Elsewhere: Global Retail Markets Reviewed

Road to Success

To succeed in this intensely competitive and increasingly consolidated marketplace, the world’s leading retailers will need powerful brands, compelling consumer value propositions, sophisticated customer management systems, and flexible and efficient supply chains that will allow them to take advantage of global expansion opportunities. Equally, if not more, important they will need strong risk management skills to navigate the minefields as globalization adds ever greater complexity to the retail business model. Such are the conclusions reached by the analysts at the Deloitte consulting company in its annual survey entitled “Global Powers of Retailing”.

The resilient US consumer continued to spend, with rising home values providing a boost. A big increase in exports gave the Japanese economy a much needed lift in 2004, leading to a pick-up in consumer spending. The UK economy remained strong in 2004, although it has slowed over the past year. Among the emerging markets, the big ones did mostly quite well. China, India and Russia all experienced robust consumer spending growth. Continental Europe, which saw slow growth and high unemployment persist, remained the major exception to an overall buoyant global environment for retailing.

Sales and profits for the Top 250 retailers generally improved over 2003 results. As a group, retail sales totaled $2.84 trillion in fiscal 2004, or nearly one-third of an estimated $9 trillion global retail marketplace. This represents an increase of 8.9% over the Top 250’s prior-year sales. The average profit margin for the 187 companies that disclosed their net income/loss figures was 2.7%.

Among the 170 companies that were profitable, net income averaged 3.6% of sales in fiscal 2004, up from 3.3% the prior year. To earn a spot on this year’s list, a company needed retail sales of at least $2.3 billion, up from last year’s $2.2 billion. The list continues to be dominated by Wal-Mart, which alone accounted for 10% of the Top 250’s combined sales. While Wal-Mart’s $285 billion in retail sales is more than three times the size of its biggest rival (Carrefour), competition for a spot toward the bottom of the list remains intense.

The largest retailers continue to increase their market share, albeit more modestly than in prior years. The top 10 generated combined sales of $817 billion, or 28.8% of the Top 250’s total sales. This compares to 28.4% last year. As the big get bigger and their market penetration increases around the globe, competition among the major players is having a significant macro-economic impact.

Intensifying competition is exerting downward pressure on prices. In addition, these companies are reinvesting the cost savings resulting from increased scale and efficiency improvements to reduce retail prices. The decline in overall consumer prices means a substantial increase in consumer buying power. Continued expansion by the leading global retailers is also having a big impact on the supplier base. Suppliers are being forced to consolidate and rationalize their brand portfolios in an effort to operate more efficiently.

Small Is Successful

A review of the fastest-growing retailers over the 1999-2004 period shows that strong growth doesn’t necessarily equate with being a global player. Nearly two-thirds of the 50 fastest-growing retailers operate in only one or two (generally contiguous) countries. For the most part, these companies have not yet faced saturation in their domestic markets.

Because it is easier to post rapid growth from a smaller base, most of the 50 fastest growing retailers can be found in the Top 250’s bottom half. Only 15 are among the top 100 largest retailers, with Schwarz Group (Lidl), at #11, the only one whose entry into the top 10 appears imminent. Compared to the Top 250 as a whole, these fast-growing companies tend to be more focused, often operating only a single retail format such as drug stores, supermarkets, convenience stores, or specialty stores.

On average, the 50 fastest-growing retailers saw sales increase at a compound annual rate of 23.8% from 1999-2004, compared with 8.4% for the Top 250 as a whole. For the 10 fastest-growing retailers, sales soared 41% per year. In contrast, the 10 largest retailers grew only 8.3% per year — on a par with the Top 250 average. At this rate, it is only a matter of time before some of these rising stars join the ranks of the top 10.

Change of Name

Like in other property sectors, key operators in retail are considerably improving their positions through mergers and acquisitions.

Thus, UK supermarket retailer Wm. Morrison more than doubled in size from its March 2004 acquisition of Safeway PLC. The merger of Sears and Kmart, which was finalized in March 2005, is not reflected in this year’s ranking, where the companies are listed separately. After being absent from the top 10 for several years, the combined companies are expected to return next year as Sears Holdings Corp. Troubled Dutch retailer Ahold continues to sell off numerous operations around the world in a bid to remain competitive.

US Dominance Waning

The Top 250 are a geographically diverse group, based in 27 different countries. US - based retailers continue to dominate the list, with 90 companies representing 36.0% of Top 250 retailers and 44.3% of Top 250 retail sales volume. However, the US share of both measures is down from previous years.

Japan, the world’s second-largest retail market, is home to 40 of the Top 250 retailers. Most of these retailers are relatively small, falling in the bottom half of the list, and many operate only in Japan. Despite Japan’s large and well-developed retail sector, most of these companies will not be able to rely on their depressed domestic retail market for continued growth.

Europe’s largest economies account for a significant number of Top 250 retailers: 24 are based in the UK, 18 in Germany, and 12 in France. French and German companies tend to be larger with their share of sales far exceeding their share of companies. Anemic consumer spending and intense competition, coupled with a tough regulatory environment, have forced these retailers to look beyond their domestic borders for growth. As US dominance wanes, a number of countries can be expected to make incremental gains in the years ahead.

China, in particular, will likely have an increasing presence on the Top 250 list as its domestic retailers expand through both organic growth and acquisition in an effort to impede foreign competition.

Food Concerns a Priority

The predominant operational formats continue to be food-related. Nearly 60% of the Top 250, and nine of the top 10 retailers, sell food, with most operating a variety of formats including supermarkets, hypermarkets/ supercenters, hard discount stores, cash & carry/warehouse clubs and convenience stores.

Although saturated in certain markets, hypermarkets/supercenters remain a leading format with considerable potential in emerging economies. Discount stores have continued their rapid expansion, following the hypermarkets and forcing them to lower their prices. Convenience stores are also registering robust growth. As a result, supermarkets, the most popular format among the Top 250 retailers, are starting to feel the squeeze from the proliferation of both larger and smaller formats.

Over half of the Top 250 operate specialty retailing concepts. In particular, retailers specializing in homegoods categories have flourished as a strong housing market and a burgeoning middle class around the world boost demand for consumer electronics, home improvement products and services, and home furnishings.

Multi-channel retailing continues to grow, with more retailers developing an e-commerce capability. In this study, however, the Non-Store format is designated only if nonstore channels accounted for at least 20% of a company’s total retail sales.

Globalization Accelerating

Globalization appears to be accelerating following a slowdown in the early part of the decade. In fiscal 2004, the Top 250 retailers were doing business in a total of 118 different countries, with an average of 5.5 countries.

Although international sales are becoming increasingly important to many large retailers’ growth strategies, foreign operations still generate a relatively small share of overall sales and profits for most of these companies. Indeed, many of the world’s largest retailers have not yet expanded beyond their own borders. Of the Top 250, 104 have no international operations at all. Over half the US – based companies are single-country operators.

Sixty percent of Japanese retailers on the list do business only in Japan. An additional 39 companies operate in just two countries.

Conversely, 44 of the Top 250 operate in 10 or more countries. Spain’s Inditex is the most international with stores in 56 countries, followed by Carrefour with 35 countries on its international roster, and IKEA with 33.

Among the most globally active are retailers based in relatively small markets that provide limited domestic expansion opportunities. As noted above, French and German retailers are also among the most globally ambitious.

Investing in Emerging Markets

China remains of interest to nearly all retailers, mostly because it represents a market of 1.3 billion people. China’s high economic growth rates, recent entry into the WTO, and the opening up of its markets offer retailers numerous opportunities for growth. Among the Top 250, 29 non-Chinese retailers were doing business in China in 2004, and a battle for market share is underway.

India represents another strong retail market opportunity that has been hampered by restrictions on foreign ownership of retail establishments. For now, foreign retailers are restricted to franchise operations and wholesaling. Although only five of the world’s largest retailers were operating in India in 2004, the country is opening up its market.

The government has recently expressed support for foreign direct investment in food retailing, which will put India on the map for many more foreign retailers.

Russia is the largest and fastest-growing retail market opportunity among the Central and Eastern European economies. However, investment risk resulting from poor infrastructure, corruption, and regulatory hurdles has discouraged many retailers from investing in Russia until recently. Twelve companies among the Top 250 included Russia on their international expansion list in 2004. Continued efforts to reduce investment risk will attract more foreign retailers looking to tap the country’s huge potential.

India has been described as the next big thing. Its strong growth in recent years, combined with its emergence as a hub for off-shoring of service functions, has created a considerable buzz in the business world. Will India be the next China? On the positive side, India has experienced relatively strong economic growth following the economic reforms first enacted in the early 1990s. Such reforms included deregulation of many domestic sectors, greater openness to foreign investment in most sectors, more sensible monetary and fiscal policies, and trade liberalization. As for the latter, India’s average tariff fell from 56% in 1990 to 28% in 2004. Still, this leaves India less open than China. By comparison, China’s tariff dropped from 32% to 6% over the same period.

In addition, the IT and communications revolutions allowed India to take advantage of its vast supply of highly educated, English-speaking professionals – many with degrees in technology related subjects. These people became the vanguard for India’s emergence as a major exporter of IT related services. Consequently, India’s IT industry revenue rose from US$8.2 billion in 1999 to US$28.2 billion in 2004. It is expected that this industry will grow rapidly in the coming years.

Europe’s largest economies have suffered relatively high unemployment and low growth for quite a long time. This used to be known as “Eurosclerosis.” The solution, according to most economists, has always been to deregulate these economies, especially their sclerotic labor markets. Yet not much has happened. Now, Europe is at something of a crossroads. Its two leading economies, Germany and France, are struggling with a conflict between the comfortable yet slow growth that comes from maintaining the status quo and the social costs involved in generating the potentially stronger growth that could come from reform.

This conflict was at the forefront of the recent elections in Germany. There, the voters split virtually down the middle, reflecting no clear consensus on how to approach new economic realities. In France, a new government includes leaders on both sides of the debate about the extent of economic reform. On the other hand, a number of smaller European economies with high social expenditures and taxation have done quite well. The countries of Scandinavia, for example, have been notable for their entrepreneurship in the midst of strong social protections.

Europe faces several long-term issues with which it must grapple soon: Europeans are living longer, retiring earlier, and having fewer children than in the past. The result of this is that, soon, the labor force will decline while the number of retirees increases. Absent a substantial boost to productivity growth, this implies declining economic growth – if any. This is not a politically or socially sustainable situation. The best solution would be to expand the share of the population that works. This means people retiring later. It also means removing some of the safety net that makes unemployment a viable alternative to labor market participation. Doing either of these will be politically challenging to say the least.

Japan may be on the verge of a gradual economic renewal, following roughly 15 years of stagnant growth and deflation. A number of factors point in this direction, not the least of which is strong political support for a government committed to reform. Sustained recovery will require not simply an ephemeral boost in exports (this has happened before), but strength in the domestic economy. It will require increased investment by Japanese business and increased spending by Japanese consumers. Investment spending might be ready for a recovery. Japan’s companies have spent much of the past 15 years cleaning up their messy balance sheets while the country’s banks have substantially reduced their portfolios of non-performing loans. The result is that companies are now in a better position to invest rather than pay down debts.

Latin America’s economy is a mixed bag. Argentina and Venezuela are growing very rapidly, but both possess economic environments that pose serious risks. On the other hand, Mexico and Brazil, the region’s largest economies, are growing at a more modest pace. Yet both offer more promise to global companies given the economic policies and environments in place.

First, consider Argentina. Growth lately has been impressively in double digits. Yet this represents a recovery from a severe downturn a few years ago. Moreover, Argentina’s external debt remains high, inflation is not yet tamed, and investor confidence is not strong. Although consumer spending has recovered, income remains low

and poverty is ubiquitous. Global retailers have scaled back their expansion plans for Argentina.

Venezuela is an even more problematic case. Economic growth has been strong due to the rapid rise in the price of oil over the past two years. Yet inflation continues to be the highest in Latin America and among the highest in the world. The government has increasingly engaged in socialist policies including massive increases in social spending, state interference in the private sector, and confiscation of central bank reserves for social spending. The result is a considerable drop in investor confidence.

Mexico and Brazil have a very different situation. Neither is growing rapidly, and both have reform-minded leaders unable to convince their legislatures of the importance of reform. Thus they have not been able to implement the kinds of changes that would push their economies toward the next stage of market-oriented development. On the other hand, both countries have well developed and sophisticated distribution industries, relatively sensible monetary and fiscal regimes, and stable and successful private sectors. Thus, both are attractive places to invest in retailing – despite a lack of strong growth potential.

Finally, the most attractive economy in the region remains Chile. Growth continues at a rapid pace, resulting in an expanding middle class. With a modest population, Chile is not big enough to warrant massive foreign retail investment. If only all of Latin America had the economic attributes of Chile.

The fastest growing economy in the region continues to be Russia. Fueled by frothy oil prices, Russia’s commodity export sector has boomed. This, combined with sensible fiscal and monetary management of Russia’s economy, has rendered the country quite attractive to foreign investors. Global retailers have accelerated their activity in Russia, with investments by Auchan, Ikea, Boots and the continuing possibility of Wal-Mart. Although Russia’s government has taken steps that scare investors about the country’s commitment to the rule of law and protection of property rights, these issues have mainly involved the resource sector. The consumer sector has been left alone.

As for Central Europe, the new EU members are growing at a modest pace that could increase substantially once these countries join the eurozone in a few years. Economic policies are quite sensible, and the attraction of the region to Western European investors will only grow. On the other hand, demographics are especially poor, with indigenous populations declining and, unlike the West, no significant immigration providing an offset. As for retailing, the region is fairly saturated with major Western European retailers – especially in the areas of food, mass merchandise and home improvement. Hence, investment opportunities are not considerable.