Lecture 3 OLI Paradigm DR. VICTOR Z. CHEN UNC CHARLOTTE

OLI paradigm by John H. Dunning  Ownership advantages (O)  Knowledge advantage  Management, marketing, financial skills  Vertical integration  Control of resources  Control of markets  * Note: O advantages should be non-location-bound and are always relative to your target peers (firstly home-country peers and then target host-country peers).  Location advantages (L) of the host countries/regions  National production functions  Government controls and regulations  Political risk  Cultural values  * Note: such advantages should support O advantages above and may change as a result of the MNE’s entry.  Internalization benefits (I)  To enforce property rights and overcome other transaction costs  To reduce buyer uncertainty  To overcome government regulations  * Note: some I benefits are a response to some L disadvantages

Case study 1: Wal-Mart Source: HBS Cases  Founded by Sam Walton in 1962 in Bentonville, Arkansas, Wal-Mart stores offered customers a broad range of goods, including lawn and garden, jewelry, shoes, electronics, family apparel, and toys. In the first year, Wal-Mart garnered $700,000 in sales, which increased to $5.4 million in In 1980, Wal-Mart became the youngest U.S. retail company, and the only regional retailer, to exceed $1 billion in net sales.  During 1980s, Wal-Mart transformed itself into a national discount retailer, saturating regional markets and forcing the closure of other domestic retailers.

Wal-Mart  In 1991, with net sales of $43.9 billion, Wal-Mart became the world’s largest retailer, and maintained this status since then.  Between , Wal-Mart Stores experienced a 35% compound annual growth of both revenue and net profit.  Between , revenue and net profit grew at 9% annually.  In 2002, Wal-Mart’s revenue equalled 2.3% of US GDP.  Total Wal-Mart sales on ‘Black Friday’ in 2002 equalled $14.2 billion, larger than the GDP of 36 countries.

Wal-Mart  The largest company in the world  It has more employees in uniform than the U.S. military  It has the world’s largest private database, behind only the Sloan Digital Sky Survey  If it were a nation, it would be China’s eighth-largest trading partner

A successful business model  Competitive advantages:  Everyday Low Prices (EDLP), through aggressive bargaining with suppliers (and non-unionized employees)  Acc UBS, 14% lower than its rivals  Zoning: efficient distribution system and inventory control  3% saving per item in purchasing costs due to logistics  Retail Link satellite/computer system, a $4 billion investment  Each store is within a day’s drive of a distribution center, which supplies 85% of inventory (compared to 50%-60% for competitors)  Super-large market construction in suburban areas.  Unique culture  Sam Walton’s three key principles:  To respect the individual  To provide superior customer service (e.g., 24- hour service; helping bag purchases)  To strive for excellence  Sundown Rule: all concerns be addressed on the day of occurrence  Critics:  Low salaries of its employees: $18,000 per year in 2002 (<Porto Rico; <1/2 USA GDP per capita).  Highly publicized legal suits concerning its hiring practices  Charges of failing to pay overtime  Underpaying hourly workers  Sexual discrimination (women make up 70% of store workers but 10% of management)  Non-compliance with the Americans with Disabilities Act.  ‘Locking in’ overnight workers  Conspiring with cleaning contractors to underpay immigrant workers

Retail globalization  US retail chains had a long history of globalization  Woolworth in Canada in 1897; in UK in 1909; in Germany in 1926;  Sears Roebuck & Co in Cuba in 1942; in Mexico in  European retailers, notably German ones, led a second wave of globalization  By 2003, Germany’s Metro Group made 47% of sales through its affiliates in 27 foreign countries, inc. China, India, Japan, Morocco, Russia, Turkey, Ukraine, and Vietnam.  Dutch food retailer Royal Ahold in US in 1977 (BI-LO, Finast, Tops, Stops & Stops, Giant Food Inc., and Peapot); in 2003, US operations accounted for nearly 75%.

Wal-Mart globalization  A late-comer, driven by flagging domestic growth.  Intl division formed in 1993, after two joint ventures (JVs) in Mexico in  By 1997, 41 stores in Mexico and 89 retail outlets (under various names) within its control.  Into Puerto Rico in  Into Canada in 1994.

Next stop?

Wal-Mart in Germany: OLI Analysis

Next stop: Germany  The largest consumer market in Europe  15% of the continent’s $2 trillion annual retail market in 2001  In 1997, Wal-Mart acquired Wertkauf chain (24 stores) from the Mann Family and the unprofitable Interspar chain (74 stores) in 1998 for a combined $1.6 billion.  Both equalled <3% of the market.  Interspar stores were in poor repair and in poor locations.  The leading German retailer was Metro Group, followed by Rewe Group.

Immediate actions  Wal-Mart started by refurbishment of stores to improve their appearance and the maintenance of price leadership through cost efficiency.  Overhaul of the supply chain systems  Implementation of new scanning systems  Centralized distribution  High quality customer service (e.g., helping bag purchases)  The fiercest price war in Germany’s recent history

German rules  Unexpected regulatory obstacles  Price regulations  Stringent zoning requirements  Limited store hours

A successful business model?  Competitive advantages?  Everyday Low Prices (EDLP), through aggressive bargaining with suppliers (and non-unionized employees) (with critics)  Zoning: efficient distribution system and inventory control  3% saving per item in purchasing costs due to logistics  Retail Link satellite/computer system, a $4 billion investment  Each store is within a day’s drive of a distribution center, which supplies 85% of inventory (compared to 50%-60% for competitors)  Super-large market construction in suburban areas.  Unique culture  Sam Walton’s three key principles:  To respect the individual  To provide superior customer service (e.g., 24- hour service; helping bag purchases)  To strive for excellence  Sundown Rule: all concerns be addressed on the day of occurrence Stringent zoning requirements Labor relations Price regulations Limited store hours; cultural differences, etc.

Pricing  Conflict with Germany’s Federal Cartel Office, e.g., German Rebate Law  Wal-Mart’s price guarantee, which offered to refund the price diff between WM price and any competitor advertising a lower price.  The Law prohibited any retailer from selling a product more than 5% below its posted price.  1998 amendment: “selling below cost is forbidden except for good justification” in order to protect existing business.  In June of 2000, the Cartel Office fined Wal-Mart $308,000 for violating the 1998 amendment.  Without a sizable scale of customers, Wal-Mart did not enjoy a high bargaining power with local suppliers and logistics.  In 2001, WM price were 11-25% higher than its German rivals.

Labor Relations  In late May 2002, Germany’s service sector union Ver.di, the largest union in the world, filed a lawsuit against the company, citing Wal-Mart Germany’s violation of HGB for not releasing year-end figures for 1999 and  Public figures for employees to negotiate wages and ensure job security  Wal-Mart’s response: Ver.di was not a legitimate plaintiff.  In April 2003, an appeal by Wal-Mart was dismissed and a fine of 330,000 euro assessed.  In July 2002, Ver.di organized 2,000 WM employees for a two-day strike to get WM into HDE, Germany’s retail sector employers’ association.

zoning  In 1997, Germany had app. 2,000 large-surface-area “green field” retail sites, inc. hypermarkets, furniture stores, and home goods suppliers, all of which had been built before  In 1977, Germany had enacted strict planning and zoning regulations (“building use plan”) designed to protect traditional retailers.  The legislation prohibited the construction of stores with more than 800m 2 (8,610 ft 2 ) sales area in locations not designated for retailing.  Indeed, by 2001, Wal-Mart had only managed to open two new stores, and enlargement of existing stores.

Zoning (cont’d)  Opening a new large-surface-area store outside of an urban center was technically possible, but it required clearing several difficult hurdles.  A neighboring city/town was required to create a “building use plan”  Environmental and conservation concerns, & potential private legal conflicts  No potential direct competition with stores in nearby towns  The reality: almost no new extra-urban hypermarkets were opened in Germany since 1977

zoning (cont’d)  “What Germany fears is the experience of cities like Bordeaux, which had lost retail business to green field sites outside of town. All that is left is old buildings and monuments in the city center … We don’t want cities that look like the United States.” -- Holger Wenzel, Head of German Retail Federation.

Store hours  1956, 6:30pm weeknights; 2pm Saturdays; closed on Sundays.  1989, 8pm on Thursdays (legislation); 6:30pm (labor union).  1996, 8pm for weeknights.  2003, 8pm for Saturdays.

Cultural Differences  Local customer loyalty is high  Metro, Aldi, and Rewe  Uncomfortable with the “friendly” service  Credit card payment  Free bags  Cashiers helping bagging purchases

A successful business model  Competitive advantages?  Everyday Low Prices (EDLP), through aggressive bargaining with suppliers (and non-unionized employees) (with critics)  Zoning: efficient distribution system and inventory control  3% saving per item in purchasing costs due to logistics  Retail Link satellite/computer system, a $4 billion investment  Each store is within a day’s drive of a distribution center, which supplies 85% of inventory (compared to 50%-60% for competitors)  Super-large market construction in suburban areas.  Unique culture  Sam Walton’s three key principles:  To respect the individual  To provide superior customer service (e.g., 24- hour service; helping bag purchases)  To strive for excellence  Sundown Rule: all concerns be addressed on the day of occurrence Stringent zoning requirements Labor relations Price regulations Limited store hours; cultural differences, etc.

Economic situation  The proportion of household income that Germans spend on retail purchases continues to decline.  Profit margins in German retailing are the lowest in Europe.

Ending story In 2006, Wal-Mart sold all 85 German stores to The Metro, incurring a loss of $1 billion.

Contact Victor Z. Chen Belk College of Business UNC Charlotte +1 (704)