In 1993, Wal-Mart had become Americas leading retailer, with net sales of $67 billion from its Wal-Mart stores, Sams Clubs, and Wal-Mart Supercenters. The Company had grown at a rate of 25% per year since 1990, and it was clear that to continue at its current rate of growth, Wal-Mart would have to seriously consider continuing its recent international expansion.
During 1992, Wal-Mart had entered into a joint venture with CIFRA, Mexicos largest retailer, which currently operated 24 stores in Mexico and had plans to open 70 new stores by 1995. The Company had also recently completed the acquisition of 122 Woolco department stores in Canada. Each of these expansions had presented unique challenges for Wal-Mart to adapt its operations to suit local market demands, but Wal-Mart had successfully risen to the challenge. Given the Companys successful track record, it seemed logical to continue to expand internationally.
If Wal-Mart didnt expand internationally, David Glass, Wal-Marts CEO, felt that companies would start to come to the US and increase competitive pressures domestically. International expansion would drive growth and help in maintaining Wal-Marts dominant domestic position. Namely, entrance into foreign markets would force competitors to focus on their primary markets. If Wal-Mart planned to maintain its dominant position in the U.S., international expansion would not only drive growth, but it would also keep potential competitors trying to operate stores in their home markets rather than expanding into the U.S.
Wal-Mart
Company Background:
Sam Walton began his retail career working at J.C. Penney while in college and later leased a Ben Franklin franchised dime store in Newport, Arkansas (1945). In 1950, he relocated to Bentonville and opened a Walton Five and Dime. By 1962, Walton owned 15 Ben Franklin stores under the Walton Give and Dime name. Walton felt that big supermarkets would eventually destroy the smaller, traditional five and dimes and in 1962, Walton opened his own supermarket discount store. Eight years later, the Company was trading on Wall Street and had 30 stores.
Wal-Marts growth accelerated greatly during the 1970s. The Company aggressively marketed itself to middle class shoppers by advertising Everyday Low Prices. Walton motivated his employees by implementing a stock participation program that allowed all employees to purchase stock at discounted prices. This created an employee ownership that helped Walton to advance the Companys emphasis on controlling costs and providing excellent customer service. Additionally, Wal-Mart established highly automated distribution centers and implemented a computerized inventory system, which allowed the Company to cut costs and speed up checkout.
In 1988, Sam Walton stepped down as CEO of Wal-Mart due to health reasons and David Glass assumed the management of the Company. Since then, Wal-Mart had acquired its own distribution division and had begun to expand internationally.
By 1993, Wal-Mart had five divisions: Wal-Mart Stores, Wal-Mart Supercenters, Sams Clubs, McLane Company, and Wal-Mart International.
There was not just one explanation for Wal-Marts success and outstanding performance among retailers. It was a combination of strong management, culture, and strategy that had made Wal-Mart one of the most powerful retailers in the world. Wal-Marts entire economics, reward systems and corporate culture focused on growing overall profits and sales, and the strategy seemed to be working. Sales had grown at more than a 25% compound annual rate since 1990, making significant performance improvement a challenge.
Despite this challenge, Wal-Mart had a five-pronged growth strategy in place. The first driver of growth through 1997 was expected to be the Supercenters, which were projected to contribute to 50% of the Companys sales growth through 1997. New store growth would follow Supercenter growth, with Wal-Mart adding an average of 156 stores per year in the U.S. International development was expected to continue, with international stores growing to 13% of the worldwide store total by 1997. The emphasis on Sams Club membership stores was decreasing, and Wal-Mart was focusing on boosting sales at existing stores rather than spreading out the chain. Finally, Wal-Mart was attempting to realize each of its stores potential by utilizing the Companys strength in technology. By tracking consumer-buying patterns in different stores, Wal-Mart was localizing the mix and tailoring store inventory and service to local markets.
Wal-Marts Financial Performance
By 1993, Wal-Mart Stores Inc. had established a proven record of financial performance. Over its twenty-year history, Wal-Mart had achieved a return on equity of 33% and sales growth of 25%. The company had experienced sales increases from $16 billion in 1987 to $67 billion in 1993 while earnings went from $628 million to $2.3 billion over the same period. The firm had also built a market capitalization of $57.5 billion and sales per square foot of nearly $300 (as compared to an industry average of $210). Exhibit 1 details the companys financial performance over the past two years and its growth trends. The company hoped to continue this growth with internal forecasts predicting sales of $84 billion in 1994.
In order to accomplish these goals, Wal-Mart had to continue to expand beyond its traditional domestic base. Competition from the likes of K-Mart and Target was beginning to deprive the company of the single market locales that had led to tremendous growth. In April 1993, the company announced that growth would not meet historical levels; company projections placed domestic growth over 1993 levels only in the 7-8% range. If those projections proved true, it would mark the first time that growth had not exceeded ten percent in eight years. The market quickly reacted with Wal-Marts stock price tumbling 22% to $26 5/8.
There were many reasons to suggest that the timing was right to expand internationally. A favorable political and economic climate was helping free trade to become easier across borders with obstacles being eliminated though agreements such as NAFTA. Also, converting currency was becoming easier with third party providers such as Coopers and Lybrand going international. Finally, improvements in technology were making it easier to do business across International borders.
With these issues in mind, David Glass and his vice chairman, Don Soderquist looked to international expansion to facilitate growth. Several initiatives were planned in Mexico, Canada and China. By introducing the discount model to foreign markets first, Wal-Mart hoped to achieve high sales and earnings growth while also increasing economies of scale among global operations.
Wal-Mart International
Along with its entry into the more established markets in Canada and Mexico, Wal-Mart was considering entering the more stable, but yet undeveloped markets of Latin AmericaXspecifically Brazil and Argentina. Argentina offered a mature and growing target market that could embrace the discount store concept at a rapid pace. If Wal-Mart made the decision to enter Argentina, upper management projected that the Company would expand into the Argentine market with a mix of Wal-Mart and Sams Club stores.
Company policy had always required that all Wal-Mart projects, regardless of the geographical or competitive environment, meet certain standards. As of 1993, management required that all new investments return 17% of investment as measured by profit contribution divided by invested capital. Further, the company allowed for a time horizon of approximately three years.
In terms of costs, Wal-Mart budgeted expansion costs for Argentina using a model similar to those used in the American and Canadian markets. The company forecasted that each new store would cost roughly $20 million to build and reach operation status. Upon opening, management forecasted that each store should gross approximately $150 million in annual revenue . Total sales were expected to grow significantly faster than its domestic operations in the first few years but would stabilize to growth rates similar to its domestic stores within five to seven years. However, external analysts assessed these forecasts and considered them overly optimistic. Management also projected that Wal-Mart should achieve gross margins of roughly 20% for its supercenters and that SG&A would initially be at least twice that of an established local retailer. All told, if Wal-Mart chose to proceed with expansion into Argentina, the Company was prepared to allocate a $400 million capital expenditure budget for the immediate future.
However, Bob Martin, the CEO of Wal-Mart International, had some concerns about entering the market in Argentina. Given the history of the country and the economy, he wanted to be sure the investment would meet Wal-Marts stringent investment criterion. In addition, he was concerned about the stability of the currency and government. Was the timing appropriate to enter Argentina? Martin also wanted to know if the investment in Argentina would reduce Wal-Marts exposure to other risks. For example, Wal-Mart had operations in Canada, which had a very stable currency, and Mexico, a country with a much more unstable currency. This balance minimized the effect of a potential major currency devaluation in Mexico should that occur.
Argentina
History Once among the worlds most prosperous economies, Argentina experienced slow economic growth from the 1940s until the start of the Convertibility Plan in 1991. By the mid-1970s long-term growth had decreased sharply and in the late 80s Argentina suffered a strong period of depression. Savings and investment rates fell dramatically from the mid-1970s until 1989. Due to the unstable macroeconomic environment, local people saved and invested abroad. Labor productivity fell and poverty increased.
This economic performance had its main root in a chronic public sector deficit and endemic inflation. After democracy returned in 1983, different stabilization programs were put in place. However, all of them failed to eliminate inflation, as they were unable to permanently attack the structural deficit of the public sector.
In 1989, when a new administration took office, Argentina was immersed in hyperinflation, and the state was insolvent and incapable of paying its debt services. In April of 1991, the Law of Convertibility was issued, which guaranteed 1 to 1 convertibility of the peso into dollars, effectively proscribing money creation other than to buy net foreign reserves. The convertibility program therefore disciplined monetary policy and limited the power of the government to finance its deficit through inflation.
Since 1991, the government had sustained structural reform efforts that improved the public accounts. Several reforms were implemented regarding legal framework, privatization, and deregulation. The tax penalty law, from 1990, implemented severe sanctions for tax non-compliance. This and other efforts produced dramatic rises in tax collections. The government relied heavily on taxes to support the fixed peso exchange rate prescribed by the Convertibility Plan.
The recent October 1993 pension reform law had begun to generate pension fund savings on a large scale, securing a growing demand for capital market instruments. Moreover, the government had been working to restructure fiscal relationships with the provinces. Additionally, Argentina was close to reaching an agreement with its Mercosur partners to establish common external tariffs on January 1995, moving toward a regional common market.
Economic situation and outlook
In 1993, President Menem was preparing for re-election and was continuing to implement economic and social reforms to secure his re-election. However, there were few potential opponents for the election. In fact, only one existed for the socialist party and was not considered a serious contender against Menem.
A one major economic reform issue was opening the economy. The administration had recently begun to encourage foreign investment, and as a result it was forecasted to increase at a rate of 12.1% per annum through 1995. Unfortunately, the government was actually slowing import growth through the introduction of surcharges on textile imports and anti-dumping duties on steel imports. These actions were doing little to promote a growing merchandise trade for Argentina, which was only 11.2% of the countrys GDP in 1992. However, the government was planning to launch a Brady plan to raise funds, and it was unlikely that the government would risk its ability to raise funds by closing its economy once again.
Menems economic reforms were generally having a positive impact on Argentinas economy. During 1991-93, Argentinas economic growth averaged 7.7 %. Employment rates increased and capital inflows had been continuous, which had helped Argentina attain a sustainable balance of payments. During 1993, the economy continued to expand. Consumer spending was forecasted to grow at 4.8% per annum through 1995. Additionally, GDP had increased by 7.3% in 1992 and was forecast to increase by 6% in 1993 and 4% in 1994. Inflation had slowed dramatically during the past few years, falling to international levels, and was expected to be approximately 15% for the year. The price increases that were happening were not attributed to inflation, but rather the fact that products in Argentina had previously been under-priced versus international price levels. Now that Argentinas economy was more stable, prices were rising to meet those levels. Overall, Argentinas immediate economic outlook was very positive
The hyperinflation of the 1980s had a number of adverse effects on the Argentine retail sector; in particular it caused a major reduction in consumer spending capacity and forced leading companies to focus on cash management at the expense of long-term investment. The turning point was the Convertibility Plan of 1991 and the opening up of the market that happened around the same time.
The immediate results were an increase in foreign investment, a rise in consumption, a major expansion of transactions and a decrease in margins, this last phenomenon due to intense competition. This new scenario favored the establishment of supermarkets and hypermarkets, in detriment of small businesses unable to keep up the pace of competition.
Although the Convertibility Plan of 1991 brought an end to the hyperinflation that characterized the previous years, the cost of living in Argentina soared, as a result of an increasingly overvalued local currency. This has clearly affected growth in the retail sector as a whole. Nevertheless, the retail sector still had huge growth potential, which would also be benefited by a sustained, strong government fight on tax evasion. This was expected to weaken the informal economy and consolidate sales within the modern, established retail sector.
In 1984, the Argentine retail trade covered 787,279 commercial outlets, employing a total workforce of 2,183,157. The majority of these establishments were geared towards food and other perishable products and around 10% are responsible for 60% of sales. This distribution reflected an old structure based on neighborhood family stores (called almacenes), and not until recently before 1993 had the sector begun to modernize, with the construction of shopping malls and supermarket chains.
Argentina had a large and sophisticated consumer base with 1/3 of the population living in Buenos Aires. This group had all of the characteristics of a 90s consumer society: 99% television penetration, 55% cable penetration, European cultural sensibilities and American tastes in clothes and food. Argentina also had 96% literacy rate and a very sizable youth segment with 54% of population under 30.