Wal-Mart looks to Chinese cities in hinterlands

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 guide. But Wal-Mart has found them as part of the company's 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 percent of the middle market is expected to be in tier-two and tier-three 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.

Emerging economies

In response, retailers are pushing into the hinterlands, including U.S. coffee chain Starbucks and French store Carrefour, the world's second-largest retailer after Wal-Mart.

These retailers, faced with saturated markets at home, are looking to emerging economies to drive sales growth. Wal-Mart's bid to gain a bigger foothold in China is anchored in smaller cities: Only three of 30 Chinese outlets Wal-Mart opened 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 his office in Shenzhen.

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

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 plagued by quality scandals, including the recent discovery of contaminated baby formula blamed for killing four infants and making thousands sick.

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 (pronounced lou-DEE), a steel and mining town of 4 million people in Central China. It's just down the road from Shaoshan, the birthplace of late leader Mao Zedong — who would likely be horrified to hear that a flagship of U.S. capitalism has moved into his neighborhood.

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

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

Regional tastes

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.

"I come here all the time," said Chen Yatian, a 21-year-old engineering student. "The prices aren't higher than the small shops outside, and I think the quality is better. My friends and I buy all our snacks here, things like spicy dried tofu."

The need to satisfy 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. "If there is one incident, it can ruin your company's reputation," Xu said.

Still, Wal-Mart's Cullen says 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 Issaquah-based rival Costco Wholesale break into South Korea and Taiwan.

In the U.S., Wal-Mart started with a single store in Arkansas in 1962 and built its distribution network slowly, said Emek Basker, a University of Missouri economics professor who has studied Wal-Mart's growth. The company had a policy of opening outlets only within a day's drive of its distribution centers, she said.

Wal-Mart is being outmaneuvered by Carrefour because its executives have taken too long to understand the China market and add stores, said Burt Flickinger, 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. Wal-Mart was 13th, with sales of $3.1 billion. Wal-Mart also owns a 35 percent stake in Trust-Mart, which has about 100 stores in 34 Chinese cities.

At the Loudi Wal-Mart, homemaker Zhang Xiaoling said the store with the lowest prices would gets her business.

"There was a small supermarket just down the road," Zhang said. "When Wal-Mart opened, it closed. It just couldn't compete."