,116,000,000 $9,083,000,000 $7,323,000,000 Income Tax Expense $3,692,000,000 $3,338,000,000 $2,740,000,000

Equity Earnings Or LossUnconsolidated Subsidiary N/A N/A N/A Minority Interest ($129,000,000) ($170,000,000) ($153,000,000)Net Income From ContinuingOperations $6,295,000,000 $5,575,000,000 $4,430,000,000Nonrecurring Events

Discontinued Operations N/A N/A N/A Extraordinary Items N/A N/A N/A Effect Of Accounting Changes N/A ($198,000,000) N/A Other Items N/A N/A N/ANet Income $6,295,000,000 $5,377,000,000 $4,430,000,000

Preferred Stock And OtherAdjustments N/A N/A N/A



Net Income Applicable To CommonShares $6,295,000,000 $5,377,000,000 $4,430,000,000

Balance Sheet Analysis

Current Assets

Cash And Cash Equivalents $2,054,000,000 $1,856,000,000 $1,879,000,000 Short Term Investments N/A N/A N/A Net Receivables $1,768,000,000 $1,341,000,000 $1,118,000,000 Inventory $21,442,000,000 $19,793,000,000 $17,076,000,000 Other Current Assets $1,291,000,000 $1,366,000,000 $1,059,000,000Total Current Assets $26,555,000,000 $24,356,000,000 $21,132,000,000Long Term Assets

Long Term Investments N/A N/A N/A Property Plant And Equipment $40,934,000,000 $35,969,000,000 $25,973,000,000 Goodwill $9,059,000,000 $9,392,000,000 N/A Intangible Assets N/A N/A N/A Accumulated Amortization N/A N/A N/A Other Assets $1,582,000,000 $632,000,000 $2,891,000,000

Deferred Long Term AssetCharges N/A N/A N/ATotal Assets $78,130,000,000 $70,349,000,000 $49,996,000,000

Current Liabilities

Accounts Payable $22,288,000,000 $23,718,000,000 $15,756,000,000

Short Term And Current LongTerm Debt $6,661,000,000 $2,085,000,000 $1,006,000,000 Other Current Liabilities N/A N/A N/ATotal Current Liabilities $28,949,000,000 $25,803,000,000 $16,762,000,000 Long Term Debt $15,655,000,000 $16,674,000,000 $9,607,000,000 Other Liabilities N/A N/A N/A

Deferred Long Term LiabilityCharges $1,043,000,000 $759,000,000 $716,000,000 Minority Interest $1,140,000,000 N/A $1,799,000,000 Negative Goodwill N/A $1,279,000,000 N/ATotal Liabilities $46,787,000,000 $44,515,000,000 $28,884,000,000Stock Holders Equity

Misc Stocks Options Warrants N/A N/A N/A Redeemable Preferred Stock N/A N/A N/A Preferred Stock N/A N/A N/A Common Stock $447,000,000 $446,000,000 $445,000,000 Retained Earnings $30,169,000,000 $25,129,000,000 $20,741,000,000 Treasury Stock N/A N/A N/A Capital Surplus $1,411,000,000 $714,000,000 $435,000,000 Other Stockholder Equity ($684,000,000) ($455,000,000) ($509,000,000)Total Stockholder Equity $31,343,000,000 $25,834,000,000 $21,112,000,000

Net Tangible Assets $22,284,000,000 $16,442,000,000 $21,112,000,000



S&P Retail Index Performance Jan. 2, 2001 to Feb. 28, 2002

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Walmart Performance Jan. 2, 2001 to Feb. 28, 2002

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Wal-Mart has a beta 0.92, thus it is no surprise that the Company has performed betterthan the market and has been relatively stable in the face of major economic shocks.The Company has posted impressive growth numbers for 2001 and has continued tooutperform the industry. Sales (TTM) vs. TTM 1 yr. ago is 13.72% for the Company and11.67% for the industry. EPS (TTM) vs. TTM 1 yr. ago is 6.13 for the Company and4.92% for the industry. In fact, Wal-Mart had a record year in 2001, becoming thelargest company in the world with about $218 billion in revenue. The Company’s 2001net income was $6.7 billion, up 6 percent. Share prices climbed more than 8 percent forthe year.

One area for concern is that Wal-Mart’s assets and liabilities are so closely matched.The Company’s current ratio is at 1, lower than the 1.3 average for the industry.Although it may not be an immediate problem, Wal-Mart should put itself in a positionwhere it has enough assets to adequately cover its liabilities. Like the current ratio, thequick ratio measures a business' liquidity. The higher the ratio is, the higher a business'level of liquidity, which usually corresponds to its financial health. The optimal quick ratiois 1 or higher. Wal-Mart’s quick ratio is 0.1. However, this low number may bedeceiving as the industry’s is only 0.3. Although the Company is not very liquid, theretail sector’s most valued asset is inventory. Thus, the low quick ratio number is notunexpected. Further, Wal-Mart is not very levered relative to the retail sector. Its debt toequity ratio is 0.7 while the industry’s is 0.9. Because of this, the Company’s lack ofliquidity may not be a serious problem.

Management has been very successful in taking advantage of available assets. Returnon Assets (TTM) for the Company is 8.34% versus 7.68% for the industry. Wal-Mart hasbeen very effective in putting its assets to work. The Company is not as levered as theindustry, yet has a higher ROA. Given that ROA is a test of capital utilization - howmuch profit a business earned on the total capital used to make that profit before interestand income tax, the figures are very impressive. Return on equity (TTM) is 20.12%versus 18.79% for the industry.

As stated earlier, Wal-Mart has increased its earnings predictions for 2002. Further, itscurrent international ventures are doing quite well. Wal-Mart México reported a 26%growth in its operation profits and a 17% sale increase during the first quarter of 2002year-on-year. Wal-Mart México strengthened its results through an aggressiveexpansion plan.

Strategic Analysis: Components for Future Growth inthe Discount Retail Industry

Wal-Mart currently faces a flattening of year-to-year revenue growth. To battle slowinggrowth, Wal-Mart has undertaken two main strategies. First, the Company plans toexploit the economies of scope it derives from the Supercenter concept. It is adding newSupercenters and converting existing discount stores into Supercenters. Second, Wal-Mart plans to continue expanding its international operations. Wal-Mart has faced manyobstacles to international expansion including particularly high acquisition and startupcosts and slow adaptation to local retail environments. While most such problems vary



from region to region, Wal-Mart has been able to iron out the significant wrinkles within afew years, as was the case in Germany.

Chart 4Wal-Mart Sales Growth Over the Past Decade

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Wal-Mart’s international revenue growth has not reflected the pace of the increase ofinternational stores. Varying acquisitions have fueled erratic store growth. In particular,the ASDA acquisition in 1999 boosted the number of international stores by 229.However, the time costs of remodeling, establishing distribution networks, and adaptingto local retail markets have delayed much of the potential revenue growth. Growthshould result once Wal-Mart has established itself in the market. Over the past threeyears, international revenue per store growth has grown faster than domestic revenueper store.

Chart 5: Sales Per Store: International and Domestic Stores



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Carnegie Consulting feels that Wal-Mart needs to increase international store salesgrowth in China by expanding in non-metropolitan areas with urban populations below500,000. This strategy is similar to Wal-Mart’s expansion strategy in the United Statesduring the 1970s. In these cities, land is cheaper than larger urban areas and their arefewer competitors. These smaller cities also have access to seaports and airportsallowing for the development of distribution centers near the stores. The Company mustimprove its relations with Chinese suppliers and begin to develop a large-scaledistribution network for its Chinese stores. Carnegie Consulting believes the bestopportunity to test markets and build supplier and distribution networks withoutsignificant investment costs is through joint ventures that allow Wal-Mart to have theoption to purchase a larger share in the future. The Company’s joint venture in Japanwith Seiyu represents a methodical and safe entry into the Japanese grocery market.Wal-Mart’s most successful international venture was first developed in 1992 as a fifty-fifty share joint venture with the Mexican firm Cifra. Wal-Mart bought out Cifra inFebruary of 2000. With proper attention, Wal-Mart can develop the Chinese market intoa replica of its highly successful Mexican venture.

From observing international competitors, Wal-Mart can learn how to add new productlines to its stores. Many discount providers in Europe have already diversified intointerrelated industries beyond retailing and groceries. Carrefour is the major worldprovider of Hypermarkets, which incorporates telecommunication services, insurance,and travel services into the discount and grocery store format.



Exhibit 4Can Wal-Mart enter new businesses?

Percent of respondents who believe that Wal-Mart would be at least as good as traditional providers, by product service type

Business Percent

Restaurants 71%

Travel 63%

Car Rentals 57%

Cinema 56%

Financial Services 53%

Insurance 53%

Airlines 52%

Hotels 52%

Television Broadcasting 52%

Source: “Retail 2010,” McKinsey Quarterly

Carnegie Consulting recommends that Wal-Mart should not only continue its efforts todevelop new U.S. growth by means of its Supercenter concept but also begin toincorporate new interrelated industries and services. We believe Wal-Mart will succeedbecause of their customer base and ability to spread operating costs over the entirestore. The Company will enjoy first mover advantages over discount retail competitors.

Wal-Mart will benefit from diversifying into interrelated industries due to its productivecapacity. Certain potential interrelated industries that Wal-Mart may diversify into do nothave the retail centers, customer base, brand reputation and buyer power that thediscount retail industry has. These industries include utility payments, travel services,and insurance. Wal-Mart will initially have lower marketing costs and operating costs.Once Wal-Mart has established itself in the interrelated industry, it can use its buyingpower to provide services at a lower cost than other competitors in the interrelatedindustry. A good example of the benefits of incorporating an interrelated industry is theplacement of personal banking locations in supermarkets. The costs are roughly two-thirds of a traditional branch and can be almost twice as profitable.xv

The shift to incorporate interrelated industries provides a platform for Wal-Mart to growbeyond the Supercenter format. First, Wal-Mart needs to experiment with interrelatedindustries that have the lowest fixed cost of entry. Second, the Company needs to weighthe options of renting space to existing competitors in the interrelated industry or toprovide the service themselves. Wal-Mart chose to purchase McDonald’s franchisesbecause brand imaging is so important in the fast food industry. The utility paymentsservice does not rely on brand imaging so Wal-Mart can operate the serviceindependently. Exhibit 5 shows the interrelated industries and the order that Wal-Martshould enter. The order is based on fixed costs and the ability for Wal-Mart to operatethe service independently.



Exhibit 5Potential Industries that can be combined into the retail experience

Industry Fixed Costs Operations Returns

Utility Payments Low Self Low

Internet Access (in-store) Low Self Medium/Low

Telecommunication Services Medium Space Rented Low

Financial Services Medium Space Rented Medium/High

Automobile Sales High Self Medium/High

Utility payments can be incorporated into the checkout process. There are little costsbeyond establishing and operating a payment network because employees need noextra training. There is no additional space necessary in the store format. Because thesmall amount of costs associated with utility payments can be spread across the store,virtually any returns on the service will increase the profitability of the entire store.

Online substitutes exist in the utility payments services. Some online banking servicesoffer bill pay for free. Wells Fargo Bank offers free bill pay to its customers if theircombined balance of all Wells Fargo accounts is above $5,000 at all times. If thebalance drops below that level, bill pay then costs $6.95 per month. Wal-Mart would bethe first retailer in the United States to offer a utility payments service. Once customerssign up for the service, Wal-Mart could charge a lower service charge than online banksand generate profits through volume. Wal-Mart has more customers than any singleonline bill pay service. If the Company can encourage its customers to use the utilitypayment service, it can potentially drive out online substitutes by offering a lower pricedue to their economies of scale.

The same basic analysis applies for the other services listed. The fixed and operatingcosts of these services are small and they can be spread across the entire store. If Wal-Mart can encourage its customers to use the service, they will be the largest singleservice provider in all of these industries. Wal-Mart can then offer the lowest servicecharge in the specific industry and capture profits based on volume.

Wal-Mart’s main goal with diversifying into interrelated services and industries is fulfillingtheir customers’ needs. Utility payments and in-store Internet access offer services thatmay be unavailable to many of their customers due to costs or accessibility. We believeWal-Mart should create an environment that will target the needs of their customer baseby first incorporating the services listed in Exhibit 5. From groceries to banking servicesto bill payments to hardline goods, the retail environment will be a one-stop shoppingexperience that encompasses their customers’ entire daily, weekly, monthly and annualneeds.

Although Wal-Mart has successfully become the largest company in the world, it cannotafford to be complacent. The Company must take the necessary steps to ensure thatthe increased number of international stores produces a comparable increase inCompany revenues. This is done through detailed and concentrated growth in theselected markets of China and Japan. In addition, by diversifying into other interrelatedindustries, Wal-Mart can potentially increase the profitability of their existing stores. An



ATM and a McDonalds in every Wal-Mart is just the beginning. If management cansuccessfully incorporate the industries outlined in Exhibit 5, each Wal-Mart store couldpotentially increase the profitability of existing stores. Given that the Company is alreadythe world’s largest, this is extremely exciting for management and investors alike. i Courtesy of Business and Company Resource Center, www.galenet.galegroup.comii Fortune Magazine, October 25th, 1999.iii “Wal-Mart Checks Labels,” New York Times, January 1st, 1993iv “Retailing 2010,” McKinsey Quarterly, number 4, 2000.v Courtesy of Multex Market Watchvi Wal-Mart 2001 Annual Reportvii “Retailing 2010,” McKinsey Quarterly, number 4, 2000.viii Ibid.ix Wal-Mart 2001 Annual Reportx Ibid.xi Mitch Stover, Target, SVP of Distributionxii Wal-Mart Annual Report 2001.xiii “Will Wal-Mart Learn to Conquer Japan?” Business Week International Editions, Japan,4/1/2002.xiv Courtesy of Multex Market Watch

xv Courtesy of “Supermarket Banks,” McKinsey Quarterly, 1996 number 4.

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