Posted by: itm2011 | May 16, 2011

Walmart’s Downfall in Germany: A Case Study

Walmart’s Downfall in Germany: A Case Study

By: Phoebe Jui

In 1997, Wal-Mart had entered in the German retail market through acquiring the failing German retail chain Wertkauf but quickly encountered problems. Wal-Mart had demonstrated phenomenal success in the US by providing an Every Day Low Prices guarantee, inventory control, and efficient distribution.

Wal-Mart’s Background

Wal-Mart, the mega-retailer, was founded by Sam Walton in 1962 in Bentonville, Arkansas. It started with $700,000 in its first year and scaled up to $5.4 million by 1974. The retailer continues to grow while others struggled with inflation and recessions. In 1980, Wal-Mart became the youngest US retailer to exceed $1 billion in net sales. During the 1980s, Wal-Mart began to further expand and thus pushing some retailers to closing some of their regional stores. The company engaged in diversification by creating membership-stores such as Sam’s Club, smaller, more conventional pharmacy/grocery stores called Neighborhood Markets, and finally Supercenters with a wide selection of consumer goods.  And, in 1991, Wal-Mart became the world’s largest retailer.

Wal-Mart’s Every Day Low Price Strategy

In 2002, UBS performed an industry study and discovered that Wal-Mart had achieved 12% lower prices on average than its competitorsWal-Mart had been able to implement its Every Day Low Price strategy by focusing on 1) developing a sophisticated logistics system with heavy information technology investments, 2) efficient distribution system by placing retail stores close to distribution centers and using RFID technology, and 3) being a non-union employer.

Retailer Shift towards Globalization

Wal-Mart was a relative latecomer to international retailing. It started in 1991 by opening two stores through a joint venture in Mexico. Then, by 1997, it had 41 stores in Mexico and had also expanded to Argentina, Brazil, China, Germany, Korea, Japan and the UK.  In 2003, Wal-Mart now with 1,288 international stores had sales growth of 18.8% (above investor expectations) because of strong performance in Mexico, Brazil, and the UK. In Britain, Wal-Mart was able to successfully transplant their US strategy after acquiring ASDA. It implemented its supply-chain management technology and was able to provide customers with prices 7% lower than competitors. This ultimately led to Wal-Mart raising its ASDA assets’ price margins and market share. During that same time, its competitors had also begun expanding. K-Mart entered the European market in 1992 and began expanding. Also, Costco had stores in the UK, Taiwan, Korea, Japan, and Mexico by 2003.

German Market & Retailing Industry

With the largest economy in Europe, Germany comprised around 15% of Europe’s annual retail market in 2001. In 1997, Wal-Mart moved into the German market through acquiring the Wertkauf chain (24 stores) and unprofitable Interspar chain (74 stores). The two chains made up only less than 3% of the market. The Interspar stores were in poor repair and in poor locations. The leading German retailer was Metro Group followed by Rewe Group. Germany’s top ten retailers captured 30% of the total retail sales in 2001.

Retail market growth rates had averaged at 0.3% per year in the 1990s. Profit margins in Germany were also low for retailers compared to retailers’ margins in other European countries. Bankruptcy filings were numerous. In 2002, 10,000 retail stores filed for bankruptcy. This points towards a competitive landscape that might prove to be challenge for Wal-Mart to succeed in.

Wal-Mart’s initial strategy was to refurbish the stores to improve appearance and maintain price leadership through cost leadership as they had done in the US market. They would overhaul the supply chain systems, and incorporate new scanning systems, centralized distribution, and high quality customer service. By doing so, Wal-Mart had created a fierce price war in Germany.

According to a Goldman Sachs report, Wal-Mart could be trusted to implement its US strategy and gain efficiency, low prices, and inventory control and thus propel the underdeveloped German market into the future. However, to the contrary, an analyst in a DG Bank report warned of many foreign retailers failing in Germany because of land-use restrictions.

Germany had limited store hours, price regulations (prohibiting retailers from selling below costs), and stringent zoning requirements. Also, Unions were more influential than their US counterparts.

Zoning

In 1977, Germany had enacted strict planning and zoning regulations designed to protect traditional retailers and thus prohibited construction of stores with more than 800m2 sales area in locations not designated for retailing. This resulted in large-store development being restricted to town/city centers. Yet, even within cities, where retail restrictions were less onerous, the approval process for a new store still could require from 1 to 4 years.

Opening a large retail store outside urban area was possible however require multiple steps. The retailer would be required to create a building use plan that would cover a comprehensive development concept that accounted for environmental, conservation, and private legal concerns. An example would be the new site could not sell products that would compete directly with stores in nearby towns. The plan would need to be first approved by the town or city council and then regional planning boards at the state and national level. This resulted in little to no success rate especially since the German government did not want retail businesses to pull away customers to outside of a town leaving old buildings and monuments in the city center vacant. This would be extremely problematic for Wal-Mart because all of its stores in Germany were Supercenters.

Labor Union Relations

Germany service sector union Ver.di, the largest union in the world, filed a lawsuit against Wal-Mart for not releasing year-end figures that could be used to negotiate wages.  This ultimately led brought Wal-Mart to the negotiating table with Ver.di. As a result, the retailer conceded a salary increase that was 0.5% over negotiated retail-sector levels.

Store Hours

As of 2003, the Store Closing Law limits store hours to a 6:30 pm closing on weeknights and 8 pm on Saturdays. Stores could not open at all on Sundays with exceptions granted by state government or if they provided ‘essential’ functions: pharmaceutical drugs and tobacco. It was instituted to protect domestic retailers from larger competitors who could afford to keep their stores open longer with lower expenses. This was also reinforced by religious factions who supported the importance of family time while the left side of the political spectrum believed that retailers working longer than other workers was inherently unfair. The shortened working hours have resulted in higher wages per worker for retailers. For instance, full-time floor staff workers in Germany demanded a 19% premium compared to UK workers on average.

Customers

Unlike many of its German competitors, Wal-Mart offered credit card payment and free bags for goods purchased, improved store interiors, and friendly customer service. Since German customers were not accustomed to friendly greetings, they focused more on how much more is Wal-Mart charging customers for these additional services. Not having to hire greeters helped mitigate costs from having to pay higher wages per worker compared to the UK. Customers were also loyal to the domestic large players in the retailing industry including Metro, Aldi, and Rewe.

Suppliers

Wal-Mart experienced great difficulties in dealing with suppliers. The retailer did not have the bargaining power to buy goods from suppliers at low cost and also did not have a reputation of low prices with German consumers. And, upon implemented its centralized distribution system, they experienced high backorder rates (20% vs. industry average of 7%) and thus successfully implemented new scanning systems to better manage inventory.

Competitors

In 2001, a consumer study showed that Wal-Mart’s prices were 11-25% higher than its German rivals. This can be explained by many of its competitors’ simple business model to minimize costs even if it is to reduce customer service levels. Many of its competitors focused on providing minimal customer service and using minimal labor in order to minimize costs. Before Wal-Mart’s entry, the retailers burdened with high labor costs and the need to keep prices low had decided not to invest in store design, IT systems, or merchandising. However, after Wal-Mart entered, an increasing number of German retailers began utilizing advanced scanner systems and increased their pressure in dealing with suppliers to lower shelf prices.

Higher costs, lower margins, smaller stores, undeveloped supply chain relationships, and price sensitive customers loyal to German chains forced Wal-Mart’s stores to only have a margin of less than 1% while Wal-Mart’s ASDA had 6-8% in the UK. Yet, this problem also affected other foreign companies such as GAP and Marks & Spencer, who both decided to leave the German market. How should Wal-Mart have approached the venture into Germany? Also, what should Wal-Mart do given the current circumstances?

Conclusion and Analysis of Wal-Mart Entering Germany

Wal-Mart has traditionally been able to set the standard in the retailing industry, especially in the US. However, there are certain advantages that may not be fully transferable to other countries.  And Wal-Mart’s venture into Germany is no exception to this fact.

Rather than engaging in acquisitions as Wal-Mart has done to gain presence in Germany, Wal-Mart should have considered the other options prior to entry: 1) greenfield investing, 2) licensing and franchising with retailer, and 3) creating joint venture with local partner.

Greenfield investing would subject Wal-Mart to similar risks (if not more risks) associated with the acquisition of Wertkauf. Therefore, this option should be ruled out. Franchising and licensing with local retailer would not contribute too much value to a German retailer since Wal-Mart’s brand has failed to demonstrate a strong perceived reputation of low prices in the eyes of German customers. The final option would be to launch a joint venture with a local retailer. This would have allowed Wal-Mart to have time to adjust to the steep learning curve associated with the German market.

Since Wal-Mart’s competitors learned from the US retailer and selectively utilized new scanning systems upon Wal-Mart’s entry, the retailer might as well have worked with a local partner to create a German venture under the terms of a 50-50 equity stake. Wal-Mart could bring its expertise in improving retailing efficiency while its partner could provide Wal-Mart its local supplier and labor union relationships, brand recognized by customers for low prices, and local market and legal knowledge.

The joint venture would greatly reduce the risk profile of the foray into Germany and provide Wal-Mart a better platform on which to analyze the German market, which greatly differs from the UK market despite their close proximity. The risks of working with a partner could include the partner learning Wal-Mart’s core competencies and implementing them beyond the joint venture project to capture a dominant foothold of the market. However, as seen in the case study, this has already been the case when Wal-Mart entered the market. The competitors quickly adapted and adjusted their infrastructure to incorporate certain strengths that Wal-Mart demonstrated such as controlling inventory well through advanced scanning systems. Furthermore, Wal-Mart does not necessarily have to provide its German partner with the entire inner workings of the IT technology that drives Wal-Mart’s logistics. The US retailer can simply implement the technology into the store in a way that allows the venture to reap the benefits but also prevent its partner from easily imitating its intellectual property behind Wal-Mart’s logistics.

Unfortunately, Wal-Mart had decided that its successful track record in US, Mexico, and the UK would serve as a sufficient prerequisite in entering Germany through acquisition. Also, it assumed that its country-dependent advantages would be able to transfer over such as supplier relationships and consumer market knowledge. As a result, the company’s German stores are facing shrinking margins and thus low profitability. However, Wal-Mart has several options to deal with this dilemma: 1) continue expanding in Germany through acquisitions/organic growth to gain economies of scale, 2) halt expansion but attempt to adjust its current assets to the industry landscape in Germany, and 3) divest its German assets.

Considering the fact that it has already spent a considerable amount of time, effort, and money in Germany, Wal-Mart may continue expanding in Germany in hopes of gaining economies of scale. These investments should be considered sunken costs and thus should not bias decision making.

Wal-Mart has already demonstrated that they have been destroying shareholder value through acquiring German retailers and expecting to turn them around. Thus, investing additional capital in hopes of turning around existing German retailers should not be reasonable. The plan to organically scale up operations would not work well in Germany given the current stringent regulatory environment. If Wal-Mart pursues organic growth, Wal-Mart would have to undergo a time-consuming and potentially financially costly process to have their proposal win the approval of the local, state, and national governments. This is highly unlikely given the perceived detrimental impact of allowing Wal-Mart to establish more Supercenters in Germany. One concern could be that the large stores if built outside the urban areas could draw populations close to the store and thus create population voids in the urban areas. Vacant old buildings in certain urban areas still remain to remind Germans of this possibility. Therefore, Wal-Mart cannot achieve the same economies of scale in Germany as experienced in the US and should not implement this expansion option.

Another more passive approach could be to keep remaining assets and adjust according to the dynamics of the industry in Germany. However, Wal-Mart competitors, who have developed relationships with suppliers and labor unions and a reputation as a low cost provider of goods to customers, have already adapted technology such as RFID, new logistics, and new scanning systems to improve efficiency and lower costs. Even if Wal-Mart reduces the quality of customer service and scales down the size of stores to help minimize costs, there is still little room for Wal-Mart to create a competitive advantage since its rivals have already taken pre-emptive action. They have learned from Wal-Mart and implemented the necessary infrastructure to prevent Wal-Mart from becoming a huge competitive threat in Germany.

The last option for Wal-Mart would be to divest its assets to a domestic retailer to cut its losses in Germany. This would be the most feasible given its current limited profitability with an increasingly competitive landscape filled with competitors taking pre-emptive action against Wal-Mart and the regulatory protocols that hindered Wal-Mart’s development in Germany.

The divestment’s feasibility was confirmed in 2006. In 2006, Wal-Mart decided to exit the German market by selling its retail stores to German retailer Metro. The exact terms of the agreement were not publicly disclosed; however, the result was that Wal-Mart’s decision to leave incurred a $1 billion loss.

Works Cited

  1. Barbaro, Michael. “GERMANY: Wal-Mart Finds That Its Formula Doesn’t Work in All Cultures.” CorpWatch. 1 Aug. 2006. Web. 25 Apr. 2011. <http://www.corpwatch.org/article.php?id=13969&gt;.
  2. Ewing, Jack. “Wal-Mart: Struggling In Germany.” Businessweek. Bloomberg, 11 Apr. 2005. Web. 24 Apr. 2011. <http://www.businessweek.com/magazine/content/05_15/b3928086_mz054.htm&gt;.
  3. Korr, Andreas, and Andreas Arndt. Why Did Wal-Mart Fail in Germany? IWIM – Institute for World Economics and International Management, 24 June 2004. Web. 24 Apr. 2011. <http://www.iwim.uni-bremen.de%2Fpublikationen%2Fpdf%2Fw024.pdf&rct=j&q=walmart%20in%20germany&ei=kgm4TeqjMJDfgQe_zcWfDw&usg=AFQjCNGjLzM8lZr4c1GeFk3uJ28kFCywPQ&cad=rja&gt;.
  4. Landler, Mark. “Wal-Mart Gives up Germany.” New York Times. 28 July 2006. Web. 26 Apr. 2011. <http://www.nytimes.com/2006/07/28/business/worldbusiness/28iht-walmart.2325266.html&gt;.
  5. “Retail Industry Background.” GlobalEDGE. Michigan State University. Web. 26 Apr. 2011. <http://globaledge.msu.edu/industries/retail/background/&gt;.
  6. “Retail Industry.” Wikinvest. Web. 25 Apr. 2011. <http://www.wikinvest.com/industry/Retail&gt;.
  7. Trumbull, Gunnar, and Louisa Gay. Wal-mart in Europe. Harvard Business School, 20 July 2004. Web.
  8. “Wal-Mart’s Reality Check: Tough Climate in Overseas Markets.” MarketWatch. 28 July 2006. Web. 25 Apr. 2011. <http://www.marketwatch.com/story/wal-marts-reality-check-tough-climate-in-overseas-markets&gt;.
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