Discount Retailers: Porter's Five Analysis

In a context of post World War II, there was an economic boom in the USA, driven by the baby boom. The families needs increased, and discount retailing stores started to appear. Their main aim was to operate within low prices, to be able to offer everyday products at a very affordable price.

In order to analyse the attractiveness of the discount retailing industry in the USA in the 1950’s, we can use Porter’s Five Forces. Porter (1980:3) stated that “competition in an industry depends on five basic competitive forces”. As seen below in figure 1.

Force 1: The Degree of Rivalry

According to Ghemawat (2008), “the degree of rivalry is the most obvious of the five forces in an industry [€¦]. It influences the extents to which the value created by an industry will be dissipated through direct competition.”

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With the economic boom, many discount retailers have emerged, especially in big cities (with a minimum population of 100 000). For the already existing supermarkets industry, their customers were used to having a lot of competitors to choose from. That is why the newly emerging discount stores attracted a lot of new entrants. That industry was characterized by an intense competition. The growth of the industry was significant and this factor of high profitability attracted many entrepreneurs willing to open new stores. As a result, in the US cities in the 50s and 60s, the concentration for the discount retail industry was low and the rivalry was intense (factor of industry unattractiveness).

The theory says that the rivalry between competitors decreases when the buyers’ switching costs are high. But in the case of the discount retail industry, the switching costs are almost nonexistent: urban customers have a lot of competitors to choose from and the recent use of the car and the quite low price of the petrol in the 50s allow them to easily change and shop in another store.

Also, unlike the supermarkets, discounters sold more or less the same kind of products. The available retailers focused on non-food products, and a competition for price began among the stores, offering a wide variety of household products such as toiletries, appliances, groceries and household goods. Thus, there is a significant rivalry here, characterized by high fixed cost and a lack of product differentiation.

However in the 50s, in small towns and rural areas, the competition was not as fierce, as not many discount retailers were willing to open a shop in the countryside. This made that business landscape less competitive. Sam Walton saw an opportunity there, and decided to locate his first Wal-Mart stores there: “Our strategy was to put good-sized stores into little one-horse towns that everyone else was ignoring”.

Force 2: The Threat of Entry

“Average industry profitability is influenced by both potential and existing competition” (Ghemawat, 2008). The Five Forces framework gives 3 basic types of entry barriers: economies of scale, brand identity and capital requirement:

Economies of scale: large economies of scale allow providing cheap products to their customers. It is an essential part for a discount retailer, and without it, could represent a real barrier to entrance.

Brand identity: the products were standard in nature, and there were little or no differences between discount stores. That means that in the 50s, it was not really a barrier for new entrants.

Capital requirements: the threat of entrants is also possible because of the high capital required. Entrepreneurs need high capital (building, equipment) and financial resources to start up a new discount store and this represents a barrier to entry the industry. Moreover, the barrier is much higher when the plan is to set up a stores chain.

There are also some other barriers to take into account:

Access to distribution: the discount retailer has to find new reliable suppliers, to have a competitive distribution channel.

Advertising: it can also be seen as an entry barrier. In order to be known and to attract customers, new entrants need to spend a lot more money on advertisements. In the 50s, the US discount industry was characterized by high price and advertising competitiveness, with little buyer loyalty.

To summarize, there were many obstacles for new entrants in the discount retail industry.

Force 3: The Threat of Substitutes

“The threat that substitutes pose to an industry’s profitability depends on the relative price-to-performance ratios of the different types of products or services to which customers can turn to satisfy the same basic need” (Ghemawat, 2008).

Due to the lack of product differentiation and the absence of switching costs, the goods sold in the discount stores can be found in other types of stores. There is a high buyer propensity to substitute.

The discount retailer just like any other has to develop strategies to sell at a low costs but this is not the solution. It constantly has to ensure that its products are exactly what the consumer needs. This means that high quality products at an affordable price should also be part of Walt Mat strategy of being competitive, as well as product differentiation.

Supermarkets represented a big threat of substitution for the discount stores selling groceries because they were cheaper than the conventional stores chains and they dominated the retail industry in the 50’s (Markin, 1968).

Force 4: Buyer Power

The buyer information availability was almost non-existent. Indeed, nothing in the way of information technology was accessible at that time, either for EPOS (Electronic Point of Sale) use or for more sophisticated applications.

The bargaining power of buyers is weak when reduced to a single individual, but the demand as a whole is extremely powerful. However, the fact that there were many discount retail industries made each of them weaker against the buyers’ bargaining power. That power was high in the USA in the 50’s: customers could easily walk away and go to another shop (low switching costs). In the post World War II years, US consumers became educated in the merits of self-service, low price shopping via the spread of supermarkets. The customers’ price sensitivity was then high, because of the high product standardization, they could find their products in every discount retail. The buyer loyalty was low.

Force 5: Supplier Power

In the US discount retail industry in the 50’s, the suppliers’ power was much stronger than today, because of the RPM (Resale Price Maintenance). The RPM was legal at this time and gave the right for the suppliers to set the final price of their products (price sometimes printed on the product). It was virtually impossible for retailers to pass on the benefits of more efficient operations to customers via lower prices. Thus, in the 50’s the strong suppliers’ power was a criterion of unattractive industry.

After the analyze of the US discount retailing industry in the 50′ through Porter’s Five Forces, it can be inferred that this industry was not attractive, due to the high new entrants barriers, the level of competition in the cities, the threat of substitutes, and the high buyer and supplier powers.

However, it is possible to slightly alter this statement: although the competition was tough in big cities, it was easier to set up a shop in the rural areas, where the degree of rivalry was lower. As a consequence, the different threats and barriers that looked like an insurmountable challenge in the cities were no longer impossible to overcome in the countryside.

QUESTION 2

Every business has to adopt a business strategy, seen by many authors as “the Paradox of Markets and Resources”. The strategic management process means defining the organization’s strategy. Managers have to make choices and set up strategies for the company that will enable it to achieve better performance. It is also sometimes referred to as a ‘Business Model’.

Porter’s theory

The ‘Outside-In’ Perspective’s key features are the positioning activities and the Value Chain, which will define a strategy through different business choices. This model is supported by the key protagonist Michael Porter (1996).

Porter’s Generic Strategies Model

According to the chart above, we can identify Wal-Mart’s positioning strategy. Wal-Mart’s main strategy is characterized by its low cost policy, accessible to anyone. It can then be put in the “cost leadership strategy” strategy. However, with particular attentions for its customers (more than its direct competitors), Wal-Mart also plays a “differentiation strategy”, and delivers an excellent customer service.

With the analysis of Wal-Mart’s value chain given above, a description of its key value drivers can be done. Every company’s activities mapped in the value chain can be a possible source of competitive advantage but it’s the way they are cheaply performed and combined that will create competitive advantage and value for customer.

In 1985, Porter suggested the value chain, which regroups functions into support and primary activities. The value chain is divided into 5 primary activities and 4 support activities. These activities can be linked and connected to the value chain to determine some factors of a competitive position and show how these activities add value to the consumer.

Wal-Mart: the Value Chain

According to the Wal-Mart value chain, two main support activities show that Wal-Mart uses a differentiation strategy through its human resource management and its technology development.

The use of the technology is coupled with the inbounds logistics activity and the operations. Indeed, Wal-art was a pioneer in applying information and communications technology to support decision making and promote efficiency and customer responsiveness.

(Zarbo, 1998) In the early 1980’s, Wal-Mart invested over half a billion dollars to boost its computer and satellite network systems. They added barcode systems, scanners and other near-real-time technology to link cash registers in every store into one unified link.

From the instant a sales transaction takes place, data simultaneously flows back and forth from stores world-wide to Wal-Mart’s distribution centres, its headquarters in Bentonville, and to Wal-Mart’s suppliers in a continuous, informative loop. In addition to offering Wal-Mart an environment that monitors and shares its current inventory trends with external vendors, this technology, through a sophisticated network which bridges individual stores, identifies the most efficient way to manage the distribution of its products internally.

Moreover, a good example of Sam Walton’s early understanding of the importance of technology is its current development and use of an automated distribution system known as the ‘Retail Link.’ This system shares sales information with Wal-Mart suppliers to ensure that customers always find the shelves well stocked at their local Wal-Mart store. Retail Link allows Wal-Mart suppliers to dial-up and retrieve the history of important sales data from the last 56-week’s worth of sales. Over 4,000 of Wal-Mart’s suppliers access this service averaging approximately 10,000 queries a day (Zarbo, 1998).

The large database of purchasing information enables Wal-Mart to set the right item at the correct price and in the right store.

Concerning the human resources management at Wal-Mart, it is considered as very efficient. Sam Walton calls his employees his ‘associates’. They are an important part of the Wal-Mart family. The relationships between Wal-Mart and his associates are based on respect, high expectations, autonomy, close communication and clear profit incentives. Through its superior management and communication, Wal-Mart created an advantage.

The Marketing and Sales activity is also a crucial point for the company. Wal-Mart has been founded on Sam Walton’s belief that: “There is only one boss: the customer”. Indeed, the basic principle of Wal-Mart was to cut prices, and was thus well below its competitors, enhanced by its slogan “Everyday Low Prices”. This confirms the company’s low cost strategy.

In summary, the key value drivers of Wal-Mart match each other to lower the costs. Every activity is involved in cost reduction and that is why we can say that Wal-Mart’s value chain is very coherent with its cost leader positioning strategy and customer focused value for money approach.

Barney’s theory

“Firms obtain sustained competitive advantage by implementing strategies that exploit their internal strengths, through responding to environmental opportunities, while neutralizing external threats and avoiding internal weaknesses”. Barney, 1991

The Resource-Based View (RBV) focus on strategic resources as the determinants of a competitive advantage. Those strategic resources are valuable because they allow to achieve superior performance (e.g. accumulated knowledge, or resources impossible to replicate).

Grant, the key protagonist of the RBV theory focuses on resources, organisational features and capabilities. In the model, resources must be rare, valuable, inimitable and unsubstituable. Although, intangible resources can create the most competitive advantage, as they are harder to copy by competitors.

The chart above reviews Wal-Mart’s tangible and intangible resources. The firm possess many intangible resources, which made its model hard to copy for competitors. So according to the RBV, Wal-Mart has some real competitive advantages here.

QUESTION 3

Tetra-threat framework

The Tetra Threat Model was first proposed by Ghemawat (2008). This model helps to determine the level of each threat category, in order to try to reduce their impact. This model can be used to identify what are the threats against Wal-Mart competitive advantage, and how it can sustain itself among the other discount retailers.

Threat of Imitation

Wal-Mart set up large barriers to overcome it:

Scale economies: efficient hub-and-spoke distribution system; high volume purchases, strong dealing power with suppliers; national and regional economies of scale.

Learning/private information: a significant effort has been made in understanding the operation of the discount retail industry. Wal-Mart has the right know-how to improve its logistics, reduce storage space, and incentive its people to work efficiently.

Switching cost/relationship: due to its pricing policy and experience, Wal-Mart is able to offer inexpensive products to its customer (low switching costs). They also possess strong relationships and sustainable contracts with their suppliers (bargain power due to Wal-Mart’s size and partnership through data sharing and communication networks).

Threat of retaliation: Wal-Mart has a strong reputation of fierceness. The local managers’ ability to adapt their prices to the local competition is a strong advantage to always have the lowest prices on the market.

Time lags, upgrading and strategic complexity: the Wal-Mart business has been built upon the years, and accumulated years of knowledge and experience. Thus, they now own a very complex logistics and technologic system, and upgrade it constantly.

To summarize, the imitation threat is not a real danger to Wal-Mart. It has raised many insurmountable barriers for its competitors to overcome. They do not have the sufficient knowledge to do it, or it will take them so much time, that by the time they catch up with their goal, Wal-Mart will already be way ahead of them in terms of innovation and technology. Wal-Mart has here a real sustainable advantage.

Threat of substitution

Substitution reduces the ‘demand’ for what a firm uniquely provides by shifting the demand elsewhere. It is the most difficult threat to predict. However, Wal-Mart has developed many strategies to overcome that threat. The chain best answer to the substitution threat has been to own numerous substitutes on the discount retailing industry, such as warehouse clubs, supercenters and neighbourhood markets. Its mobility across format is a successful alternative against substitution threat.

However, Wal-Mart has demonstrated being very good at scanning the landscape broadly and understanding underlying customer needs. It has continually been studying the competition in order to be responsive in fighting the upcoming threat.

Finally, thanks to its low cost competitive advantage, Wal-Mart’s cheap prices restrain many competitors to enter a fight with the discount retailer giant.

Threat of Holdup

Holdup refers to customers, suppliers, complementary organizations, or other industry participants capturing value created by the focal company through the exercise of bargaining power.

Concerning this threat related to Wal-Mart, two aspects can be distinguished: suppliers and employees. First, Wal-Mart has a total control over its suppliers, even the largest ones (e.g. Procter & Gamble), in order to restrain their hold it up value. However, the holdup can be found the other way around: Wal-Mart ask its suppliers to closely integrate into their system and requirements. The requirements that Wal-Mart imposes on its suppliers extends well beyond low prices. Increasingly, the chain has involved itself in its suppliers’ employment policy (workplace safety, working hours€¦), making Wal-Mart possibly pose a threat of holdup to them.

Nonetheless, labor holdup can be considered as a real issue. With a weak percentage of union penetration, employees’ abuse (low wages, unpaid overtime, discrimination) are widespread. As a result, it depicts a negative image of the company, as well as employee demotivation and turnover. Wal-Mart should take into consideration this aspect to avoid a labor holdup.

Threat of Slack

Slack tend to dissipate value within the firm, and is not easy to identify. It regroups all form of inefficiency. However, this is not a big threat to Wal-Mart. In fact, there is a high organizational effectiveness within the human resource management. The relationships with the ‘associates’ is based on respect, high expectations, close communication and clear incentives. Everything is done to motivate the staff and increase their loyalty to the firm. Finally, according to Casadesus-Masanell and Ricart (2007), “protection against slack comes from the right mix of incentives and monitoring”.

As it is drawn in this analyse, Wal-Mart has develop strong responses to threats from imitation, substitution, holdup and slack, setting mechanism which allowed Wal-Mart to sustain its competitive advantage.

QUESTION 4

The Dunning’s Eclectic Paradigm (1981) of Foreign Direct Investment (also known as the OLI-Model) sets up 3 conditions that a company has to meet in order to engage in foreign operations: Ownership advantages, Location/Country-specific advantages and Internalization advantages.

This theory will be used to contrast Wal-Mart’s entry into the German market in 1997 and into the UK market in 1999, in the following table.

Wal-Mart’s entry into

German market

UK market

Acquisitions (1997 and 1998):

21 stores Wertkauf ($1.04 billion)

74 hypermarkets Interspar (‚¬560 million)

Both were renamed Wal-Mart stores.

Acquisitions (1999):

219 outlets Asda (£6.7 billion)

Kept its name.

Ownership Advantages

Wal-Mart owns several intangible assets, which will allow it to overcome the costs of expanding abroad. These intangible core competencies are:

Dominant clothing/textile and food retailer on the US market

Every week, around 100 million shoppers frequent its stores

Its 2003 turnover is 3 times bigger than Carrefour’s, the world’s no. 2 retailer (Knorr and Arndt, 2003)

Internationalization experience: more than 1100 outfits abroad, which leads to considerable experience and management learning from a portfolio of stores in diverse markets

Wal-Mart’s Retail Link-system (backbone of its sophisticated inventory management and logistics infrastructure)

Operating the world’s biggest private satellite communications system (to track sales, to replenish inventories, to process payments in real-time)

Wal-Mart’s retail proposition of everyday low prices, good customer service, wide assortment and community values

High customer service levels, strong organizational culture, efficient logistics operations

Location Advantages

Location advantages are the factors in a foreign country that lead the company to make profits on its FSAs.

Germany accounts for around 15% of Europe’s $2 trillion-a-year retail market

German GNP: ‚¬2 trillion

80 million customers: biggest national retail market in Europe

Germany is meant to be its bridgehead into Europe

After its acquisition, Wal-Mart became the country’s fourth biggest operator of hypermarkets (Knorr and Arndt, 200)

Politically stable country

Economically powerful with big family incomes

Very similar culture and social laws between UK and the US

Internalization Advantages

A firm possessing an advantage can either use the advantage itself (internalize it) or lease the advantage to other firms. The FDI decision depends on which option presents the best net return. Internalization also allows avoiding transactional costs.

Internalization is the option chosen by Wal-Mart in many countries:

Closer control by the Wal-Mart management (full control strategy)

Economies of scale

Sharing of the organization’s knowledge and management capabilities to the new business

According to the OLI-Model, implementing Wal-Mart stores in those two countries could really help the US firm to set a foot in Europe. Wal-Mart’s goal is to be the “number one” in every market in which it operates. Its international retail model equates to the aggressively industrial model. However, despite a bright success in the UK, the German venture has been unprofitable, and led it to exit the country in July 2006.

What are the reasons for Wal-Mart’s failure and success?

The reasons for Wal-Mart’s:

• Failure in Germany
• Success in the UK

Acquisition of the wrong German companies

Acquisition of the adequate UK company

First, the German acquisitions have been very costly for Wal-Mart.

The German market in renowned for its minimal profit margins and price-led strong domestic competition. Wal-Mart entered Germany at a time when the grocery market was saturated. At the time, Aldi was its major competitor, already holding a strong share of the discount retail segment.

Wal-Mart now possessed 2 small disparate retail chains with different organizational structures and a heterogeneous portfolio of stores (the Wertkauf was a highly centralized family store) (Fernie et al., 2006).

As a consequence, Wal-Mart did not have enough impact on the German market. For example, nearly 80% of the population did not have access to a Wal-Mart store (bad geographic penetration).

Moreover, the patchy geographical coverage of Wal-Mart’s meant that its nationwide competitors have been able to adopt a zone pricing policy to compete on price in specific local markets.

The weakness of the German economy in those years, coupled with the increased prominence of discounters, has reinforced this trend and discounters now account for 30% of the German grocery market and have been growing at 5% per year in a static market. Wal-Mart’s market share of 1.5% is dwarfed by its major competition (Fernie et al., 2006). There is a strong price competition where price leadership is already occupied by discounters.

Asda was already a major discount retailer player before the entry of Wal-Mart. In fact, it was the third major grocer in UK in 1999.

Wal-Mart acquired a well-established retail chain and Asda’s management had already applied Wal-Mart practices to its corporate culture (Fernie et al., 2006).

Asda’s marketing, operations and organisational culture mirrored that of the US giant (Burt and Sparks, 2000) and was regarded as good “strategic fit”.

Wal-Mart strategy for UK was to build on these similarities.

There has been a high degree of stability throughout the chain during the merger, especially at store level, which facilitated the transition.

Wal-Mart’s takeover also increased Asda’s supply chain efficiency and improved its stock availability.

Government regulations

The German market had a strict legal and institutional framework, often ignored by Wal-Mart. German labor regulations are very different from these in the U.S. : obstacle to embrace the Wal-Mart culture.

For example:

The zoning regulations impose severe restrictions on the construction of large-scale store

Restrictive shopping hours regulations: legal maximum of 80 hours/week store opening hours. Sunday and holidays openings are not permitted

Fair trading and antitrust laws contain some important restrictions for retailer’s pricing policies: it forbids merchants to sell goods below cost on a permanent basis (Knorr and Arndt, 2003)

In the UK, the Government was concerned about high food prices and that British consumers were being “ripped off” by retailers.

That is why they were in favour of the creation of a more price competitive environment (Fernie et al., 2006).

Moreover, the legal and institutional UK surroundings were not as complex and heavy as in Germany. For example, the legal maximum of a store opening hours was 168 hours/week, and was also allowed to open on Sunday and holidays (Knorr and Arndt, 2003). In the UK, Wal-Mart was able to recreate its 24/7 opening format.

Inability to understand the German consumer and business culture

The closeness of the UK and the US culture

Wal-Mart culturally failed in delivering its “Everyday low prices” or “excellent customer service”. Indeed, the expectations are very different from a country to another. The German acquisitions were very different in their organizational structure from the Wal-Mart US model.

That is why, when Wal-Mart try to impose its new culture (Anglo-Saxon management level), it led to resistance. Operational errors has been made when remodelling stores to look like US stores, which was not customer wanted (Fernie et al., 2006).

Thus, Wal-Mart’s strategy was contradictory and disoriented to German customers. They didn’t see Wal-Mart as a low-price store, due to confusing advertisements.

Moreover, German notion of customer service is different from that in the U.S. (e.g. German consumers prefer to pack their own bags and pay by cash), because they hold price and value in much higher esteem than service and quality (Knorr and Arndt, 2003).

The British culture was very similar to the American one, and that is why the takeover ran more smoothly in the UK.

Also, Asda was already working on a Wal-Mart’s model, so the consumers did not feel any major difference after the Wal-Mart acquisition.

For the British customers, price was a key attribute along with convenience; price is the most important factor in the retail offer.

And finally, the UK workforce responded positively to the ‘Wal-Mart way’, and the integration was very successful, with good employee relationships (Fernie et al., 2006).

Conclusion:

When Wal-Mart entered the UK, the economic situation was favourable for a low pricing strategy. Wal-Mart’s entry created a high competitive environment on prices, and the customers responded well to this new form of discount retail.

However, Wal-Mart has failed on every point in Germany. It resulted mostly from a cross cultural inconsideration. Wal-Mart has not been able to adapt its business model to a different culture and ignored the basic key principles of internationalization strategies and intercultural management. The firm should have tried to understand the German surroundings, the market rules and the consumer habits. Thus, they could have shape their business model, the human resources practices and a proper marketing message to fit that local market. Wal-Mart’s failure in Germany highlighted its inability to select and implement an adequate entry and business strategy. That is why its inability to understand the German retail market and business culture and the consumer needs led it to a bitter failure.