Wal-Mart Operations in Brazil

Professor Masaaki Kotabe of The University of Texas at Austin Graduate School of Business 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, 1997. Copyright © 1997 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, a monthly inflation rate was 40%, whereas by September it was a relatively low 3%. Lower inflation rates would help improve the purchasing power, particularly of 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 150 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.

Wal-Mart Stores would own 60% of Wal-Mart do Brasil, whereas Lojas Americanas would retain the remaining 40%. The North-American "giant" was known to provoke a market revolution in every country it decided to enter. Wal-Mart not only announced the decision to enter the market with Supercenters (stores with 20,000 m2 of area and more than 50,000 different items) and Sam's Club stores (a buyers' club, founded in 1976 in the U.S.).

Brazilian competitors had good reasons to be concerned. Wal-Mart was known also to be a leading company for its low operational costs and logistics. Another concern was that the partnership with Lojas Americanas could leverage Wal-Mart businesses in Brazil. Lojas Americanas has been owned by Banco Garantia, an aggressive and very profitable investment bank, since 1989. Only after Banco Garantia assumed Lojas Americanas' management did it achieve the number one position in department store sales. Banco Garantia also has the control of Companhia Cervejaria Brahma, the leading brewer in Brazil and the fifth largest in the world.

Wal-Mart Operations

Sam Walton opened a small store in Newport, Arkansas, in 1945, as a franchisee of variety stores owned by Ben Franklin. 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.

In 1962 the first Wal-Mart Discount Store was opened, but Sam Walton was already known as a very sensitive and clever retailing businessman. Wal-Mart expanded very rapidly. By 1970, when Walton decided to go public in order to accelerate the expansion, as many as 30 Wal-Mart stores had been spread out in Arkansas, Missouri, and Oklahoma.

The fast and consistent Wal-Mart expansion, which enabled the company to achieve the number one position in retailing by surpassing Sears, Roebuck, made his founder and main shareholder, Sam Walton, a legend in the industry. He was the ultimate practitioner of what is now called ñManagement By Walking Aroundî (MBWA), namely, to go to every store, observe the customers and talk to them to find out what they desired and what kind of complaint they might have.

Sam Walton's most famous paradigms, present in his biography ñMade in Americaî are:

• Be different
• Be close to the customer; be the first one to notice the changes in consumer habits
• Simplicity reduces costs
• Reinvest all the profits
• If you want your staff to take care of the customers, take care of your staff first

By the end of 1995, there were 2,799 Wal-Mart units around the world, with 2,562 located in the U.S., 134 in Canada, 83 in Mexico, 11 in Puerto Rico, 5 in Brazil and 4 in Argentina.

Wal-Mart operates with five different divisions: Wal-Mart Stores, Wal-Mart Supercenters, Sam's Club, McLane's Company and Wal-Mart International.

Wal-Mart Stores is the division accounting for 55% of total company revenues (US$93.6 billion in 1995, and US$100 billion in 1996). Wal-Mart Supercenters generates 10% of total company revenues and is the fastest growing division. In the U.S., there are three different ñSupercentersî : Wal-Mart Supercenters, Hypermart USAs and Bud's Warehouse Outlets. ñSupercentersî 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 ñbuyers' clubî, namely, a store where the consumer pays an annual fee to have access - was opened in 1976. By the end of 1995, there were already more than 400 Sam's Clubs in the U.S. 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 U.S. and caters not only to Wal-Mart needs but also to other 25,000 retailing stores in the U.S. Wal-Mart International, the fifth division, will be described in details later.

The closest Wal-Mart competitor in the U.S. in terms of revenues is K-Mart with total sales of US$43 billion in 1995. Wal-Mart has special characteristics and qualities that enabled the company to be a leading retailer giant: namely, the company

• operates with low operational costs, due to efficient logistics, an advanced information technology systems and scale economies.
• has a high level of employee involvement; the company has been sharing profits with its employees since 1974.
• has low prices; Wal-Mart famous slogan, ñEveryday Low Pricesî, is accepted by the customer as absolutely true.
• has high bargaining power vis-Ã-vis its suppliers, which permits the above mentioned low price policy
• is spread out throughout the U.S.; it is present in all 50 states. Most of the stores are located in small and medium towns, which has been one of the major corporate strategies.

In the second half of the 1980's, Wal-Mart began its international expansion. The company expected that all its strengths and retailing knowledge could leverage operations abroad as well as the efficient logistics and communication systems. Also, the company considered that with a prospective of market globalization, the brand, ñWal-Mart,î 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.

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. Despite a tremendous initial hype, Wal-Mart has now 25% less sales than predicted five years ago.

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 U.S. for a long time. Another problem in Mexico is related with the Mexican habit of buying food in small stores rather than in supermarkets. Wal-Mart has been trying to change this habit without much success.

In Canada, Wal-Mart preferred to acquire a local chain - Woolco - instead of having a local partner. Coincidence or not, Canada is the most successful Wal-Mart operation abroad. Nevertheless, out of the 134 stores in Canada, 122 were originally Woolco stores.

Entry in Argentina was also different from the original strategy: Wal-Mart entered alone in 1994, with four stores, two Supercenters and two Sam's Club, all of them in the Buenos Aires area. Similar to the Brazilian situation (to be described later), competitors in Argentina reacted very quickly, opening new stores and neutralizing Wal-Mart's promotions and discounts. As a result, Wal-Mart had two years in sequence with losses in Argentina.

The greatest failure happened in Hong Kong, where Wal-Mart entered with three home appliance stores in partnership with local retailing companies. The poor results caused the decision to leave the Hong Kong market by closing those three stores.

Since 1991, when the first store was opened in Mexico, Wal-Mart International Division has kept losing money, which is, to say the least, concerning. Its total 1995 sales reached US$4 billion.

Although the results do not justify an aggressive expansion plan, Wal-Mart still intends to expand globally. In 1996, the first store was opened in China. One more time, Wal-Mart decided to enter alone in China instead of having a local partner.

So far, the greatest challenge is to tackle the following issue: Is it possible to transform a typical American company in a global economy without changing its corporate culture? According to David Glass, Wal-Mart president, everything that is done in Arkansas or Kansas can also be done in Brazil or China.

Brazil Entry Decision

In 1982, one event took place that would link Wal-Mart to the Brazilian market. Sam Walton answered a letter in which a Brazilian company - Grupo Garantia - was prospecting a possible partner for its retail business in the domestic market. This letter represented the beginning of a long business relationship. But it was only twelve years later, more precisely in September, 1994, that the official communiquÚ was announced: Wal-Mart had decided and was ready to enter the Brazilian market. The entry mode would be in association with Lojas Americanas, which is controlled by Grupo Garantia. Wal-Mart would own 60% of the partnership and Lojas Americanas the remainder 40%.

Grupo Garantia has a very aggressive strategy in all businesses in which it participates and has made Lojas Americanas the leading department store in Brazil.

The bombastic announcement, which made Brazilian supermarket operators and wholesalers ñshudder,î included an initial investment of US$ 120 million, to construct and initiate an operation of 5 stores - 3 Sam's Clubs and 2 Supercenters - in a record short time. The first stores would be located in Brazil's largest city - São Paulo and also its outskirts.

Supermarket and Wholesale Industry in Brazil

The supermarket sector in Brazil accounted, in 1995, for about 6.6% of GNP, with consolidated sales of US$ 43.7 billion. The ranking, which considers only companies with a minimum of 24 checkout lanes, includes 360 different organizations, operating a total of 3,743 stores.

The five largest supermarket chains, in terms of sales volume, are Carrefour (US$ 4.68 billion), Pão-de-Açúcar (US$ 3.17 billion), Casas Sendas (US$ 1.32 billion), Bompreço (US$ 1.18 billion) and Paes Mendonça (US$ 876 million). The general profile of Wal-Mart's five main Brazilian competitors is presented in Exhibit 1.

Contrary to a trend in countries like Germany, where only 5 companies dominate 70% of the market, or France, with 65%, the trend in Brazil shows a declining concentration. The 20 largest companies had generated 64% of the total sales of the 300 largest companies in 1987. This percentage fell to 57.6% in 1995.

During the last five years since 1990 (see Exhibit 2), sales have grown by 25.3% for the largest 300 companies, while the 20 largest companies grew only by 15%. The explanation is simple: facing problems such as high inflation, economic plans and changing government rules, the largest companies initiated a restructuring process that compromised their performance during this period. But the adjustment was worthwhile, because they exhibited a consistent sales growth rate over the five year period.

Exhibit 2

Another indicator confirming the favorable results of restructuring was that they were able to increase sales even with a significantly reduced number of stores. Besides restructuring, another important factor contributing to a favorable performance was the consumers' increased purchasing power as a result of reduced inflation under the ñReal Plan.î

The economy of supermarket and wholesaler sector in Brazil is concentrated in the Southeast region (see Exhibit 3a and 3b), the richest and most developed part of the country, with São Paulo State being located in this region.

. Exhibit 3a

. Exhibit 3b

The main competitor for Wal-Mart in Brazil is Carrefour, a famous French supermarket chain, which entered the Brazilian market in 1974. Today, the chain is responsible for the operation of 39 stores spread over the country, and is fully adapted to Brazilian culture and consumption habits, therefore not being perceived by customers as a foreign company. As a matter of fact, Carrefour is known as the lowest price retailer by people of all social classes. With a decentralized management style, it encourages initiative and creativity among store managers and employees. Using an effective advertising campaign, with constant presence in most important domestic media (TV, newspapers, radio and outdoors), the company made its annual campaign known as Carrefour Birthday Month.

Makro, a Dutch company, in a partnership with a local group, is the leading wholesale outlet with total sales of around US$ 800 million. Established in Brazil in 1972, it has more than 25 stores spread across several states, including the Northeast region with the highest consumer purchasing power in the nation. Makro has registered about 1.3 million customers, mainly owners of small businesses, constituting about 80% of the total clientele base. The other 20% of its customer base consists of individual customers. To become a Makro customer, people need to apply for association, but do not have to pay any fee. One of its main strategy components is to sell products from third parties under its own brand. These products have no associated promotional expenses and can be sold at competitive prices.

A recent research study conducted by CBPA (a Brazilian market research company) shows that price continues to be a major determinant of the consumer's preference of a store chain. But the same survey shows other interesting results: a significant part of consumers surveyed mentioned quality of products as being more important than price, and certain features such as services and store cleanliness as equally important.

Strategy for Brazil

The intention of Wal-Mart was to achieve the number one retailer position in the Brazilian retail market 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.

To rapidly achieve the number one position, a fast expansion strategy was planned by executives of Wal-Mart International. The store location strategy was developed, targeting at the most populous areas with high consumer purchasing power. The São Paulo State satisfied those characteristics. 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 U.S., including product assortment and internal space utilization as well as its product mix.

Market Entry

Wal-Mart began its operation in Brazil in an absolutely fantastic way. The 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.

Inside the stores, consumers found a large variety of products that has never been offered by any other retailer in Brazil. Especially in the Supercenters, with a mix of 50,000 different products, from domestic apparels to golf club sets, including a complete lline of food products.

Another attraction was employees' disposition to help consumers, trying to do everything to get every customer who entered the stores to come back home with their purchase needs fully satisfied. It is important to mention that executives of Brazilian operation had successfully recruited a well motivated team, which facilitated the training activities and organizational learning.

To locate near its main competitors, Wal-Mart Supercenter and Sam's Club are both located in Osasco, a suburb of São Paulo, in front of a Carrefour unit across the street and near two PÑo-de-AÙþcar stores. After all, Osasco Supercenter broke the sales record in Wal-Mart's history, selling US$ 1 million a day, twice the sales volume of Extra, another major competitor, located not far from there.

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.

Wal-Mart executives certainly would wish the golden times could last forever. But reality has been a bit different. They were not prepared for such a sensational success in a short period: the crowded stores' positive signal soon showed its negative side --- long lines at the check-out lanes.

Customers impressed by low prices and extensive product lines, besides special offers, who had to travel several miles to reach the stores, were in for a surprise. In case the products that customers were looking for had been sold out a few moments earlier, there was no provision as to when a new stock would arrive in the store. A badly planned product turnover? The fact is that they were facing an average stockout rate of 40%, while its stockout rate in the U.S. stores is no higher than 5%. Maybe this stockout rate has occurred due to various problems with suppliers, whom Wal-Mart executives expected to be capable of working in a just-in-time delivery environment.

But the worst situation had yet to occur --- seemingly false advertising of products, which were not available in the store shelves as had been announced. It made customers angry.

Managers' behavior was another source of headache. Since performance was measured based on sales volume, many products had their prices set below cost by managers as a way to increase sales and obtain a high performance evaluation, independently of the net loss this practice would bring to the bottom line results.

Every customer appreciates low prices. However, when the prices were lowered much too deeply, important suppliers such as NestlÚ, Gradiente (electronics) and Brastemp (refrigerators and air-conditioners) were not satisfied at all to see their products being sold in Wal-Mart stores at prices below their production costs, and launched a dumping accusation against the American company.

Trying to bring its Brazilian operation back on track, Wal-Mart headquarters resorted to a hasty solution for a management turnaround with some local executives dismissed and head managers switched between Brazilian and Argentine units, and more recently, even store managers switched between two units in Brazil. Wal-Mart advertising in Brazil also has been inconsistent (See Exhibit 4). Wal-Mart chose a local advertising agency - Norton, currently the 13th ranked Brazilian advertising agency in the industry. However, Norton professionals, according to a former executive for Wal-Mart, had very little autonomy to determine the appropriate advertising as well as the right media. Wal-Mart invests not more than 2% of the revenues in advertising in Brazil.

Exhibit 4

The customers, once very happy and satisfied to cross São Paulo traffic lights despite a constant traffic jam to shop in one of the Wal-Mart stores, are now becoming almost a rare view along both Supercenters and Sam's Club empty corridors. The vast parking lots in front of the stores, most of the time with just a dozen or so cars, are a worrisome picture.

In the mean time, Wal-Mart's competitors began to work harder to recover their lost time. Not only did they answer Wal-Mart's inroads with many promotions and lower prices to recover their lost customer base, but they also accelerated their own expansion. Just to mention one case, Carrefour opened as many as five stores in 1996.

On the other hand, Wal-Mart planned expansion, considering 8 new stores to be opened during 1997, was significantly modified. Now, only 10 Supercenters are planned to be constructed in the next two years. It is a much slower and conservative pace than initially announced. Despite the initial success, Wal-Mart International has consistently posted a net cumulative loss, considering Supercenter and Sam's Club together, of around US$ 32 million by 1996.

For further research, consult the following web pages:

Wal-Mart Home Page

Wal-Mart International Division

MERCOSUR and Beyond