Course Correction at Wal-Mart

Retailer Cautiously Seeking Fashion

Brent Felgner, June 18, 2007

Wal-Mart Stores president and ceo Lee Scott and the company's most senior executives are locked in a frank conversation about rescuing and retooling the retailer's up-market segmentation strategy — and determining more broadly how they will drive growth throughout its dominant but aging domestic store base.

For a brief time at events surrounding the company's annual shareholders meeting here earlier this month, those discussions appeared unusually candid and took place in public. The executives appeared circumspect but, at times, mildly contentious in their search for the right fix.

It has been a tough year for Wal-Mart. Only a few months after announcing the merchandising move up from its traditional focus on the working-class base, portions of the effort began to unravel along with same-store sales, exacerbated by a sputtering economy and rising gas prices. With a few notable exceptions, comparable sales have been challenged across the store base. This is particularly true in home and apparel, which lagged, producing negative comps in some instances, according to Eduardo Castro-Wright, president and ceo of Wal-Mart Stores U.S.

This was all the more ironic because of the fanfare with which Wal-Mart had announced the new strategy in the spring of 2006, showcasing it in a new "store of the future" in Plano, Texas. At the time, Scott cautioned that the plan needed to bring Wal-Mart's core customer along — something he clearly believes did not happen.

"We just got up one morning and decided we could move that customer and because they trusted us at $13.88 they were going to trust us at $39," Scott offered during a session with analysts here following the annual shareholders meeting. "And I think John [Fleming, evp and chief merchandising officer] understands clearly, and his team does, that it is a slower transition. And during the time you're doing that transition you've got to strengthen your core — which we didn't do."

"In some ways we turned around and walked away from that velocity so we could focus on something different," Scott acknowledged. "And that was a mistake."

Admitting the problem

Coming over two days surrounding the shareholders meeting — in store tours, formal presentations, a press conference, and an analysts session — it was the first, full public acknowledgement that Wal-Mart tripped, that the problem went beyond prices at the pump.

In the latest effort to correct some of those missteps while offering a nod to investors seeking better returns, Wal-Mart slowed domestic supercenter growth plans by nearly a third, freeing capital to contribute to a new $15 billion stock buyback. And last fall, Scott told vendors that the company would reassert its price leadership on staple items — a reemphasis of EDLP — a pronouncement some took to mean it was backing away from the merchandising trade-up strategy.

A walk through virtually any Wal-Mart store would indicate that is simply untrue. While tests of 1,000- and 800-thread-count sheets have disappeared from the shelves, the programmed 600-count sheets in the Hotel line remain in the assortments at many stores. The $5,400 diamond solitaires are gone, but $2,400 diamonds hold center stage in Wal-Mart's mid- to upper-tier stores. And that doesn't even account for multiple skus of $1,000-plus high-definition TVs.

At the same time, the company has continued to selectively lift some opening price points, driven by enhancements to style or quality. In one home textiles example, the opening price on a wash cloth has risen from $0.88 to $1.38, visits to stores in several states indicated.

'Core' requirements

Wal-Mart simply overreached. As part of the quick fix, Wal-Mart recommitted to being the low-price leader on the most price-shopped items — primarily consumables.

"So we're going to strengthen our core, then we're going to move on a very thoughtful basis on investments in quality and experience for the customer so that we earn the right to have them shop across the store in the way we so gloriously talked about last year," Scott said. "I think that's the only strategy that will work. I don't think it's a marketing issue; I don't think it's anything — we have to earn this."

The merchandising segmentation effort is now in the second year of its three-year plan, said Fleming. Last year, the company "identified the opportunity" but didn't have the structures, processes and systems in place to execute.

But in that context Fleming offered no explanation why Wal-Mart went full tilt into the Plano prototype at the same time it moved better goods into many of its remodels and new stores. The changes were striking.

"There's a lot of complexity in segmentation. There's demographic information, there's psychographic, there's geography, density. There's a lot of different things we're looking at so it's a work in progress," he said. "I think it's still going to be a year or so before we're ready to activate it with merchandise for each area."

Fleming, who at first denied Wal-Mart overreached in its initial efforts, apparently rethought that answer. "In terms of the elasticity of the brands, many of the [efforts] worked well in certain stores, but in some cases we took them too far," he said. "The segmentation approach over time will get us into the right clusters with the right range of products."

Added Castro-Wright: "Apparel and home is a work in progress. We're revisiting our segmentation — what works and what doesn't."

Question of Pacing

The slowdown in store growth, too, is part of a much broader plan that will focus on merchandise and improving the customer experience, he said. Moreover, ratcheting back remodels should help store-level management digest many of the changes that have been thrust upon them over the last couple of years, evp and cfo Tom Schoewe suggested. While arguing that the remodels have been positive for the company on balance, he indicated that the pace may have overwhelmed Wal-Mart's ability to keep up.

"We probably tried to accomplish too much, too fast as we moved through some of those remodels," Schoewe said. "There's just an awful lot going on in our stores. So what you're seeing us do now is regulate what we're doing to the point where we can take our resources and apply them where we're going to get the greatest returns."

Castro-Wright said that after a remodel, a store's performance improved on average by 50 to 150 basis points. But he parted company with Schoewe over the slowdown.

"If I had to do it all over again, I would do it faster, not slower — that's where I disagree with Tom," Castro-Wright said. "The size of the task is enormous, obviously, because of the number of stores. So, no matter how fast we would want to go we can't because there are constraints on management resources, like Tom said. I think I wouldn't do it slower. What we have to do is devote management resources so that you can cope with the pace of change in the stores you are remodeling."

In the meantime, the company will continue focusing on converting its discount store inventory into supercenters, Fleming said. There are about 1,060 discount stores today that can be converted through relocation or expansion. Those conversions also deliver the highest returns, he said, because there is less capital involved and they are already in defined markets with established customer bases. There are 800 approved supercenters in Wal-Mart's backlog now.

"But the issue is," Fleming said, "if we don't fix comp-store sales at some point, we won't be happy with the results."

The challenge will be to not repeat the mistakes.

"I work closely with Eduardo and his team mostly on the 'thoughtfulness:' Now that we've gotten ourselves into this, how are we going to get ourselves out?" Scott explained. "What are we thinking about and how are we going to be sure that we don't compound whatever the issues are?"

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