Wal-Mart:



Wal-Mart Operations in Brazil (2):

An Emerging Giant

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Professor Masaaki Kotabe, Louie Pranic and Richard Smith of the Fox School of Business and Management at Temple University and Kleber G. de Godoy and Moacir Salzstein of Fundação Getúlio Vargas, São Paulo, Brazil, prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective management of a situation described, 2003.

Copyright @ 2003 by Masaaki Kotabe

Introduction

In September 1994, Brazil was experiencing a new thrust in its economy. After several years of hyperinflation, the "Real Plan", implemented in March, 1994, an economic stabilization program that indexed the Brazilian currency to the U.S. dollar, began to reduce inflation to reasonable levels. In February 1994, the annual inflation rate was 40%, whereas by September of that same year, it was a relatively low 3%. A lower inflation rate was viewed as a viable step in improving the purchasing power of the Brazilian people, particularly in the lower socioeconomic segment of the population.

The optimistic scenario encouraged many foreign companies to make new investments in Brazil. If Brazil is the leading economy in Latin America with a population of more than 170 million, why not invest there, now that a better business horizon lies ahead in this continental country? Wal-Mart Stores, the world leader in retailing, announced on May 9, 1994 that it had decided to invest heavily in Brazil through a partnership with Lojas Americanas, Brazil's leading department store chain.

Following the implementation of “Real Plan” in 1994, and subsequent stabilization of Brazil’s economy, appreciation of the U.S. dollar in the late 1990s and global economic slowdown due to the Asian crisis forced the country to float its currency in January of 1999. As a result, the inflation increased moderately from 3% to 8.9%, but has steadily declined since, with a 5.3% inflation rate at the end of 2001. Additionally, with estimated economic growth of 4.2% for 2000, Brazil was viewed as a viable investment opportunity by foreign investors. As an illustration of Brazil’s economic prospects, it must be pointed that the year 2000 showed a record amount of direct foreign investment in Brazil from abroad, amounting to U.S. $30 billion. However, a current energy crisis presents significant problems to Brazil’s economy and its retail industry, in lieu of changes in consumers’ purchase behavior and income allocation.

Wal-Mart Operations

Sam Walton entered the retail business through a small store in Newport, Arkansas, in 1945, as a variety store franchisee. Six years later, Walton decided to open his own stores with the name “Walton's Five and Dime,” referring in the name to the coins that could have value to the customers.

As of 2002, there were 4,395 Wal-Mart units around the world, with 3,225 located in the United States, 551 in Mexico, 250 in the United Kingdom, 196 in Canada, 95 in Germany, 22 in Brazil, 17 in Puerto Rico, 19 in China, 11 in Argentina, and 9 in Korea. Net Sales for the year 2002 totaled $ 217 billion (see Exhibit 1 and 2).

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Wal-Mart operates with five different divisions within the United States: Wal-Mart Stores, Wal-Mart Supercenters, Sam's Club, McLane's Company and Wal-Mart International. Wal-Mart Stores is the division accounting for about 55% of total company revenues. Wal-Mart Supercenters generates 10% of total company revenues and is the fastest growing division. In the United States, there are three different “Supercenters”: Wal-Mart Supercenters, Hypermart USA’s and Bud's Warehouse Outlets. “Supercenters” are stores with more than 10,000 m2 of area and a minimum of 40,000 items. Sam's Club is the division responsible for 25% of revenues. The first Sam's Club - a “buyers' club,” namely, a store where the consumer pays an annual fee to have access - was opened in 1976. By the end of 2002, there were already more than 500 Sam's Clubs in the United States. McLane's Company is Wal-Mart's distribution company. Wal-Mart acquired this company, a leading distribution company, in 1990. In 1995, McLane's represented 6% of Wal-Mart total revenues. McLane's has 14 distribution centers in the United States and caters not only to Wal-Mart needs but also to other 25,000 retailing stores in the United States. Wal-Mart International, the fifth division, accounts for 17% of Wal-Mart total revenues, with net sales of $35 billion for the year 2002. The international division is the fastest growing, with over 41% increase in net sales from the year 2000.

International Expansion

In the second half of the 1980s, Wal-Mart began its international expansion in Mexico, Canada, Argentina, Hong Kong, and Brazil, among others (For detail, see Part I of this case). The company expected that all its strengths and retailing knowledge could leverage operations abroad as well as the efficient logistics and communication systems. The company considered that with a prospective of market globalization, the brand, “Wal-Mart,” could be a competitive advantage in many countries where it would operate. The company also decided that the entry strategy in each country should be through a partnership with local companies. A brief summary of Wal-Mart’s international operations in Mexico and Canada is provided in order to ensure better understanding of Wal-Mart’s operation in Brazil.

Mexico

Mexico was the first country in which Wal-Mart initiated its international expansion. The first store was opened in 1991. The local partner was Cifra, a Mexican retailing leader. It is undeniable that Wal-Mart has had some difficulties in adapting to and understanding Mexican culture and consumer habits. For example, Mexican consumers prefer to buy Mexican food and other goods rather than American products. Wal-Mart insisted on prioritizing imported goods from the United States for a long time. Another problem in Mexico is related with the Mexican habit of buying food in small stores rather than in supermarkets.

Despite the initially disappointing performance, Wal-Mart is currently Mexico’s largest retailer. This success was achieved only after the company changed its name from Cifra to Wal-Mart de Mexico, and spread its operations into six different retail formats and the country’s largest sit-down restaurant chain. Wal-Mart de Mexico’s six retail formats allowed the company to meet the needs and the purchase behaviors of various customer segments.

Canada

In Canada, Wal-Mart preferred to acquire a local chain - Woolco - instead of having a local partner. Due to maturity of Canadian retail market, and due to significant income and cultural similarities between the U.S. and Canadian markets, acquisition was arguably the easiest way for Wal-Mart to tap into Canada. Since most Canadians live near the U.S. border, they were already familiar with the company. Hence Wal-Mart leveraged this high brand recognition into customer acceptance and loyalty by introducing its “everyday low prices” approach to a market accustomed to high/low retail pricing. Coincidence or not, Canada is the most successful Wal-Mart operation abroad. Nevertheless, out of the 196 stores in Canada, 122 were originally Woolco stores. By the year 2002, Wal-Mart was Canada’a No. 1 retailer with revenues of approximately $8.75 billion, just eight years after its entry into Canada.

Entry in Brazil

The original intention of Wal-Mart was to achieve the number one retailer position in the Brazilian retail market through a partnership with a local “player” in a very short period of time. In order to achieve this ambitious goal, Bentonville headquarters planned a logistics and communication infrastructure capable of supporting no less than 80 stores in the Brazilian market. In addition, the headquarters’ intention was to export its expertise and practices in the form of an extensive set of operational manuals that proved successful in the United States, including product assortment and internal space utilization as well as its product mix.

Wal-Mart began its operation in Brazil in an absolutely fantastic way. The initial five stores were opened in a few months and, through a very aggressive pricing strategy, attracted thousands of enthusiastic consumers ready to empty the shelves. Another attraction was employees' disposition to help consumers, as well as wide product offering. Overall, during its initial periods of operation in the Brazilian market, Wal-Mart had captured a very favorable image from consumers and, subsequently, had painted a dark picture for its competitors' future.

The initially aggressive and promising entry strategy came to a halt after Wal-Mart immediately encountered severe unexpected operational problems. Long checkout lines, high stockout rate (40%), unreliable supply lines, faulty management-performance measures, traffic congestion, competitors’ reactions, and governmental forces were responsible for Wal-Mart’s initial failure in the Brazilian retail market.

Following Wal-Mart’s disappointing performance in the Brazilian retail market, the company had to revise its originally aggressive strategy. To accomplish this, some valuable lessons learned from Wal-Mart’s international expansion into Mexico and Canada had to be incorporated into the redesigned strategy for Brazil. Consequently, Wal-Mart’s strategy revision planned for adoption of a more conservative and controlled expansion, consolidation of distribution lines, and improved assimilation into the Brazilian culture. An example of Wal-Mart’s revised strategy included for the opening of only 10 stores from 1995 to 1997, down from the initial 80 plus stores. Furthermore, Wal-Mart intended to acquire an existing retail chain instead of exploring other partnerships, as was originally planned. In addition, the company wanted to acquire experienced managers from other competitors.

Challenges in Brazil

The challenges that Wal-Mart has experienced in Brazil may be grouped into six categories: state of the economy, cultural differences, management, advertising, logistics & distribution, and competition.

Economy

Since Wal-Marts entry into the Brazilian retail market in 1994 until the end of 2001, Brazil’s economy has been all but stable. The “Real Plan,” implemented in 1994 to curb the currency hyperinflation, brought the inflation from 40% in the year it was instituted, to 3% in 1999. Thanks to appreciation of the U.S. dollar, the Asian financial crisis, and a resulting global economic slowdown, Brazil floated its currency in 1999, as was the case prior to the Real Plan of 1994. This caused the inflation to moderately increase to 8.9% in 1999, but was brought down to 5.3% at the end of 2001. However, triggered by national currency depreciation, inflation increased again in 2002 and was expected to cross 8%.

The Brazilian economy was recently struck with the energy crisis. The crisis was caused by electricity consumption in Brazil being greater than its production, thus forcing the import of electricity from Paraguay. Although the current state of the Brazilian economy could be characterized as somewhat stable as compared to that before 1994, the future outlook of the economy does not provide any guaranties on a long-term basis.

Cultural Differences

Brazilian retail consumers consider product quality the most important factor in the decision-making process of purchasing, followed by product price, customer service, store cleanliness, and store distance.

Most Brazilians prefer shopping in small- to medium-size neighborhood stores. Nevertheless, they also enjoy the occasional shopping trip to a big discount supercenter. This trip, however, occurs only once a month, and thus making so-called “monthly purchases,” instead of once a week as in the United States. Yet the current energy crisis has forced most Brazilians to turn off their freezers and to adjust their shopping habits accordingly. Namely, food-related trips to the store in Brazil have increased in frequency, but decreased in the quantity of food purchased, especially in perishable goods.

Despite the unbelievably bad traffic jams, the average Sao Paulo resident is willing to take the long lasting trip to a specific supercenter if he/she perceives it as cost efficient and need satisfying. Similarly, the notion of having to pay a membership fee in order to shop at Sam’s Club is not greatly appreciated by Brazilian consumers, especially when shopping at “buyer’s club” is not perceived as providing greater savings and overall extra benefit to the end-consumer.

The product mix in Wal-Mart’s supercenters should be as close to reflecting the needs of Brazilian consumers as possible. Offering products popular in the United States such as golf equipment, vacuum cleaners for garden leaves, American footballs, and food grinders shows complete ignorance to Brazilian consumers since they have little or no use for these items. Likewise, assigning 25% of supercenter space for food in a country where food represents 60% of supermarket sales is another example of Wal-Mart’s cultural ignorance.

Management

Due to dissimilarities in income and culture between U.S. and Brazilian markets, a greater degree of managerial autonomy may be desirable for Wal-Mart in Brazil. In addition, getting back to the basics, or in other words, implementing Sam Walton’s “management by walking around” concept has not been used to its fullest extent by Wal-Mart in Brazil. A faulty product mix and store-space misallocation present examples of bad management policies. Moreover, the overall corporate grip that Wal-Mart has on its subsidiary in Brazil can best be exemplified by the fact that performance of the local managers in Brazil was based primarily on store sales volume. Thus, mangers set prices below cost to artificially stimulate demand and inflate sales volume numbers. Managers should have greater freedom in managing on a micro level. Wal-Mart has recognized the need to hire professionals, and has recently started a head-hunting campaign to acquire proven professionals from local competitors. This move should reduce Wal-Mart’s need to micromanage the Brazilian effort.

Advertising

Many Brazilian consumers, and housewives in particular, have the habit of listening to the radio during the day, while cooking and/or cleaning the house. Radio advertisements, therefore, should be used to reach and attract potential shoppers. Contrary to logic, Wal-Mart did not use radio as a medium for communicating to its customers. Some television and newspaper advertising is used by the company, but the resources allocated to the overall advertising campaign amount roughly to only 2% of Wal-Mart’s revenues. Although Wal-Mart has hired a Brazilian advertising agency, the lack of autonomy given to the agency defeats the whole purpose of “going local” through advertising.

Logistics & Distribution

Initially, Wal-Mart experienced an alarming 40% stockout rate in Brazil, as compared to 5% in the United States. Although the stockout rate has decreased since, the problem is far from being completely eliminated. Namely, Brazilian suppliers are lagging behind their U.S. counterparts in logistics technology, thus making computerized inventory management systems useless. Additionally, constant traffic jams present another major obstacle to consistency and predictability in supply of both Wal-Mart stores and distribution center(s).

Competition

Since Wal-Mart entered the Brazilian retail market in 1994, competition has been ever increasing, and all to the benefit of end-consumers. Many retailers are focused on expansion into different retail formats with the purpose of targeting different customer segments. Increasing the number of stores across the country is another way retailers compete in Brazil. Thanks to Wal-Mart, “price wars” are the most visible effects of fierce competition.

The 1995 data state that Brazil’s entire retail industry accounts for 6.6% of GNP, with total consolidated sales of U.S. $43.7 billion. The top 5 retailers in the Brazilian retail market account for roughly U.S. $11.2 billion. The 1997 data show that Wal-Mart’s major competitors are Carrefour, Companha Brasileira de Distrubuição (Pão de Açucar), Royal Ahold, and Makro Atacadista. In addition, some smaller retail chains and a large number of individually owned stores account for the remaining portion of the Brazilian retail market.

Carrefour

Carrefour, a French giant retailer that entered the Brazilian retail market in 1974, is the oldest and most established foreign competitor. This company has fully adapted to Brazilian culture and, thus, not viewed as a foreign company. Carrefour currently controls 20% of the Brazilian market with 229 stores total. Interestingly enough, the French retailer purchased 23 supermarkets from Wal-Mart’s entry partner, Lojas Americanas, in 1998 when that company exited the grocery business.

In addition, Carrefour has merged with Promodes SA, the rival Brazilian retailer, in 1999, in an attempt to achieve an even stronger position in that market. Decentralized management style and effective advertising campaign continue being Carrefour’s competitive strengths.

Companhia Brasileira de Distrubuição (CBD)

CBD, the second largest food retailer in Brazil, currently operates more than 400 stores in Brazil with U.S.$4.1 billion in total sales for 2000. The company is grouped into hypermarkets, supermarkets, electronics & home appliances division, and an e-commerce division. The supermarket division consists of two retail formats: Pão de Açucar and Barateiro Supermercados. Pão de Açucar has total 2000 sales similar to that of Carrefour. When adding the sales of Barateiro Supermercados, the division that caters to the lower class, CBD’s total sales make it the number one competitor within Brazil. As far as the ownership of the company, France’s Casino Group currently owns minority share (40%) in CBD. Use of Sam Walton’s “management by walking around” concept continues to be one of CBD’s advantages.

Royal Ahold

Royal Ahold is a Dutch firm specializing in supermarket retailing. Surprisingly enough, the company entered the Brazilian retail market through a joint venture with Brazil’s fourth largest retailer, Bompreco, in 1996. The company has since purchased Bompreco and is currently the leading food retailer in the northeast region of Brazil with 108 hypermarkets and supermarkets. Royal Ahold’s 2002 sales totaled 16.4 billion euros (approximately US$17 billion). Local retailer flexibility and rich product mix present the company’s source of advantage.

Makro Atacadista

Makro Atacadista is another Dutch retailer whose wholesale outlets represent direct competition to Wal-Mart’s Sam’s Club. Established in 1972, the company currently operates more than 30 stores across most of the country. It has over 1.3 million registered users, of which 80% are small business owners and the remaining 20% are individual customers. Unlike Sam’s Club, Makro Atacadista charges no annual fee to its members. Selling third-party products under its own brand name (thus achieving economies of scale in advertising) continues to be a major advantage for the company.

Wal-Mart Now

Since originally entering the Brazilian retail market in 1995, Wal-Mart has revised its strategy and consequently gained a substantial share of the marketplace. Although Wal-Mart is currently the 6th largest retailer in Brazil, it still holds a relatively small share of the retail market, which is dominated by the French retailer Carrefour. Still, future prospects are looking good for Wal-Mart in Brazil.

As of 2002, Wal-Mart has a total of 22 stores in operation (see Exhibit 3) and has 2% of the market. Out of 22 Wal-Mart stores in Brazil at the moment, it operates under three different formats, 12 Supercenters, 8 Sam’s Clubs, and 2 Wal-Mart Todo Dia stores in the states of Sao Paulo, Rio de Janeiro, Minas Gerais and Parana (AOL Latin America Announces Marketing Alliance With Wal-Mart Brazil, 2001). As previously stated, Wal-Mart’s first revised strategy called for the opening of only 10 stores from 1995 to 1997, down from initial plans of over 80 stores. Looking back, Wal-Mart actually opened only 3 stores over that same time period. Most of the expansion occurred within the past two years until 2001(see Exhibit 4 for store openings). Wal-Mart revealed its revised plan for expansion in Brazil in July 2002. According to the plan, the company would inaugurate 5 stores in Brazil. However, by the end of 2002, the total number of stores in operation continued to be 22.

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In May of 2001, Wal-Mart opened the Barueri distribution center in São Paulo. Wal-Mart previously had three rented, limited-capacity distribution centers. The new distribution center has 35,000 square meters of storage space and is built on a 200,000 square meter lot owned by Wal-Mart. This new facility is designed to easily supply 20 local stores at its current size, gives Wal-Mart better control over supply lines, and allows for future building expansion.

In May of 2001, Wal-Mart opened its first “Todo Dia” store in the eastern Sao Paulo section, Sapopemba. Since the Sapopemba section of São Paulo is mostly inhabited by a lower income segment of the population, this move signals that Wal-Mart is looking to increase its market share through catering to different market segments. Another Todo Dia store opened on October 10th, 2001 in Taboao de Serra region of Sao Paulo, with a third store scheduled for opening by the end of the fiscal year 2001. As opposed to Wal-Mart Supercenter that carries 60,000 items, Wal-Mart’s Todo Dia carries only 12,000 items. Besides being a smaller format store, Todo Dia’s inventory is stored directly above display shelves. It is reasonable to suspect that Wal-Mart’s introduction of the Todo Dia store format is used to test the market in Brazil for future expansion into local, and extremely value-conscious neighborhoods. This strategy is similar to that of Wal-Mart de Mexico where the company currently dominates the retail market with six retail formats.

In line with Wal-Mart’s revised strategy that called for improved assimilation into Brazilian culture, the company is currently involved with local communities, supporting social programs such as “Special Olympics Brazil” and “Mesa Sao Paulo”.

Wal-Mart’s latest move is the announcement of the marketing alliance with AOL Latin America whereby AOL Brazil will be promoted in all Wal-Mart and Sam’s Club units in Brazil. This marketing partnership is a logical strategic response to a current growth of the e-commerce sector. The value of business-to-consumer (B2C) e-commerce sales is forecasted to reach $4.3 billion in 2005. The number of Internet users in Brazil is expected to jump to 29 million in 2005.

The Wal-Market executive team in Brazil will be meeting with business consultants in a few weeks. In the meantime, they are wondering whether they have made right moves for further expansion in the Brazilian market.

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