Teaching Wal-Mart New Tricks

By TRACIE ROZHON
New York Times
May 8, 2005

Bentonville, Ark.

WAL-MART'S chief financial officer, Thomas Schoewe, had just returned from a trip to Wall Street, and was still shaking his head about a question analysts there had directed at him. "They kept asking me if Lee Scott didn't know what Tom Coughlin was up to," he said.

H. Lee Scott Jr. is the feisty chief executive of Wal-Mart Stores, and until recently Thomas M. Coughlin was its vice chairman. A hunting and fishing buddy of Sam Walton, the founder, Mr. Coughlin retired in January amid great fanfare - with a local library branch named for him. But two months later, he was unceremoniously dumped from the board after accusations of expense account fraud.

Mr. Schoewe told the Wall Street analysts that Mr. Scott had known "absolutely nothing" about any problem. Recounting the story last week, Mr. Schoewe paused. "I mean, if he had known, would we have named a library after the guy?" Then he looked into the middle distance, and, as if speaking to himself, said softly: "I'm not sure they believed me."

Glasnost, Wal-Mart is starting to learn, can be unsettling. But after decades of battening down the hatches and refusing to deal with pesky analysts and reporters, the company has decided to open up and let a little sun in. The less confrontational approach to the outside world is part of its effort to repair a reputation that, especially in the last year, has suffered blow after blow, the latest being Mr. Coughlin's travails.

That is not the only big change taking place at Wal-Mart, the country's largest company ranked by sales. It is also beginning to rethink some of Sam Walton's most closely held tenets, including his determination to sell only the cheapest of merchandise to some of the least affluent Americans.

Why now? Because Wal-Mart suddenly seems, well, vulnerable - a word seldom associated with the $288 billion-a-year juggernaut that once swatted down rivals as if they were so many gnats. Its stock price has been flat for five years, and competitors like Target (whose name the cognoscenti love to pronounce the French way: tar-ZHAY) are giving it fits. "Which would you rather have?" one analyst asked. "A $1.99 plastic ice bucket from Tar-zhay or one from Wal-Mart?"

While Target long ago enlisted Isaac Mizrahi to design $19.99 giraffe-printed sweaters and Michael Graves to design tea kettles, Wal-Mart has been trying to figure out both its men's and women's clothing lines - with only limited success.

But now Wal-Mart executives say the company is getting its act together with apparel and home furnishings, which have been weak spots. In the grocery aisles, it is also experimenting with healthy frozen dishes and even organic food.

And so Mr. Schoewe finds himself spending much more time on the company jet, flying to places like New York to sell Wall Street on not only the company's finances but also, to a certain extent, its marketing strategies. "Two years ago, I might have held two meetings annually with analysts," he said. "Now I'm meeting with them all the time."

Last month, the company also held its first corporate open house for journalists, where it addressed accusations of union-busting (it remains staunchly anti-union), of forcing employees to work off the clock, of hiring illegal immigrants and of discriminating against women.

This depressing litany was tackled head-on in interviews last week with a parade of executives, some of whom couldn't quite shake the "us against them" tone for which Wal-Mart is so well known.

Mr. Scott, who said last month that the missteps were isolated incidents that should never happen again, has since acknowledged that some problems still need to be addressed.

He and others, for example, said they would never again try to go over the heads of local politicians in their quest for store growth, as they did in Inglewood, Calif., where they sponsored a referendum last year to try to sidestep city zoning. That failed, amid cries that Wal-Mart was trying to subvert the political process.

In a telephone interview last week, Mr. Scott added that Wal-Mart was now "harsher" on rule-breakers, and gave the hypothetical example of a truck driver who "has been involved with alcohol." A district manager might once have given the driver another chance, he added, but now the driver would be fired.

He also struck a conciliatory note with opponents. "We're trying not to look at critics as annoyances," he said. "The thing is to find out the truth. We've changed as a company. We listen more to people coming to us with diversity issues, overseas sourcing, shareholder rights.

"We're getting past the idea that everyone who criticizes you has an ulterior motive and wants you to fail."

Analysts said they see change at Wal-Mart but say they still worry about what they call "headline risk" at the company - the chance that it will stumble again, very publicly. "That's the biggest thing," said Gary Balter, a stock analyst at UBS who has covered the stock for 20 years. "It's bound to be bad for morale.

"How can you think about selling clothes," Mr. Balter added, "when you're thinking about Tom Coughlin and who's going to be next?" A federal grand jury recently began an investigation into the allegations that Mr. Coughlin had abused his expense account and told Wal-Mart employees to help him cover it up; through a lawyer he denies any impropriety.

FOR years, Wal-Mart had simply roared along, gathering up accolades - and enemies. The management was tough then, and it still is. Mr. Scott, after all, first came to Sam Walton's notice when employees complained that he was firing too many company truck drivers.

But since it opened its first discount store in 1962, Wal-Mart was always paternalistic and devoted - some say too devoted - to giving the customer the lowest price possible. To get that lowest price, executives still say, the company must be unfalteringly demanding.

During the weekly meeting of company officers, Mr. Scott asks embarrassing questions like: "Why does Target make a better coffee maker and sell it for $19.95?" The buyer in charge of small appliances, put on the spot, may acknowledge that he doesn't have a clue.

But before the meeting is over, the buyer is expected to get on his BlackBerry, or his phone, and not only find out why but, ideally, to have found the same or better coffee maker. He is also expected to bargain with shippers so the company can sell it for less. Oh - and to place an order.

An announcement that the coffee maker, or whatever product, will be in stores the next week is the kind of line that gets applause, and a nod from Mr. Scott.

Such relentless pressure, combined with hiring new teams of designers and buyers across all merchandise categories, seems to be paying off.

"They're starting to turn it around," Mr. Balter of UBS said, singling out the contributions made by Michael T. Duke, the chief executive of stores, and Eduardo Castro-Wright, who in February became the chief operating officer of Mr. Duke's division. "They're starting to get their internal act together again."

Earnings per share rose 19 percent last year. Gross margin, meanwhile, has grown from 21.2 percent in 2001 to 22.9 percent. That may not seem like a big change, but for a huge discounter like Wal-Mart it represents almost $5 billion in additional earnings.

For the first time, Wal-Mart agreed last week to break out comparable sales figures for several of its most-improved categories. Youth-oriented handbags, for instance, are up 40 percent over last year. Sales of flat-screen televisions, music players, DVD players and modems have doubled. Sheets and towels rose "in the double digits," the company said.

Wal-Mart is remarketing and expanding its sporting goods. One sign of the payoff: sales of pedometers are double what they were a year ago.

Like most retailers, Wal-Mart is wary of giving figures for actual sales volume, but it did provide a rare example: it expects to sell 30 million "attitude tees" - T-shirts with slogans - before the year is out. Last year, it sold 20 million.

Nevertheless, Wal-Mart's same-store sales - the vital comparison involving stores open at least a year - have not been impressive, especially when compared with Target's. Last week, Wal-Mart said its same-store sales in April were only 0.9 percent higher than they were in the same month a year earlier.

Mr. Schoewe said the increase was so small because Wal-Mart believes in saturating markets with its stores, a strategy designed to keep out its so-called big-box competitors. That also results in a certain amount of cannibalization within Wal-Mart: When a new store opens near an older one, it drains away some of the sales. "But that's only for two years or less," he said. "By the end, it's back up to what it was."

Yet there is no getting around the fact that comparable sales fall for a time. "And Wall Street puts an emphasis on same-store sales," he said.

That it does. "For good reason," said Christine K. Augustine, an analyst at Bear, Stearns. "It's a proxy for market share."

And better news may be coming. While same-store sales have slipped from healthy to wimpy in the last year, analysts note that starting in June, the comparisons will improve because sales started to weaken last June, so the company won't have such high numbers to beat. Improved sales may offset some of the pain from worrisome higher-than-normal expenses, caused mainly by higher shipping costs.

So is Wal-Mart's stock undervalued? Mr. Scott certainly thinks it is. So do 17 of the 29 analysts whose recommendations are tracked by Bloomberg Financial Markets; they rate the stock a "buy." Wal-Mart's stock, which traded at $69 at the end of 1999, closed on Friday at $48.96.

"The fact that everybody hates them now, that's great!" Mr. Balter said. "People have essentially said: 'We don't know where you're going, but we know we don't like it.' "

Not surprisingly, Mr. Balter is one of the analysts who has rated the stock a "buy."

IN the main auditorium of Wal-Mart headquarters here, where Mr. Scott presides over the famous Saturday-morning meetings and where division vice presidents meet on Fridays to critique all the latest toys and blenders and bikinis, the walls are ringed with price signs, the same ones that are, or will be, posted in the 3,159 stores across the country.

"Blue Ice - 97 cents," "HP Office Jet 4215v Printer - $98.74," " Kellogg's Cereal with Star Wars Characters on Boxes - $2.84."

Wal-Mart is offering more new products than ever, its executives say, and not just cheap stuff at the cheapest prices. In design studios and in a food-testing laboratory tucked behind the home office here, Wal-Mart is reviewing merchandise that will be significantly more middle-income - a necessity in order to stay competitive, according to analysts like Ms. Augustine. These newer items, some already on the shelves, are not being designed to replace the cheaper ones - executives are adamant about not losing their core customers - but to expand the company's offerings.

In the last nine months, Wal-Mart has developed and introduced 44 new grocery items, including nine-layer lasagna, Key lime pie and toffee cookies. It has brought in hundreds of new "branded" items - products not developed exclusively through the company. These include more healthy alternatives, like Kashi trail bars and granola mixes.

Higher quality does not always mean higher prices. Wal-Mart recently started stocking a thick new towel, in hot colors like orange and more sophisticated tones like taupe, for $4.24. Many stores also have an entire aisle of newly designed turquoise and orange plastic goblets and daisy-flowered plates, and they sell them for an average price of $1.97.

Wal-Mart has introduced hundreds of new, more upscale products in the last three months, from gourmet roast beef to an $89 two-drawer, two-door console with a wood veneer to 400-thread-count sheets that are $20 cheaper than Target's 400-count sheets. And more products are coming, Mr. Scott said, because Wal-Mart's customers love the new lines.

"Just because you don't have a lot of money doesn't mean you don't have taste," he said.

Wal-Mart is also introducing a variety of gourmet foods and frozen dinners, some of which come in "healthy" recipes. Compare the new (healthy) frozen chicken Marsala that serves two for $5.86 with the new, cholesterol-laden nine-layer lasagna that can feed six for $5.86.

A portion of the chicken Marsala, with portobello mushrooms, has a saturated-fat content that is 13 percent of the recommended daily allotment - not more than many so-called energy bars - and 17 percent of the recommended sodium. A portion of the lasagna, which is made with béchamel sauce and Bolognese sauce as well as four cheeses, has 50 percent of the daily recommended limit of saturated fat and 36 percent of the sodium.

Introduced two months ago, the lasagna is already Wal-Mart's top-selling frozen entree. "We tested 26 lasagnas available at restaurants," said Nancy Nagle, director of product development. "We found the best."

This is a different approach for Wal-Mart. "There's a whole new team, and we're growing exponentially," she said. "When I first came, it was my boss, Dede, and myself. Now, we have a team of seven."

Wal-Mart, Ms. Nagle said, is a no-nonsense negotiator. "People are afraid of Wal-Mart," she said. "We're not an ogre. We're not playing any game: just give us your net-net cost." Wal-Mart, she said, doesn't accept any "slotting fees," the money demanded by most supermarket chains in exchange for a prominent place on the shelves. Wal-Mart offers many brand names, like Kellogg and Nabisco, but also its own labeled foods, like the newer and pricier Sam's Choice.

For Ms. Nagle and her staff, the tough specifications are just that, specs - "not a weapon" to use against suppliers, she said. But, she added, they must be adhered to. Quality controls are rigorous: "Hello," she said, as if talking to one of these suppliers: "Where are the bananas? We're supposed to have 3 percent in this trail mix."

Wal-Mart executives said they could not legally pressure manufacturers to sell their branded goods for less than they offer anyone else, based on volume. "Where we can offer the savings," said Mr. Duke, "is through efficiencies in shipping and delivery."

AT the Wal-Mart Supercenter in Rogers, Ark., about seven miles from the company headquarters, it's been a tough week.

"Yesterday's traffic was down 3 percent from the same day last year," said Matt Loveless, the store manager. "Sales were down 4.3 percent." On the other hand, "paper goods were up 12.3 percent; paint was up 16.2 percent; housewares were up 37 percent. ..."

The list was almost endless. So what was down? Because of the cold weather, Mr. Loveless said later, plants in the garden center weren't selling as well as they did a year ago. Not so many customers were ready to buy spring and summer clothes, either. And the crafts and fabrics departments were weaker than normal, he said.

Still, employees were quick to offer the Wal-Mart cheer, a high-schoolish recitation of "Give me a W, Give me an A" and so on, with foot-stomping and a grunt at the end. Then several employees stepped forward with newly arrived products they particularly liked.

One young man talked about a rocket-launching "air gun" called Total Extreme. "Show us!" chanted the 40 to 50 workers. He pumped the plastic gun and a plastic-foam rocket went off, soaring high and long over all their heads, to applause. "And it's only $2.82," he crowed, to more clapping and foot-stomping.

Just after the cheers and the individual testimonials about the new products, Loretta Hartgrave, 48, said she felt that Wal-Mart has been getting bad publicity lately. She blamed "people that have already left the company, who didn't feel they were treated right."

The important thing, she added, was to buy into the company's profit-sharing plans. "I have the stock options," Mrs. Hartgrave said. "I built my house nine years ago - a three-bedroom brick house in Lowell - and we paid for it the day we moved in." Mrs. Hartgrave's husband had worked in the maintenance department of a nearby turkey processing plant owned by Cargill before he died last November. "What he was making only paid the taxes," she said.

Wal-Mart's health plans have been attacked by critics, but Mrs. Hartgrave presents the opposing view. "When we first were presented with the option for cancer coverage, my husband didn't want it: 'Nobody in my family ever had cancer,' " she recalled him saying. "But for me, that went in one ear and out the next." She signed up for the extra coverage for $30 a month; standard Wal-Mart health insurance costs $40 a month for an individual, $155 for a family.

Altogether, Wal-Mart's medical insurance laid out $60,000 to treat Mr. Hartgrave's single-cell cancer before he died. "Six pills prescribed for pain and chemotherapy would have cost $1,000," Mrs. Hartgrave said. "We paid $50 until we met our deductible. After that, we paid nothing.

"All these people complain about the benefits," she added, "but I think they haven't been explained well." She paused, then added: "I don't know if they don't listen. I preach a lot on it."

Critics say the biggest problem with Wal-Mart's health insurance is not with the long-term illness and hospitalization coverage, but with the waiting periods to qualify: six months for full-time hourly workers, two years for part-time workers. Wal-Mart says the terms are more generous than those of most retailers.

But Wal-Mart's deductibles are also high: a family must spend $1,000 a year of its own money before the insurance kicks in - except on prescriptions, like the ones Mrs. Hartgrave got for her husband. "We have no H.M.O. where you pay $5 for a doctor's visit," said Mona Williams, a vice president and the chief spokeswoman for the company.

MS. WILLIAMS, who says that some critics seem to "make their living by attacking Wal-Mart," conceded she once might have thought that the Wal-Mart cheer was hokey. "I would have rolled my eyes," she said. "But now I'm a part of something bigger than myself; it's like being in the military or in a religion. Here it's like a fanatical mission to save our customers money."

She rattles off statistics: 30 percent of the company's 1.5 million employees had no health insurance at all when they were hired, hourly wages are comparable to - or greater than - Target's, and half of the company's workers are full time.

She said she resented accusations that Wal-Mart's wages were not enough to support a family. "Only 7 percent of our workers are trying to support a family," she said. "The rest are seniors, college kids, people working to supplement the main wage earner. Those are the people we're recruiting. The average wage is $9.68 an hour."

It may stay there for a while. Mr. Scott was characteristically blunt last week when he dismissed the idea he might re-examine Wal-Mart's wage and price structure, if only to satisfy some of his more vocal critics. "No" was all he said.

He was positively chatty, though, when asked a question many retailers hate: Who are your biggest competitors?

"Bed Bath & Beyond is phenomenal," he said. "Walgreens may be as good a competitor as we've got. And of course Target does so many things well." He went on to list Home Depot, Lowe's, Crate & Barrel, Pottery Barn, Ikea and Dollar General.

He likes to walk the aisles of other stores. "What are the colors of the new Coach purses?" he wondered. "They're hitting on all cylinders now and if we don't have the same - uh, I mean, something similar - before long, we're in trouble."