Restoring Wal-Mart

By Bill Saporito / Bentonville

Eduardo Castro-Wright could see the problem instantly. One of his first exercises as the newly appointed president of Division No. 1, the highfalutin internal designation for Wal-Mart's 3,500-unit domestic discount chain, was to map every underperforming store in the country. Most of the worst were clustered around big coastal cities like Boston and Los Angeles. As he toured those stores, Castro-Wright could sense they weren't connecting with their neighborhoods. And neither were the managers--they weren't in Arkansas anymore. "You'd talk to managers and they'd ask, 'If I do a good job, can I come home in two years?'" he says. Who other than Yankees fans would consider two years in Boston to be hard time? "It was an indication that something in the structure of how we were organized and how we went to market was not working," he says.

It's a remarkable statement: the best retail company ever created, the largest company in the world, with annual sales of $345 billion, is struggling. So it requires a big, bold fix. The company that Sam Walton created for the rural South is being massively overhauled to compete in the more urban, more competitive universe where it now lives. You might not notice it yet if you shop there, but Wal-Mart is in the midst of a revolution, an audacious three-year plan that will change practically everything the company does: the way it builds and operates stores, the way it buys and stocks merchandise, the way it hires, trains and compensates employees.

In truth, Wal-Mart is a little desperate--it launched a price war for Christmas toys in early October and then slashed 15,000 prices storewide. It increasingly seems the company's 45-year-old business model--based on a continuously improving supply-chain loop--is better suited to developing economies like Mexico, Brazil and China, where it is doing well, than to mature markets like the U.S. and Japan, where it isn't. In the U.S., same-store sales increases are bumping along at 1% to 2% a month, while rival Target, the fashion-forward, design-centric glamour girl of discounting, runs up 2% to 4% monthly increases. Wall Street complains that Wal-Mart spends too much money opening the same old big boxes, so much so that Wal-Mart announced it will cut store growth and even trim store size. "You do more and more of the same thing and put more and more energy against the same activity, and the rate of improvement diminishes," CEO Lee Scott acknowledges. "So then do you put more resources against doing the same thing, or do you finally back up and say, 'You know what? The world's changed.'"

And you know what? So has Wal-Mart. Under Castro-Wright's prodding, Wal-Mart is trying to become a local merchant again. It is moving managers away from the all-powerful Bentonville, Ark., headquarters and closer to the customers. It is developing snazzier and highly efficient store designs to entice existing customers to shop more broadly across the store rather than just for groceries and health- and beauty-care products. "We have enough customers," insists Scott, 57, who can boast that nearly 20 million Americans shop at a Wal-Mart every day. But while they're happily buying toys, toothpaste and tomatoes, they're walking right by the more expensive, more profitable nonfood lines--apparel and home decor. Wal-Mart's grand strategy of becoming more fashionable has fizzled and is being retooled. "It's us," says Scott. "It's not anything beyond us."

The pressure is providing impetus to attempt new things. Back at headquarters, Wal-Mart is also trying to improve its standing as a corporate citizen. The company has overhauled its wage-and-benefits package and rolled out an ambitious sustainability program that even cynics are praising. Using its negotiating muscle against rising health-care costs, the company expanded the number of drugs available in its $4 generic-prescription program to 361 drug products.

What Wal-Mart does matters--certainly to its 1.35 million U.S. employees but also to its competitors, since Wal-Mart ends up effectively setting wage rates in retailing. And to organic farmers, whose industry has been turbocharged by the company's decision to promote organic foods; and to refrigeration manufacturers, who must create greener equipment to meet this giant customer's desire to shrink its carbon footprint. And to the economy itself: the "Wal-Mart effect" of those $4 generics is being cited as one reason drug prices are falling after years of double-digit inflation, just as its entry into the supermarket trade moderated food inflation.

Your new Wal-Mart is being baked on the premises. The company is testing a dozen new store prototypes that have lower sight lines, woodlike fixtures and a more department-store feel in some sections. Let's not get carried away: it's still a big-box store, but that box isn't quite so stuffed anymore. The stores will use tons of recycled material and be vastly more energy-efficient. Wal-Mart has pledged to reduce energy usage at its stores 30% by 2012. It has embraced compact fluorescent lightbulbs (CFLs) and less packaging. For instance, by next May, to save energy and space, the company will stock only concentrated detergents. In a high-efficiency prototype near Kansas City, Mo., the company is testing LED-illuminated refrigerator cases that don't light up until you approach them, so the lights stay off 40% of the time. Elsewhere it is testing solar panels and windmills.

Wal-Mart shoppers like its stores but don't necessarily love them. Low-income shoppers, one of its three core groups, absolutely need the low prices. The two others aren't buying enough: an aspirational middle-income group that likes the brand names, and a third group of regulars that has plenty of spending power but tends to cherry-pick the store without really shopping in it.

In its search for that shop-till-you drop formula, Wal-Mart is testing one prototype in the middle of Middle America--Elyria, Ohio. Castro-Wright strides into a very un-Wal-Mart-like area that features low, wood-veneer (actually recycled plastic) side counters where towels are displayed. You can actually see over the department, and the sight makes you want to linger; you're not hemmed in by the usual 8-ft.-high (2.5 m) discount-store shelving crammed with merchandise. The assortment--the colors and styles--is broad and deep, even attractive. The prices are killer, natch, but it's the look of the department that is designed to stop traffic and perhaps get a shopper to take a glimpse at that $200 Dyson vacuum cleaner nearby.

In the kitchen section, low, faux-granite counters display small appliances in a similar open style. With this design, Wal-Mart has adapted a strategy created by its highly successful Mexican operation, Wal-Mex (which Castro-Wright used to run), that groups domestic wares by room. Wal-Mart recently told analysts that "comp" sales in the newly designed section are doing 3.33 percentage points better than in the old-model sections.

That's the future. For now, getting shoppers to change their habits is difficult. In a store in Secaucus, N.J., 470 miles (750 km) east of Elyria, CEO Scott is looking sternly at a serving platter priced at $24.99 as if it didn't get the memo. Around the pricey platter, lower-cost merchandise has sold briskly, and Scott is seeing evidence that Wal-Mart's attempt to move up the fashion/design/price ladder still has a way to go. It's not clear whether shoppers simply won't buy higher-priced stuff at Wal-Mart or, as happened in apparel, it's the wrong stuff on the shelves. "It just doesn't work," he is muttering while acknowledging the problem: "How do you move an entire company across this category?" Answer: "You've got to be smart."

To get smarter, Wal-Mart's U.S. organization is experiencing a gravitational shift. Wal-Mart has always been run from Bentonville, the defiantly hick-town global home office in Benton County, Ark. Each Tuesday, for decades, an armada of planes would fling regional bosses to the far parts of the empire. They would return Friday and report Saturday morning at the big weekly meeting that has been held since Mr. Sam was in charge. Numbers would be counted; plans would be made; orders would be cut. In the field, store managers wouldn't change their socks unless the home office gave the go-ahead.

This kind of central command and control, long out of favor in corporate America (not to mention the People's Republic of China), is now being de-emphasized. Castro-Wright, 52, is pushing executives out to where the stores are and bringing in local hires. The company has created five U.S. regions and staffed them as if they were independent $8 billion-to-$12 billion retailers. The Southeast regional headquarters is in Atlanta; the Midwest is run out of Chicago. Both regions are headed by locals, which will give the company more political clout in the sometimes contentious battles for store locations. The store-management structure has been similarly overhauled to emphasize a local touch in marketing and human resources. "It's not that it was too much Bentonville-centric," Castro-Wright says a tad defensively. "That was the strength of the company. But with our growth far away from the center, our model needed to be changed."

Wal-Mart wants to tailor about 10% of each store's merchandise to the neighborhood--a long-unrealized goal. Given the company's appetite for goods, its buyers' primary focuses have been price and logistics: How do you get millions of 20-lb. (8 kg) bags of dog food delivered to 3,500 stores efficiently? They're good at that. They're not so good at figuring out what to do when shoppers in Dallas don't buy the giant bags of dog food that they've become so expert at supplying. What if doggie apparel is just as sellable in Big D? (Stop that snickering.) "In Bentonville, you don't have a lot of dogs running around in sweaters," Castro-Wright says, almost containing a giggle.

The dog-food/dog-sweater example frames Wal-Mart's tactical quandary. The company's cultlike focus on supply-chain logistics grinds away at costs but doesn't allow it to know the neighbors. The new strategy tries to make that connection--editing for the area, offering a point of distinction. "It's going to tell the customer that we understand what they need," says Castro-Wright. "We not only understand what you need, we respect your point of view. We want to be your store of choice because we understand you better than anyone else in the marketplace."

There'll still be plenty of data-diving at the home office. A software program will evaluate merchandise selection in 4-ft. (1.2 m) shelf intervals every six weeks, factor in the demographics of the store's customers and spit out adjustments. One tantalizing opportunity: a smaller store, since the match between goods and shoppers' needs will be more precise.

In trying to relate better to shoppers, Wal-Mart has bumped up training to improve what it calls customer engagement. In its redesigned consumer-electronics section, for instance, the company has discovered that it can sell pricier merchandise like flat-panel televisions and GPS equipment, but customers need a little hand-holding before laying down $1,500 for a set. It's happening just as consumer-electronics giant Circuit City has laid off 9% of its sales force and replaced it with less experienced, less expensive hires. Wal-Mart says same-store sales were up 4.6% in electronics in the past quarter, besting both Best Buy and Circuit City.

The retraining is part of Wal-Mart's response to critics who accuse the company of being a repository of faceless, low-paying work. Now it's threatening to get squishy, rolling out an idea called Associates Out in Front, known as active listening in the HR trade. Store managers must meet with 10 associates each week and hear them out.

Not surprisingly, the hourlies have a lot to say. They want more flexibility--at least half are students, retirees or second-job holders--more opportunity and more attention paid. And, of course, they want more pay. The company raised wages in 1,200 stores last year and expanded its 10% employee discount on nonfoods to include produce. Long-term employees asked for an extra week's pay instead of an extra week's vacation. (They got it.) Workers with less experience asked for quarterly, not annual, bonuses if their store met targets. (They got it.) Wal-Mart, in turn, wanted help available at peak demand in the stores, meaning nights and weekends. (Of course it got it.) The company has also instituted some wage caps.

To Wal-Mart's ardent, union-backed critics such as Wal-Mart Watch and Wake Up Wal-Mart, these improvements are just crumbs from the corporate table. Wal-Mart's national hourly-wage average of $10.74 is more or less competitive with Target or Kmart, but its total package still lags behind union competitors in the supermarket industry.

The company's newest medical-insurance plan, for instance, offers associates the chance to buy family coverage for $14 to $21 a month. But the deductible is $2,000--a huge outlay for a cashier earning $17,000 a year. Wal-Mart says this Value Plan is the most cost-efficient approach for 70% of its associates, many of whom have other coverage through either a family member or the state. Fewer than 10% of its associates lack health insurance, the company says.

And while Castro-Wright and his team plan the Wal-Mart of the future, the company's legal team has been fighting the same old ugly labor battles. Wal-Mart has been tarred by an ongoing gender-discrimination class action filed in California in 2001, and it recently was ordered to pay $62 million in penalties on top of the $78.5 million judgment awarded by a jury last year after it found Wal-Mart guilty of shortchanging associates in Pennsylvania who worked during their breaks or after they clocked out. (Wal-Mart says it will appeal.) Nor has it looked all that cuddly in its death-match legal posture in a couple of high-profile firings, the issues notwithstanding. Case in point: the dismissal of advertising chief Julie Roehm, accused of having an affair with a subordinate (also fired) and taking freebies from an advertising agency (also fired) in violation of company policies. She denies the allegations and has sued, loudly.

More to the point, outgoing executives have characterized Wal-Mart as hopelessly inflexible, clinging to its old culture. Even if the company wants to change its image, argues Roehm, who helped reposition Chrysler and Ford, it can't help itself.

Another issue is more basic: absolute size. "One of the difficulties that we face at Wal-Mart is scale, the fact that we have so many stores. Getting execution across all stores is difficult," says Castro-Wright. Any big change is difficult for large corporations. To change so many things, as Wal-Mart is doing, is asking a lot.

Next year is critical for Wal-Mart: it must deliver on the promises made to Wall Street. In its struggles, Wal-Mart faintly resembles another company that once ruled retailing from a central HQ. Sears, Roebuck grew fat supplying rural and small-town America, but ultimately its culture couldn't adjust to shopping-mall America or to discounters. Shoppers today have little idea how awesome was the power of the Chicago merchant. And before Sears there was the Great Atlantic & Pacific Tea Co., the A&P, an urban power that once ran nearly 16,000 U.S. stores. Competitors quaked before it. This is the history of retailing. It says that every company that has reached No. 1, from Woolworth's to Kmart, has eventually spit the bit, unable to cope with market shifts. Wal-Mart is a far superior operator to any of those has-beens--it will produce $20 billion in operating income this year. But being king is an awfully heavy weight to bear, and Wal-Mart is feeling the strain.