Walmart in China 2012

Linda Garrett prepared this case under the supervision of Professor Ali Farhoomand for class discussion. This case is not intended to show effective or ineffective handling of decision or business processes. © 2012 by The Asia Case Research Centre, The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise (including the internet)—without the permission of The University of Hong Kong. Ref. 12/516C 1 ALI FARHOOMAND WAL-MART IN CHINA (2012) Introduction Summer was making its picture-perfect debut in New South Wales that day in October 2011, but Mr Greg Foran hardly noticed. Newly hired away from his role as head of Australia’s leading supermarket chain, Woolworth’s Supermarket Division, he was set to work as a senior vice president at Wal-Mart International, the fastest growing division of the world’s largest retailer, Wal-Mart Corporation. However, what exactly he would be doing was still open to discussion. It was not until the sudden and somewhat mysterious departure of Mr Ed Chan, the president of Wal-Mart China, that Foran’s new role suddenly emerged. That Australian summer, far from the approaching winter back in Bentonville, Arkansas, Wal-Mart’s corporate headquarters in the United States, Foran tried to learn more about why Chan had resigned after only four years at Wal-Mart China’s helm. China promised Wal-Mart a market potential like none seen since the company’s own monumental growth and retail dominance in the United States decades earlier. Was it the pork-labelling probe that temporarily shut all 13 of Wal-Mart’s stores in the southwestern Chinese city of Chongqing (not to mention the detaining of over two dozen employees) nine days earlier that forced Chan’s departure? Or was it the resignations, only five months earlier, of Chan’s chief financial officer and his chief operating officer? Although all the executives cited “personal reasons”, the financial media suggested that it was Wal-Mart International’s plans to introduce its Every Day Low Price (“EDLP”) pricing strategy in China that prompted the resignations. But how could such a successful model for cost reduction be viewed as negative in the Middle Kingdom? Foran found out the answers to many of his questions when, five months later, in early February 2012, Mr Scott Price, then president and CEO of Wal-Mart Asia and the interim CEO for Wal-Mart China, announced Foran’s promotion to president and CEO of Wal-Mart China. Foran was moving to Futian District, Shenzhen, a nine-hour plane ride, some 4,500 miles, from Sydney. At the press conference announcing Foran’s new role, Price proudly presented Foran as a man with a “distinguished career in retail” and “uniquely qualified to lead our growing business in China”. Only three months later, with Foran only in the job a HKU984 For the exclusive use of C. SFORZA-FLICK This document is authorized for use only by Cameron Sforza-Flick in Competition & Strategy Spring 2013 taught by Theodore Herbert from January 2013 to April 2013. 12/516C Wal-Mart in China (2012) 2 little over a month, Price told the investment community that Wal-Mart China must work harder to become the dominant player in China.1 But it was when Price announced the following that Foran finally knew where his future would lead: “I’m very pleased he (Greg Foran) is bringing his talents to help us continue Wal- Mart’s expansion (in China) and enhance our efforts to help Chinese customers save money so that they can live better.”2 Price’s challenge to Foran, made publicly for the world to witness, was to expand in China, increase Wal-Mart China’s online presence, and work to contain its costs. Price’s comments probably left even more questions in Foran’s mind. However, with his second summer of the year approaching, it appeared that Foran was indeed in for an endless summer. Background Wal-Mart’s Growth in China In 1996, China’s national economy was growing at a rapid pace. The gross domestic product reached over US$1,064.4 billion, an increase of 9.7% over the previous year. It was also the first year of China’s implementation of its Ninth Five-Year Plan for National Economic and Social Development. There was a marked improvement in China’s economy. To further increase and attract foreign investment, the Chinese government increased its numbers of experimental, special economic-zoned cities in which foreigners could operate a business. There were, however, restrictions set forward by the government. One restriction in 1996 was that all foreign businesses would have to be in a joint venture or other type of cooperative agreement with at least one Chinese partner, with that Chinese partner getting a stake greater than 51%. In August 1995, Wal-Mart, the great American retail chain and Middle America success story, arrived in China, establishing a joint venture with Shenzhen International Fiduciary Investment Co, Ltd, China. In the following year, 1996, Wal-Mart opened its first supercentre and a Sam’s Club, its members-only big-box store, in the special economic zone of Shenzhen, in the southernmost Guangdong Province. However, it took the Chinese government’s removal of further trade restrictions for foreign retailers in 2004 for Wal-Mart to kick-start its expansion plans. Three years later, in 2007, Wal-Mart acquired a 35% stake in Trust-Mart, a Taiwanese-owned chain of retail supercentres operating in the Middle Kingdom. By 5 August 2010, Wal-Mart’s presence in China grew to 189 units in 101 Chinese cities, with the creation of over 50,000 local jobs. By early 2012, Wal-Mart nearly doubled its presence with 370 stores in 140 cities. 1 Burkitt, L. (15 April 2012) “Wal-Mart to Work Harder on Growth in China”, Wall Street Journal, http://online.wsj.com/article/SB10001424052702304356604577340912309012378.html (accessed 18 April 2012). 2 Wal-Mart China (7 February 2012) “Wal-Mart News—Greg Foran Named President and CEO of Wal-Mart China”, http://www.wal-martchina.com/english/news/2012/20120201.htm (accessed 18 April 2012). For the exclusive use of C. SFORZA-FLICK This document is authorized for use only by Cameron Sforza-Flick in Competition & Strategy Spring 2013 taught by Theodore Herbert from January 2013 to April 2013. 12/516C Wal-Mart in China (2012) 3 EXHIBIT 1: NUMBER OF WAL-MART STORES OPENED IN MAINLAND CHINA BY OUTLET TYPE Total Retail Units 374 Supercentre 334 Sam’s Club 6 Neighbourhood Market 2 Compact Hypermarket 3 Trust-Mart Hypermarket 29 Source: Wal-Mart stores’ website: http://www.walmartstores.com (accessed 31 May 2012). EXHIBIT 2: GEOGRAPHICAL DISTRIBUTION OF WAL-MART STORES BY TYPE (SUPERCENTRE, SAM’S CLUB, SMALLER FORMAT) IN MAINLAND CHINA IN 2004 AND THEN UPDATED TO PRESENT DAY Source: Wal-Mart (2005), Wal-Mart stores’ website: http://www.walmartstores.com (accessed 13 July 2012). For the exclusive use of C. SFORZA-FLICK This document is authorized for use only by Cameron Sforza-Flick in Competition & Strategy Spring 2013 taught by Theodore Herbert from January 2013 to April 2013. 12/516C Wal-Mart in China (2012) 4 Source: Atlantic Monthly (11 November 2011) What’s at Stake: The Chinese Market By the late 2010s, doing business in China was no longer optional for any Western corporation that hoped to survive into the next century. As the US and European economies slumped in late 2011 and into 2012, the world’s number-two economy became an even more important growth market. In the first quarter of 2012, China’s retail sales climbed 15% to US$783.03 billion, according to the country’s National Bureau of Statistics.3 Furthermore, China’s grocery retail market was predicted to continue growing at a rate of 11% from 2012 to an estimated US$1.5 trillion in 2015. Over the same period, according to the Institute of Grocery Distribution, a food-industry research firm, US growth would peak at less than half that rate, at only 4.2%. Growth in the Middle Class In the late 1990s and early 2000s, scores of Chinese workers left their villages to work and prosper in China’s first- and second-tier cities. With their growing prosperity came an increase in domestic consumption by the Chinese in their pursuit of a better life. In 2009, credit card balances rose more than 17% from the year prior. That same year, it was estimated that roughly 75% of all urban households in China had traded up in at least one product category of spending.4 Several opportunities emerged for international retailers as China’s middle class gained power. Even beyond what was reported, many analysts believed that most Chinese had more money than reported. Chinese households hid “grey income” that was never reported. Specifically, in 3 Burkitt, L. (15 April 2012) “Wal-Mart to Work Harder on Growth in China”, Wall Street Journal, http://online.wsj.com/article/SB10001424052702304356604577340912309012378.html (accessed 18 April 2012). 4 Seeking Alpha (30 March 2012) “5 Ways to Invest Into the Chinese Consumer”, http://seekingalpha.com/article/468641-5- ways-to-invest-into-the-chinese-consumer (accessed 18 April 2012). For the exclusive use of C. SFORZA-FLICK This document is authorized for use only by Cameron Sforza-Flick in Competition & Strategy Spring 2013 taught by Theodore Herbert from January 2013 to April 2013. 12/516C Wal-Mart in China (2012) 5 late 2011, Forbes reported that many state companies in China gave big bonuses that were not accounted for as official salaries. Also, middle-class status brought a more selective Chinese consumer. No longer satisfied with cheap imitations, the Chinese became status conscious. Paying premium prices for products and services that might enhance their “status” was quite common. Interestingly, if the product or service did little or nothing to boost their status, then the Chinese consumers were very price conscious, eg, a man who bought and proudly wore a genuine Rolex watch might haggle over his taxi fare or, when traveling, skip the taxi and take public transportation. Finally, the rise of the middle class brought more prosperity to China’s second-tier cities, which numbered in the hundreds. By 2011, with populations that numbered in the low millions, the second-tier cities, such as Chengdu, Xi’an, Guilin and others, also sported high- end European and American retail stores such as Cartier and Louis Vuitton like their larger neighbours Beijing and Shanghai. In the United States, such brands would be found in only a handful of first-tier cities, such as New York, Chicago or Los Angeles. In China, the demand for luxury goods was clearly far greater and far more widespread. EXHIBIT 3: PER CAPITA INCOME GROWTH OF CHINESE CONSUMERS (FROM 2000 TO 2010) Source: WDI and GDF (2010) The world’s number-two economy was an important growth market throughout the early 2010s for Wal-Mart. With a population of 1.3 billion people, China was slated to emerge as the largest consumer market in the world, surpassing the United States, by 2020. By then, experts suggested, the Chinese population would be firmly planted into a true middle-class status. In contrast, during this same period in the early 2010s, the European sovereign debt crisis brought fiscal ruin to key European states. Although designed to rescue its failing members, the European Union’s 750 billion euro bailout package, titled the European Financial Stability Facility, did little to ease international retailers’ woes, especially in the short term. In the United States, Wal-Mart faced consumers who were tightening their belts and not spending amid that country’s slow growth and stubborn unemployment. 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 China 2340 2560 2830 3180 3590 4090 4750 5580 6230 6870 7640 US 35690 36460 37070 38400 40680 43170 45680 46800 47320 45440 47310 0 5000 10000 15000 20000 25000 30000 35000 40000 45000 50000 GNI PER CAPITA, PPP (US$) For the exclusive use of C. SFORZA-FLICK This document is authorized for use only by Cameron Sforza-Flick in Competition & Strategy Spring 2013 taught by Theodore Herbert from January 2013 to April 2013. 12/516C Wal-Mart in China (2012) 6 In contrast, China’s retail sales climbed 15% to US$783.03 billion in the first quarter of 2012, according to the country’s National Bureau of Statistics. China’s grocery retail market was predicted to grow 11% in 2012 to roughly US$1.5 trillion in 2015, compared with a 4.2% growth in the United States over the same period. This stark contrast in growth projections only reinforced why China was so critical for Wal-Mart’s future. But was the Chinese market so easy to conquer for a multinational player like Wal-Mart? The country announced in 2012 that it planned to reduce exports and increase its own consumer spending. Such changes were expected to bring renewed competition from domestic Chinese retailers, China Resources and the Shanghai Brilliance Groups, as well as other multinationals—and there were plenty of them. According to Euromonitor, in the early 2010s, China had at least 32 hypermarket operators, or food and beverage outlets with more than 2,500 square meters. At the same time, the United States had only 10 operators, with Wal- Mart being the largest and controlling 80% of the market. Wal-Mart Strategy in China—2012 In 2012, as Wal-Mart approached its second decade in China, it continued to struggle to reaffirm its strategic presence. But how exactly was Wal-Mart planning on using Foran to emerge from its less than stellar performance in China? According to Wal-Mart International’s CEO, Mr Doug McMillon, Wal-Mart China would set forward a winning strategy to combine “local relevance and global leverage” to woo the ever- growing market of Chinese middle-class consumers. Expansion through Multiple Channels In the company’s 2012 annual report, CEO Michael Duke reported that its Wal-Mart International Division was the company’s “primary growth engine.” With US$125 billion in sales at the time, the international business division, if valued outside of the larger Wal-Mart Corporation, would have been ranked as the third largest retailer in the world. As Wal-Mart looked at its China business in particular, it chose to improve returns through increased profitability in the Middle Kingdom. Its focus, according to the CEO, would be on middle- income customers in high-growth markets. The middle-income customers, according to the hypermarket data, were moving out of the large urban centres like Beijing, Shanghai and Shenzhen and into smaller urban settings. By expanding into these growing secondary and even tertiary cities, Wal-Mart would target these ever-more prosperous consumers. With low profit margins of between 2% and 3% in China, according to estimates from Shanghai-based consulting firm China Market Research, Wal-Mart had to build up its scale to win long-term.5 5 Burkitt, L. (15 April 2012) “Wal-Mart to Work Harder on Growth in China”, Wall Street Journal, http://online.wsj.com/article/SB10001424052702304356604577340912309012378.html (accessed 18 April 2012). For the exclusive use of C. SFORZA-FLICK This document is authorized for use only by Cameron Sforza-Flick in Competition & Strategy Spring 2013 taught by Theodore Herbert from January 2013 to April 2013. 12/516C Wal-Mart in China (2012) 7 Competition in China EXHIBIT 4: PERCENT BY MARKET SHARE OR SALES VOLUME OF THE TOP EIGHT HYPERMARKET OPERATORS IN CHINA Source: Access Asia, CCFA, Trade Sources and Company Information When Wal-Mart began expanding outside North America in the 1990s, its largest international rival was the French retail chain Carrefour SA. The world’s second-largest and Europe’s largest retailer, Carrefour opened its first big-box superstore in France in 1963. Carrefour, meaning “crossroads” in French, entered Beijing, China, in 1995, only a year before Wal-Mart. Never one to enter a new market on a small scale, Carrefour was determined to open large stores at a steady pace throughout the Middle Kingdom. At the time of Carrefour’s entry, however, foreign retailers were only allowed to operate in a select few mainland cities in China. All foreign ownership was also limited to no more than 49% of the shares in any Chinese joint venture or cooperative enterprise. Working under such tight controls, Carrefour formed a joint venture with Zhongchuang Commercial Company. Mr Jean-Luc Chereau, the head of Carrefour China in 2006, believed that it was the company’s entry into Taiwan in 1989 that brought it its advantage when entering China six years later. Simply put, Chereau believed that Carrefour learned how to adapt and work within China by first learning in Taiwan.6 Chereau believed that, although the economic systems were different between Taiwan and mainland China, both countries shared similar lifestyle and business cultures. Such beliefs and preparation paid off. By the end of 2006, Carrefour was ranked sixth in the Chinese retail market in terms of sales with 95 sales.7 Carrefour’s success seemed to continue, with only a few setbacks along the way. In early 2012, the company announced it would accelerate its new store openings in China. 8 Averaging 20 to 25 new openings per year in the late 2010s, Carrefour was set to open 30 new stores in 2012. At the same time it announced its decision to accelerate its growth in China, Carrefour issued its fifth profit warning when its third-quarter 2011 sales in Western Europe and Asia revealed a downturn. In 2010, profits were so poor that Carrefour closed or sold some of its stores in Malaysia, Thailand, Singapore, South Korea, Russia and China’s western city Xi’an. In addition to profit warnings, Carrefour shared Wal-Mart’s own revolving-door personnel changes in the early 2000s when its CEO, Mr Lars Olofsson, a former Nestle executive, 6 Roberts, A. and Matlack, C. (20 October 2011) “Once Wal-Mart’s Equal, Carrefour Falls Behind”, Bloomberg Businessweek Magazine, http://www.businessweek.com/magazine/once-walmarts-equal-carrefour-falls-behind-10202011.html (accessed 19 March 2012). 7 For details, see Carrefour’s website: www.carrefour.com.cn. 8 Li, W. (31 May 2012) “Carrefour to Hire Chinese MBAs”, China Beverage News, http://chinabevnews.wordpress.com/category/china-hypermarket-stores (accessed May 2012). For the exclusive use of C. SFORZA-FLICK This document is authorized for use only by Cameron Sforza-Flick in Competition & Strategy Spring 2013 taught by Theodore Herbert from January 2013 to April 2013. 12/516C Wal-Mart in China (2012) 8 became the company’s third CEO in seven years in 2009. Four other top executives were replaced in just 12 months between 2011 and 2012. By this time, Chereau was long gone. Why China? China was considered, by many Wal-Mart watchers, as the best place to export the US merchandising powerhouse that Sam Walton founded in 1962. With its wide-open retail landscape and its growing middle class, the company entered a marketplace, at least on the outside, similar to the United States. In 2006, many retail experts suggested that China would be as big and as successful a market for Wal-Mart as the United States. Expansion through Acquisition Trust-Mart Acquisition Wal-Mart’s first acquisition in China took place in 2007 when it acquired a 35% stake in Trust-Mart Group, a Taiwanese-owned, low-end retail supermarket chain, for US$264 million. The integration of Tru