Questions of appeal as Wal-Mart tackles China

Wal-Mart's plans to double its presence in China will test whether failed adventures in Germany and South Korea have persuaded the world's largest retailer to abandon corporate creationism in favour of Darwinism.

Wal-Mart is considering paying US$1 billion ($1.5 billion) for Trust-Mart, a closely held chain of grocery and appliance stores, a person familiar with the proposal told Bloomberg News.

A report this month by the University of Pennsylvania Wharton School of Business and the Boston Consulting Group suggests Wal-Mart risks throwing good money after bad if its selling strategies fail to evolve to suit local preferences.

China ranks as the fifth-most-attractive opportunity out of the 30 countries on consulting firm AT Kearney's 2006 Global Retail Development Index, down one place fromlast year. India, Russia, Vietnam and Ukraine topped the list.

About 400 million of China's 1.3 billion people live in urban areas, where income growth is about 10 per cent a year compared with just 1 per cent in rural areas.

The Wharton/BCG report estimates there are 25 million to 30 million middle-class households with annual incomes of US $4300 to US$8700, and 8 million affluent households with incomes of at least US$11,600.

Gross domestic product in China grew by 10.4 per cent in the third quarter, compared with 11.3 per cent in the second quarter and 10.3 per cent in the first three months of the year. Retail sales are growing at an annual pace of almost 14 per cent.

"Because international retailers are fuelling this growth, market saturation is also on the rise," AT Kearney said in its 2006 report on retailing in emerging markets. "More than 40 foreign retailers have entered the market to date."

Wal-Mart abandoned South Korea after shoppers shunned its gloomy, no-frills stores that emphasised bulk frozen foods over the fresh produce favoured by Koreans. At the time of its exit, the company had just 3.8 per cent of the country's US$30 billion-a-year discount market.

Two months later, Wal-Mart sold its 85 stores in Germany to Metro AG after underestimating the loyalty of shoppers to their local retailers.

Clashes with German workers over labor policies sparked strikes, contributing to US$1 billion of losses in Wal-Mart's eight years in the country.

Wal-Mart's ambitions to expand its Seiyu business in Japan were thwarted this month when Aeon Co won exclusive rights to acquire the supermarket company Daiei.

Wal-Mart, based in Bentonville, Arkansas, aims to generate a third of its sales and earnings from the company's international division, up from about a fifth currently.

It runs 66 stores in 34 Chinese cities, employing 36,000 people. Acquiring Trust-Mart would add more than 30,000 employees selling about 20,000 items from at least 100 stores in 20 Chinese provinces.

In the next five years, most of the growth in retail sales will come from China's smaller cities, which are typically harder for overseas companies to crack.

"With global strategies and global products it becomes very difficult," writes Deepak Advani, chief marketing officer of Lenovo Group, the world's third-largest personal-computer maker.

"You need to develop products that appeal to them, speak to them with messaging that is relevant to them. You need channels that are more accessible to them - like storefronts, which are very popular in China."

As it expands, the US company risks falling into the crack between the market for basic consumer goods, dominated by local stores, and the luxury segment of global brands that already have acceptance among Chinese buyers."They don't spend money on products their friends and neighbours can't see," writes Hubert Hsu, the Hong Kong-based head of Boston Consulting Group's unit for Asia-Pacific consumer goods and retail. "They may not be willing to pay premium prices for brands like Windex window cleaner or Kiwi shoe polish."

About 70 per cent of retail goods are sold in the nation's "mom and pop" stores, says the Wharton/BCG report.

What's missing in China's retailing market, the report suggests, is the middle ground Wal-Mart has targeted so successfully in the US domestic market.

"It's important for companies to segment consumers and understand where they're willing to trade up and down," writes BCG's Hsu.

Among more-affluent consumers, China has 1.6 million households with US$500,000 or more of assets, and about 250 million worth US$100,000 to US$500,000.

The most successful brands are those deemed to enhance social standing. Unlike in many countries, however, conformity is important.

"The higher-order needs in China are still collective rather than individualistic," writes Harjot Singh, China planning director for Omnicom Group's BBDO advertising agency.

"Everyone in China wants to conform to standards in a way that gives them social acceptance. It's no longer a game about creating esteem, it's a game about creating popularity."

It's not hard to see why China appeals to Wal-Mart. The trick will be figuring out how to make Wal-Mart appeal to China, and how to avoid another costly misadventure.

- BLOOMBERG