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Wal-Mart goes small in China

The U.S. retailer is counting on outlying cities to provide a strong consumer base as incomes rise.

October 26, 2008|William Foreman | Foreman writes for the Associated Press.

LOUDI, CHINA — Maoming, Wuhu and Loudi.

They're Chinese cities so far in the boonies that Lonely Planet doesn't even bother to mention them in its popular travel guides. But Wal-Mart has found them, as the company makes an aggressive push into China's smaller markets.

China's economic growth is rapidly spreading out from the main cities like Beijing and Shanghai into the hinterlands, where the middle class is taking off. In a report last year, the consulting firm A.T. Kearney said 75% of the middle-class market is expected to be in Tier 2 and Tier 3 cities by 2017.

These cities are "small" only by the standards of a country with 1.3 billion people. For example, Wuhu in eastern China has 2.3 million people and Maoming in the south has 6.8 million, providing a strong consumer base as incomes rise.

In response, retailers are pushing into the hinterlands, including American coffee chain Starbucks Corp. and French store Carrefour. Carrefour, the world's second-largest retailer after Wal-Mart, is the largest foreign retailer in China.

Faced with saturated markets at home, these retailers are increasingly looking to emerging economies such as China to drive sales growth. Wal-Mart's attempt to gain a bigger foothold in China is anchored in smaller cities: Only three of the 30 outlets Wal-Mart Stores Inc. opened in China last year were in Shanghai, Beijing and Shenzhen. The rest were in provincial capitals or other cities.

"I think the capacity for growth in China might exceed that of the U.S., if you look at it in the long term," Terrence Cullen, Wal-Mart's vice president of development in China, said in an interview at his office in Shenzhen, the southern boomtown across the border from Hong Kong.

Wal-Mart said its China sales rose 32.2% in the second quarter, while international sales overall were up 16.9%.

But experts warn there are risks in smaller markets. People are not as well-off, so it's harder to turn a profit. Local suppliers may be less reliable, a concern in a country beset by product-quality scandals, including the recent discovery of contaminated baby formula blamed for killing four infants and sickening thousands.

Moreover, the big-bang growth strategy -- opening stores across China -- requires a bigger investment than the gradual expansion the company pursued in the U.S.

Two of the newest stores are in Loudi, a steel and mining town of 4 million in central China. It's just down the road from Shaoshan, the birthplace of late leader Mao Tse-tung -- who would probably be horrified to hear that a flagship of American capitalism has moved into his neighborhood.

At one of the new Loudi Wal-Marts, a woman in blue overalls greets shoppers. The sprawling, brightly lighted and spotlessly clean store has the same general look and feel of one of the company's well-stocked, wide-aisled stores in the U.S.

But a few steps inside, it becomes clear that Wal-Mart is trying to deliver everyday low prices with Chinese characteristics.

The scent of thick slabs of dried, smoked pork piled high in a display case mixes with that of laundry detergent and plastic. There are foreign brands: Raid roach killer, Head & Shoulders shampoo, Budweiser beer and "pesto Italiano" flavored Pringles potato chips.

But there are also bins of reddish-brown dried squid and vacuum-packed packages of preserved Wuchang fish, one of Mao's favorites.

The need to satisfy sharply different regional tastes is one of the challenges Wal-Mart faces in smaller markets, said Dean Xu, professor of strategy and international business at the University of Hong Kong. Wal-Mart will have to source many goods from local suppliers, potentially raising quality issues.

Still, Wal-Mart's Cullen said the expansion is a logical step as China's middle class swells and the economy becomes driven more by consumers than exports. Major markets have their drawbacks too, he added.

"The big cities are very difficult to do business in for all the obvious reasons: They're crowded. It's difficult to find real estate. It's expensive and there's competition," said Cullen, who previously helped rival Costco Wholesale Corp. break into South Korea and Taiwan.

In the United States, Wal-Mart started with a single store in Arkansas in 1962 and built up its distribution network slowly, opening stores in adjacent counties and avoiding big leaps, said Emek Basker, a University of Missouri economics professor who has done extensive research on Wal-Mart's growth. The company had a conscious policy of opening outlets only within a day's drive of its distribution centers, she said.

Wal-Mart declined to comment on whether it would be scaling back its international expansion plans amid the global financial crisis.

Wal-Mart is being outmaneuvered by Carrefour because its executives have taken too long to understand the China market and add stores, said Burt P. Flickinger III, managing director of retail consulting firm Strategic Resource Group.

Carrefour, with $4.3 billion in sales, ranked sixth among all retailers in China in 2007, according to the China Chain Store & Franchise Assn. Its sales were up 24% over the previous year.

Wal-Mart was 13th, with sales of $3.1 billion, a 42% increase over the previous year. The American chain also owns a 35% stake in Trust-Mart, which operates about 100 stores in 34 Chinese cities.

A few blocks away from the Loudi Supercenter, in the dark and dingy basement of a dilapidated building, most of the merchants at a traditional food market appeared blase about the new competitor.

Shau Youming, who sells spices and soy sauce in a small stall, said Wal-Mart hasn't hurt his business.

"I've got my old customers and they all live nearby," he said. "It's convenient for them to come here. My prices aren't high and I keep an eye on Wal-Mart's prices. I'm not trying to make a lot of money. Just enough to make a living."

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