Wal-Mart Rising To China Challenge

Wal-Mart has spent the past 17 years trying to perfect its business model in China, garnering about 8% of the retail market share in this massive nation of 1.3 billion consumers.

This market contributed about $10.6 billion to Wal-Mart’s gross revenue last year, up 15% from the previous year, but still only a drop in the bucket of the retailer’s total $469 billion in topline revenue, according to IBIS World Inc.

The clunky big box model was not an immediate sensation in China, given population density, logistical struggles and tighter government regulations with a lack of transparency.

It seems the low-cost titan met its match amid a plethora of other frugal options from street vendors to local stores stocked with brand knock-offs. But Wal-Mart has pledged to stay the course as it continues to roll out its “Every Day Low Price” model this year.

Wal-Mart’s International President Doug McMillon said the retailer is still trying to perfect its internal operations in China but sees good long-term prospects.

In the short run, Wal-Mart is working to gain better locations and layouts that are more suited to a supercenter format.

He said Wal-Mart still has much work to do in China and that would mean some stores would be shuttered and others relocated as time and opportunity allowed. Wal-Mart closed four of its stores in China last year, with three additional closings planned in 2013.

But unlike other big box players (Best Buy and Home Depot) who have baled on China’s golden opportunities, Wal-Mart is investing $80 million more to remodel 50 stores and construct 30 new venues. The retailer has pledged to continue making improvements in infrastructure over the next three years as well.

Last week, Wal-Mart said it will invest $16.3 million over three years to improve food safety in China as it works to bolster its image after a couple of food-related citations for mislabeled and tainted products came from within its supply chain.

Wal-Mart said it will also increase supplier training, improve store standards, recruit more food-safety experts and expand its fresh-food distribution with this investment, a move analysts believe will resonate with Chinese consumers.

SCALING UP
Wal-Mart has just under 400 stores compared to 4,500 in the United States and while the countries are roughly the same size in land mass, China has four times the U.S. population and buying potential.

Analysts agree Wal-Mart will likely need to play its global e-commerce wildcard to win long-term in China as the nation gradually transforms into a customer-driven economy.

Wal-Mart began its retail operations in China in 1996, with the opening of a supercenter and Sam’s Club in Shenzhen. But it was a full decade later before Wal-Mart really jumped in with both feet purchasing a 35% interest in Trust-Mart in February 2007.

Trust-Mart operates 101 hypermarkets in 34 cities in China under the Trust-Mart banner and the investment in Trust-Mart gave Walmart an opportunity to expand its footprint in China, IBIS World notes.

In 2011, Wal-Mart acquired a majority interest in Trust-Mart and has become the largest foreign-funded supermarket operator in China, surpassing French retailer Carrefour. Even so, Wal-Mart still lacks scale in its brick and mortar stores, according to industry analysts at Kantar Retail.

In 2011, the retailer signed an agreement with the Shanghai local government to establish Wal-Mart’s China e-commerce headquarters. This laid the groundwork for another investment which is seen as a “wildcard” that will propel Wal-Mart’s growth in China over the next five years.

In October 2012, Wal-Mart purchased a 51% stake in Yihaodian, one of the leading website shopping platforms within China’s e-business market.

Carol Spieckerman, CEO of New Market Builders in Bentonville, credits Wal-Mart with taking a long-term approach in China plodding a course that integrates brick-and-mortar with an important e-commerce catalyst they secured in the Yihaodian acquisition.

For the time being, the Wal-Mart-Yihaodian exclusive partnership essentially locks out European retailers Carrefour and Tesco who are also carving out their own niches in China, Spieckerman said.

She said as the barriers to entry are lowered in the coming years, other smaller players will have more e-commerce access, but for now Wal-Mart and Yihaodian have the opportunity to share insights and potentially override any weaknesses they might have individually.

“Wal-Mart is hedging its bet in China, continuing to perfect its brick-and-mortar model there, but also jumping feet first into the rapidly growing e-commerce market with Yihaodian, who is a leader in the grocery and consumable space,” Spieckerman said.

LESSONS LEARNED
Low prices are everywhere in China and Wal-Mart’s core message of “saving people money so they can live better” has not necessarily translated with Chinese consumers who have no problem saving money on their own.

Dr. Pu Liu, professor of international finance at the University of Arkansas, said China’s population is extremely disciplined with respect to saving money.

“China lacks the social safety net that Americans enjoy with social security, pensions and Medicare programs. The Chinese are reliant on their children for this support as they age. WIth the one child policy in place, Chinese consumers save throughout their lifetimes. As they shop, they are more attuned to value and quality assurance than lowest prices,” Liu said.

He said multi-national retailers with large stores also face very stiff competition from local businesses who run smaller convenience stores that cater to neighborhoods within large urban areas, though more modern supermarkets are gradually growing in popularity.

Analysts said retailers have to decide early on how they will conquer the massive land size with limited capital expenditures. Most often that means concentrating on targeted key cities or sometimes penetrating certain regions which can leave the retailer vulnerable to local competition and conceding turf to other competitors.

Liu said China’s middle class has ample money to spend but culturally they only purchase enough food for one or two days at a time, preferring to buy fresh as they have minimal refrigeration and often lack cars to transport larger grocery purchases.

“Most will shop near their homes and purchase only what they carry, which means more frequent trips and lower overall ticket totals,” he said. “It’s a very different dynamic than typically seen in Wal-Mart’s traditional supercenter,” he added.

Analyst said Wal-Mart’s strategy in recent years has been to decentralize away from headquarter control giving store managers more authority for inventory sourcing in the diverse country.

Kantar Retail notes it’s no coincidence Wal-Mart’s toughest big box competitor in China — RT-Mart — posts nearly double the same store sales as its main foreign competitors. The Taiwan-French partnership is a near perfect blend of Wal-Mart-like efficiency with China’s home-town flare.

RIPE OPPORTUNITIES
Liu agreed the rise of mobile phone usage in China over the past few years gives retailers who service e-commerce customers a wide-open opportunity to grow sales in the coming years.

“Mobile phones are like jewelry in China, and the smartphone is very much a status symbol that middle class consumers have to own,” Liu said.

A report from Pricewaterhouse Coopers indicates e-commerce shopping has emerged into $211 billion market last year, from nearly non-existent just five years ago.

In China, 58% of respondents in the PwC report said they shopped online at least once a week. By comparison, only 42% of U.S. respondents said they shopped online at least once a week.

A separate report from McKinsey & Company released in March notes, “China’s retail sector is among the most wired anywhere — e-tailing commanded about 5 to 6% of total retail sales in 2012, compared with 5% in the United States, though it is distinctly different from that of other countries.

McKinsey notes only a small portion of Chinese e-tailing takes place directly between consumers and retailers as most occurs on digital marketplaces akin to Amazon.

Another major discovery in the McKinsey study is that Chinese e-tailing is not just replacing traditional retail transactions but also stimulating consumption that would not otherwise take place.

This e-tailing engine is enabling China’s shift from an investment-oriented society to one that is more consumption driven. It appears to be spurring incremental consumption, particularly in less developed regions, according to McKinsey.

By analyzing consumption patterns in 266 Chinese cities accounting for over 70% of online retail sales, McKinsey found that $1 of online consumption replaces roughly 60 cents of sales in offline stores and generates around 40 cents of incremental consumption. Based on these estimates, McKinsey expects online sales could generate 4 to 7% in incremental consumption by 2020.

Spieckerman said those retailers like Wal-Mart that invest in e-commerce with the patience to wait on profits will likely be in the best position for growth as China’s economy continues moving toward a consumption model.

In the three years it’s been in business, Yihaodian has not become profitable and Wal-Mart has continued with baby steps toward gaining market share; however, Spieckerman said as these companies share best practices their sum total will undoubtedly be greater than the original parts.

BY THE NUMBERS
106,500: The number of employees Wal-Mart has in China
95%: The amount of merchandise in its China stores that is sourced locally.
20,000: The number of suppliers within China.
21: The number of provinces in China where Wal-Mart has stores.

Wal-Mart China Sales Revenue
2008 $4 billion
2009 $4.97 billion
2010 $7.5 billion
2011 $8.37 billion
2012 $9.21 billion
2013 $10.59 billion (estimated)