Loblaws Responds to Walmart’s Expansion into Canada

Case Type: business competition, competitive response.
Consulting Firm: Boston Consulting Group (BCG) 2nd round full time job interview.
Industry Coverage: retail.

Case Interview Question #00907: Your client Loblaws is the largest discount retailer in Canada, with more than 500 stores spread throughout the country. Headquartered in Brampton, Ontario, Loblaws stores are mostly located in Alberta, British Columbia, Ontario and Quebec. Loblaws is a division of Loblaw Companies Limited, Canada’s largest food distributor.

For several years running, the client Loblaws has surpassed the second largest Canadian retailer (with ~300 stores) in both relative market share and profitability. However, the largest discount retailer in the United States, Walmart, has just bought out Loblaws’s competition Woolworth Canada Inc. and is planning to convert all 300 Woolworth stores to Walmart stores. The CEO of Loblaws is quite perturbed by this turn of events, and asks you the following questions: Should I be worried? How should I react? How would you advise the CEO of Loblaws?

Additional Information: to be given to candidate upon request

(1) Company

* A discount retailer sells a large variety of consumer goods at discounted prices, generally carrying everything from grocery to consumer products, from housewares and home appliances to clothing. Prime examples include Kmart, Woolworth, Target, and Wal-Mart.
* Loblaws stores have a wide variety of brand names.
* Loblaws uses a franchise model in which each individual store is owned and managed by a franchisee who has invested in the store and retains part of the profit.
* Loblaws sells about $750 million worth of goods annually.

(2) Competition

A. Canadian Competitor

* Loblaws’ stores are located in similar geographic regions as the competition’s. In fact, you might even see a Loblaws store on one corner, and the competition on the very next corner.
* Loblaws’ stores tend to have a wider variety of brand names, but by and large, the product mix is similar.
* For certain items Loblaws is less expensive, and for others the competition is less expensive, but the average price level is similar.
* Loblaws has higher profits than the competition on a per-store basis.
* Loblaws’ cost structure isn’t any lower than the competition’s. Its higher per-store profits are due to higher per-store sales.
* Loblaws’ average store size is approximately the same as that of the competition.
* The competitor’s stores are centrally owned by the company while Loblaws are franchised.

B. U.S. Competitor: Walmart

* Walmart owns 4,000 stores in the U.S. and the second-largest competitor in the U.S. owns approximately 1,000 stores.
* Walmart stores average 200,000 square feet, whereas the typical discount retail store is approximately 100,000 square feet.
* Walmart’s sales are approximately $5 billion, whereas the nearest competitor sells about $1 billion worth of merchandise.
* Its cost of goods is approximately 15% less than that of the competition (due to volume of sales giving it clout with suppliers).
* Its prices are on average about 10% lower than those of the competition.
* Walmart has larger selection of products, given the larger average store size.
* Walmart was started by building superstores in rural markets served mainly by mom-and-pop stores and small discount retailers. Walmart bet that people would be willing to buy from it, and it was right.
* As it grew and developed more clout with suppliers, it began to buy out other discount retailers and convert their stores to the Walmart format.
* When a store is converted to the Walmart format, it carries the same brands at prices that are on average 10% lower than the competition’s.
* Walmart decides whether it should physically expand a store it’s just bought out based on several factors, such as the size of the existing store, local market competition, local real estate costs, and so on (but it doesn’t plan to expand the Canadian stores beyond their current size).
* Although members of the Canadian business community are certainly familiar with the company because of its United States success, the Canadian consumer is basically unaware of Walmart’s existence.
* Loblaws and Walmart carry similar products, although the Loblaws stores lean more heavily toward Canadian suppliers.
* Canada has significantly higher labor costs than the U.S., but Loblaws must also cope with the same high labor costs.

Possible Answer:

1. Canadian Competitor

After comparing Loblaws to its Canadian competitors, the interviewee should realize that:

* Loblaws stores are better managed, since the individual store owners have a greater incentive to maximize profit.
* Loblaws’ higher sales are due primarily to a significantly higher level of customer service. The stores are cleaner, more attractive, better stocked and so on. The company discovered this through a series of customer surveys last year.

2. Walmart

Similarly, after comparing Loblaws to its U.S. competitor Walmart, the interviewee will realize that:

* Walmart might incur higher distribution costs than Loblaws because it will have to ship products from its United States warehouses up to Canada.
* Loblaws has the advantage in distribution costs, since its network spans less geographic area and it gets more products from Canadian suppliers.

Once the interviewee reaches the above conclusion, the following additional information can be shared if asked for:

* However, since Loblaws continues to get a good deal of products from the United States, the actual advantage to Loblaws is not great – only about 2% of overall costs.
* Walmart will be able to retain a significant price advantage over Loblaws’ stores: if not 10%, then at least 7%-8%.

3. Conclusions

In the near term, Loblaws might be safe. Its stores have a much stronger brand name in Canada than Walmart’s, and they seem to be well managed. However, as consumers get used to seeing prices that are consistently 7%-8% less at Walmart, they will realize that shopping at Walmart means significant savings over the course of the year.

Although some consumers will remain loyal out of habit or because of the high level of service, it is reasonable to expect the discount shopper to shop where prices are lowest. Moreover, over time Loblaws’ brand-name advantage will erode as Walmart becomes more familiar to Canadian consumers. Loblaws certainly has to worry about losing significant market share to Walmart stores in the long term. They should probably do something about it now, before it’s too late.

4. Recommendations to the client Loblaws

* Find ways to cut costs and make the organization more efficient, so it can keep prices low even if its cost of goods is higher.
* Consider instituting something like a customer loyalty program or frequent shopper program, where consumers accumulate points that entitle them to future discounts on merchandise (might not be that cost-effective, since it would be rewarding a significant number of shoppers who would have continued to shop there anyway).
* Prepare a marketing or advertising campaign that highlights its high level of service. Perhaps even institute a Loblaws Service Guarantee that surpasses any guarantees offered by Walmart.
* Consider offering fewer product lines, so that it can consolidate its buying power and negotiate prices with suppliers that are competitive with Walmart’s. It might lose some customers who want the variety of products that Walmart has, but it may be able to retain the customer who is buying a limited array of items and is just looking for the best price.

Sample Interview Transcript

1. Establish understanding of the case

Candidate: So, the client, Loblaws, is facing competition in Canada from a United States competitor. Our task is to evaluate the extent of the threat and advise the client on a strategy. Before I can advise the CEO I need some more information about the situation. First of all, I’m not sure I understand what a discount retailer is!

Interviewer: A discount retailer sells a large variety of consumer goods at discounted prices, generally carrying everything from housewares and appliances to clothing. Kmart, Woolworth, Target, and Wal-Mart are prime examples in the United States.

2. Set up the framework

Candidate: Oh, I see. Then I think it makes sense to structure the problem this way: First, let’s understand the competition in the Canadian market and how Loblaws has become the market leader. Then let’s look at the United States to understand how Walmart has achieved its position. At the end, we can merge the two discussions to understand whether Walmart’s strength in the United States is transferable to the Canadian market.

Interviewer: That sounds fine. Let’s start, then, with the Canadian discount retail market. What would you like to know?

3. Evaluate the case using the framework

Candidate: Are Loblaws’ 500 stores close to the competition’s 300 stores, or do they serve different geographic areas?

Interviewer: The stores are located in similar geographic regions. In fact, you might even see a Loblaws store on one corner, and the competition on the very next corner.

Candidate: Do Loblaws and the competition sell a similar product mix?

Interviewer: Yes. Loblaws stores tend to have a wider variety of brand names, but by and large, the product mix is similar.

Candidate: Are Loblaws’ prices significantly lower than the competition’s?

Interviewer: No. For certain items Loblaws is less expensive, and for others the competition is less expensive, but the average price level is similar.

Candidate: Is Loblaws more profitable just because it has more stores, or does it have higher profits per store?

Interviewer: It actually has higher profits than the competition on a per-store basis.

Candidate: Well, higher profits could be the result of lower costs or higher revenues. Are the higher per-store profits due to lower costs than the competition’s or the result of higher per-store sales?

Interviewer: Loblaws’ cost structure isn’t any lower than the competition’s. Its higher per-store profits are due to higher per-store sales.

Candidate: Is that because it has bigger stores?

Interviewer: No. Loblaws’ average store size is approximately the same as that of the competition.

Candidate: If they’re selling similar products at similar prices in similarly-sized stores in similar locations, why are Loblaws’ per-store sales higher than the competition’s?

Interviewer: It’s your job to figure that out!

Candidate: Is Loblaws better managed than the competition?

Interviewer: I don’t know that Loblaws as a company is necessarily better managed, but I can tell you that its management model for individual stores is significantly different.

Candidate: How so?

Interviewer: The competitor’s stores are centrally owned by the company, while Loblaws uses a franchise model in which each individual store is owned and managed by a franchisee who has invested in the store and retains part of the profit.

Candidate: In that case, I would guess that the Loblaws stores are probably better managed, since the individual storeowners have a greater incentive to maximize profit.

Interviewer: You are exactly right. It turns out that Loblaws’ higher sales are due primarily to a significantly higher level of customer service. The stores are cleaner, more attractive, better stocked, and so on. The company discovered this through a series of customer surveys last year. I think you’ve sufficiently covered the Canadian market – let’s move now to a discussion of the United States market.

Candidate: How many stores does Walmart own in the United States, and how many does the second-largest discount retailer own?

Interviewer: Walmart owns 4,000 stores and the second-largest competitor owns approximately 1,000 stores.

Candidate: Are Walmart stores bigger than those of the typical discount retailer in the United States?

Interviewer: Yes. Walmart stores average 200,000 square feet, whereas the typical discount retail store is approximately 100,000 square feet.

Candidate: Those numbers suggest that Walmart should be selling roughly eight times the volume of the nearest United States competitor!

Interviewer: Close. Walmart’s sales are approximately $5 billion, whereas the nearest competitor sells about $1 billion worth of merchandise.

Candidate: I would think that sales of that size give Walmart significant clout with suppliers. Does it have a lower cost of goods than the competition?

Interviewer: In fact, its cost of goods is approximately 15 percent less than that of the competition.

Candidate: So it probably has lower prices.

Interviewer: Right again. Its prices are on average about ten percent lower than those of the competition.

Candidate: So it seems that Walmart has been so successful primarily because it has lower prices than its competitors.

Interviewer: That’s partly right. Its success probably also has something to do with a larger selection of products, given the larger average store size.

Candidate: How did Walmart get so much bigger than the competition?

Interviewer: It started by building superstores in rural markets served mainly by mom-and-pop stores and small discount retailers. Walmart bet that people would be willing to buy from it, and it was right. As it grew and developed more clout with suppliers, it began to buy out other discount retailers and convert their stores to the Walmart format.

Candidate: So whenever Walmart buys out a competing store, it also physically expands it?

Interviewer: Not necessarily. Sometimes it does, but when I said it converts it to the Walmart format, I meant that it carries the same brands at prices that are on average ten percent lower than the competition’s.

Candidate: What criteria does Walmart use in deciding whether it should physically expand a store it’s just bought out?

Interviewer: It depends on a lot of factors, such as the size of the existing store, local market competition, local real estate costs, and so on, but I don’t think we need to go into that here.

Candidate: Well, I thought it might be relevant in terms of predicting what it will do with the 300 stores that it bought in Canada.

Interviewer: Let’s just assume that it doesn’t plan to expand the Canadian stores beyond their current size.

Candidate: OK. I think I’ve learned enough about Walmart. I’d like to ask a few questions about Walmart’s ability to succeed in the Canadian market. Does Walmart have a strong brand name in Canada?

Interviewer: No. Although members of the Canadian business community are certainly familiar with the company because of its United States success, the Canadian consumer is basically unaware of Walmart’s existence.

Candidate: Does Loblaws carry products similar to Walmart’s, or does the Canadian consumer expect different products and brands than the United States discount retail consumer?

Interviewer: The two companies carry similar products, although the Loblaws stores lean more heavily toward Canadian suppliers.

Candidate: How much volume does Loblaws actually sell?

Interviewer: About $750 million worth of goods annually.

Candidate: Is there any reason to think that the costs of doing business for Walmart will be higher in the Canadian market?

Interviewer: Can you be more specific?

Candidate: I mean, for example, are labor or leasing costs higher in Canada than in the United States?

Interviewer: Canada does have significantly higher labor costs, and I’m not sure about the costs of leasing space. What are you driving at?

Candidate: I was thinking that if there were a higher cost of doing business in Canada, perhaps Walmart would have to charge higher prices than it does in the United States to cover its costs.

Interviewer: That’s probably true, but remember, Loblaws must also cope with the same high labor costs. Can you think of additional costs incurred by Walmart’s Canadian operations that would not be incurred by Loblaws?

Candidate: Walmart might incur higher distribution costs than Loblaws because it will have to ship product from its United States warehouses up to Canada.

Interviewer: You are partially right. Loblaws has the advantage in distribution costs, since its network spans less geographic area and it gets more products from Canadian suppliers. However, since Loblaws continues to get a good deal of product from the United States, the actual advantage to Loblaws is not great – only about two percent of overall costs.

Candidate: All this suggests that Walmart will be able to retain a significant price advantage over Loblaws stores: if not ten percent, then at least seven to eight percent.

Interviewer: I would agree with that conclusion.

4. Summarize and make recommendations

Candidate: I would tell the CEO the following: In the near term, you might be safe. Your stores have a much stronger brand name in Canada than Walmart’s, and they seem to be well managed. However, as consumers get used to seeing prices that are consistently seven to eight percent less at Walmart, they will realize that shopping at Walmart means significant savings over the course of the year.

Although some consumers will remain loyal out of habit or because of your high level of service, it is reasonable to expect the discount shopper to shop where prices are lowest. Moreover, over time your brand-name advantage will erode as Walmart becomes more familiar to Canadian consumers. You certainly have to worry about losing significant share to Walmart stores in the long term. You should probably do something about it now, before it’s too late.

Interviewer: Can you suggest possible strategies for Loblaws?

Candidate: Maybe it can find ways to cut costs and make the organization more efficient, so it can keep prices low even if its cost of goods is higher.

Interviewer: Anything else?

Candidate: It might consider instituting something like a frequent shopper program, where consumers accumulate points that entitle them to future discounts on merchandise.

Interviewer: What might be a potential problem with that?

Candidate: Well, it might not be that cost-effective, since it would be rewarding a significant number of shoppers who would have continued to shop there anyway.

Interviewer: Any other suggestions?

Candidate: Loblaws might want to prepare a marketing or advertising campaign that highlights its high level of service. It might even institute a Loblaws Service Guarantee that surpasses any guarantees offered by Walmart.

Interviewer: Assuming the only way to keep customers is through competitive pricing, is there anything Loblaws can do to appear competitive to the consumer?

Candidate: It might want to consider offering fewer product lines, so that it can consolidate its buying power and negotiate prices with suppliers that are competitive with Walmart’s. It might lose some customers who want the variety of products that Walmart has, but it may be able to retain the customer who is buying a limited array of items and is just looking for the best price.

Interviewer: All of your suggestions are interesting, and you would want to analyze the advantages and disadvantages of each in more detail before making any recommendations to the CEO.