After saturating its target market of working class, bargain-hunting consumers, Wal-Mart is ratcheting up its low-price strategy to appeal to more upscale shoppers by expanding its merchandise lines to include organic foods, better wines, high-end consumer electronics and new fashion-oriented apparel. It’s an approach that carries some risk, say Wharton faculty and analysts, but that is dictated by intense competition and the lack of other opportunities for growth.

The changes come as Wal-Mart — the world’s largest retailer with annual sales of more than $300 billion — has struggled with slowing growth and rocky transitions internationally as well as into urban areas of the northeastern United States. In a speech at the company’s annual meeting this month, Wal-Mart chief executive Lee Scott outlined elements of the strategy and quoted Wal-Mart founder Sam Walton: “You can’t just keep doing what works one time. Everything around you is always changing. To succeed, stay out in front of that change.”

Wooing the Baby Boomers

According to Wharton marketing professor Xavier Dreze, now that Wal-Mart has conquered the value end of retailing, its options are limited. “They are going upscale. It’s the only choice available,” he says. “They have expanded to the point where they can’t expand in the U.S. anymore. If you can’t grow by reaching more people, you have to grow by selling more — and more expensive — [merchandise].”

Approximately 80% of American shoppers now visit a Wal-Mart store at least once a year and more than 170 million consumers around the world shop at a Wal-Mart store each week. In addition, the company has expanded to 6,100 stores in 70 countries. “Wal-Mart is sending a signal that they are about more than price,” says Wharton marketing professor David Bell. “They have played price. Now they want to play quality and broaden their image. It will be interesting to see whether people believe it.”

The new strategy will help Wal-Mart compete against Target, its chief discount-chain rival, adds Wharton marketing professor John Zhang. “Target is doing well. Customers perceive it as more trendy and higher-end. Wal-Mart now is forced to move to the high end to look more like Target instead of just looking cheap.” Demographics are also driving the changes at Wal-Mart, which traditionally has had the most appeal to young families. The chain is making an effort to woo the nation’s 70 million aging baby boomers, according to Zhang. “These are the customers with more spending power. You have to figure out a way to follow them and satisfy their needs.”

The new higher-end products will be sprinkled throughout Wal-Mart’s core offerings and are not likely to alienate the company’s established base, suggests Wharton marketing professor Stephen Hoch, who says he sees no reason for the initiative to fail. “Target has been successful at going slightly above where Wal-Mart is. Wal-Mart may not be perfectly associated with a trading-up image, but my guess is they can buy brands that have that panache as well as anybody else, or even better.”

Of course there is always a chance Wal-Mart could jeopardize its current position by aspiring to move up the customer ladder, Dreze notes, comparing the situation to regional airlines that do well in their niche, then expand nationally, but ultimately fail because they have lost their competitive edge. “The question for Wal-Mart is, if they sell high-end [goods], is there a competitive edge to that? Or will it make them just another retailer? That’s the risk.”

In March, Wal-Mart opened an experimental store in Plano, Tex., an affluent area where the average income of $140,000 is triple that of the typical Wal-Mart shopper, according to market research firm Information Resources, Inc., (IRI). The store carries 2,000 premium items, including meat, cheese, wine and fresh produce not available in typical Wal-Mart supercenters.

In a report to clients, Bank of America analyst David Strasser says Wal-Mart’s shift up the price continuum is already showing results. For several years, the chain’s sales growth was led by food and consumables, while general merchandise was weak. Strasser analyzed sales of consumer electronics at 1,300 stores where higher-end merchandise, particularly flat-panel televisions, was introduced last year. For the first time in four years, consumer electronics became a non-grocery category to contribute growth to the overall sales mix at U.S. Wal-Mart stores.

Strasser also points to sales of the chain’s new, more upscale private-label clothing line, Metro 7 — which have been so strong that the company has had trouble keeping items in stock — and its line of 400-thread count sheets, which have recently been selling out and are another symbol of Wal-Mart’s move up the luxury continuum.

Even within the food and beverage category, Wal-Mart is changing its menu, most notably with new lines of organic foods, fresh produce and top-shelf wines and liquor. William Cody, managing director of Wharton’s Jay H. Baker Retailing Initiative, says Wal-Mart’s expansion in wine represents a departure from the chain’s cultural roots in Bentonville, Ark., where founder Walton shied away from selling alcohol. According to Cody, changing federal regulations over the distribution of alcohol may open up new opportunities for Wal-Mart, Costco and other national retailers. Recent federal court cases have overturned statutes written at the end of Prohibition that gives states control over alcohol distribution.

Adjusting to Organics and Other Innovations

Organics represent a new, growing category of demand for all retailers and is expected to experience double-digit growth through 2010, according to an IRI report issued in May that states: “Wal-Mart has been relatively slow to enter the fray, given a potential disconnect with its core lower-income consumer.”

The $15 billion organic foods market represents just 2% of overall U.S. food and beverage sales, but is growing at a rate of 20% a year, compared to 2% to 4% for non-organic groceries, according to the Organic Trade Association. “The opportunity for the consumer is that Wal-Mart can hypothetically offer organics at a lower price, but that’s assuming unlimited access to the supply,” says Cody. “Can they position themselves as the low-price leader in organics? Possibly, but it’s more a way to bring in new customers who buy organics.”

Moving into organic foods will create new challenges for Wal-Mart’s legendary supply-chain system, adds Serguei Netessine, Wharton professor or operations and information management. “Coming into organic foods is somewhat tricky, especially for someone as big as Wal-Mart. While Wal-Mart’s typical supply model is to push vendors into a centralized distribution system, the wholesale organic foods market is made up of many small suppliers selling perishable goods that require complicated handling. “It’s essentially hopeless and meaningless to try to centralize distribution. You have to change the distribution system somehow to go back to the model in which suppliers supplied directly to the nearest store.”

Without major industrial-scale supply operations, Netessine says he doubts Wal-Mart’s claim that it can substantially reduce the price of organic foods. Still, he’s not counting Wal-Mart out just yet. “They will have to adjust,” he says. “People incorrectly think of Wal-Mart as only supplying cheap goods to people on a budget. If you look at Wal-Mart merchandise, the list includes gold and diamonds and expensive electronics. Wherever there is some demand for something, even expensive items, Wal-Mart tries to come in. Every time, they have to adjust the supply chain for different merchandise, but for organic food [this adjustment] seems especially tricky.”

Another new innovation Wal-Mart executives are promoting is walk-in medical clinics, operated by outside firms like RediClinic, a healthcare startup created by America Online founder Steve Case. Wal-Mart leases space at 11 stores to pilot clinics and has said it may increase that number to 50 by the end of this year.

According to Cody, the clinics fall more in line with Wal-Mart’s traditional consumer base, and while they may not be profit centers themselves, the clinics could help boost pharmacy sales or simply draw more shoppers into Wal-Mart stores.

Morris Cohen, Wharton professor of operations and information management, suggests the healthcare clinics will get leverage from Wal-Mart’s real estate clout. However, they pose new issues of supply-chain management specific to services, as opposed to product inventory where Wal-Mart is viewed as the master. “It makes a lot of sense that Wal-Mart should be providing services in carefully selected convenient locations where you can share some of the overhead of the store,” he says, noting that the chain already has optical and pharmacy services. “Why not manicures?”

Cohen explains the challenges of operating a service supply chain center around consistency and quality. “A service is consumed as it is produced, unlike a product that can sit on a shelf and come out of a box when the customer wants it. So often the quality rests on the dependability of the front-line people delivering the service.” Consistent service, for example, requires companies to maintain excess capacity for times when they are not busy in order to meet customer needs when they arise, says Cohen. “It’s still matching supply and demand, but the knobs you have to turn are different.”

The clinics may also fit into Wal-Mart’s push to present itself as a kinder company, particularly after unions generated reports showing that Wal-Mart employees lacking health insurance coverage are among the top users of state and federal-financed Medicaid programs. CEO Scott has said that 30% to 40% of those visiting the Wal-Mart clinics are uninsured, while surveys indicate that if those people had not been able to come to the clinic, 20 to 40% would have sought expensive emergency room care. Another 10% to 20% would have gone without treatment.

Hoch points out that Wal-Mart is taking other steps to improve its appeal to shoppers, including new image-oriented advertising and a major initiative to operate with greater sensitivity to the environment. “I do think they are engaged in more outward-reaching public relations efforts to burnish their image, such as feel-good ads,” he says. “They need to constantly evolve.”

Successes and Setbacks Abroad

Meanwhile, Wal-Mart’s international expansion, which is an earlier attempt at generating growth beyond the company’s well-established base, continues to have both successes and setbacks. In March, Wal-Mart raised its stake to a controlling 51% share in Central American Retail Holding Co., with 375 supermarkets in Guatemala, El Salvador, Honduras, Nicaragua and Costa Rica. In May, it pulled out of South Korea, where it had 16 stores.

Wal-Mart officials have indicated that India, where government reforms lifting restrictions on foreign ownership of retail operations are underway, could be a major target market for the company. Meanwhile, Wal-Mart is expanding rapidly in China, where, Zhang says, there “are a large number of value-conscious customers and where infrastructure and logistics will play an important role. Wal-Mart has the advantage [in this area]. I sense the company probably will do well.”

Wal-Mart has had some success in Britain after stumbling in Germany, says Hoch. In Japan, after struggling for years, Wal-Mart several months ago took a controlling stake in the country’s fifth-largest retailer, Seiyu Group. The company operates more than 400 supermarket and general merchandise stores in that country. “You win some and you lose some,” Hoch says. “Each individual global market has its own set of issues. Wal-Mart has been successful in North America, including Canada and Mexico, and will continue to look for opportunities. The company is designed to grow. If it can’t grow, it’s in trouble.”