Analysis of Wal-Mart’s Strategy and Business Model for Expansion into China. Introduction Business organizations in the modern world face an ever-increasing challenge to compete for a share of the global market. Advances in transportation, communications, and technology make it possible for a company to build a device in one country out of components made in a dozen other countries and sell it anywhere in the world.
To survive in this business environment, businesses must devise strategies that minimize the risks associated with global expansion and maximize the return. A successful global strategy brings growth and a larger share of the market. A failed strategy can seriously affect growth and, in some cases, force the business to close. The key to a successful strategy is to understand the differences within each market.
It is also important for the business to adapt its domestic model so as to best utilize the business’ strengths in response to those differences. The market within the United States is relatively homogeneous and stable. The global market and markets within other nations are just the opposite. Distance matters in the global market. With distance comes a wide variety of cultural, administrative, political, geographic, and economic differences. [i]The strategy that embraces these differences will succeed.
The purpose of this paper is to review Wal-Mart’s domestic business model and identify the factors contributing to the success of that model, identify the unique characteristics of the market in China and how these characteristics compliment or work against the strengths of the domestic model, evaluate the success of Wal-Mart’s strategy and the application of its domestic business model in China relative to the models used by its primary competitors, and recommend changes to Wal-Mart’s strategy and business model to improve Wal-Mart’s competitive edge in China and other Asian nations.
Wal-Mart’s Domestic Model and Strategy Wal-Mart’s domestic business model and strategy, as applied to the market in the United States and Canada, is based on the following principles: Exceptional pricing and customer service, combined with equally exceptional cost savings and operational efficiencies. Locating stores in small towns deemed too small for their competitors to serve but that had a homogeneous client base with the means to support the stores. An unrivaled distribution and logistics management system coupled with an excellent transportation and communications network.
A stable and cohesive government structure in which all competitors were able to operate according to the same rules and regulations. The ability to leverage all of these factors to reduce prices for consumers and generate profits for the company. Pricing Sam Walton, the founder of Wal-Mart, built the company on the belief that superior pricing was a cornerstone of a successful business. Wal-Mart built its entire marketing strategy on the idea of offering “Every Day Low Prices” (EDLP) rather than periodic sales.
This was a successful move to undercut the competition and secure a larger share of the retail market. The strategy worked and drew millions of customers into Wal-Mart each day. Walton was passionate about matching or beating his competitors, so much so that it was widely held that he would shop at his competitors to check their prices – then call his managers and reduce his own if he found them to be lower. Wal-Mart also instituted the “Roll-Back” program designed to reduce prices on bundled merchandise, items that would normally be purchased together.
These marketing campaigns and strategies, when combined with quality products, built Wal-Mart’s reputation as the place to shop for the best prices, regardless of a customer’s income level. Customer Service Sam Walton understood that in the United States, pricing alone was insufficient to maintain a loyal customer base. Pricing might bring customers into the store, but only a combination of exceptional pricing and customer service would keep them coming back. This approach is particularly important when one considers the small cities and towns in which Walton positioned stores.
There is a tendency in smaller cities and towns for all members of the community to intermingle, regardless of the economic and social differences. Walton understood this and set forth three cardinal beliefs that formed the backbone of Wal-Mart’s corporate philosophy and ensured that the company would reflect the same values as its customer base. These beliefs are Provide great customer service Show respect for the individual/family Strive for excellence These beliefs, coupled with the idea that the “customer is always number one” and exceptional pricing enabled Wal-Mart to become the retail juggernaut it is today.
Cost Savings and Operational Efficiencies Pricing and customer service are two cornerstones of Wal-Mart’s domestic business model and strategy. Cost savings and operational efficiencies are the other two. It was only possible for Walton to reduce prices if he reduced overhead and operational expenses as well. To that end, he dictated that every dollar spent should tie into providing customers with greater value or savings. Corporate officers share rooms at inexpensive motels and fly coach when they travel.
Corporate officials meet vendors in the company lobby rather than in conference rooms. Every action by every person in the company is oriented to saving money and passing those savings on to customers. Vendors are not immune to the constant drive toward lower prices. The company’s buying power gives it incredible bargaining power and it uses that power to minimize the cost of goods sold through negotiations with vendors and by working with vendors to improve their operational efficiency and cost structure.
In exchange for helping vendors improve their processes, Wal-Mart negotiates special pricing. Suppliers are motivated to accommodate these pressures from Wal-Mart due to the significant sales that Wal-Mart contracts offer. Distribution, Communications, Transportation, and Logistics A sophisticated satellite-based communications system coupled with an equally sophisticated inventory tracking system enables Wal-Mart to coordinate the flow of products flow from vendors to the distribution centers and then on to the stores.
In essence, Wal-Mart, runs a perpetual, real-time inventory management system. The highly efficient inventory tracking system is based on highly-evolved electronic data interchange (EDI) software that coordinates the flow of inventory and other business data between stores, warehouses, and suppliers. This results in enhanced supply chain efficiency by enabling rapid and even anticipatory responses to changes at all levels of the chain. Wal-Mart utilizes a hub and spoke supply chain design, which places all stores geographically within a day’s drive from the distribution centers.
This hub and spoke supply chain design helps Wal-Mart take advantage of economies of scale by serving up to one hundred twenty stores from a single distribution center. Each distribution center is highly automated and operates twenty-four hours a day. Wal-Mart owns its own diesel truck fleet, which boasts an impressive 99. 5% on-time delivery. This system enables Wal-Mart to effectively manage its product flow and inventory throughout its distribution network This highly efficient system makes it possible for Wal-Mart to minimize the space it requires for storing inventory.
The inventory supply system reaches all the way to the vendors and suppliers that provide the products. This makes it possible for Wal-Mart to require that goods be shipped in specific quantities to ensure that no product sits on a shelf any longer than is necessary and minimizes storage requirements. Characteristics of the Market in China Wal-Mart found itself facing political, ideological, cultural, and technological barriers in its attempt to enter the market in China. These barriers include:
An inadequate transportation and communications network that prevented the implementation of an efficient distribution and logistics management system. A disparity of wealth between social and economic classes that prevented Wal-Mart from locating stores in small towns deemed too small for their competitors to serve. A government structure that allows local and regional governments expansive powers for regulating trade and development as well as a central government that restricts competition and access to new markets.
The inability to realize the cost savings and operational efficiencies necessary to support “Every Day Low Prices” and generate profits for the company. Communications and Transportation The communications network in China, suffers from the same disarray as the transportation system. The central government banned satellite usage within the country. This ban, coupled with weak land-based telecommunication and IT infrastructures, makes it impossible for Wal-Mart to utilize the same inventory control system used in the domestic model.
This seriously hampers Wal-Mart’s ability to track inventory and pricing. This in turn means a less efficient, more costly system that does not provide the cost savings necessary to support the pricing structure Wal-Mart uses in its domestic model. Wal-Marts distribution and logistics model ran into numerous barriers in China. The reason why Wal-Mart’s domestic model is so successful in the United States is because it has the transportation and communications infrastructure necessary to make the Wal-Mart supply chain the most efficient and effective in the world.
In the United States, the company has access to efficient, cost-effective means of transporting goods throughout its network of stores and distribution centers. All means of transportation are available and interconnected, be it via air, rail, sea, or road. By contrast, the transportation infrastructure in China is underdeveloped and fragmented. There is little connection between the various forms of transportation and the land transportation system is underfunded, underdeveloped, and undermined by local governments who implement unreasonable and illegal tolls for highway travel.
The inability to move products through the system in China the way the company does in the United States means the company shoulders increased transportation and inventory costs. Chinese Consumers. Local markets have also presented challenges to Wal-Mart. The income disparity between classes within China and government restrictions on the number of stores further inhibit the application of Wal-Mart’s domestic model in the China. In the United States, smaller towns have a homogeneous customer base and a standard of living that supports the market and a store. In China, this isn’t the case.
The standard of living in China as a whole, especially in rural areas, is significantly lower than in the United States and the smaller towns can’t necessarily support a hypermarket or even multiple stores. First, the central government dictates the areas in which the company may expand. Second, income disparities between classes and areas suggest that many of the smaller regions and cities do not have a client base with the standard of living that can support a store. Wal-Mart’s strategy failed to take into account the disparity between China’s economic classes.
Such is this disparity that the average worker in a rural area or small city makes only subsistence wage, barely enough to pay for food and lodging and nothing else. Cultural differences between the United States and China, specifically the way consumers shop, are significant and seriously undermine Wal-Mart’s ability to profit on margins. Wal-Mart’s domestic model enables the company to profit on margins by selling large quantities of products and making less on each sale through the hypermarket format. American buying habits support this model. Chinese shoppers are the complete opposite of their American counterparts.
Where shoppers in the United States live in large homes with ample storage, the average Chinese consumer has little room for storage or extraneous possessions. A typical Chinese shopper will visit a store every day and will purchase just enough to make it through to the next day. This in turn means that the average Chinese consumer will spend significantly less per trip, perhaps $6-$10 rather than $40-60 per trip. Chinese consumers are also obsessed with the freshness of food and prefer to purchase live animals and fresh vegetables as opposed to processed meats or food.
To meet this need, Wal-Mart must purchase many products from local vendors in smaller lots. This prevents the company from taking advantage of economies of scale and the operational efficiencies that make its domestic model work in the United States. Government There is often a disconnection between the policies of the central government and those of local and regional governments. As demonstrated by Wal-Mart’s efforts to enter the market in Shanghai, local governments have the ability to derail expansion in a region.
Protectionism may be prohibited, but still exists and is inhibiting Wal-Marts market expansion. Local governments are able to retain a percentage of tax revenues, giving them the incentive to protect their tax base. There is an implication that local governments benefit from more than tax revenues, but there is little proof that this is the case at this time. Wal-Mart’s domestic model calls for a central distribution center and headquarters. In this model, all accounts are settled at the central headquarters and taxes are paid to the government controlling the area in which the headquarters is located.
This means little or no revenues are paid to other local governments and there is no incentive for them to encourage Wal-Mart to enter their local markets. On the contrary, there is incentive for them to block access. Wal-Mart’s biggest competitor, Carrefour, delegates account and financial control to each store. This ensures that local governments receive tax revenues from their operations and encourages their support of Carrefour’s growth and operations. A strict adherence to regulatory restrictions works against Wal-Mart’s strategy in China. The distribution centers are underused.
The Chinese government restricts both the number of stores per market area and the number of market areas in which the company is allowed to operate. All stores are supposed to be approved first by the central government, a bureaucratic morass at best. After approval by the central government, the company must then take their request to the local government for approval. As seen by the case in Shanghai, this can delay the process further or end it all together. Carrefour found success by opening stores in cities subject to local approval, then asking the central government for its forgiveness.
As all of Carrefour’s stores pay taxes locally, they were welcomed as an addition to the tax base and supported by the local government when the company petitioned the central government for approval Though not strictly illegal, this was contrary to the rules laid out for development by the central government and gave them an advantage in the market. Wal-Mart’s Experience in China Wal-Mart entered the Chinese market with an eye on potential revenues but failed to fully understand the distance between its home country and China.
Pankaj Ghemawat provides keen insights as to why Wal-Mart’s experience in China failed to live up to its expectations in the article “Distance Still Matters: The Hard Reality of Global Expansion. ” Ghemawat shows that distance is more than a linear concept in business. Distance is a measurement of differences. The more geographic, cultural, administrative, and economic differences, the greater the distance between a company’s home market and the one into which it is venturing. Ghemawat specifically identifies China as a challenging market.
He notes that language, a business culture based on personal connections, consumers who prefer home brands over foreign brands, market-access restrictions, high taxes, and custom duties are specific contributors to distance between the United States and Chinese markets. [ii] In order for Wal-Mart to be successful in this market, the strategy it employs must contain points that address the differences. Wal-Mart’s domestic model fails to address the differences that increase the distance from the United States market and the market in China. Wal-Mart’s initial analysis of the market in China was incomplete, not necessarily inaccurate.
A complete analysis, using the CAGE Distance Framework detailed by Chemawat[iii], would have provided Wal-Mart management with a clearer view of the market and brought forward the barriers to trade that exist within China. Managers should have known how a ban on satellite communications, a critical piece of Wal-Mart’s distribution, management, and logistics operations, would affect the company’s operations in China. Likewise, the management team should have known consumer buying habits in China and adjusted the model to better reflect the needs of the Chinese consumer.
Without that information or a plan to address the market differences, there was simply no way for Wal-Mart to succeed in China. The distance was too great to overcome simply by transporting and implementing the domestic model in this situation. Moving Wal-Mart’s Business in China Forward Wal-Mart must reevaluate the market in China using a thorough and complete analysis such as the CAGE Distance Framework to clearly identify the differences that magnify the distance between the markets in the United States and China. This analysis must be unprejudiced and realistic.
It must identify those differences that can be overcome as the company moves forward and it must identify alternative courses of action that differ from its domestic business model. Government Wal-Mart must be more aggressive in developing and establishing relationships with local governments and politicians. This is an area in which Wal-Mart’s primary competitor, Carrefour, excels. It is important to recognize that local protectionism will prevent the expansion of Wal-Mart stores in different regions of China as long as those in power have no incentive to change.
The custom in Chinese business is to focus more on relationships than on transactions. Wal-Mart would benefit from establishing and improving relationships within each community, and spend more time courting local politicians and business leaders. One method for gaining local support is to, as much as the business model will allow, aggressively seek out and focus more on relationship building with local leaders and change the model it uses in China to enable the payment of taxes to the local entity as a sign of appreciation.
This could potentially lead to Wal-Mart being exempt from paying these local governments. This will give local leaders the incentive they need to cooperate more fully with the company’s plans. Communications, Distribution, and Logistics Wal-Mart’s domestic model depends of the use of satellites to coordinate its business Given that satellite technology is banned in China, an alternative system is necessary to ensure some form of real-time inventory control and a reasonable level of efficiency with regard to distribution and inventory control.
One option is to maximize the use of existing telecommunications networks to enable an electronic data interchange (EDI) based inventory and business control system for its business locations and suppliers in China. Although considerably slower than a satellite-based system and less reliable, given the infrastructure in China, such a system is possible and can help the company move forward in the market. Wal-Mart should scale back the logistics and distribution system used in the domestic model to reflect the inefficiencies of the system it must use in China.
By utilizing a periodic inventory maintenance system instead of a real-time system, the company will experience some improvement in efficiencies. The periodic system is not as cost effective and efficient as the system used in the United States, but it is much less expensive and would serve as a foundation for a system that can grow as the infrastructure in the country improves. Neighborhood Stores Vs. Hypermarkets Wal-Mart should also adapt its current business model to emulate some of the local business in the communities.
In effect, Wal-Mart should open smaller, neighborhood stores with limited inventories and products specifically oriented to the more limited needs of small communities. These neighborhood stores could even be mobile, traveling stores that move from town to town on a set schedule, but with consistent product offerings tailored to a specific clientele. Developing such a local presence will enable Wal-Mart to secure additional sales and good will as well as grow its business. Hypermarkets as Distribution Centers
The smaller stores should be set up using the hub and spoke pattern successfully applied to the domestic model. In this case, however, the hypermarkets serve as the distribution centers for the surrounding neighborhood stores. This does add an additional layer in the distribution chain, but it also better utilizes the space and supply chain for the hypermarkets. Using hypermarkets as mini-distribution centers for neighborhood stores would give Wal-Mart a mechanism for supplying all of its businesses in a cost-competitive manner.
In addition, Wal-Mart may be able to use hypermarkets as distribution centers without seeking local approval, given that the stores already exist. In essences, the neighborhood stores become the bulk shoppers for the hypermarkets. Conclusion The market, the culture, the political systems, and the environment in China prevented Wal-Mart from replicating its domestic business model in China. Wal-Mart will improve its overall performance in the market by adapting its business model and leveraging available technologies.
By using a combination of aggressively pursuing and establishing relationships with local politicians, implementing an EDI system across its businesses and suppliers, developing and implementing periodic inventory system, adapting its business model to include a local business model, which would be neighborhood stores selling a limited amount of goods and limited amount of volume, and using the larger supercenters as smaller distribution centers, Wal-Mart could improve its competitive position in China.
These business model changes will address the key factors working against the successful application of Wal-Mart’s domestic model in China, factors that include: A government structure that is inefficient, parochial, and bureaucratic. An inadequate and disconnected transportation and communications network that prevents the company for utilizing its distribution and logistics management system to attain cost savings and improved margins.
A significantly higher disparity in the standard of living between urban and rural areas, and between classes. A modified business model designed to address the wants, needs, and demands of the Chinese consumers will enable Wal-Mart to become more successful in China. ———————– [i] Ghemawat, P. (2001), Distances Still Matter, Harvard Business Review, www. hbr. org [ii] Ghemawat, 2001. P. 6 [iii] Ghemawat, 2001, P. 5