Wal-Mart Eyes Smaller and Higher-End Stores

Corporation also aims to become “number one health-care company”

By Gary McWilliams
First published by the Wall St. Journal, August 17, 2007

Twelve years ago, Wal-Mart Stores Inc. executives welcomed Terry Leahy to the company’s Bentonville, Ark., headquarters. Mr. Leahy, newly promoted at Tesco PLC and considering an overhaul of the British retailer, spent an afternoon discussing operations with Wal-Mart executives.

Today, Wal-Mart is doing everything it can to stop Mr. Leahy from crashing its last big growth business: groceries. It has a team of executives hunkered down far from Bentonville in the San Francisco Bay area devising two new small-footprint stores, including a response to the November launch of Tesco’s U.S. grocery stores, according to people familiar with the group.Twelve years ago, Wal-Mart Stores Inc. executives welcomed Terry Leahy to the company’s Bentonville, Ark., headquarters. Mr. Leahy, newly promoted at Tesco PLC and considering an overhaul of the British retailer, spent an afternoon discussing operations with Wal-Mart executives.

Their brainchildren represent an unlikely step for staid Wal-Mart: One idea calls for urban convenience stores less than a tenth of the size of the company’s supercenters and stocked with groceries geared to more affluent tastes. Another plan calls for stand-alone stores offering a variety of health services and products. The new outlets are being prepared for introduction early next year, the people say.

David Wild, the Wal-Mart senior vice president of new business development, is leading the initiatives. He declined to comment. A Wal-Mart spokesman wouldn’t provide specifics but said, “Our business is constantly evolving, and we’re always looking for new and innovative ways to serve our customers.”

The company may have waited too long to develop successors to its big-box U.S. stores. Analysts now chopping their profit estimates for this and next year say Wal-Mart has seemed tone-deaf to consumer trends. Failed pushes in women’s fashions and home decor continue to sap profits, and high gasoline prices are eating into supercenter visits. Recently, Wal-Mart has tried running ads promoting its low prices as worth the extra travel.

Nonetheless, the smaller stores could help Wal-Mart do more than fend off Tesco. The retailer has been largely shut out from upper-income and urban markets, including those in California and New York. High land costs and local opposition have limited the discounter to just 28 supercenters in California, a tenth of the number in Texas. Smaller stores are less likely to stir up opponents than the hulking 200,000-square-foot big-box stores.

In health care, Wal-Mart sees itself providing an array of services and home-health equipment along with the prescription eyeglasses and pharmaceuticals that it already sells, according to a person familiar with the effort. “In five years, Wal-Mart wants to be on its way to becoming the No. 1 health-care company in America,” that person said.

In April, the retailer announced that over the next three years it would open up to 400 in-store clinics, offering basic services, including school physicals and treatments for sinus infections and allergies. It also said it hoped to have 2,000 clinics in operation in five to seven years. Wal-Mart has already teamed with some big employers hoping to improve employee health by providing standards for electronic health records. If that effort succeeds, it would give the Wal-Mart clinics a boost.

The world’s largest retailer hopes to begin rolling out the new convenience and health-care stores early next year, and it’s looking at locations in California for the pilots. A Wal-Mart spokesman said the company “regularly tests new formats” but declined to describe the effort further.

California has been an embarrassing stumbling block for the Arkansas retail giant. “Wal-Mart doesn’t have a format that works in California,” says Burt P. Flickinger III, managing director of retail consultant Strategic Resource Group. He believes the convenience-store effort is based in the San Francisco area because it is home to the Trader Joe’s chain, retailer of prepared foods and groceries, and it has become the biggest market for Whole Foods Inc. “Wal-Mart really needs to take a strategic stand” in the state, he says.

Tesco’s impending arrival in the U.S. Southwest has accelerated Wal-Mart’s plans. The British retailer is expected to open 30 Fresh & Easy Neighborhood Market stores by February and invest $2 billion in the U.S. rollout over the next five years, according to a spokesman for Tesco’s U.S. operation, which is based in El Segundo, Calif. After the first stores are launched, the company has 70 more stores in its pipeline for early 2008.

“The impact on the competition depends on how fast Tesco rolls out. I think it’ll be fast,” says David McCarthy, a London-based deputy head of equity research for Citigroup. He estimates Tesco could have 500 U.S. stores and U.S. revenue of $5 billion by 2010.

The proposed Wal-Mart stores would fit with U.S. chief Eduardo Castro-Wright’s goal of localizing the retailer’s business. As part of its effort to appeal to a broader range of consumers, Wal-Mart has begun tailoring merchandise and food selections to regional and ethnic groups and tastes. It recently asked fruit vendors to package apples, now sold in plastic bags, in paper sacks similar to those at roadside orchards. And it is reaching out to major suppliers, including Johnson & Johnson and Procter & Gamble Co., for advice.

Wal-Mart could use an injection of new ideas. Its earnings are expected to rise just 3.5% this year, to $12.52 billion, compared with a 10.2% increase just two years ago. The company remains the world’s largest retailer, with sales this year projected to hit $370 billion. But its rivals — Costco Wholesale Inc., Target Corp. and J.C. Penney Co. — have been turning in better comparable-store sales for more than a year.

Food sales are a double-edged sword for Wal-Mart. They represent its fastest-growing business, with revenue rising 14% last quarter and comparable-store sales up about 5% this year. But slim profits mean the company’s overall margins weaken as food’s share of the business gains. Wal-Mart shares hit a new 52-week low yesterday before bouncing back to close at $43.50, up 22 cents on the day.

In addition, Wal-Mart hasn’t successfully incubated new-store concepts since the first supercenter was created in 1988. Its effort to build a conventional grocery business via Neighborhood Market stores has been a modest success at best. The 40,000-square-foot outlets were designed to fill the gap between supercenters. But the company has opened just 124 of them since 1998.

Efforts to start new retail outlets overseas in countries like Germany were stark failures. In contrast, Wal-Mart has had some success entering into joint ventures with local retailers, as it did with Mexico’s Cifra SA in 1991, buying majority control after it understood the market.

Wal-Mart isn’t the only company readying new store formats. Major grocery chains are testing ideas that combine convenience and grocery stores. The third-largest U.S. supermarket chain, Safeway Inc., recently opened Citrine New World Bistro, a restaurant that uses its private-label brands.

FamilyMart Co., the third-largest convenience store operator in Japan, has opened 12 Famima convenience stores in the Los Angeles area and plans 250 U.S. stores by 2009. “This is a big, big target,” says Hidenari Sato, Famima’s vice president of U.S. operations.

Analysts say Wal-Mart hasn’t been able to penetrate the markets where wealthier America resides. “In the Northeast Corridor, California and Chicago you have 33% of U.S. income and retail sales. Yet these areas account for 10% of [Wal-Mart] stores and less than 2% of their supercenters,” says Greg Melich, a retail analyst at Morgan Stanley.

© 2007 Dow Jones Company