Academic journal article
By Barth, Karen; Karch, Nancy J.; McLaughlin, Kathleen; Shi, Christiana Smith
The McKinsey Quarterly , No. 1
Huge markets await, but profit formulas often get distorted * What won't work: a standalone approach, inflexible purchasing, and 100% ownership * Three new expansion strategies
Trends in retailing reverberate far beyond the confines of the industry. Many commentators look to retail sector performance as an indicator of general economic well-being. The issues retailers face and what they do about them trickle down into almost every facet of any business that ultimately sells its products to consumers. At packaged goods, pharmaceutical, appliance, electronics, and apparel companies, key activities like category management, logistics, and new product development are all closely tied to - and often designed in conjunction with - the strategies and processes of retailers.
One of the most problematic trends in today's retail industry is globalization. Given the substantial productivity advantages enjoyed by the world's best retailers, opportunities to move successful and innovative formats abroad would appear to be boundless. But experience suggests otherwise. The global arena has proven extraordinarily difficult for many retailers over the past two decades.
The reality is that certain structural characteristics make it harder for retailing to operate across distinctive national markets in comparison with other industries such as car making, steel, or computers. As a result, few companies have succeeded in globalizing, and many barriers remain. All the same, the opportunity is sufficiently compelling to warrant further attention.
Challenges and hurdles
The challenge of global retailing begins with the consumer. Retailers' performance in local markets will be highly sensitive to variations in consumer behavior. Entrants in such markets as Thailand and Indonesia will find pronounced differences in consumer tastes, buying habits, and spending patterns from one country to another. Accommodating these differences means tailoring the merchandise offering along dimensions such as color, fabric, and size for apparel; brand and sport for toys and leisure goods; and flavor for candy and snack foods. Yet the very changes that are needed to satisfy consumer preferences may hamper an entrant's efforts to leverage its global sourcing scale and stay competitive on cost with local retailers.
Other problems retailers will encounter when operating internationally include shortages of key resources such as land and labor; unfavorable tax and tariff structures; restrictions on trading hours and foreign ownership; and impenetrable established supplier relationships. Such hurdles will be only too familiar to any company that has attempted to compete outside its home market.
Market differences like these mean that a retail profit formula can get distorted overseas in all kinds of ways, to the point where it no longer resembles the original domestic formula. One US specialty retailer enjoyed superior sales productivity and gross margins in its new European stores, yet was unable to drop as much profit to the bottom line [ILLUSTRATION FOR EXHIBIT 1 OMITTED]. It found that its productivity and margin gains were not high enough to cover greater operating expenses in areas such as real estate and labor and still deliver comparable profit levels.
As a result of these distortions, international value creation is difficult to achieve, and even more difficult to sustain. If we look at the return on capital for the foreign operations of three international retailers [ILLUSTRATION FOR EXHIBIT 2 OMITTED], we find it is below their estimated cost of capital (calculated as a corporate weighted average). Moreover, the foreign returns are fairly volatile, probably reflecting both the risks that come with operating across borders and the various financial tradeoffs that these companies have made over time.
Progress to date
Though these hurdles have slowed the globalization of the retail sector, many participants have ventured overseas in the past 20 or so years. …