Wal-Mart



Wal-Mart Argentina

Case

Prepared by:

Luciene De Paulo

Andrew Martin

Esther Montiel

Jennifer Pogue

Gabriel Szulik

Wal-Mart International Case

Introduction

In 1993, Wal-Mart had become America’s leading retailer, with net sales of $67 billion from its Wal-Mart stores, Sam’s Clubs, and Wal-Mart Supercenters. The Company had grown at a rate of 25% per year since 1990, and it was clear that to continue at its current rate of growth, Wal-Mart would have to seriously consider continuing its recent international expansion.

During 1992, Wal-Mart had entered into a joint venture with CIFRA, Mexico’s largest retailer, which currently operated 24 stores in Mexico and had plans to open 70 new stores by 1995. The Company had also recently completed the acquisition of 122 Woolco department stores in Canada. Each of these expansions had presented unique challenges for Wal-Mart to adapt its operations to suit local market demands, but Wal-Mart had successfully risen to the challenge. Given the Company’s successful track record, it seemed logical to continue to expand internationally.

If Wal-Mart didn’t expand internationally, David Glass, Wal-Mart’s CEO, felt that companies would start to come to the US and increase competitive pressures domestically. International expansion would drive growth and help in maintaining Wal-Mart’s dominant domestic position. Namely, entrance into foreign markets would force competitors to focus on their primary markets. If Wal-Mart planned to maintain its dominant position in the U.S., international expansion would not only drive growth, but it would also keep potential competitors trying to operate stores in their home markets rather than expanding into the U.S.[1]

Wal-Mart

Company Background:

Sam Walton began his retail career working at J.C. Penney while in college and later leased a Ben Franklin franchised dime store in Newport, Arkansas (1945). In 1950, he relocated to Bentonville and opened a Walton Five and Dime. By 1962, Walton owned 15 Ben Franklin stores under the Walton Give and Dime name. Walton felt that big supermarkets would eventually destroy the smaller, traditional five and dimes and in 1962, Walton opened his own supermarket discount store. Eight years later, the Company was trading on Wall Street and had 30 stores.

Wal-Mart’s growth accelerated greatly during the 1970s. The Company aggressively marketed itself to middle class shoppers by advertising “Everyday Low Prices.” Walton motivated his employees by implementing a stock participation program that allowed all employees to purchase stock at discounted prices. This created an employee ownership that helped Walton to advance the Company’s emphasis on controlling costs and providing excellent customer service. Additionally, Wal-Mart established highly automated distribution centers and implemented a computerized inventory system, which allowed the Company to cut costs and speed up checkout.

In 1988, Sam Walton stepped down as CEO of Wal-Mart due to health reasons and David Glass assumed the management of the Company. Since then, Wal-Mart had acquired its own distribution division and had begun to expand internationally.

By 1993, Wal-Mart had five divisions: Wal-Mart Stores, Wal-Mart Supercenters, Sam’s Clubs, McLane Company, and Wal-Mart International.

1. Wal-Mart Stores represented the lion’s share of company sales and were the nation’s largest discount chain. They accounted for approximately 75% of the Company’s profit.

2. Wal-Mart Supercenters were the company’s fastest growing division and included Supercenters, Hypermarts, and Bud’s Warehouse. This segment provided the Company’s primary growth vehicle going forward, with units combining 110,000 square foot discount stores with 40,000 square foot grocery and 20,000 square foot strip mall merchandise.

3. Sam’s Clubs typically ran at 100,000 square feet and accounted for approximately 23% of total company sales and 14% of profits in 1993.

4. McLane Company was acquired by Wal-Mart in 1990 and comprised the world’s largest food and nonfood distributor. In addition to supplying Wal-Mart’s divisions, McLane also distributed to more than 25,000 convenience store and food service retailers.

5. Wal-Mart International was created in 1990 to address globalization and represented a critical growth vehicle as Wal-Mart sprawled across the nation's borders into the international market.[2]

There was not just one explanation for Wal-Mart’s success and outstanding performance among retailers. It was a combination of strong management, culture, and strategy that had made Wal-Mart one of the most powerful retailers in the world. Wal-Mart’s entire economics, reward systems and corporate culture focused on growing overall profits and sales, and the strategy seemed to be working. Sales had grown at more than a 25% compound annual rate since 1990, making significant performance improvement a challenge.

Despite this challenge, Wal-Mart had a five-pronged growth strategy in place. The first driver of growth through 1997 was expected to be the Supercenters, which were projected to contribute to 50% of the Company’s sales growth through 1997. New store growth would follow Supercenter growth, with Wal-Mart adding an average of 156 stores per year in the U.S. International development was expected to continue, with international stores growing to 13% of the worldwide store total by 1997. The emphasis on Sam’s Club membership stores was decreasing, and Wal-Mart was focusing on boosting sales at existing stores rather than spreading out the chain. Finally, Wal-Mart was attempting to realize each of its store’s potential by utilizing the Company’s strength in technology. By tracking consumer-buying patterns in different stores, Wal-Mart was “localizing the mix” and tailoring store inventory and service to local markets.

Wal-Mart’s Financial Performance

By 1993, Wal-Mart Stores Inc. had established a proven record of financial performance. Over its twenty-year history, Wal-Mart had achieved a return on equity of 33% and sales growth of 25%. The company had experienced sales increases from $16 billion in 1987 to $67 billion in 1993 while earnings went from $628 million to $2.3 billion over the same period. The firm had also built a market capitalization of $57.5 billion and sales per square foot of nearly $300 (as compared to an industry average of $210). Exhibit 1 details the company’s financial performance over the past two years and its growth trends. The company hoped to continue this growth with internal forecasts predicting sales of $84 billion in 1994.

In order to accomplish these goals, Wal-Mart had to continue to expand beyond its traditional domestic base. Competition from the likes of K-Mart and Target was beginning to deprive the company of the single market locales that had led to tremendous growth. In April 1993, the company announced that growth would not meet historical levels; company projections placed domestic growth over 1993 levels only in the 7-8% range. If those projections proved true, it would mark the first time that growth had not exceeded ten percent in eight years. The market quickly reacted with Wal-Mart’s stock price tumbling 22% to $26 5/8.

There were many reasons to suggest that the timing was right to expand internationally. A favorable political and economic climate was helping free trade to become easier across borders with obstacles being eliminated though agreements such as NAFTA. Also, converting currency was becoming easier with third party providers such as Coopers and Lybrand going international. Finally, improvements in technology were making it easier to do business across International borders.

With these issues in mind, David Glass and his vice chairman, Don Soderquist looked to international expansion to facilitate growth. Several initiatives were planned in Mexico, Canada and China. By introducing the discount model to foreign markets first, Wal-Mart hoped to achieve high sales and earnings growth while also increasing economies of scale among global operations.

Wal-Mart International

Along with its entry into the more established markets in Canada and Mexico, Wal-Mart was considering entering the more stable, but yet undeveloped markets of Latin America—specifically Brazil and Argentina. Argentina offered a mature and growing target market that could embrace the discount store concept at a rapid pace. If Wal-Mart made the decision to enter Argentina, upper management projected that the Company would expand into the Argentine market with a mix of Wal-Mart and Sam’s Club stores.

Company policy had always required that all Wal-Mart projects, regardless of the geographical or competitive environment, meet certain standards. As of 1993, management required that all new investments return 17% of investment as measured by profit contribution divided by invested capital. . Further, the company allowed for a time horizon of approximately three years.

In terms of costs, Wal-Mart budgeted expansion costs for Argentina using a model similar to those used in the American and Canadian markets. The company forecasted that each new store would cost roughly $20 million to build and reach operation status. Upon opening, management forecasted that each store should gross approximately $150 million in annual revenue[3]. Total sales were expected to grow significantly faster than its domestic operations in the first few years but would stabilize to growth rates similar to its domestic stores within five to seven years. However, external analysts assessed these forecasts and considered them overly optimistic. Management also projected that Wal-Mart should achieve gross margins of roughly 20% for its supercenters and that SG&A would initially be at least twice that of an established local retailer. All told, if Wal-Mart chose to proceed with expansion into Argentina, the Company was prepared to allocate a $400 million capital expenditure budget for the immediate future.

However, Bob Martin, the CEO of Wal-Mart International, had some concerns about entering the market in Argentina. Given the history of the country and the economy, he wanted to be sure the investment would meet Wal-Mart’s stringent investment criterion. In addition, he was concerned about the stability of the currency and government. Was the timing appropriate to enter Argentina? Martin also wanted to know if the investment in Argentina would reduce Wal-Mart’s exposure to other risks. For example, Wal-Mart had operations in Canada, which had a very stable currency, and Mexico, a country with a much more unstable currency. This balance minimized the effect of a potential major currency devaluation in Mexico should that occur.

Argentina

History

Once among the world’s most prosperous economies, Argentina experienced slow economic growth from the 1940s until the start of the Convertibility Plan in 1991. By the mid-1970s long-term growth had decreased sharply and in the late ‘80s Argentina suffered a strong period of depression. Savings and investment rates fell dramatically from the mid-1970s until 1989. Due to the unstable macroeconomic environment, local people saved and invested abroad. Labor productivity fell and poverty increased.

This economic performance had its main root in a chronic public sector deficit and endemic inflation. After democracy returned in 1983, different stabilization programs were put in place. However, all of them failed to eliminate inflation, as they were unable to permanently attack the structural deficit of the public sector.

In 1989, when a new administration took office, Argentina was immersed in hyperinflation, and the state was insolvent and incapable of paying its debt services. In April of 1991, the Law of Convertibility was issued, which guaranteed 1 to 1 convertibility of the peso into dollars, effectively proscribing money creation other than to buy net foreign reserves. The convertibility program therefore disciplined monetary policy and limited the power of the government to finance its deficit through inflation.

Since 1991, the government had sustained structural reform efforts that improved the public accounts. Several reforms were implemented regarding legal framework, privatization, and deregulation. The tax penalty law, from 1990, implemented severe sanctions for tax non-compliance. This and other efforts produced dramatic rises in tax collections. The government relied heavily on taxes to support the fixed peso exchange rate prescribed by the Convertibility Plan.

The recent October 1993 pension reform law had begun to generate pension fund savings on a large scale, securing a growing demand for capital market instruments. Moreover, the government had been working to restructure fiscal relationships with the provinces. Additionally, Argentina was close to reaching an agreement with its Mercosur partners to establish common external tariffs on January 1995, moving toward a regional common market.

Economic situation and outlook

In 1993, President Menem was preparing for re-election and was continuing to implement economic and social reforms to secure his re-election. However, there were few potential opponents for the election. In fact, only one existed for the socialist party and was not considered a serious contender against Menem.

A one major economic reform issue was opening the economy. The administration had recently begun to encourage foreign investment, and as a result it was forecasted to increase at a rate of 12.1% per annum through 1995. Unfortunately, the government was actually slowing import growth through the introduction of surcharges on textile imports and anti-dumping duties on steel imports. These actions were doing little to promote a growing merchandise trade for Argentina, which was only 11.2% of the country’s GDP in 1992. However, the government was planning to launch a Brady plan to raise funds, and it was unlikely that the government would risk its ability to raise funds by closing its economy once again.

Menem’s economic reforms were generally having a positive impact on Argentina’s economy. During 1991-93, Argentina’s economic growth averaged 7.7 %. Employment rates increased and capital inflows had been continuous, which had helped Argentina attain a sustainable balance of payments. During 1993, the economy continued to expand. Consumer spending was forecasted to grow at 4.8% per annum through 1995. Additionally, GDP had increased by 7.3% in 1992 and was forecast to increase by 6% in 1993 and 4% in 1994. Inflation had slowed dramatically during the past few years, falling to international levels, and was expected to be approximately 15% for the year. The price increases that were happening were not attributed to inflation, but rather the fact that products in Argentina had previously been under-priced versus international price levels. Now that Argentina’s economy was more stable, prices were rising to meet those levels. Overall, Argentina’s immediate economic outlook was very positive[4]

Retail Market

The hyperinflation of the 1980s had a number of adverse effects on the Argentine retail sector; in particular it caused a major reduction in consumer spending capacity and forced leading companies to focus on cash management at the expense of long-term investment. The turning point was the Convertibility Plan of 1991 and the opening up of the market that happened around the same time.

The immediate results were an increase in foreign investment, a rise in consumption, a major expansion of transactions and a decrease in margins, this last phenomenon due to intense competition. This new scenario favored the establishment of supermarkets and hypermarkets, in detriment of small businesses unable to keep up the pace of competition.

Although the Convertibility Plan of 1991 brought an end to the hyperinflation that characterized the previous years, the cost of living in Argentina soared, as a result of an increasingly overvalued local currency. This has clearly affected growth in the retail sector as a whole. Nevertheless, the retail sector still had huge growth potential, which would also be benefited by a sustained, strong government fight on tax evasion. This was expected to weaken the informal economy and consolidate sales within the modern, established retail sector.

In 1984, the Argentine retail trade covered 787,279 commercial outlets, employing a total workforce of 2,183,157. The majority of these establishments were geared towards food and other perishable products and around 10% are responsible for 60% of sales. This distribution reflected an old structure based on neighborhood family stores (called almacenes), and not until recently before 1993 had the sector begun to modernize, with the construction of shopping malls and supermarket chains.

Argentina had a large and sophisticated consumer base with 1/3 of the population living in Buenos Aires. This group had all of the characteristics of a 90s consumer society: 99% television penetration, 55% cable penetration, European cultural sensibilities and American tastes in clothes and food. Argentina also had 96% literacy rate and a very sizable youth segment with 54% of population under 30.

Approximately 1,000 supermarkets and 20 hypermarkets accounted for 35% of retail sales, self-service stores for 22% and the smaller establishments for 43%. The five leading super/hypermarket chains in 1993 were:

▪ Disco (57 branches)

▪ Casa Tia (46)

▪ Coto (29)

▪ Norte (17)

▪ Carrefour (6)

Together, these 155 outlets garnered US$ 3 billion in sales and employed a workforce of 20,000. The size of the total Argentine Retail Market grew from US$64.5 billion in 1992 to US$67.9 billion in 1993. Total retail sales for 1994 were expected to reach US$72 billion. The Argentine retail trade had recently passed through a deep restructuring process. In about 2 years, home appliance outlets in the entire country fell from 5,600 to 3,200 establishments, a reduction of around 40%. Traditional small and medium-scale home appliance retailers retained 48% of the market in 1990. Hypermarkets, on the other hand, had increased their share from 9% to 22% during the same period, with major chains, such as Fravega, Ozores, and Garbarino, rising from 20% to 35%.[5] Because of the high levels of competition by the large-scale retailers, in addition to higher tax rates and rents, smaller businesses were being forced to close.

Many countries in Latin America had underdeveloped infrastructures that hobbled transportation. According to retail consultant Tom Schaeffer, Argentina was not an exception. Retailers, vendors, and transportation companies did not have high technology in place, such as inventory control and EDI systems. This meant a significant challenge for any foreign chain planning to invest in Argentina. However, this was not the only challenge they might face: historically, retailers had rushed to attain critical mass in new markets, therefore gaining significant buying power over suppliers. The process had included increasing buying in a centralized manner. In Argentina, and in Latin America in general, the process had been different, as suppliers tended to be more fragmented and regional. Local retailers had developed long relationships with these suppliers, which gave them more immediate power in the marketplace.

Most of the major supermarket and hypermarket retailers had recently begun to invest in expansion as well as in more advanced technological infrastructure, both in food and non-food segments. The battle for market share in the food sector had created competitive climate in Argentina. Net profits averaged 5%. Many retailers had to modernize their stores and change their product mix to compete. The top four chains in the sector – Carrefour, Norte, Disco and Coto, accounted for nearly $3.5 billion in sales and 14% of total sector sales in 1993, up from $2.1 billion and 10% of sales in 1992. The entire food sector was approximately $44 billion with the formalized supermarket formats representing about 60% of sales.[6] The following table shows total retail sales at constant prices for the 1991-1995 period.[7]

| | |actual | | |forecasted | |

| | |1991 |1992 |1993 |1994 |1995 |

| | | | | | | |

|Retail market |57,868 |64,475 |67,876 |72,000 |75,500 |

|(US$ billions) | | | | | |

Competitive Climate

The Argentine retail market was highly fragmented due to the presence of small and micro businesses that in total accounted for a substantial share of overall sales. Moreover, there were a significant number of strong regional chains dispersed in the different provinces.

Carrefour, a French owned hypermarket center, was Wal-Mart's largest potential competitor in Argentina. The Company had been in Argentina for 15 years and operating under a low-price strategy similar to Wal-Mart's in the U.S. It had 14 stores in operation, including one grossing over $200 million per year, and the firm had enormous financial clout in Argentina. [8]

Based on the overall participation of the country’s top 35 retail companies, the top six companies in the ranking accounted for 65% of total retail market share, while the remaining 29 companies accounted for a share of 35%. The following table shows the market share data among supermarket/hypermarket/grocery chains, totaling US$ 8.6 billion:

|Year 1993 |% Retail Market Share |

| | |

|Carrefour |19.8% |

|Cadesa (Norte) |10.3% |

|Coto |10.2% |

|Disco |9.4% |

|Casa Tia |8.2% |

|Cencosud (Jumbo) |7.7% |

|J. Angulo (Super Vea) |3.3% |

|Su Supermercado |3.0% |

|Supermercados Americanos |2.9% |

|Casa Petrini |2.9% |

|Other |22.3% |

| | |

|TOTAL |100.0% |

Method of Entry

Options for Argentina

After extensive research, the Wal-Mart management team had laid out four potential strategies in regard to entry for Argentina:

1. Internal Funding- Wal-Mart would enter the Argentine market on its own with entire funding requirements provided by general operations. Although this provided management with complete control and protection of the corporate brand identity, it forced Wal-Mart to navigate a foreign environment with risks unseen in more developed American markets.

2. Joint Venture- As had been done in Mexico, Wal-Mart could forge an alliance with an

established retail player in the foreign market. Currently, Disco S.A was the main retail partner Wal-Mart was considering. Disco was the largest retailer in Argentina, operating 57 hypermarkets both within Buenos Aires and throughout the country. A partnership with Disco would make it easier for Wal-Mart to adapt to cultural differences and potentially easier to establish government contacts as well as relationships within the local business community. Additionally, a joint venture would allow Wal-Mart to share the political and economic risks of the location while also gaining specific market knowledge and experience. However, profits would be divided and control would be somewhat diminished. Also, would the partner be able to contribute their portion of capital in the event of an economic crisis? Although reforms in Argentina were looking well underway, there was always an outside possibility that something could go wrong.

3. Acquisition- An acquisition would also be an excellent way to gain an immediate presence in Argentina. Again, Disco seemed to be an ideal target company for acquisition because of its established brand in Argentina. Not only would a purchase of a local chain provide a trained staff and established organization in Argentina, but it could also potentially help Wal-Mart obtain a preferred location for its store locations. Assuming a good cultural fit with the company, this would be the fastest and smoothest entrance option. Argentina had recently seen a wide range of retail acquisitions as American and European players attempted to gain a foothold. Wal-Mart had identified several potential targets and management eventually determined that Disco would be the best fit. This option would require extensive due diligence regarding price and it may force Wal-Mart to expend further funds modifying and aligning store designs and operations.

4. No Entry- The Company may determine that the risks are too great to enter Argentina at this time, or that the alternatives do not meet the Company’s strict investment criterion. In this case, Bob Martin could focus resources on either continuing its current expansion plans in Mexico, Canada, and China, or identify some more attractive opportunities.

In evaluating each of these options, Wal-Mart had to closely consider the cash flows inherent in terms of initial outlays and continuing revenues and costs. Crucial in these calculations was the determination of cost of capital[9]. Revenue would be received in pesos and corporate results would be judged in dollars. Furthermore, the company would have to take into consideration the varying political and economic risks associated with the different options. Lastly, although Wal-Mart enjoyed financial prosperity, management had to consider the level of capital expenditures appropriate given the expected return. In other words, a measure of success had to be laid out.

DISCO S.A.

Disco was the largest retailer in Argentina, operating a network of 50 hypermarkets and 7 convenience stores. The company had been controlled by Grupo Velox since 1991, and had positioned itself as one of the retail leaders in Argentina.

Disco owned four different chains (Disco, Elefante, La Gran Provision, and Stop) and the company’s main objective for the near future was to increase its total square footage of sales by 50%. In order to achieve this goal, Disco had been opening around 10 outlets per year on average during the last few years. The average size of Disco’s outlets was between 6,000 and 40,000 square feet.

Disco was the first chain to open hypermarkets in Argentina, offering both food and non-food items in its "convenience stores." Historically, the company’s results had been highly correlated with the level of economic activity, consumption growth, and GDP growth. However, more recently changes in consumer preferences –namely, the “one-stop-shopping” concept- had positively influenced the company’s performance.

In addition, the economic stability had favored the purchase of high-margin products such as meat, perishables, and imported goods, which were the most popular products at Disco.

Disco currently operated two distribution centers, had relationships with more than 1,000 suppliers, and had been working in the development of Bell’s, its main private label. Disco’s strategy was to strengthen this label, foster customer loyalty, and build an aggressive customer service policy. The company offered deliveries, phone orders, day care, and a “frequent customer” program.

According to Carlos Paciarotti, Disco's director of investor and public relations, Disco’s five strategic strengths were:

▪ Outstanding locations

▪ Broad assortment of items

▪ Extremely high quality in perishables (50% of sales)

▪ Excellent customer service

▪ Highly competitive prices

There were two main differences between the strategies of Wal-Mart and Disco S.A. First, Disco did not operate under a low-cost strategy, which was the core of Wal-Mart's strategy in the U.S.. Second, Disco had a large number of smaller stores whereas Wal-Mart had large Supercenters in fewer locations. Wal-Mart needed to carefully consider these differences as it decided whether or not to select Disco as a partner.

Partnership Options

Acquisition:

Wal-Mart’s analysts had reviewed Disco’s 1992 and 1993 financials and had made some projections of Disco’s financial results for 1994[10]. Don Soderquist had expressed a desire for Wal-Mart to fully fund any future entry into international markets through home office funding. For this reason, Martin felt that if Wal-Mart acquired Disco, it would most likely pay off its debt at acquisition. Martin hoped that if Wal-Mart acquired Disco, it could take advantage of Disco’s current market share and profitable operations in Argentina.

Joint Venture:

If Wal-Mart entered into a joint venture with Disco, the two companies would most likely form a new company with shared ownership. Of course, Wal-Mart would want to maintain control of the venture. Analysts estimated that Disco might be open to an offer of a 60/40 split of the estimated $400 million of capital expenditures. Since Wal-Mart would be entering Argentina with a local partner, analysts expected the new stores to be able to capture additional market share and initially achieve lower operating and administrative expenses than if Wal-Mart entered on its own.

Martin wondered which of these alternatives would be most beneficial to Wal-Mart.

Summary

The annual shareholders meeting was coming up, and Bob Martin needed to make a recommendation to Glass on how to proceed. Although Glass agreed with Martin that international expansion needed to continue, he wasn’t convinced Argentina was the best choice. Glass wanted to be sure that they had considered all of the risks involved before making such a large investment in a new country. If Martin did decide that Wal-Mart should invest in Argentina, Martin wondered which alternative to recommend. He needed to finish his analysis and prepare a report for Glass that compared the alternatives. Whatever Martin’s recommendations, he knew they needed to be presented with a compelling argument. This was a critical year for Wal-Mart, and Glass would want to be able to demonstrate to Wal-Mart’s investors that the Company could overcome its slow down in growth during the last year.

-----------------------

[1] “Brazil, Argentina Next Stop on Wal-MartTrail” Discount Store News; New York; June 20, 1994; Dan Longo

[2] “Wal-Mart: Yesterday and Today” Discount Merchandiser; Bristol; Sept 1995; Jennifer Pellet

[3] Argentina’s Tax Rate was 30% in 1993.

[4] All of these improvements were evident in the recent increase in Argentina’s credit rating. See Exhibit 2 for credit rating history.

[5] Source: Estudio Hacer de Reengenharia

[6] “Argentina: A Growing Retail Opportunity,” Chain Store Age; New York; April 1996; Keith Kohler

[7] Source: Euromonitor Plc. Consulting Firm

[8] “Wal-Mart Bullish on South America,” Discount Store News; New York; October 21, 1996; Pete Hisey

[9] U.S Risk Free Rate was 6.348% and U.S Risk Premium was 8.76%.

[10] See Exhibit 3 for financial history and projections for Disco S.A.

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