August 29, 2004

Hitting the wall

There's no doubt Wal-Mart has become the most influential retailer in history

DAVID OLIVE

Last week, Wal-Mart sent tremors through the U.S. economy when it slashed its August sales forecast, predicting only flat to 2 per cent growth for the period. Wall Street got the wobblies, U.S. economic projections were rejigged, and there was renewed speculation about the impact of an apparently softening economy on George W. Bush's re-election prospects.

And no wonder: With $259 billion ( U.S.) in sales and 20 million customers visiting its 6,500-plus stores in nine countries each day, the world's five-and-dime has few rivals as a leading economic indicator.

Yet there's another side to the Wal-Mart story that keeps its head-office employees in Bentonville, Ark., awake at nights. It's the story of a company increasingly under siege by a growing and diverse legion of critics and class-action litigants. It's the drama of a company that has stumbled at home and overseas as it encounters for the first time the prospect of limits to growth. It's the tale of a firm, currently regarded as predatory and all-powerful, that is having to rethink the internal culture and 42-year-old business model that made it so astonishingly successful. And whose stock has been treading water for the past several years. Investors no longer perceive it as a dynamic growth company, but one that is vulnerable to a wide array of threats to its continued prosperity.

Make no mistake: If it was a country, Wal-Mart's GDP would match Saudi Arabia's. Wal-Mart is more than twice the size of its biggest global competitor, France's Carrefour SA. Blue-chip suppliers such as Procter & Gamble, Mattel Co. and Gillette Co. count on Wal-Mart as their most important customer. They tailor their output to Bentonville's requirements — even to the point, in the case of one music label, of producing a sanitized version of a bestselling CD to earn a place on Wal-Mart's shelves.

But as it has grown, Wal-Mart has become a victim of its enormous size — a phenomenon that will only become more pronounced as it expands by a projected $33 billion ( U.S.) in sales this year alone. That's more than two-thirds the entire revenues of Sears, Roebuck & Co., a firm that as recently as the 1970s was itself once a proxy for the U.S. economy, accounting for about 1 per cent of the nation's GNP.

Sheer size makes Wal-Mart vulnerable in a way founder Sam Walton would never have imagined. With the world's largest private-sector workforce — its staff of 1.4 million employees makes it 56 times bigger than the average Fortune 500 company — Wal-Mart, by Fortune's calculation, is 5,500 per cent more likely to be hit by bad news such as violent crime in its parking lots, workers injured by malfunctioning forklifts, exposure to gender-related discrimination suits, than the likes of, say, bookseller Borders Group Inc.

At any given time, Wal-Mart is coping with about 8,000 lawsuits. CEO Lee Scott concedes, "My mornings start with reading sales, followed by a visit from our general counsel." The distraction of mounting litigation is another burden not foreseen by "Mr. Sam," who settled most issues with a handshake.

Size also compels Wal-Mart to seek growth outside small-town America, to which its business model is best suited, and to experiment, often with disappointing results, with forays into sometimes hostile markets in North America's big cities and equally unfamiliar territory abroad in order to generate the additional $30 billion or so in new revenues each year required to maintain a respectable 10 per cent growth rate.

Finally, size and ubiquity make Wal-Mart a lightning rod for a swelling multitude of critics. Coleman Peterson, who headed Wal-Mart's human resources operation for a decade and still consults for the firm, explained in the New York Times earlier this year that "because of our size, and the agendas in many cases of those external to Wal-Mart, there are more third-party players who are developing opinions of us."

As one of the world's most familiar companies, Wal-Mart is the subject of symposia like the gathering of more than 250 anthropologists, sociologists and other academics at the University of California last April, where UC history professor Nelson Lichtenstein matter-of-factly stated that Wal-Mart "legislates for the rest of us key components of American social and industrial policy."

The obvious implication of such an assertion is that this powerful entity must be constrained for the public good. A surprisingly diverse number of organizations and individuals seek to do just that, consisting in part of labour leaders, community preservationist groups, civil-rights activists and anti-sweatshop agitators.

Jesse Jackson describes Wal-Mart as an exploitative "plantation," while John Kerry campaigns against its meager health-care and other benefits for employees. Students from the University of Arkansas protested at Wal-Mart's latest annual meeting about the firm's practice of selling such "unethical" goods as ammunition and diet pills. Three months ago, the National Trust for Historic Preservation designated the entire state of Vermont an "endangered place" in a bid to squash Wal-Mart's plans to add four new stores to the three it already operates in the Green Mountain State.

How many more consumers would visit Wal-Mart if not for what The Economist calls the "invisible picket line" around its stores? True, Wal-Mart has kept unions at bay in North America, save for a single, recently organized store in Jonquiere, Que. But the noise made by Wal-Mart's critics does inflict reputational damage.

"Union-sponsored campaigns have meant little to consumers," argues Wall Street Journal columnist Steven Malanga. But "the constant attacks are scoring in the elite media." And "acclaim from common folk may not protect a company when elite opinion turns against it, influencing legislators, regulators and the courts."

Wal-Mart CEO Lee Scott takes a similar line, arguing that attempts to ban his superstores are a blow to the least affluent consumers. "It simply means that they can't have a good life," Scott told Britain's Financial Times last month, "because you have chosen your image of the world versus what is the most efficient manner of serving that consumer."

A valid point, perhaps, but one that has been lost on local protesters who have recently succeeded in blocking planned Wal-Mart supercentres in Los Angeles, Chicago and New Orleans, and are standing in the way of planned stores in mid-sized cities like Guelph. Wal-Mart frequently cites the list it maintains of towns begging for one of its stores. But there are at least 220 U.S. communities on record opposing a Wal-Mart in their midst.

This is a severe problem for the world's biggest company. Wal-Mart's supercentres, the size of three football fields, are key to the firm's strategy of high-volume sales of low-margin goods. But community resistance in the most affluent parts of the U.S. helps explain why most of Wal-Mart's 1,500 U.S. supercentres are in the so-called heartland, where the company has 20 outlets in zoning-friendly Phoenix but none at all in New York City. Only recently has Wal-Mart succeeded in opening its first supercentres in Britain and Japan. Germany's strict laws protecting mom-and-pop stores are a factor in Wal-Mart's chronic losses since it entered that country.

After years of denial in the 1990s about the growing backlash, Wal-Mart this year has begun to take it seriously. "Shoppers could start feeling guilty about shopping with us," Wal-Mart spokesperson Mona Williams told Fortune in March. "Communities could make it harder to build our stores."

And a startling makeover is indeed underway at Wal-Mart. Weary of its Everyday Low Wages moniker and bumper stickers spotted in Illinois that read "Mal-Mart: Home of cheap crap," Scott announced at the firm's annual meeting in May a wide range of compensation and other reforms. He introduced new job classifications intended to raise pay at a firm where the average wage is $9.64 (U.S.) an hour, and the firm's 16,000 employees in China earn about $90 (U.S.) per month.

Scott also vowed to promote women and minorities in proportion to their willingness to apply for managerial posts, and to trim the bonuses of everyone from store managers right up to Scott himself by 7.5 per cent to 15 per cent if that goal isn't met. The company now pledges to be assiduous in preventing discrimination against gay employees. Scott even unveiled an experimental cash register that tells the clerk it's time for a meal break, and shuts down if there's no response.

That annual meeting was a watershed. Previous Wal-Mart conclaves were "lovefests" featuring entertainment celebrities, but the gathering last May was notable for how much Scott dwelled on setbacks including the U.S. government's raid of Wal-Mart's head office and several stores last year in search of evidence the company had employed illegal immigrants as cleaners. At one point, Wal-Mart executive Susan Oliver asked, "How many of you have heard something negative about a Wal-Mart job?" Lots of hands went up. "It hurts to hear it, doesn't it? she said.

That wasn't the only complaint at the meeting. More ominously, perhaps, many shareholders wanted to know why their shares have been dead money for years. They might be raising that same concern for years to come.

For its first two decades, Wal-Mart had the luxury of being dismissed by Sears, Roebuck and Kmart Corp., the goliath of discounters in the 1960s, as an idiosyncratic enterprise run by a guy who tooled around the northwest corner of Arkansas in a beat-up red pickup truck and piloted his own Cessna in search of new store locations in middle-American towns of 5,000 to 10,000 people that weren't worthy of Kmart's attention.

Today Wal-Mart is the Harvard of retailers, its every move studied not only by direct rivals but companies of every stripe. Wal-Mart has lost the element of surprise. As it enters new markets, Wal-Mart confronts competitors that have copied its best ideas — principally its sophisticated computerized inventory control systems and intimate relationship with suppliers — and perfected winning concepts of their own.

National chains like Costco Wholesale Corp. and Target Corp. are holding their own against the "Beast of Bentonville" with a hybrid formula best described as chic cheap. Costco, for example, stocks vintage wines and $55,000 diamond rings alongside the walls of family-size detergent and pallets of 10-kilogram sacks of dog food.

"Costco does trading up and trading down under one roof," says Michael Silverstein, co-author of Trading Up: The New American Luxury (Portfolio Press, 2003). "Wal-Mart just does trading down. At some point, that will have played out." Actually, it has already played out sufficiently for savvy regional chains like Trader Joe's in California, the HEB chain in Texas and Mexico, and upscale grocer Wegman's of upstate New York, to thrive in Wal-Mart's shadow.

In pointing to its rosy future, Wal-Mart reminds stock market analysts that for all its size, it still commands just 8 per cent of the U.S. market. What it doesn't mention is its traditional reluctance to lay claim to the other 92 per cent, located in unionized markets with customers more demanding of smart store design and quirky merchandise. Which long ago prompted the Bentonville braintrust to seek growth offshore.

But here again, Wal-Mart has encountered tougher competition than expected, from entrenched retailers like Canada's Loblaw Cos., Germany's Metro, Aldi and Lidl, and Japan's Aeon Co. — companies that are accustomed to paper-thin profit margins, and have made a priority of replicating the logistics acumen and pricing formula that underpins Wal-Mart's success.

In Canada, Britain and Mexico, Wal-Mart's sole foreign triumphs, it has won largely by default, filling a void created by the weak Canadian players T. Eaton Co. and Hudson's Bay Co. and Britain's J. Sainsbury, and in Mexico through acquiring its largest retailer.

Global retailers Carrefour and Britain's Tesco PLC are another story, making life miserable for Wal-Mart in its South American markets with price wars and battles for the most lucrative store locations. Wal-Mart has already quit Hong Kong and Indonesia due to adverse market conditions and merchandise foul-ups, and its South Korean stores lack traffic for being located too distant from major cities. A decade after its international expansion, Wal-Mart still derives 87 per cent of its profits in the U.S.

More troubling are threats to the sanctity of Wal-Mart's vaunted low-price policy. Wal-Mart's long-standing mission is to "lower the world's cost of living." But earlier this year, the chain realized it was suppressing its own revenue growth by continually slashing prices, which also impaired its ability to show the healthy same-store sales growth that impresses Wall Street. So it has lately eased up on its ceaseless price-cutting. It has also begun to give its suppliers a break, letting them pass on rising raw material costs to customers. Having already squeezed its suppliers to the max over the years, and long ago becoming the biggest U.S. buyer of cut-rate Chinese goods, Wal-Mart has begun to exhaust the easy savings from these methods.

Wal-Mart's all-important labour-cost advantage — wages that are typically 20 per cent to 30 per cent lower than its retail peers — is also under pressure. Scott acknowledges that his wage reforms will raise Wal-Mart's labour costs. Meanwhile, as Wal-Mart continues to grow domestically and abroad, its massive hiring spree will oblige it to curb turnover rates that already require it to hire about 600,000 employees each year just to maintain its current workforce. That creates the spectre of more longer-tenured employees becoming eligible for higher pay, and removes the biggest obstacle to union organizers. They traditionally have signed up transient retail workers at Wal-Mart and elsewhere only to see them defect for better jobs before a union certification can be won.

Wal-Mart is gradually losing its labour-cost edge by having pulled survival-minded competitors down to its level. The company's Darwinian instincts have been absorbed by competitors like Loblaw, which last year sought to head off the threat of Wal-Mart's entry into the Canadian grocery arena by securing wage and other concessions from workers at its new Wal-Mart-style superstores, and by California's largest grocery chains, which similarly extracted wage and benefit givebacks from their unionized workers last year in advance of an anticipated Wal-Mart invasion.

It takes only a visit to a Wal-Mart store to see that the firm's negative press is exaggerated.

When I last wrote about the company's "drive to the bottom" in wages and outsourcing, a satisfied Toronto Wal-Mart customer wrote me that, "A number of Wal-Mart staff at my store are not the people even a company like Zellers would employ. There are retirees, morbidly obese people, some who are mentally challenged, and some `colourful' characters such as the woman who dresses like a gypsy under her work vest.

"I have been served by devout Muslims, openly gay people, members of the bingo crowd (we live near a bingo hall, so I am able to apply that label), and just about any and every type. And they are all pleasant, efficient and better trained than those I've met at the Bay, Canadian Tire and most anywhere else. No one seems to be suffering from poor management, and certainly have better attitudes than their peers elsewhere."

At the chain's Dufferin Mall store, in a working-class district in west-end Toronto, I saw the truth of my correspondent's assessment. The staff was cheerful and, for a discounter, relatively abundant. But I also saw a store trying to do too much.

Here were $100 lawnmowers, dowdy kids' apparel, plastic hub caps, a $99 faux ironwork chandelier, pyramids of cashew tins, flimsy bedside tables, and a sampling of mass-market fragrances that claimed rather less shelf space than the "hamster accessories."

So, something for everyone. Unless you're put off by peeling cherry wood veneer masking a particleboard frame or area rugs made of polypropylene. What's on offer is determined by the Wal-Mart demographic. In defence of Wal-Mart's professed populist image, CEO Scott points out that 20 per cent of his clientele don't have a bank account, and are one paycheque away from eviction.

Which, obviously, leaves a huge opening for: (a) retailers who position themselves even slightly upscale in quality and product presentation while keeping prices reasonable; and (b) specialty merchants who carry in-depth products that make only a token appearance at Wal-Mart. It doesn't take long for even the not-particularly-well-traveled shopper to sense that much of what Wal-Mart does is done better by others: more selection in cosmetics at Shoppers Drug Mart, in apparel classics at Gap, in auto and hardware supplies at Canadian Tire and Rona, in office supplies at Staples, in furniture at Ikea, and in computer and electronics gear at Future Shop. To compete effectively with all those rivals, as Wal-Mart attempts to do, would require a breadth of selection that Wal-Mart could accommodate only with a new generation of supercentres the size of 16 football fields.

Behind the Wal-Mart mystique is a firm that spent three decades achieving a near-monopoly in small-town America. Outside that stronghold, the going is rougher. At the end of the day, Wal-Mart is a department store, with all the limitations of that fading concept. It's no surprise that Wal-Mart's most conspicuous victims have been other department stores, the demise of which is gradually curtailing Wal-Mart's opportunity to score relatively effortless gains in market share.

Forty-two years after Sam Walton launched his chain in Rogers, Ark., the company still demands, as Sam did — and as Ed Mirvish does — that customers purchase what the store's buyers were able to obtain on the cheap. For depth of selection, innovative goods and a sense of theatre, shoppers must go elsewhere.

The formula works with a captive, modest-income client base. But while admittedly vast, it's a finite clientele. And when it has been exploited to the full, the savants in Bentonville will be hard-pressed to expand beyond it — something the stock market appears to have figured out, if not yet those who still fear Sam Walton's legacy.

©Toronto Star 2004

 

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