Wal-Mart, the largest retailer in the world, may be at the top of the Fortune 500, but it is ranked number 20 in the Chinese retail industry whereas Carrefour, its long-time rival, ranks number 5 on the list. However, following its withdrawal from Germany and South Korea this spring, Wal-Mart is taking significant steps to reshape itself in China.

On July 29, 2006, the first-ever union in Wal-Mart’s history was established in Jinjiang, a small city in South China’s FuJian Province. On October 17, Wal-Mart, which has 66 stores in the country, announced its intention to acquire a Taiwanese chain retailer, Trust-Mart, for $1 billion. The latter has more than 100 stores on the mainland. (The deal is subject to approval by China’s regulators.) Two days later, on October 19, Wal-Mart announced its new president and CEO of China operations — Ed Y. Chan, who succeeds Joe Hatfield after the latter’s 12 year-tenure in China. Chan was the former head of North Asia operations for Dairy Farm Group, a top retailer in Asia.

“Wal-Mart has finally used the acquisition weapon, which indicates it will be entering into a period of fast expansion,” says Yurong Ai, a partner in AccuWin, a marketing consulting firm based in Guangzhou, a major city in south China. “The layout of Trust-Mart’s superstores will be very helpful for Wal-Mart. For example, in South China, Wal-Mart has never been a presence in Guangzhou. Meanwhile, Trust-Mart’s six Guangzhou Stores are doing very well.”

John Zhang, a marketing professor at Wharton, says that “Wal-Mart’s growth is slowing down in the U.S. There is only so much cheap merchandise people can buy. Recent initiatives at Wal-Mart include a major move into low-priced pharmaceuticals and the introduction of more upscale goods and fashion — steps which indicate that the strategy of growing by building more stores has run its course. Wal-Mart is now trying to increase its revenues by mining its existing customers.” Its international operations in Europe and in some Latin American countries “have not done nearly as well as in the U.S.,” Zhang adds. “The spearhead of growth for Wal-Mart is clearly in China. Its purchase of Trust-Mart shows Wal-Mart’s strategic intentions as well as its determination.”

The Heat Is On

To meet its commitment to the World Trade Organizaton (WTO), China has completely opened its retail industry since December 11, 2004. Furthermore, China lessened its restraints on overseas investment in licensed chain store businesses in February 2005. In less than two years, competition in the retail domestic market has hit an all-time high. According to the Ministry of Commerce, China approved the establishment of 187 foreign-funded retail enterprises in 2005 alone, which is six times the number approved in 2004. Of those 187, 66%, or 124, were solely-foreign owned enterprises. Retail companies have been expanding at breakneck speed in order to stay ahead.

A report titled, “Retail Revolution – A Look at Mergers & Acquisitions in China’s Retail Industry,” released by Ernest & Young on September 27, 2006, notes that competition has forced many retailers to explore inorganic growth via mergers or focused and synergistic acquisitions. It says that French-based Carrefour, the world’s second largest retailer and the top foreign retailer in China, opened 16 stores in China alone last year. Carrefour has indicated that it may acquire at least 10 local retailers as part of its expansion plan in China, although no specific targets or time frames have been given.

Meanwhile, a report in the New York Times on October 17 said that Carrefour, a longtime rival of Wal-Mart’s, “is the largest foreign retailer in China by sales, with more than $2 billion. It has been expanding much more aggressively than Wal-Mart. Carrefour plans to open 100 new superstores this year, which will raise its total to more than 300.”

Chinese local retailers, for their part, are not sitting quietly on the sidelines. Beijing Gome Electronics Co., the number-one chain store in home appliances, announced on November 1 that it has completed the acquisition of Shanghai Yongle Electronics, the second largest stores in the industry. Shanghai Bailian Group, the number one retailer in China, is making moves to integrate its two brand supermarkets: Hualian and Lianhua.

“No other country has assembled so many international retail magnates at the same time than China. Meanwhile, local retailers are not [just standing by]; they are fighting hard for their chances,” says Accuwin’s Yurong Ai.

“Wal-Mart’s China strategy can be divided into three phases,” suggests Haiqing Ni, duputy director of the economic & trade commission of Jiangsu province. “Phrase one, beginning in 1996, the time when Wal-Mart first entered the China market, ended with its plan to acquire Trust-Mart. In the past decade, Wal-Mart was a success in terms of its purchasing power. The company set up a global purchasing center in Shenzhen in 2002. The total purchases it makes from China accounts for 10% of U.S. imports from China.”

The continuously opening market “and the growing middle class in China in recent years provide excellent opportunities for Wal-Mart to expand,” he adds. “Phase two for Wal-Mart China will be a time where it successfully integrates Trust-Mart’s overall business. The newly appointed CEO, who is experienced in integration with Taiwan enterprises, will make it easier for Wal-Mart to complete the acquisition of Trust-Mart with the objective to upgrade its sales to a new level.” The third phase will be Wal-Mart’s success integrating itself into the daily lives of the Chinese people and becoming the top retailer in the industry.

Does its U.S Model Sell in China?

In the July 2005 issue of Fortune, David Glass, the former Wal-Mart CEO, announced that China will be “the one place in the world where you could replicate Wal-Mart’s success in the U.S.” This, however, may not be quite so easy. Fei Li, professor of economics and management at Tsinghua University, says that in a recent research project on “Cross-Bordering Migration for Multinational Retailers’ Core Competitiveness”, he and the other authors concluded that international companies tend to migrate their original models into another country due to the low cost of doing business, among other reasons. But because every country is unique, they always present a challenge for multinationals in terms of how to combine their original successful standards and localization. Experts worldwide hold the view that it normally takes seven to eight years for multinational retailers to successfully migrate their core competencies to a foreign country. Li is also deputy director of the China Retail Research Center, sponsored by Wal-Mart.

In his recent paper titled “The Rise of Power Retailers in China and Manufacturers’ Counter Strategies,” Wharton’s Zhang points out that in America, Wal-Mart has shown that “size” can trump “location” as the key to success in today’s retailing. Wal-Mart’s huge power comes from both the one-stop shopping model — with its wide selection of merchandise — and its relentless efforts to remain faithful to its sales slogan, “Always low prices. Always.”

Zhang also notes the other methods Wal-Mart follows in lowering costs through “bare-essentials” efficiency: Its stores are mostly located away from major urban centers where real estate prices are high; it does not have to pay union wages, and its managers have very small expense accounts.

What is of vital importance, Professor Zhang writes in his paper, is that Wal-Mart works with its suppliers to do everything possible to improve logistic, operations and production efficiency. Wal-Mart has the most extensive and most efficient distribution network for its stores in the U.S., consisting of 96 strategically located distribution centers throughout the country and a trucking fleet with over 8,000 drivers. The company has also built a proprietary information network — Retail Link — that allows managers at Wal-Mart and suppliers to monitor sales flow and to optimize product manufacturing and delivery. Wal-Mart suppliers — 68,000 world-wide, including 2,500 from China — are expected to do everything possible to lower their costs.

However, not everything in Wal-Mart’s success model sells in China. “Wal-Mart has not always been as flexible as Carrefour in China. In the eyes of ordinary consumers, Wal-Mart is still a ‘foreign superstore’ which hasn’t melted itself into people’s daily life,” says Haiqing Ni at economic & trade commission of Jiangsu province. “Wal-Mart relies too much on its experience in the American market and it hasn’t seriously observed and followed the internal demand from Chinese consumers.”

“The distribution channel is a mess  in China. To manage Chinese suppliers and logistics with Wal-Mart’s highly technical management system is impossible in China.” Yurong Ai argues. “On the other hand, Chinese consumers’ purchasing power is not as homogenous as that of Americans. Most buyers don’t have cars, which makes the location of supermarkets an important parameter. What’s more, American consumers prefer to buy in bulk, Not so the Chinese, he adds.

Ruiguang Ma, president of Fly-Horse International Consulting Group and an expert in domestic chain-store consulting, says that Wal-Mart has allowed some of its stores to set up unions and even a Communist Party organization. (In China, companies are asked by law to set up a union as well as a Party organization.) This could be considered as one signal that Wal-Mart is trying to be more Chinese. “You have to be more localized,” he advises. “China is unique. The retail industry is very close to ordinary people. The average Chinese person is not” quickly adopting the “international style.”

Challenges and Advantages

Ma points out that the acquisition of Trust-Mart accelerates Wal-Mart’s move into China and improves its competitiveness, although the integration process after the acquisition is very important.  “But it looks good now,” he adds. And the “acquisition is divided into two stages which will make the challenges smaller. The first stage, in which 31 well-operated stores are to be bought, will be good for Wal-Mart’s China” expansion.  

In the future, adds Haiqing Ni, Wal-Mart has to adapt itself to be in tune with the Chinese consumer’s daily purchasing patterns and habits.” 

Ma suggests that an important angle to consider is that, compared to its relationship with the central government, Wal-Mart’s ties with local governments are not so close.”  Also, integrating the supply chain in a highly complicated country will be also a big challenge. However, he adds, “Wal-Mart also enjoys lots of advantages in China. It’s a highly recognized brand name in people’s minds and its relationship with suppliers is ranked high among all retailers. All the expenses it imposed on suppliers are less than half of what Carrefour collected. All in all, Wal-Mart will be in a good position to succeed.”

Wharton’s Zhang echoes Ma’s outlook. “Wal-Mart does have some advantages in China relative to other foreign operators: It has a good reputation among suppliers; its combined purchases for the China and north American markets are huge, which gives it the leverage with suppliers that no other retailers have in China; it has a sterling reputation for following regulations in China and a good working relationship with the Chinese government; and it has the know-how to build the most efficient distribution networks in a large, diverse country.”

The two main challenges for Walmart, he says, “are: It has to adapt to work in an urban environment instead of a rural, or suburban environment; and it needs to have a more upscale positioning in China. This means that it cannot count only on low prices to sell.”

Hot Debate on Legislation

Because fierce competition has caused many local retailers to shut down and because multinational retailers still enjoy more favorable treatment from the government in China, many local retailers and suppliers are calling on the legislative bodies to restrict the moves of overseas retailers in order to make the competition environment more equal.

For example, Qinghou Zong, the president and CEO of Wahaha Beverage Company, the number one player in the domestic beverage industry, is a long-time lobbyist for more legislation in the retail industry. Zong, a representative of the National People’s Congress, submitted a bill in March to eliminate the negative impact of the potential monopoly imposed by multinational retailers. He strongly proposes to eliminate the beyond-national treatment that foreign retailers receive.

However, opinions vary. Fei Li of Tsinghua University argues that it is a survival of fittest. He wants to set up a comprehensive evaluation system for policy making and to focus more on an “Anti-Monopoly Law” instead of imposing restraints on multinational retailers.

Yet Ruiguang Ma of FlyHorse Consulting says that contrary to South Korea, the Chinese government embraces Wal-Mart’s entry. Unlike the cities in coastal China, the local governments in the Middle West and in the smaller cities have been excessively hospitable to Wal-Mart’s arrival. They have provided favorable conditions and efficient support for the giant retailer to open stores in their precincts.