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ID# CU20 PUBLISHED ON AUGUST 4, 2015

Wal-Mart In Search of Renewed Growth BY STEPHAN MEIER * AND FELIX OBERHOLZER-GEE †

Introduction In 2015 Wal-Mart Stores, Inc., the world’s largest retailer, faced several strategic challenges. The company had just been ranked number one on the Fortune 500 list, but same-store sales in the United States had barely been growing for the past six years. International expansion had turned out to yield uneven results, and Wal-Mart lagged in online sales. Wall Street’s support for Wal-Mart was tepid: Market Realist reported in early 2015 that the firm’s stock performance was “below par,” noting that “Walmart’s stock is only up by 8.8% since the start of 2014. This compares unfavorably to Kroger (KR, a supermarket). It’s up by a whopping 84.4%. Costco (COST, a warehouse club) and Target (TGT, a discount retailer) are up by 25.4% and 21.7%, respectively.” 1 (See Exhibit 1.) Finding new sources of growth would be no easy task. With more than 5,000 stores across the United States, the company had achieved broad geographic coverage. Cutting costs to boost financial performance seemed equally daunting. Wal-Mart’s laser-like focus on its famous “Everyday Low Prices” (EDLP) policy seemed to have wrung almost every conceivable expense from the firm’s supply chain and operations. Competitive pressure from ultra-low cost dollar store chains had increased substantially. As a result, the company found itself looking outside its traditional paths for growth opportunities. One option was to make a strategic shift toward a more upscale shopping experience. Target had already staked a claim to this positioning in discount retail, with its “Expect More, Pay Less” message and exclusive deals with top designers. Could Wal-Mart top Target? As CEO Doug McMillon envisioned a new kind of Wal-Mart, he carefully weighed the risks and benefits of such a move.

Author affiliation * Associate Professor of Business Management, Columbia Business School † Andreas Andresen Professor of Business Administration, Harvard Business School Acknowledgments Axel Ramm, MBA’16, provided valuable research and insights for the updated version of this case. Kate Permut, MBA’83, and Lori Qingyuan Yue, PhD’10, provided support for earlier versions of the case.

Copyright information ©2008–2015 by The Trustees of Columbia University in the City of New York. This case includes changes made to the version originally published on July 30, 2008. This case is for teaching purposes only and does not represent an endorsement or judgment of the material included. This case cannot be used or reproduced without explicit permission from Columbia CaseWorks. To obtain permission, please visit www.gsb.columbia.edu/caseworks, or e-mail [email protected]

Humble Beginnings In 1962 Sam Walton and his brother opened the first Wal-Mart Discount City store in Rogers, Arkansas. Walton was already an experienced retail manager, having worked both at J. C. Penney and as a franchise manager for the Ben Franklin chain. He had become intrigued by a growing trend in retailing—discount stores. These new establishments combined the lowmargin/low-price strategy of supermarkets with the broader selection of merchandise often seen in department stores. Discount stores featured minimal decor, bare-bones staffing, and few services, rarely providing delivery or credit. By eliminating these costs and charging margins at least 10%–15% lower than other retailers, discounters were able to offer customers a wide variety of goods at sharply decreased prices. Top discounters such as Woolco, Korvette’s, King’s, Caldor, Two Guys, and Mammoth Mart were already prospering with this low-price, high-volume strategy. In 1962 Kmart and Target were also launched as discount businesses. Walton’s idea was to bring the discount store concept and the benefits of lower prices to a neglected consumer demographic—shoppers in rural America. He opened his first stores in small towns, in sharp contrast to his competitors, who were reluctant to do business in cities with populations below 50,000. By operating in locations that larger competitors shunned, Wal-Mart found itself competing primarily against small, locally owned shops—just the type of businesses Walton could challenge with his EDLP policy. The crux of EDLP was to sell goods at a lower price per item at all times, not just during holidays or special sales periods, and to reap profits by selling a larger volume of those goods. Walton explained: Here is the simple lesson we learned…say I bought an item for 80 cents. I found that by pricing it at $1.00, I could sell three times more of it than by pricing it at $1.20. I might make only half the profit per item, but because I was selling three times as many, the overall profit was much greater. Simple enough. But this is really the essence of “discounting”—you can lower your markup but earn more because of the increased volume. 2 To be successful, Walton paid close attention to costs, carefully monitored the prices charged by each store’s neighboring competitors, and invested heavily in operations and logistics. CONTROLLING COST

Wal-Mart’s concern with controlling costs reached into every aspect of the business. To reduce expenses, Walton shunned bureaucracy and traditional marketing. Wal-Mart housed its lean senior team in a nondescript building in rural Bentonville, Arkansas. When managers visited suppliers, they rented inexpensive cars, stayed in low-cost hotels—often sharing a room—and walked instead of taking taxis. The operational rule was to hold trip expenses to less than 1% of purchases. As Wal-Mart grew, the company asked buyers to come to Bentonville, where negotiations were conducted in bare-bones rooms. Meetings with suppliers were set up via collect calls. In the early 1990s, in a move that was challenged and upheld in the courts, WalMart bypassed manufacturer representation altogether to deal directly with suppliers, thus saving 3%–4% on the cost of goods.

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PRICING PRACTICES

While Wal-Mart’s competitors set prices at headquarters, Walton delegated pricing and merchandising decisions to store managers who often visited neighboring stores to observe their rivals’ prices. Decentralization allowed the company to react quickly to local market conditions. For example, Wal-Mart prices were approximately 1% lower where Wal-Mart and Kmart were located next to each other. However, if a store had no immediate local competition, its prices were about 6% higher than the company’s average.3 INFORMATION TECHNOLOGY

Starting in the early 1980s, the company made large investments in technology. Wal-Mart was an early adopter of electronic scanning, automated distribution systems, and satellitesupported electronic data interchange (EDI) with its suppliers. By the 1990s EDI supported inventory management throughout the company. At the same time, Wal-Mart launched Retail Link, a private exchange that gave thousands of suppliers access to point-of-sale data and offered inventory information for the previous two years on a store-by-store basis. This wealth of data allowed store managers and suppliers to determine the specific traits of a Wal-Mart location by indexing local demand against more than 1,000 other stores and market characteristics.

Distribution Wal-Mart’s distribution strategy reflected the isolated locations of many of its stores (see Exhibit 2 for sociodemographic information about Wal-Mart and competitors). Walton explained: We were in the boondocks, so we didn’t have distributors falling over themselves to serve us….Our only alternative was to build our own warehouse so we could buy in volume at attractive prices and store the merchandise.4 The company’s first warehouse served 18 stores. Suppliers delivered goods to the warehouse, but Walton used his own trucks to ship the merchandise to his stores. Wal-Mart expanded its retail network by adding stores that were within one day’s drive of each one’s associated distribution center (see Exhibit 3). Professor Thomas J. Holmes, an economist at the University of Minnesota who studied Wal-Mart’s distribution strategy, explained: Wal-Mart started in a relatively central spot in the country and store openings radiated from the inside out. Wal-Mart never jumped to some far-off location to later fill in the area in between. When stores are packed close together, it is easier to set up a distribution network that keeps stores close to a distribution center. And when stores are close to a distribution center, Wal-Mart can save on trucking costs. 5 Walton’s trucks were usually able to reach a store in time for shelves to be restocked within one day, a critical advantage over the weeklong delivery time historically experienced by WalMart’s competitors. Over 80% of sales went through the company’s own distribution centers. Wal-Mart introduced cross docking—moving merchandise items from one truck to another Page 3 | Wal-Mart: In Search of Renewed Growth BY STEPHAN MEIER* AND FELIX OBERHOLZER-GEE†

without ever storing them in a warehouse. Because the company owned its own fleet of trucks, it controlled all parts of the delivery and schedule process. In recent years, Wal-Mart had even taken over the transportation of some of its suppliers’ merchandise—which, due to the size of its trucking fleet, Wal-Mart could do more efficiently than the suppliers themselves.6 As a result, the company was able to drastically reduce the number of items that experienced stockouts or overstocks. At the same time, a typical store allocated just 10% of its footprint to inventory storage, versus the 25% historical retail-industry average. The continued expansion of Wal-Mart’s network made it more likely that people would shop at its stores, since many customers lived within a short walking distance of several Wal-Mart locations (see Exhibit 4).

Creating a Culture Walton died in 1992, but the core company values he created lived on. He had articulated them with three phrases—respect for the individual, service to our customers, and striving for excellence. These values were reflected in numerous company policies: COST

Throughout its history, cost concerns remained front and center at Wal-Mart. Walton’s own behavior exemplified this in many ways: when he traveled between stores (first in his old pickup truck and then in the plane he flew himself, thus saving the cost of hiring a pilot); when he designed his stores (which had cement floors and industrial shelving); when he eschewed fancy corporate trappings (keeping a cramped, spartan office at headquarters); when he banned gifts from suppliers (believing those costs might be passed on to Wal-Mart); and when he was reluctant to add overhead (Wal-Mart did not have a PR department until the 1990s). As Wal-Mart grew, Walton’s midwestern values, emphasizing frugality, independence, and propriety, permeated the company. CUSTOMER FOCUS

Walton explained: There is only one boss: the customer. And he can fire everybody in the company from the chairman on down, simply by spending his money somewhere else. Whenever I come within 10 feet of a customer, I look him in the eye, greet him, and ask if I can help him.7 The yellow smiley-face logo became the corporate symbol. At the entrance of every store a greeter said, “Welcome to Wal-Mart” as shoppers arrived. Suppliers were called partners, and employees were called associates, implying that both had a different, closer relationship to management than was common at other companies. To build a bond between management and associates, everyone was asked to give a Wal-Mart cheer at the start of meetings (see Exhibit 5 for a photo of Walton doing the “squiggly”).8 Senior executives were expected to avoid ostentatious displays of power or wealth. AGILITY

Wal-Mart’s culture was fast paced, allowing it to react to market opportunities swiftly. Walton started his work day at 4:30 a.m. and his management team arrived by 6:30 a.m. At the Wal-Mart: In Search of Renewed Growth | Page 4 BY STEPHAN MEIER* AND FELIX OBERHOLZER-GEE†

mandatory company-wide 7:00 a.m. Saturday meeting, executives shared (live via satellite to all store locations) the week’s priorities, including up-to-the-minute sales trends, new products, and competitive developments. Saturday meetings were “equal parts talk show, financial update, merchandising workshop, town-hall forum, talent revenue, gripe session and pep rally.”9 Actions that were called for on Saturday morning were implemented by the end of that day. COMPETITION

Wal-Mart’s culture was characterized by a fierce sense of competition and a keen focus on business improvement. After managers visited the stores of local rivals, they had to come up with ways to undercut their prices. Every associate was asked to make suggestions about ways to improve sales for his or her area. Buyers aggressively negotiated the best prices from their suppliers and then went back each year to demand another 5% savings. The company was not shy about asking suppliers to modify their products or packaging. Despite such pressures, many manufacturers continued to view Wal-Mart as the best retailer to do business with. WalMart had taken the top spot in Kantar Retail’s annual ranking of about 350 retailers every year since the first survey was published in 1997. Out of 12 categories in the 2013 survey, Wal-Mart scored first in eight, with key competitor Target topping the remaining four. 10

New Store Formats To grow its business, Wal-Mart experimented with a variety of new store formats (see Exhibit 6). SAM’S CLUBS

Modeled after San Diego’s Price Club, Wal-Mart’s warehouse club offered a limited selection of merchandise (3,500 SKUs, compared to 70,000 at a regular store) at near-wholesale prices exclusively for Sam’s Club members. The company delineated the differences between these ventures and Wal-Mart stores clearly. Sam’s Clubs’ inventory was purchased separately from Wal-Marts’, seasonal merchandise played a much bigger role, and inventory turnover was much faster. As was typical for stores of this format, Sam’s Clubs sold merchandise in industrial quantities. Although the division’s gross margin was 13%—significantly lower than Wal-Mart stores’ average of 23%—each Sam’s Club had sales-per-square-foot averaging $401, versus $150 at a Wal-Mart. 11 SUPERCENTERS

In the late 1980s, Wal-Mart adapted the European hypermarket store format, pioneered by the French retailer Carrefour, to create supercenters. Supercenters added a grocery market to an existing Wal-Mart store. Despite the thin margins in the grocery business—3%–4% was considered typical, compared to 20% in the general merchandise segment—supercenters came to fuel Wal-Mart’s growth and profitability (see Exhibit 7). The company expanded into supercenters at a blistering pace; by 1999 it had opened 683. By the mid 2000s, this figure had grown to 1,980. In 2015 groceries accounted for 56% of the company’s annual revenues.12

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NEIGHBORHOOD MARKETS

As Wal-Mart’s grocery business grew, the company seized on closely related opportunities, as reported in the company’s 1999 Annual Report: Supercenters effectively serve a large trade area, but we think there may be some business that we are not getting purely because they may not be as close to the customer or convenient for small shopping trips. That’s where we think there may be an opportunity for the small grocery/drug store format where we are testing the Neighborhood Market. 13 Neighborhood Markets signaled Wal-Mart’s entry into the small-scale grocery business, and by 2015 growth in that format had intensified. A Neighborhood Market store was one-quarter the size of a supercenter and carried one-fifth the number of items available there. The smaller size also gave Wal-Mart a useful format for trying out new merchandise and service concepts. For example, the company first tested pharmacies in Neighborhood Markets and found them to be an attractive new revenue stream. Wal-Mart also experimented with private-label grocery and household product brands in its Neighborhood Markets. While the number of Neighborhood Markets had increased dramatically, in 2015 there were still none in New York, New Jersey, Pennsylvania, Massachusetts, Ohio, Michigan, and many other states.

International Expansion In the early 1990s, Wal-Mart’s executives turned to global markets for growth opportunities. The company’s initial move outside the United States was to the south, where it entered into a joint venture with Cifra, Mexico’s largest retailer. Wal-Mart purchased Cifra outright in 1998. In similar moves, Wal-Mart acquired 122 Canadian Woolco discount stores in 1994 and 21 hypermarkets in Germany in 1998. One year later, Wal-Mart completed the purchase of ASDA, a 232-store supermarket chain in the United Kingdom with $14 billion in sales. In 1996 WalMart entered China. By 2015 Wal-Mart International operated in 26 countries, producing 28% of the company’s revenue in 6,290 locations.14 While international sales grew quickly, Wal-Mart often faced savvy competitors who matched the company’s management skills and sophisticated consumers who were little impressed by its mid-western frugality. The company was forced to exit Germany and South Korea in 2006, ceding these markets to better-positioned rivals.15 Especially in Germany, competition was strong, labor laws were very different than in the United States, and zoning regulations were extremely strict and unfavorable to megastores.16 Mexico was an encouraging growth story, and Wal-Mart’s sales there were by far the largest of any country outside the United States; however, the Mexican market had slowed in recent years. In June 2012 Wal-Mart’s senior executives in Mexico were charged by the US Justice Department for allegedly bribing local officials to sidestep zoning laws in order to fast-track new store permits. As of 2015, the case was still under investigation.17

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In view of these setbacks, Wal-Mart started to take a more measured approach to international expansion. For example, the company scaled back its ambitions in China, setting more modest growth targets. 18

Continuing Challenges In 2013 Doug McMillon became Wal-Mart’s new CEO, the youngest CEO since Walton first took the helm and only the fourth since Walton’s death in 1992. McMillon had started out in a Wal-Mart distribution center as a summer intern and had spent almost his entire career at the company. A tough-minded buyer for many years, McMillon assumed responsibility for Wal-Mart’s international business in 2009. When McMillon was appointed CEO, he led the largest retailer in the world—an international behemoth with 2.2 million associates (1.4 million employees in the United States alone) and $482 billion in annual sales (see Exhibits 8A and 8B).19 Wal-Mart revenues surpassed those of its top five competitors combined.20 As McMillon learned soon, the company’s scale invited scrutiny, posing management challenges in two distinct areas: labor relations and community impacts. LABOR RELATIONS

Wal-Mart had a long history of staunch opposition to labor unions. Rather than allowing its workforce to organize, the company preferred to restructure its operations to eliminate positions that could potentially be unionized. Although Walton had emphasized maintaining good relations between employees and management, the company’s reputation as an employer grew increasingly negative. Many saw Wal-Mart’s culture as bullying and mean spirited and believed that the firm exploited its market power. 21 Critics alleged that WalMart’s wage policies kept employees below the poverty line. According to these estimates, a typical sales clerk earned $8.50 an hour, or about $14,000 a year, which was $1,000 below the poverty line for a family of...