Wal-Mart's China Card

While the revaluation will crimp U.S. store profits, it should boost outlets in China. Expect the retailer to up its bets on the Middle Kingdom

By Pallavi Gogoi

In Dalian, a coastal town in northeastern China, Wal-Mart (WMT ) has a multilevel underground store beneath a soccer field named Olympic Square. The local tourism bureau has designated the store as a tourist destination.

As the world's largest retailer enters into an aggressive phase of Chinese expansion, with the goal of almost doubling the number of its stores -- to 90 -- over the next two years, you can expect more such marketing machismo. China is rapidly becoming an extremely competitive market, where Wal-Mart's largest rival, France's Carrefour (CRERF ), already has 240 stores.


  Wal-Mart revealed its ambitious expansion plans to Chinese journalists on July 25, just four days after the People's Bank of China decided to abandon the yuan's decade-old peg to the dollar. The move will lift the Chinese currency's value by 2.1% initially -- and perhaps by much more over the long term. That should help boost Wal-Mart's earnings from its operations in China.

However, the yuan situation is a double-edged sword for Wal-Mart. While China's decision came after increasingly insistent U.S. criticism of Beijing's monetary policy and calls from U.S. Treasury Secretary John Snow to free up its currency, it will also "raise the cost of Chinese imports, putting pressure on margins for retail," says Sam Stovall, Standard & Poor's chief investment strategist (see BW Online, 7/26/05, "The Yuan and You").

In fact, Stovall expects the cost of goods to rise very rapidly in the short term (see BW Online, 7/21/05, "The Yuan: A Baby -- But Key -- Step").


  The impact of the downward pressure on profits will hit Wal-Mart front and center. About 70% of the company's goods are made in China. By CEO Lee Scott's own admission a couple of months ago at the company's annual meeting, "Last year it was estimated we imported about $18 billion worth of goods from China."

And Matthew Fassler, an analyst at Goldman Sachs, expects retailers of footwear, apparel, sporting goods, and toys, all areas on which Wal-Mart heavily relies, to take the hardest hits.

Still, retailers that have operations in China will benefit from the higher value of the yuan, mitigating the negative effects in home markets. And Wal-Mart knows a little about overcoming adversity (let's not forget all those failed no-Wal-Mart-in-my-town campaigns). The company may have opened just 48 stores in China since venturing there in 1996 -- vs. 3,700 locations in the U.S. since 1962 -- but clearly it is looking to China for growth in coming decades.


  As Wal-Mart CFO Tom Schoewe recently pointed out, its stores have 1.2 billion prospective customers in the country. "Do you think we have an opportunity? You bet we do!" he said. Given that retail sales in China have made it the world's third-largest market -- having jumped 15% annually, to $628 billion in 2004 -- Wal-Mart's ambitious plan might even seem a little modest.

Wal-Mart's plans coincide with China's late-2004 move -- under the country's commitment to the World Trade Organization to remove a requirement that foreign companies tie up with local partners -- to open up its retail sector to foreign players. But Wal-Mart continues to partner with CITIC Group, a Chinese outfit, and has said it doesn't plan to expand on its own for now. (Wal-Mart didn't respond to requests for details.)

However, even for a tough competitor like Wal-Mart, gains in China might not come that easily. Overseas expansion, especially into territories unfamiliar to U.S. companies, has proven tough. A Bain & Co. study of U.S. retailers that expanded in 100 international locations over 15 years found that not even a third of them continued to expand after recording high margins and profits.


  The study revealed that the success rate was higher in Western industrialized nations -- up to 80% in Canada -- but only about 30% in Asia. Why? Most of the retailers are familiar with the shopping habits of consumers closer to home and get thrown off in countries with unfamiliar populations.

Frank Badillo, director of global retailing at research firm Retail Forward, says that retailers find it challenging to serve diverse shoppers: "Consumer behavior varies significantly from country to country."

And local retailers are gearing up for a fight. China's largest, Shanghai Bailan Group, recently bought four rival supermarkets and department stores. It boasts more than 5,000 stores and has bulked up to better compete with Wal-Mart and Carrefour.


  And another rival, the China Resources Enterprise, which operates 1,700 supermarkets, hired away managers from foreign chains and cut staff to boost profitability.

As China continues to move toward joining the global economy, its policies increasingly affect profits and strategies for multinationals like Wal-Mart. The yuan revaluation showcases how complex the effect can be.

While profits suffer in the U.S., Wal-Mart stores will benefit in China, a market that the outfit is determined to make grow. No one should underestimate Wal-Mart's drive but, given how competitive the Chinese market is becoming, Wal-Mart might need more soccer stadiums on top of stores, or even something more compelling, to lure shoppers away from local rivals.

Gogoi is a reporter for BusinessWeek Online in New York

Edited by Beth Belton

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