Strategy Management

Strategic Analysis

Section A1 Group 12 Peter De Boeck Alejandra Duran Ilan Hadass June Tan Christian Zapf

1. Define Wal-Marts 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-Marts 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-Marts growth of sales figure very closely. WalMarts 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-Marts 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. Its 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-Marts 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

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 lockedin) 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 3

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-Marts 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 Distribution capabilities1 Activities Efficient distribution; e.g. cross-docking, predominance of Walmarts own distribution centers, and inside-out location strategy Wal-Mart integrates suppliers via IT and Fit and Scope - Economies of scale match volume-based strategy - Cost savings from lower inventory levels - Cost-savings can translate into lower prices and more customer satisfaction - Improves supply chain and lowers distribution costs Trade-Offs - Expense - Requires partnership relationship with suppliers - Requires sophisticated IT - Relatively high cost of goods sold

Partnership relationship
1

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

with suppliers Advanced data-mining

treats them well in terms of pricing; they are more partners than value takers Active collection and usage of customer purchase behavior info

- Additional cost savings from elimination of manufacturer reps - 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 - 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

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

Workforce culture

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

EDLP2

- Improves customer satisfaction through low prices - Matches volume-driven strategy - Drives down costs through less advertising - Steady prices improve stability of supply chain To supplement the qualitative analysis below, we have analyzed Wal-Marts cost structure vs. the competition in the chart below:
- 1 9 9 3 : c o s t s tru c tu re (% o f s a le s )
102 100 98 96 94 92 90
Advertsing COGS diff Rent Shrinkage operating Wal-Mart Inbound Industry average IT costs Other exp log

Maintenance of every day low prices

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

+2 ,3 9 7 ,4 -0 ,6 -0 ,3 -1 ,1 +0 ,2 -0 ,3 9 3 ,2 -4 ,4

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-Marts 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-Marts 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-Marts 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 skus.

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)

- 1993 : Sales/sq.ft. Comparison Warehouse clubs 681 Supercenter 595 535 500

Discount Departments stores

385

374 332

397 357

289 211 179 144 105 228 248

Arnes

BJ's wholesale club

Price Club

Caldor

Sam's club

Fred Meyer

Smitty's

Costco

Bigg's

Kmart

Pace

Meijer

4. How sustainable are those advantages in the U.S.? The advantages are sustainable in the U.S. Distribution capabilities. Wal-Marts 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-Marts 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-Marts 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

Average supermarket

Target

Wal-Mart

Wal-Mart

advantages of Wal-Mart that reduce its costs (IT and distribution), it is hard to imagine another competitor matching Wal-Marts 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-Marts competitive advantages. Advanced data mining. Wal-Marts IT capabilities can be easily adapted. Wal-Marts assortment will be different in other formats, customer demand will be different, but all this will be easily manageable by Wal-Marts existing IT. EDLP. We have some doubt whether Wal-Marts 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 45.000 Sales/sq.ft 366 422 Total 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

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) - 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 NON-FOOD (General Merchandise discount store) - # 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 (instore-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 volumebased 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
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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.

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 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 nations 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 The assortment is affordable to the population and fits with the local taste. In clear terms this means that western countries are preferable Wal-Mart can work with the same suppliers in other countries to the extent that: The corporate culture is related to a number of factors:

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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 suppliers 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-Marts 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-Marts large stores and able to transport large quantities of goods easily home. This may not be trivial: imagine carrying 20 bags home using Singapores 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-Marts 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-Marts 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-Marts highest growth will be generated in the international arena. It is our view that this is the most promising opportunity for WalMart. As discussed above in Section 5B, the overall strategy for Wal-Mart makes sense in other countries too and for the most part Wal-Marts 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-Marts 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.

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