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Strategy Management

Strategic Analysis

Section A1 – Group 12

Peter De Boeck

Alejandra Duran

Ilan Hadass

June Tan

Christian Zapf

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1. Define Wal-Mart’s strategy

Traditionally, Wal-Mart has essentially had a low-cost, high volume strategy. The strategy aims at

customer satisfaction through low prices and relatively good customer service. Here are the basic details.

• Low cost: Wal-Mart has lower operating expenses than the industry average. The primary cost

advantage is Wal-Mart’s superior distribution capability (location of stores, inside-out growth patterns,

cross-docking, superior information management). Quantitative details on cost advantage are set forth in

Section 3 below.

• High Volume: Industry analysts watch Wal-Mart’s growth of sales figure very closely. Wal-

Mart’s prices are low by the industry standard, which, combined with its lower costs, indicates a strategy

that aims at growth in volume through grabbing increased market share (cf. Dell).

• Customer Satisfaction: Low prices, advanced data management and extremely motivated

employees (“10 ft rule”, “sundown rule”) means a better customer experience than at other discount

retailers, even though Wal-Mart remains a self-service retailer. In addition, the large size of the

traditional Wal-Mart stores adds convenience by offering a one-stop solution by offering a wide range of

products.

In the words of Sam Walton, “Wal-Mart’s aims at creating a loyal customer base by lowering their

cost of living through offering quality and other products at significantly lower prices, while surprising

them on the convenience and service level side.”

It’s worth mentioning that Wal-Mart acquired volume through a careful consideration of locations,

away from competition. Today, however, Wal-Mart is experimenting with extending its original strategy.

There are three avenues being considered: internationalization, different formats (neighborhood stores)

and expanding the product range to offer more complete “customer solutions” like travel, insurance and

banking services. These growth options are discussed in Section 6. Still, in terms of strategy, we can say

here that the “internationalization” option is essentially an extension of Wal-Mart’s traditional strategy to

different countries (which is no doubt why Wal-Mart is pursuing it so aggressively), whereas the other two

options are new ground for Wal-Mart (which explains why they are being much more tentative in those

areas).

2. Evaluate the attractiveness of the discount retailing industry

We have analyzed the market attractiveness from the perspective of an existing player in the discount

retailing industry (as opposed to from the perspective of an entrant). We conclude that, for the average

retailer, the industry is unattractive principally because of the intense internal rivalry among the principal

retailers and the low switching cost for end-customers.

• Suppliers: weak power

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The suppliers are the consumer goods manufacturers (both food and durables) and they have little power.

In the first place, with very few exceptions, the consumer goods are commodities (or at least, acceptable

substitutes are readily available, both from other manufacturers and from in-house private labels). The

availability of alternative suppliers puts the retailers in a strong position. In addition, retailers have high

power of negotiation due to the high volumes purchased (and the projected growth of the discount

market). Who wants to put off a retailer who supplies 15% of a growing market? The limited number of

big discount retailers also creates an imbalance in the importance of the accounts for the retailers and the

suppliers. A Wal-Mart or Target account is enormously important to a supplier, but Wal-Mart can easily

live without this or that supplier. (Of course, the suppliers have more power vs. smaller or newer

entrants.)

• Buyers: average power

The end-consumer has significant power, because of (a) the ready availability of substitutes (for the most

part you can shop elsewhere), (b) the ease of switching between different stores (customers are not locked-

in) and (c) the lack of real differentiation among the retailers. Since all the retailers explicitly compete on

value, shoppers can easily compare the offerings. The transparency of any price advantages on what are

generally commodity products decreases consumer loyalty. As a result, any retailer that underperforms on

day 1 (being out of stock on milk for example) can find himself losing customers on day 2.

• Internal rivalry: strong

Of the 15 top discount stores shown in Exhibit 3 to the 1993 case, three were in Chapter 11 proceedings in

1993 and at least one more has declared bankruptcy since then (Kmart). Enough said? Obviously,

competition is fierce among discount retailers. The reasons are (a) the lack of differentiation in product

offerings, (b) low switching costs for end consumers and (c) volume-driven strategies that aim at grabbing

market-share at the expense of profitability (which creates a potential for price wars). The heavy pressure

for increases in volume arises because only volume allow the retailer to generate cost efficiencies, which

can then be passed on to the consumer in the form of price discounts, thereby creating even more volume

in terms of both basket size and visit frequency. Launching yourself into this upward virtuous spiral is an

essential ingredient of success for a discount retailer.

• Substitutes: moderate

A number of substitutes are available for consumers, principally from retailers having different formats:

food-supermarkets, local grocery stores, department stores, specialty stores, etc. Generally speaking,

these other formats offer more convenience at higher prices. Discount retailers have to keep track that

their price discounts remain sufficiently large to justify the extra effort for consumers to come to them.

An interesting second substitute is the direct sales channel. Manufacturers like Dell who sell

directly to the consumer may be a growing rival for discount retailers. As consumers become more used

to purchasing relatively large items over the internet (the sort of items for which the price savings offered

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by a discount retailer would have justified the effort of making the trip), online sellers will be an

increasing threat to the traditional discount retailers. However, of course, none of these online sellers

can offer the one-stop convenience of a discount retailer: none of them will be able to offer a comparable

range of products in the immediate future.

• Barriers to entry: high

As explained above, volume is essential to survive as a discount retailer. A new entrant must achieve

substantial market share to reach minimum efficient scale. Ingredients for volume selling are (a) a

complex and expensive distribution network, (b) a base number of stores to justify the distribution

network, and (c) a data management system matching supply and demand. High capital expenditures are

therefore a prerequisite. Even if this money can be raised (which is unlikely given the overall

unattractiveness of the industry), there is a scarcity of desirable property, at least in the U.S.: the country

is already carpeted with large retail discount centers (Wal-mart itself has run out of space) and so it is hard

to find locations without head to head competition with one or more incumbents. As a result, incumbents

will almost inevitably retaliate and attempt to squeeze out the entrant through price wars (which the

entrant will lose because of its lack of economies of scale). (An additional reason for retaliation is the

large exit barriers for the current players created by the enormous amount of capital tied up for them in

their existing operations.)

3. What are Wal-Mart’s competitive advantages? Please clearly articulate how Wal-Mart activities

translate into competitive advantages, and to the extent possible, quantify these effects.

We believe that Wal-Mart has five distinct competitive advantages, which are set forth in the table below.

In each case, the activities that implement that competitive advantage are listed. Under fit and scope, we

list how we believe these activities implement the basic strategy of Wal-Mart described in Section 1 (low

cost, high volume, customer satisfaction). It can be seen that the competitive advantages always fit with

the strategy and are also mutually supportive.

Competitive Advantage

Activities Fit and Scope Trade-Offs

Distribution capabilities1

Efficient distribution; e.g. cross-docking, predominance of Wal-mart’s own distribution centers, and “inside-out” location strategy

- Economies of scale match volume-based strategy - Cost savings from lower inventory levels - Cost-savings can translate into lower prices and more customer satisfaction

- Expense - Requires partnership relationship with suppliers - Requires sophisticated IT

Partnership relationship

Wal-Mart integrates suppliers via IT and

- Improves supply chain and lowers distribution costs

- Relatively high cost of goods sold

1 One could argue that Wal-Mart’s distribution capabilities are not a competitive advantage, though merely an activity that, for now, is being executed better than that of its competitors

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with suppliers

treats them well in terms of pricing; they are more partners than “value takers”

- Additional cost savings from elimination of manufacturer reps

- Requires integrated IT - Access to sales and inventory info for third parties

Advanced data-mining

Active collection and usage of customer purchase behavior info

- Useful data for suppliers - Improves customer satisfaction through more accurate forecasting of demand - Lower costs through reduced inventory and shrinkage - Improved matching of supply and demand creates superior sales/ sq ft

Expense and time

Workforce culture

Customer-oriented workforce motivated through generous monetary participation and belief in Wal-Mart culture

- Good customer service is not compromised by self-service and low cost structure, thereby improving customer loyalty - Stores can respond more quickly/ flexibly to changing demand - Continuous improvement mindset

- Expensive in terms of benefits (profit sharing) - Requires strong corporate culture (need proxy for Sam Walton) - Requires employee enablement from sophisticated IT (employees are hired with little educational background)

EDLP2 Maintenance of “every day low prices”

- Improves customer satisfaction through low prices - Matches volume-driven strategy - Drives down costs through less advertising - Steady prices improve stability of supply chain

- Only possible so long as you really have the lowest prices

To supplement the qualitative analysis below, we have analyzed Wal-Mart’s cost structure vs. the

competition in the chart below:

- 1993: cost structure (% of sales)

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What the chart shows is that Wal-Mart overall has a 4.2% cost advantage over its average competitor

(based on percentages of net sales), which breaks down as follows:

COGS are actually higher at Wal-Mart. This is consistent with Wal-Mart’s partnership relations

with suppliers that are aimed not at squeezing suppliers but at producing cost reductions in distribution

from improved cooperation and IT integration.

Advertising expenses are lower given the EDLP strategy: no promotion folders need to be

composed and distributed. In addition Wal-Mart probably realizes economies of scale through nation-wide

TV advertising.

Rent per square meter is actually higher for Wal-Mart ($8,8/sq.ft. vs. $4,4/sq.ft) though this better

locations apparently pay-off as Wal-Mart has lower rent expenses as % of sales.

Inbound logistics: Cross-docking and other distribution improvements result in cost savings of

1.1% of net sales.

IT costs are higher than those of Wal-Mart’s competitors. However, these additional costs are

offset by benefits on many fronts: (a) higher sales/sq.ft through better forecasting of demand, (b) (b) lower

supply chain costs through integration with suppliers, (c) more effective communication both internally

and externally, and (d) lower shrinkage costs (due to improved tracing)

A portion of the cost savings, which the chart above identifies as “other operating costs” remain

unallocable to specific categories. We believe that these additional cost savings are principally due to

economies of scale in Wal-Mart’s distribution system that simply dwarfs those of its competitors. In

addition, we suspect that staffing at Wal-Mart stores is leaner than those of its competitors, so that

employee costs are relatively low at Wal-Mart (on a per square foot basis), even taking into account the

generous benefit schemes.

The costs do not tell the complete story. A sales/sq.ft. comparison shows that the combination of its

competitive advantages lead to higher sales ratios. We believe that this is merely the result of (a) its low

prices, (b) its corporate culture, and (c) its insight in purchasing behavior that allows them to eliminate

bad-selling sku’s.

2 We consider ADLP as a competitive advantage as Wal-Mart is the only player able to offer lower prices than competition in a sustainable matter (or in other words: without going bankrupt)

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- 1993 : Sales/sq.ft. Comparison -

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Discount Departments stores

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Supercenter

4. How sustainable are those advantages in the U.S.?

The advantages are sustainable in the U.S.

Distribution capabilities. Wal-Mart’s distribution system is already in place. It is massive and very

difficult to replicate by competitors, in particular when you consider the electronic linkage of sales and

inventory information all around the country.

Partnership relationship with suppliers. The supplier partnerships also constitute a sustainable

advantage. This relationship is something that evolves over time and the more time that passes, the higher

the level of integration. Wal-Mart has already demonstrated its commitment and seriousness in their

operations so the relationships should prosper even more over time. Other competitors will lack the

volume of purchases that Wal-Mart can offer and will lack the years of relationship that Wal-Mart already

has with their suppliers. In addition, Wal-Mart beats the other discount retailers on compensation paid to

suppliers because it reaps cost savings in the operations area (as discussed above).

Advanced data-mining. Wal-Mart’s IT systems are very advanced and even though their competitors

will continue to copy them, they are always one step behind. The company has developed expertise in this

issue so it is able to constantly upgrade their systems. However, one would expect Wal-Mart’s

competitive advantage in this area to shrink over time.

Workforce culture. The advantage of having motivated and proactive employees can be replicated by

others, but it is not an overnight thing. Wal-Mart has created a corporate culture that is considered one of

the best in the U.S. and “matching” this by their competitors will take time. Creating a culture is an

everyday effort on the part of management and it involves careful focus on the interactions that occur in

the company. It is impossible for another discounter to replicate Wal Marts culture exactly but they can

follow the same idea. However, it is difficult to match the “best working place in the U.S.”

EDLP. You cannot replicate EDLP unless you can actually offer consistently low prices. Competitors

can only do this to the extent they are able to match Wal-Mart on cost. Given the other competitive

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advantages of Wal-Mart that reduce its costs (IT and distribution), it is hard to imagine another

competitor matching Wal-Mart’s EDLP.

5. How transferable are those advantages as Wal-Mart moves into new formats and especially into

new international locations?

(A) New formats. Currently, Wal-Mart is considering “neighborhood stores” as a new format.

Accordingly we have used that format to analyze the transferability of Wal-Mart’s competitive

advantages.

Advanced data mining. Wal-Mart’s IT capabilities can be easily adapted. Wal-Mart’s assortment

will be different in other formats, customer demand will be different, but all this will be easily manageable

by Wal-Mart’s existing IT.

EDLP. We have some doubt whether Wal-Mart’s cost structure for this new format will be good

enough to support EDLP for the new format. In particular, we expect rental costs/ sq ft to be higher given

the urban locations. Urban locations also create higher distribution costs (more frequent, smaller

deliveries, delivery problems due to traffic congestion). However, Wal-Mart may be able to partially

offset some of these costs through reduced inventory costs resulting from high inventory turnover

Workforce culture. The corporate culture can be transferred easily to new formats. New

employees are no harder to socialize at neighborhood stores than at supercenters.

Distribution capability. The neighborhood stores can benefit from the existing distribution

system. In fact, locations are chosen so that neighborhood stores can be served as part of runs to

supercenters. This is probably the biggest plus for the new format: the increased volume will generate

cost savings in distribution for both the existing formats and the new neighborhood stores.

Partnership relationship with vendors. The neighborhood market will use the current suppliers;

there are no transfer issues.

Our main concern about the neighborhood stores is therefore whether the same economics of the

successful supercenters are transferable to any new formats. The table below summarizes our concerns for

the neighborhood markets. 2002 Supercenter economics Neighborhood markets# sg.ft. 180.000 45.000Sales/sq.ft 366 422Total sales($)/store 65.825.699 18.990.000% COGS 75,10% 84%Operating expenses 18,10% 18,10%Operating profit (%) 6,80% -2,10%Operating profit($)/sq.ft. 24,9 -8,9

The table shows that COGS represent 84% of sales, which leads to a 16% gross margin for

neighborhood markets (assuming the same price levels as Supercenters). Even assuming the same

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operating expenses for neighborhood stores as for Supercenters, which is a generous assumption for the

neighborhood stores, we notice that the neighborhood markets would run at a loss3. The high COGS and

lower gross margin, we believe, reflect the fact that the product mix is more oriented towards food.

The table below summarizes the succesfactors of the supercenter format. Gross profit can be expressed as

(# of customers) x (visiting frequency) * (average $ in shopping basket) * average gross margin. Each

format adds to the successful mix of the supercenter: FOOD (grocery supermarket) NON-FOOD (General Merchandise discount store)

- Visiting frequency: the frequency visit is high (weekly or bi-weekly) because supercenters offer food, and Americans have the habit of weekly stocking the majority of their food items

- # of customers: the # of potential supercenter customers is high given the high geographic span of the format

- The average $ in shopping basket is high. The trip to the supercenter is done to fill the basement with food, but also to buy non-food items.

- The gross margin is relatively high: whereas food drives traffic, general merchandise drives profit. The floorplan shows that the food and non-food sections are nicely separated to allow for a quick visit (in-store-time-consumption is one of the drawbacks of large supercenters). Though the intermediary section between food and nonfood will typically be filled with cheap non-food items to draw the customer into the moneymaking non-food part of the supercenter.

Overall we now understand why supercenters are such money machines: the non-food section provides the

customer span and profit; the food section provides the frequency and low price image. In conclusion we

summarize that the competitive advantages are transferable, but that Wal-Mart should carefully consider

its price-level and assortment to make new formats profitable.

(B) Current formats in other countries.

Expanding the existing formats to other countries is intuitively appealing. A low cost volume-

based strategy offering superior customer satisfaction seems appealing anywhere we can identify a

sizeable middle class (or aspiring middle class) and decent population growth. Though when reviewing

the competitive advantages, one notices that Wal-Mart might prefer a mature and developed retail market

to realize its low-cost advantage on the one hand, but an underdeveloped, emerging slowly growing retail

market to have time to grow corporate culture perspective.

• Advanced data mining / customer insight

Technology advancement and trained employees are the key requirements for implementing the IT system

abroad. Though this is not a barrier to overcome, shopping and consumption habits differ across most

3 However, one should not jump to conclusions: (a) overall operating expenses can go down due to the economies of scale (b) marginal distribution costs for the neighborhood stores are low as they are supplied on trips to supercenters (c) prices will be higher at neighborhood markets given the added convenience of their location.

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countries making it hard to build on the US data. Mature retail countries as Western Europe are

preferable over emerging modern-retail countries as China given (a) the countries’ availability of

technology/infrastructure and (b) its similar consumption habits to the US.

• EDLP

Despite the fact that Wal-Mart is the inventor, we see different retailers in different countries adopting an

EDLP strategy. We see little problem in copying this part of the strategy.

• Customer oriented workforce

The corporate culture is related to a number of factors:

- The entry strategy: if Wal-Mart grows organically in a new country, it can build its own corporate

culture. Though when it acquires a retailer, it has to convert the existing corporate culture, which

has proven to be difficult.

On the other side organic growth in an emerging country brings the major disadvantage that

volume grows slowly which limits the economies of scale.

- The culture of the country: the Wal-Mart culture is atypical and not all workforces might cope

with it given their nation’s culture

- The role of the partner: most retailers enter a new country through a partnership to increase the rate

of success. This requires a mutual understanding and a fit between the two corporate cultures to

work together effectively

In conclusion we see that organic growth is the preferred option to build a similar customer oriented

workforce. Though this may not be trivial if Wal-Mart needs to acquire volume fast.

• Distribution capability

The distribution network has to be build from scratch in a new country. This limits the optimal choice of a

target country:

- In order to get the competitive cost advantage, volume is needed. This means that acquisition is a

preferred tool from a cost perspective.

- A decent infrastructure is needed so all goods can be transported efficiently

- The country is preferably large so economies of scale can be attained. That means similar

assortments, and therefore similar consumer tastes, across large regions

So from a distribution point of view, a large developed retail market is the preferred choice.

• Partnership relationship with vendors

Wal-Mart can work with the same suppliers in other countries to the extent that:

- The assortment is affordable to the population and fits with the local taste. In clear terms this

means that western countries are preferable

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- The supplier is present in these other countries and/or has the financial power to develop itself in

these countries.

This means that from a supplier’s perspective, mature western oriented countries are preferable.

• Economics of the format

We already explained the economics of the supercenter format. This format has to fit with local

purchasing habits:

- Weekly stocking of items: Japanese consumers do not have the habit of stocking items on a weekly

basis. Wal-Mart’s existing formats as the supercenter may therefore clash with the local shopping

habits

- Mobile population: the population has to be mobile, willing to travel to the Wal-Mart’s large stores

and able to transport large quantities of goods easily home. This may not be trivial: imagine

carrying 20 bags home using Singapore’s MRT.

Conclusion: we see that transferring the different competitive advantages puts different and sometimes

conflicting requirements on the country that Wal-Mart wants to enter. This is in line with their experience:

when acquiring the Wertkauf retail chain, they had large difficulties in converting the existing corporate

culture towards the customer-oriented culture (it took a while before German employees wanted to open

the day with shouting in group: “the customer is the king!”).

6. Attractive growth options for Wal-Mart.

(1) Continue converting discount formats to supercenters: we illustrated the success of the

supercenter format. Overall, we believe it will be difficult for Wal-Mart to find a similar golden egg

amongst its alternatives. Therefore it should pursue converting discount formats to supercenters to the

extent this is possible.

(2) New product categories and services. First, Wal-Mart can move up in the quality of its

products. Wal-Mart’s experience in the UK shows that consumer perceptions can be altered from a focus

on low-cost to providing high quality at value prices. Expanding its own higher-quality brands, such as the

‘George’ apparel line and increasing the selection of known brands (Levi Strauss jeans, etc.) are ways to

implement this strategy. Second, Wal-Mart can further expand its one-stop-solution by offering more

store-in-store specialty stores. For example, in 2002 Wal-Mart began to offer PC fix centers, but it can go

far beyond that to areas such as financial services (including residential brokerage), insurance, banking

and credit, entertainment, home and garden improvement, etc. All of these moves can drive improved

margins and, in the case of new services, create entirely new revenue sources. However, we are skeptical

about whether this is the right move for Wal-Mart. It is, at heart, a high-volume, low-cost retailer. If its

existing strategy were not working, it might be worth doing something else.

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New store formats. Our concern with new formats is the preservation of Wal-Mart’s cost

structure and the profitable format economics. As discussed above in the context of the neighborhood

stores, all competitive advantages are transferable into other formats with the possible exception of EDLP;

so because of these synergies incremental investments stay relatively limited. Though Wal-Mart should

only do this to the extent they can assure making profits with these formats.

Internationalization. At some point in the not so distant future, Wal-Mart’s highest growth will be

generated in the international arena. It is our view that this is the most promising opportunity for Wal-

Mart. As discussed above in Section 5B, the overall strategy for Wal-Mart makes sense in other countries

too and for the most part Wal-Mart’s competitive advantages can be transferred abroad. It is therefore not

surprising that the number of Wal-Mart stores outside the U.S. has almost doubles to 1200 (compared to

1647 in the United States) in the past four years. Though we should also emphasize that some markets as

South Korea, China, and Japan have been less successful because of reasons we indicated: volume did not

come instantaneously because of the early stage of development of the retail market, local partnerships did

not fit Wal-Mart’s own culture, differences exist in consumer preferences requiring totally different

assortments, the countries’ infrastructure was rather underdeveloped, etc. Though we see that in more

developed and more western-like retail markets, Wal-Mart (despite some initial growing pains)

successfully gained market share and attained profitability.