Wal-Mart looks to grow by embracing smaller stores

Retailer tries new business models as its superstores fall out of favor

The Wall Street Journal

Just weeks after being named chief executive of the world's biggest retailer, Wal-Mart's Doug McMillon held a meeting with his top executives and gave them a homework assignment: Read "The Everything Store," the tell-all book about Amazon.com Inc. (AMZN) founder Jeff Bezos.

It was a surprising order from the top of a company that long ago devised one of retail's most successful formulas and milked it for nearly half a trillion dollars in sales last year. According to the book, Mr. Bezos himself studied Wal-Mart as he built Amazon, internalizing its credo of acting fast and experimenting often.

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But now, with the price gap shrinking between Wal-Mart Stores Inc. (WMT) and its competitors, the retailing giant faces the double sorrow of sluggish sales and traffic.

In May, the company reported its fifth straight quarter of negative U.S. sales, excluding newly opened or closed stores, and its sixth straight quarter of dwindling traffic. Wal-Mart's return on investment dropped to 17% in the year ended Jan. 31, down from 20% seven years ago. The weak results led to the lowest levels of bonuses to executives in several years.

The discounter is also dogged by allegations of bribery overseas, and continues to face regulatory challenges from its nonunionized workforce. It has stumbled in country after country in its attempts to expand overseas, even as it remains a dominant retailing force in countries like Mexico and Canada.

For Mr. McMillon, who at 47 years-old is the youngest CEO to lead the company since founder Sam Walton, the problems of the past are forcing him headlong into the future. Since taking the helm in February, Wal-Mart executives say he has doled out urgent instructions to accelerate new store concepts and online strategies in an attempt to gain back market share from encroaching rivals like Amazon and fast-expanding dollar store chains.

It's a tall order. "We need to move fast," the CEO said at the company's June shareholders meeting. "That's why we're piloting so many new ideas."

Even speed and imagination may not be enough to move the dial meaningfully for the country's largest company as measured by revenues. To achieve 1% sales growth in any given year, the retail behemoth must pull in nearly $5 billion in additional sales.

The U.S. recession had brought some relief, as battered shoppers sought rock-bottom prices. But Wal-Mart's low-income customers—who spend 18% of all food- stamp money at the chain—have been slow to recover.

Some of the retailer's initiatives—from new store formats to a shift in some pricing models—don't much resemble the old Wal-Mart, where bigger stores were touted as better, and prices were "always low."

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This year, for the first time in its history, Wal-Mart will open more smaller grocery and convenience-type stores than supercenters. At 10,000 to 40,000 square feet, its Wal-Mart Express and Neighborhood Market concepts are a fraction of the size of a 200,000-square-foot superstore. Stores now double as pickup stations for shoppers to collect televisions, bicycles and other items purchased online.

Taking a page from Costco Wholesale Corp. (COST), the big-box king of booze, Wal-Mart has said that it aims to double its alcohol sales by 2016. The chain is weighing plans to build free-standing liquor stores in states like Florida which prohibit retailers from selling booze inside grocery stores, according to Wal-Mart employees.

Unlike some of his predecessors Mr. McMillon embraced e-commerce early on. As such, some of the more sweeping changes are evident online, where Wal-Mart has been particularly stung by Amazon's product breadth and pricing models.

At its website, Wal-Mart has quietly scrapped the "everyday low prices" model that underpins its stores. Instead, it is using a "dynamic pricing" system, similar to Amazon's, which frequently changes prices based on fluctuating data and competitive offerings.

The online assortments also now include upscale items like $146 Nike sunglasses and wine refrigerators costing more than $2,500—things that might appeal to customers who never set foot in a Wal-Mart.

Another Amazon-like feature touts a "value of the day" and a "value of the hour" complete with countdown clock. At Amazon, shoppers troll for "today's deals."

Last year, Wal-Mart pulled ahead of Amazon in terms of its web sales growth rate. According to data from Internet Retailer, the chain's online sales in the year ended January 31 rose 30% to $10 billion. Amazon, by comparison, posted a 20% gain on $68 billion in revenues from sales of electronics, media and other products during the year ended Dec. 31.

Wal-Mart's e-commerce war chest illustrates Mr. McMillon's desire to get clicking faster. In the year ended Jan. 31, Wal-Mart plowed roughly $500 million into e-commerce investments, including three new online fulfillment centers and 1,000 employees in Silicon Valley. In February, Wal-Mart told investors it planned to spend an additional $150 million on e-commerce investments this year.

Mr. McMillon's forward march unsettles some investors, who worry about whether the smaller formats and online sales will cannibalize business at its traditional stores and dent profits.

"You're basically saying thousands of supercenters are going the way of the horse and buggy," says Wolfe Research analyst Scott Mushkin. "It's a scary thing."

While he predicts that the new initiatives are apt to make a negative impact over the next few quarters, Mr. Mushkin believes that management is looking beyond short-term results.

"Doug isn't there to make next quarter or next year's earnings," says Mr. Mushkin. "He's there to try to bring Wal-Mart into the 21st century."

To glimpse a part of Wal-Mart's future, head a few miles south from the company's corporate headquarters in Bentonville, Ark. There, at a test store called Walmart To Go, shoppers grab pulled pork sandwiches, slurp 30-ounce Cherry Cokes and fill up their cars with gas. The setup looks like a cross between a 7-Eleven and a 1950s drive-in. It's part of the company's big push into gasoline—one commodity that can't be bought online—that is expected to add filling stations to some 2,000 new Wal-Mart stores in the coming years.

In April, Mr. McMillon asked a handful of executives to clear their schedules and report to the company plane first thing one morning. It wasn't until they were aloft, say trip participants, that he told them they were headed to Denver to tour a Wal-Mart test store where shoppers order their groceries online then stop by a drive through to pick them up.

As he steers the retailing behemoth, Mr. McMillon must stay focused amid pre-existing complications, including an expensive probe into alleged bribery in Mexico and persistent complaints that the company underpays its 1.4 million-strong U.S. workforce. Earlier this year, the National Labor Relations Board accused the retailer of unlawfully retaliating against workers who took part in protests over working conditions. Wal-Mart has denied wrongdoing in the NLRB case. It says its average hourly wage of $11.81 is in line with, or above, its peers. Separately, the company says it is cooperating with ongoing federal investigations into bribery allegations and is conducting its own international probes.

Despite these issues, Wal-Mart remains a formidable financial force with enormous resources to throw at its reinvention. While sales growth has been slow, the company added about $70 billion in revenue in the past five years—roughly the sales of a company the size of Johnson & Johnson (JNJ) or PepsiCo Inc. (PEP).

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Wal-Mart is planning a big push into gasoline (Wesley Hitt/The Wall Street Journal)

Wal-Mart is planning a big push into gasoline (Wesley Hitt/The Wall Street Journal)

Mr. McMillon is a Wal-Mart lifer, an unlikely candidate to rethink the company. Growing up in Jonesboro, Ark., his family moved to Bentonville when he was 16 years old. He started working at the company about a year later, unpacking boxes in a distribution center.

He rose quickly. Co-workers say he forged a wide network of top executives via Sunday services at the Fellowship Bible Church—sometimes referred to as the "Wal-Mart church" due to the stable of executives and suppliers who regularly attend. He also holds board positions at favorite Walton charities like the Crystal Bridges Museum of American Art and student entrepreneurship group Enactus.

By the age of 38, he was named chief executive of Sam's Club and put in charge of the warehouse division's $37 billion in revenue.

Four years later he was appointed chief of Wal-Mart's international unit and would go on to attend A-list confabs like the World Economic Forum in Davos, Switzerland and the Aspen Ideas Festival.

"There's a short list of major decisions one has to make in life," Mr. McMillon once told a trade publication. "Things like who you will marry and what company you will work for. I think I made the right decision in terms of where I would spend my career."

The same goes for his wife Shelley of more than 20 years.

Wal-Mart declined to make Mr. McMillon available for this article.

Mr. McMillon made a name for himself as a buyer, zeroing in on products that set Wal-Mart apart from competitors, say co-workers. He pioneered the creation of private-label diapers that attracted low-income mothers and boosted sales. At Sam's Club, he restored the warehouse chain's focus on small business customers and introduced higher-end items like wine vacations.

More recently, he overhauled Wal-Mart's flagging overseas operations, hiring new management in nearly every international outpost where Wal-Mart does business and shifting away from short-term discounts in favor of everyday low prices in countries like Brazil and China.

To figure out how to get back to a nimbler Wal-Mart, Mr. McMillon has been seeking advice from former executives. Shortly after taking the helm, for example, he asked David Glass, Wal-Mart's chief executive from 1988 to 2000, to spend the day with him in San Antonio.

"Doug isn't like most CEOs that say 'I want to do it my way," says Mr. Glass, who is now CEO of the Kansas City Royals, in an interview. "He furiously takes down notes and wants to learn everything he can from others' experiences."

The two walked the aisles at a Wal-Mart store quizzing employees on what was selling, what items were out of stock and asking if they would choose different products to display in the prime end-of-aisle spots. In the lawn and garden department, the manager said he particularly worried about product shortages during the key spring selling season.

The observation highlighted a two-pronged problem at Wal-Mart. While the chain needs to update and evolve certain aspects of its business, it must also operate its stores better—simply by picking the right items and keeping them in stock.

Amid all the tests and trials and rollouts, Mr. McMillon has sent the message to employees not to let the small stuff slide.

At Wal-Mart's annual meeting of store managers in Orlando, Fla., in March, Wal-Mart U.S. Chief Operating Officer Gisel Ruiz interrupted a day of cheering, employee promotions and product debuts with a stark admonition to managers to take ownership of their stores and clean up their operations, according to employees that attended the meeting.

Ms. Ruiz told the story of a customer named Sherry who had complained about shoddy customer service and a dirty store in Troy, Ala. The criticisms echoed those of other shoppers who had posted negative comments about Wal-Mart on Facebook.

"She could easily get what she needs somewhere else," said Ms. Ruiz. "She could have walked away."

The store didn't lose Sherry. But it did replace its manager and got its service act together. According to a transcript of the meeting, the store's sales at the time were running 2.4% higher than the same period a year before, up from negative 3.3% before the revamp.

During a May global executives' meeting, Mr. McMillon demanded that his executives similarly bear down on the basics to achieve quantifiable results. He said that even simple fixes, like cleaning up messy stores and making sure products are in stock could boost sales by 1%—turning U.S. sales positive for the next quarter, according to people familiar with the discussion.

While he assured listeners that he was focused on future strategy, he said, "What I need you to do now is to figure out how we perform better today.

Write to Shelly Banjo at shelly.banjo@wsj.com

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