Wal-Mart's Foray
Into Japan Spurs
A Retail Upheaval

As Giant Confronts Barriers,
Local Competitors Rush
To Emulate Its Methods

On Wal-Mart Stores Inc.'s newest battlefield, the obstacles are huge. Pricey real estate and cramped space make it tough to build big stores. An "everyday low price" strategy is befuddling shoppers accustomed to poring through newspaper ads for discounts. Traditions force retailers to go through layers of middlemen instead of buying directly from suppliers. And employees have even balked at Wal-Mart's "10 foot" rule, which encourages them to offer assistance to any customer within 10 feet. Here, grocery clerks usually wait for a customer to ask a question.

By Ann Zimmerman in Dallas and Martin Fackler in Tokyo

But Wal-Mart is making its first big push into the Japanese market. And its Japanese rivals are already trying to out-Wal-Mart the U.S. giant. They've slashed prices, built single-story supercenters with acres of parking, launched "Made in Japan" campaigns and made headway in breaking the stranglehold of middlemen over the supply chain.

"Wal-Mart is taking its time to get ready. This is our chance to get a step ahead," says Kenichi Arai, spokesman for Aeon Co., Japan's second-largest supermarket chain, which has plans to open 30 supercenters in the next three years.

The result has been a retail upheaval in Japan, where discount stores are still fairly new and long-protected mom-and-pop stores make up 58% of all retailers. The lower prices and broader selection are good news for Japanese consumers, who have suffered through a decade-long downturn while still paying some of the highest prices in the world. But the competition could also end up making it tougher for Wal-Mart to build a juggernaut in Japan, as rivals strip away Wal-Mart's advantages.

Wal-Mart, which entered Japan 18 months ago by buying a stake in supermarket chain Seiyu Ltd., concedes local retailers are being quick and aggressive in mimicking the company's methods. But Wal-Mart is sticking to its plan of approaching the market slowly, gradually remodeling Seiyu's 400 food and apparel stores in Wal-Mart's image. Wal-Mart executives say they don't want to turn off Japan's notoriously finicky consumers by rushing through the process.

"We've been criticized for going too slowly," says John Menzer, chief executive of Wal-Mart's international division. "But we have to do it step by step. In three years, we'll be fully loaded."

Despite its enormous success in the U.S., the Bentonville, Ark., discounter has sometimes stumbled overseas, especially when it acted too hastily. In Germany, Wal-Mart rushed to overhaul the two chains it bought, lowering prices before its computerized inventory-monitoring systems were in place. Operations there are still posting losses six years later. Wal-Mart needs to conquer new countries to help sustain its torrid expansion pace, relying on overseas operations to contribute a third of its yearly sales growth rate.

So far, results in Japan have been disappointing. Earlier this month, Seiyu reversed a previous profit forecast for the March-December period to an $83 million loss, blaming the sluggish economy and an unseasonably cool summer that led several retailers recently to slash profit forecasts. Sales at stores open at least a year are expected to be down 4.5% for the first six months, far below the company's expectations.

Tough Market

Japan is one of the world's quirkiest and most difficult retail markets. Until a few years ago, laws restricted store size and operating hours to help protect small, inefficient retailers. In urban areas, steep real-estate prices have forced retailers to build multilevel outlets selling a mix of food, apparel and household items that resemble department stores. Big discount stores have emerged only recently in new suburban communities.

Japanese customers often demand the freshest food and orderly stores, with short checkout lines and an abundance of clerks to do everything from answer questions to keep fruit displays tidy. Then there's Japan's complex and expensive distribution system, a labyrinth of wholesalers and transport companies with long-term business ties to suppliers. Under these ties, suppliers will sell only to certain wholesalers, who sell to other wholesalers and so on. A product might go through three or more hands before reaching a retailer.

U.S. computer maker Gateway, Office Max, Foot Locker and Burger King all failed here. Even savvy international operators such as Costco Wholesale Corp. -- which has successful operations in Mexico and Canada, among others -- and France's Carrefour SA admit their progress in Japan has been slower than anticipated.

Wal-Mart spent four years studying the market and concluded it needed a local partner. In Seiyu, Japan's fifth-largest supermarket chain, it found an established chain with plentiful, well-situated -- if shabby -- outlets and a sorry balance sheet. The 40-year-old company had expanded into scores of different businesses during Japan's boom, and the bust left it saddled with debt and starved for cash. Wal-Mart bought a 6% stake in Seiyu for $46 million in March 2002, with the option of increasing it to 67% by 2007. Last December, it upped its stake to 37%.

Wal-Mart created an extensive five-year reorganization plan, filled with enough market studies, projections and detailed action plans to fill rooms the size of three executive offices, says the company's Mr. Menzer. Seiyu management signed off on it.

But cultural differences are stumping Wal-Mart. It tried to move Seiyu toward its trademark "everyday low prices" strategy while ending weekly sales and dropping its traditional colorful newspaper ads to save on marketing costs. But it underestimated how diligently many shoppers studied these ads to compare prices. It had to resume the sales and the ads when customers dried up. Wal-Mart and Seiyu executives also admit that customers, and even employees, have had trouble figuring out some of Wal-Mart's jargon, such as "rollbacks." Signs are being redesigned to explain that these are items with long-term price cuts.

"Our biggest challenge is that Japanese people think if it's too cheap, the quality is bad," says Seiyu President Masao Kiuchi. "We have to change those perceptions. The lower price on sashimi" -- fish meant to be eaten raw -- "doesn't mean it's a few days old, but that we got a better price on it."

Wal-Mart says it will announce plans for new stores in the next few months, possibly including supercenters -- large stores that combine a grocery store with extensive general merchandise. But its main focus now is on making existing stores more efficient. Wal-Mart is showing wholesalers and suppliers how to lower their prices by shaving costs and forecasting demand. A new computer system will soon allow manufacturers to track their product sales at Seiyu by item, hour and gross margin, which would enable them to manufacture and deliver goods more efficiently.

One goal is eventually to bypass the network of suppliers and wholesalers. With the economy weak for so long, suppliers are beginning to break ranks and sell to retailers, if that means they can earn some extra money.

Wal-Mart has held several meetings with its 400 largest suppliers to discuss buying directly, dangling the prospect that Wal-Mart might carry their products in all its stores world-wide. Since Seiyu lacks its own network of warehouses and trucks, however, Wal-Mart is working with wholesalers for the time being.

Both Wal-Mart and some Japanese competitors are trying to cut labor costs by shifting more workers to part time, and Wal-Mart plans to eventually tackle the company's salary structure. "To improve competition, we have to crack the wage system, move it from seniority-based to merit-based," says Mr. Kiuchi.

As Wal-Mart proceeds steadily, Japanese retailers are moving fast. Aeon, which operates 368 Jusco supermarkets, sent hundreds of employees to visit Wal-Marts in the U.S., South Korea and China.

Masaaki Toyoshima, Aeon's vice president of corporate strategy, visited Wal-Mart superstores in the U.S. two years ago, and found them messy by Japanese standards. The lighting was too dark, the shelves thinly stocked, and the selection of brands for each item limited. But he was impressed with the prices. He couldn't resist buying a Gillette razor at half the price he paid in Japan.

Mimicking Wal-Mart

Mr. Toyoshima concluded his company could match Wal-Mart's low prices and still meet Japanese standards. The best way, his company decided, would be to copy the efficiencies of Wal-Mart's single-story supercenters. Jusco's new stores not only look like Wal-Marts but borrow labor-saving tricks such as displaying clothes on hangers instead of folded, employing fewer clerks and having products delivered in boxes that can be put on display without being unpacked. Aeon has opened three supercenters since 2001 and hopes to build 27 more in the next three years. It's targeting smaller cities, where land is cheaper and rivals scarce -- the same strategy Wal-Mart founder Sam Walton followed decades ago.

One of the Jusco Supercenters opened last fall amid green rice paddies outside Tenri, a small city an hour from Japan's No. 2 commercial center of Osaka. Steep land prices forced the store to put half of its parking spaces on its own roof, reached by a ramp in the back. Inside, shoppers on a recent weekday said they were disoriented by the cavernous store. But they raved about the low prices.

Sachiko Hirata, a 42-year-old housewife, drove six miles to see the store. "Look at this," she said, holding up a brown T-shirt that said "Non-Conformist." "Here, this costs 770 yen [$6.40]. Near my home, it costs 2,000 yen [$16.70]."

Aeon won't disclose the store's sales, though it says the Tenri supercenter has yet to turn a profit. A survey by Goldman Sachs found prices on the store's nongrocery items were 9.4% below the average locally. That's on par with Wal-Mart's best effort so far in Japan, a newly remodeled store in the Yokohama suburb of Futamatagawa. At the same time, the Tenri store has tried to keep the broad selections and service that Japanese consumers cherish. Its fish section boasts six types of tuna, all hand-cut by a team of white-smocked workers.

Getting a step ahead of Wal-Mart, Aeon has already moved aggressively to squeeze out middlemen. It spent six months in 2001 persuading snack-food maker Calbee Co. to sell products to it directly, rather than going through wholesalers. Since then, 21 more domestic companies have agreed, and Aeon plans to add another 20 by year's end.

Aeon still lags way behind Wal-Mart in some key areas, such as delivering goods as they are needed. Japanese stores have long had large and expensive inventories. Aeon has spent $314 million to install a new computer system and build six new distribution centers, each with loading docks to serve more than 100 trucks at a time. But Mr. Toyoshima concedes Aeon, whose sales of $25.8 billion last year were just a tenth of Wal-Mart's $244.5 billion, lacks the deep pockets of the U.S. giant. It has no plans to use satellites to track the location of specific trucks as the U.S. retailer does, he says, because it's too expensive.

Ito-Yokado Co., Japan's largest supermarket chain, says it isn't going to build supercenters because it believes land costs remain too high in Japan. And it says it's skeptical that Japanese consumers will appreciate the emphasis on price and efficiency over service and quality. For instance, Ito-Yokado isn't reducing its store staff because it feels it needs enough employees to keep shelves constantly stocked and checkout waits short.

"Ito-Yokado isn't offering everyday low prices. It's offering higher quality," says Yoshinobu Naito, an Ito-Yokado board member.

At the same time, Ito-Yokado is responding to Wal-Mart by adapting a strategy from the U.S. retailer. Last year, it launched a "Made in Japan" campaign, reminiscent of Wal-Mart's buy-American drives. Japanese products, ranging from suits to briefcases to polo shirts, have price tags colored red, to evoke the rising sun on Japan's national flag. On the tag's back is written the item's maker and location. Ito-Yokado says it sold $171 million of the clothes in the first year of the campaign, about 5% of its total clothes sales.

Wal-Mart's best effort so far is the four-story Seiyu store in Futamatagawa that it renovated in June. Newly widened aisles boast taller display fixtures. There are other Wal-Mart flourishes, such as trademark yellow smiley faces and tables piled with large dog-food bags, jumbo rice sacks and other fast-moving merchandise. Wal-Mart says sales are up 15% since the remodeling.

Still, only about 500 of the store's 50,000 items are being sold at Wal-Mart's famous rock-bottom rates. And, despite the efforts to change the Futamatagawa store's appearance and service, some customers say they are only mildly impressed. "I think it is easier to find things," says Yuka Nakagone, a 28-year-old housewife shopping the food aisles in a newsboy cap and headphones. "But I don't think the items have changed very much."

There are also problems with the "10 foot" rule. Chieko Tan, a 10-year Seiyu veteran who runs one of the store's lingerie departments, has tried to get employees to be more aggressive about approaching customers. "The Japanese are a very restrained people," says Mrs. Tan.

Mrs. Tan recently joined about 400 other Seiyu employees in Arkansas for Wal-Mart's annual shareholders meeting, where she visited U.S. stores. Since her return, Mrs. Tan has been trying to boost sales by persuading customers to use shopping carts rather than the small baskets Japanese favor.

Write to Ann Zimmerman at ann.zimmerman@wsj.com and Martin Fackler at martin.fackler@wsj.com

Updated September 19, 2003