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Wal-Mart vs. the world
Overseas expansion is critical to growth, but success beyond the U.S. will be difficult.
December 19, 2005: 2:22 PM EST
By Matthew Boyle, FORTUNE writer

NEW YORK (FORTUNE) - While its retail competitors are grappling with what has proved to be a sluggish holiday season in the United States, Wal-Mart has been busy overseas, snapping up the Brazilian operations of Portuguese retailer Sonae for $757 million, and confirming the long-rumored opening of two or three supercenters in Canada in 2006.

"Expanding into new countries will play a critical role in whether or not Wal-Mart meets its aggressive growth goals," says Retail Forward analyst Sandy Skrovan. But will Wal-Mart's recent moves put the squeeze on its overseas rivals, or will it get squeezed itself?

With sales growth slowing in its home country—quarterly same-store sales increases (excluding Sam's Clubs) have dipped from between 7%-9% in 2002 to 1%-3% this year—Wal-Mart has little choice but to look outside America for a boost. International operations currently account for only about a fifth of Wal-Mart's sales, but the company says it hopes to increase that proportion to a third eventually.

Big in Brazil

By adding Sonae's 140 stores to the ones it acquired back in 2004 from struggling Ahold, Wal-Mart bolstered its position as the third-largest retailer in Brazil. It now operates nearly 300 stores in Latin America's biggest economy. Meanwhile in Canada, the beast of Bentonville already has about 260 discount stores, which do not sell food, and a handful of Sam's Clubs.

All told, Wal-Mart currently operates in 15 countries besides the US, but its record outside these shores is spotty. It has struggled in Japan, failed miserably in Germany, and lately has even had troubles in the United Kingdom, where management of its Asda subsidiary recently admitted to analysts that some of its stores were "unshoppable" on occasion. One exception: Its Mexican operations are thriving.

As it plots its latest expansion, Wal-Mart would do well to pore over new research from Bain & Co. The consultants there analyzed about 100 overseas expansion moves by retailers between 1989 and 2004 and found that less than one in three were successful. Expansions into Latin American countries had only a 40% success rate, Bain found, while forays into Canada were much more likely to do well (over 80% were successful).

An analysis of Wal-Mart's overseas opportunities by Retail Forward confirms those findings. Wal-Mart's move into Brazil, for example, is forecast to have low prospects for growth and high risk, making it a poor choice for expansion. Canada, like Australia and the United Kingdom, is viewed as a much less risky proposition, with better growth prospects.

Tough prospects

That stands to reason, as the U.S. is much closer culturally to its northern neighbor than it is to Latin America, but Bain found other reasons why expansion plans fizzle. For example, retailers make things difficult for themselves when they enter a market with clear and established leaders. Both Brazil and Canada have such frontrunners in Companhia Brasileira de Distribuição and Carrefour (Brazil) and Loblaw and Sobeys (Canada).

And while both Brazil and Canada are large markets, are they healthy enough to justify the massive investment? Brazil's retail scene is not exactly robust, and brutal price wars have turned at least one Canadian province, Ontario, into a "bloodbath," according to one analyst.

Wal-Mart (Research) already gets a substantially lower return on assets in international markets (6%) than it does with its domestic operations (24%), according to a report issued last week by Merrill Lynch analyst Virginia Genereux. Even so, she writes, "Wal-Mart's international operations are on balance a positive in our view, because the contribution of revenue and earnings growth outweighs the slight dilution to consolidated returns." Indeed, the 140 Sonae outlets generate annual revenue of $1.4 billion.

Theories abound as to why expansion has bedeviled retailers in the past. In a recent edition of the McKinsey Quarterly, authors John Horn, Dan Lovallo and Patrick Viguerie write that companies entering new markets frequently fail to learn from history. A "myopic focus on the market entry decision," they argue, prevents management from analyzing a group of similar past cases, which can provide a valuable reality check. One common expansion error is the "brick wall effect," where executives assume that competitors won't adjust their prices, broaden their product offerings, or otherwise change strategy in response to the entry.

It's been said that Wal-Mart's widely admired logistical prowess only extends to countries that it can drive a truck to. Brazil provides a perfect opportunity for Wal-Mart to prove those doubters wrong. Given its stagnant stock—flat in 2004 and down 5% so far this year—and the bad publicity surrounding recent Wal-Mart bashing documentaries, it's clear that investors are desperate for some good news out of Bentonville. Boa sorte, as the Brazilians would say. Good luck.


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