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Will Wal-Mart Take Over the World?

By Amy Tsao In the old days, there were shops of all kinds -- bakeries, shoe stores, pharmacies, and the like. Then came Wal-Mart. And the fear that the giant all-in-one store would come to small towns and squash mom-and-pop operations turned out to be real. American consumers find the Bentonville, (Ark.)-based discounter, which topped $226 billion in revenues in 2001, irresistible for its convenience, selection, and low prices. As local stores have continued to close, Wal-Mart has grown to 2,780 outlets in the U.S. alone. And that breakneck expansion shows little sign of slowing, despite the rough economy.

Now, Wal-Mart (WMT) is outmuscling big-name retailers. The outfit's incomparable efficiency already has sounded the death knell for second-tier discount retailers like Ames (AMESQ), Caldor (CLDRQ), and Bradlees (BRADQ). Kmart's (KM-T) future is looking iffy after the company filed for bankruptcy protection earlier in 2002. And Wal-Mart is eyeing new categories to dominate, says Ira Kalish, chief economist for Retail Forward, a retail consultant. "Wal-Mart's aggressive rollout of [retail gas] stations could be followed closely with the company selling used cars, financial services, home improvement, and food service." The retailer also says it is considering adding a new section to its stores to compete more vigorously with so-called "dollar format" retailers such as Family Dollar (FDO).

HAPPY CUSTOMERS. The implications of such moves are enormous. Because of its buying power and savvy technology, Wal-Mart is a highly cost-efficient operator in a business with tight margins. And customers couldn't be happier. "These innovations allowed the company to pass its savings on to customers," writes Brad Johnson with McKinsey Consulting in a recent report, "The Wal-Mart Effect." Wal-Mart succeeds on two counts: Being such a huge buyer, it can negotiate the best wholesale prices. And it is such a huge seller that it can offer customers the lowest prices and make up the difference in volume.

Meanwhile, less-efficient competitors selling the same goods must ask higher prices to earn the same profit. Still, competitors do slash prices, hoping, often in vain, that increased sales will make up for lost margins. "What has happened to the discount department-store segment over the past decade will now play out in food over the next couple of years," says Carl Steidtman, retail-sector economist at Deloitte Research. Translation: Expect big grocery chains to consolidate or disappear. The pain is being felt by all competitors. In just a few short years, Wal-Mart has nabbed the top spot in grocery sales, beating out the Kroger (KR) supermarket chain, the long-time leader.

All this explains why many investors are bullish on Wal-Mart. At around $53, shares are down about 6.5% year-to-date, but that's considerably less than the 15.5% hit the shares of retailers as a group have endured. In part, Wal-Mart has fared better because of the outfit's reliable performance, no matter the health of the economy. With analysts projecting double-digit earnings growth for the next several years, they see it remaining a stable holding for the long-term.

PLAYING MONOPOLY. It's hard to name a retail segment that's immune from Wal-Mart-inspired pressures. For instance, Wall Street recently cheered strong quarterly results from Toys "R" Us (TOY), but the good news may be short-lived. Toys "R" Us "will face great promotional pressures this year in its overwhelmingly important fourth quarter," Jefferies & Co. analyst Don Trott warned in a recent report. The long-term problem for the toy retailer, which is No. 2 in market share to Wal-Mart, is that its rival is much more nimble. While Toys "R" Us must stock toys, -- highly seasonal products -- throughout the year, Wal-Mart can pull back or step up inventory and shelf space as demand dictates.

Other Wal-Mart targets of opportunity are likely to be apparel and consumer electronics. On the clothing front, the chain this fall unveiled a line of women's career clothing under the label George, which it acquired in its acquisition of U.K.-based retailer ASDA. And it has also signed a deal with Levi's to sell $30 jeans. If Wal-Mart succeeds in convincing shoppers to view it as a destination for fashion needs, the impact will spread quickly. Among the first likely to feel the heat are department stores, teen clothiers such as Abercrombie & Fitch (ANF), even "shabby chic" discounter Target (TGT).

Consumer electronics is in for similar treatment. Wal-Mart has been taking sales away from consumer electronics retailers for years -- mainly on lower-priced products. These days, the price of hot products falls so fast that Wal-Mart can afford to jump in and handle them much earlier in the product cycle, says Colin McGranahan, retail analyst at Bernstein Research. This means Best Buy (BBY), Circuit City (CC), and higher-end stereo-equipment retailers like Tweeter (TWTR) have a shorter window in which to charge a premium for the latest gadgetry, says McGranahan.

SHARPENING THE EDGE. All this is a boon for consumers -- and for U.S. productivity in general. Wal-Mart is the nation's largest single importer and a major force in lowering the price of apparel and general merchandise, says Deloitte's Steidtman. Its general-merchandise market share soared from 9% in 1987 to 27% in 1995, says McKinsey's Johnson.

Wal-Mart's aggressive adoption of information technology to improve logistics and back-office efficiency has also been a major driver of productivity. While suppliers scrambled to meet Wal-Mart's demands, competitors big and small followed the retailer's lead and ratcheted up productivity by 28% from 1995 to 1999, Johnson says. But because of its early adoption, Wal-Mart reaped the most gains and continues to enjoy an edge over competitors.

There are plenty of other ripple effects, too. For instance, the difficult economy of the last two years has been a major factor in the traffic fall-off at shopping malls. But there's little question Wal-Mart has picked up long-term market share from the malls as well, says Michael Baker, director of research at the International Council of Shopping Centers. The mass migration to Wal-Mart effectively takes shoppers away from venues that contain dozens of specialty apparel outlets and mall-based department stores. "Mom-and-pop stores are gone, regional chains are gone, and the national retailers are thinning out," says Al Norman, anti-sprawl activist and author. "We're left with only the very big players at the top now that Wal-Mart has chewed right up the food chain."

SURVIVAL TACTICS. How can other retailers survive the Wal-Mart juggernaut? The answer is, and has always been, differentiation. Baker cites the good job Target has done setting itself apart with marketing and merchandising that attracts a more affluent demographic. He also lauds Safeway's (SWY) efforts to attract wealthier consumers. Best Buy's solution, according to spokeswoman Julie Keslik, is educating its salespeople about the gadgets and accessories it carries, as well as keeping them on top of the innovations that most interest customers.

Brave strategies one and all. But it's clear that big retailers of all kinds are facing the same perils that have wiped out a lot of mom-and-pop stores over the last 25 years. That's good for consumers and good for the economy. And it's best of all for Wal-Mart and its shareholders. Tsao covers financial markets for BusinessWeek Online in New York

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