Retail
Wal-Mart's Mexican Rivals Go Shopping
Aude Lagorce, 10.29.03, 6:00 PM ET

If you can't beat Wal-Mart Stores, should you join it in the world of power retailing? For Wal-Mart's three largest Mexican competitors, the answer seems to be yes.

On Oct. 21, Gigante (otc: GYGJY - news - people ), Soriana and Controladora Comercial Mexicana (nyse: MCM - news - people )--or Comerci--announced the creation of a joint purchasing and distribution alliance. The three retailers hope their venture can force suppliers to give them the big discounts they need to implement the same low-price strategy as Wal-Mart de Mexico (otc: WMMVY - news - people ), the retail giant's second-largest international operation.

Cooperative purchasing alliances have been formed by retailers in the U.S. before, but never on the scale of the one just launched in Mexico. While Sinergia de Autoservicios may help its three struggling founders, its implementation will likely be rocky. And in the end, it may address only one of the reasons why Walmex--as the Mexican operations are known--is keeping their sales as flat as a tortilla.

Wal-Mart's (nyse: WMT - news - people ) foray into Mexican retailing started in 1991, when it formed a joint venture with Cifra, a retailer that operated six different formats of supermarkets and restaurants around Mexico. In 1997, Wal-Mart acquired a majority share in Cifra, and today owns 62% of Walmex. Last year, Mexico accounted for one-fourth of Wal-Mart's $40 billion in international sales, second only to the U.K. Walmex's sales for this year, at $7.4 billion as of the third quarter, are ahead of 2002's by about $700 million.

But while Walmex's stores now number 630, self-service retail accounts for only 35% of consumption in Mexico, versus 60% in Chile and 50% in Brazil. A July report by J.P. Morgan Chase noted that "self-service stores in Mexico could post 8% annual growth, as an industry, for the next 14 to 15 years."

Domestic retailers are eager to capture some of that growth, but given the pace at which Walmex is adding stores, they know they won't unless they can reposition themselves. "Domestic retailers must be able to implement the same everyday low prices as Wal-Mart if they want to survive," says Cristina Morales, an analyst with Valores Mexicanos Casa de Bolsa, a brokerage that is part of Grupo Bal.

Gigante, which has nearly 270 outlets and now has frozen all expansion, has fared the worst. Its profit plunged 48% in 2002, and sales in the second quarter of 2003 decreased 5.1% from the year-earlier quarter. Comerci's 2002 revenue fell 8.3%, but a new pricing effort pushed up sales by 3.6% in the first nine months of 2003, compared to the same period last year. Soriana almost managed to keep its head above water in 2002, with revenue growing 5.8% but profit down 0.3%. Unfortunately, its aggressive expansion campaign is hurting the bottom line further, with profit down 13.2% for the first half of 2003.

Walmex says it welcomes "any effort that will benefit the consumer" and is confident that the alliance will have little impact on its business, which is booming: Third-quarter sales were up 9% from a year ago; profit was up 14%.

The buying co-op likely won't benefit suppliers, who must serve it while not ignoring Walmex. "If you miss a sale for Walmex because you don't want to give them the discount they're asking for, you could miss your annual sales target by as much as 50%," estimates Morales, who believes that the alliance is a good move for all three chains.

Merrill Lynch analyst Robert Ford doesn't entirely share that view. "They [the alliance members] will certainly benefit," he says, but notes that they will have to clear some operational hurdles. The three chains will keep separate operations, distribution centers and pricing strategies, but must jointly decide which quantities of what products to buy together and coordinate shipping and inventory.

"A purchasing alliance or combining with other retailers is no panacea," warns Rob Culin, a principal with retail consulting firm Kurt Salmon Associates. He cites the example of Safeway (nyse: SWY - news - people ), which bought retailers in Texas, Chicago, Alaska and the Northeast, but had a hard time integrating them. In 2002 Safeway booked a net loss of about $828 million, according to Hoover's, thanks to writedowns at its Dominick's and Randall's units.

"The real challenge the Mexican retailers have to confront is that Wal-Mart's low prices are only partly driven by size," says Willard Ander, a principal with retail consulting firm McMillan and Doolittle. "Wal-Mart gets the bulk of its benefits from superior logistics and a much simpler distribution system. Walmex competitors are going to have to do more than just get discounts from their suppliers if they want to survive."

Taking on Wal-Mart is possible, say Pat Johnson and Dick Outcalt, the founders of retail strategy firm Outcalt & Johnson, but it would take more than any Mexican--or U.S.--retailer is currently doing. They say it would take a "troika": the venture would have to combine a proven retailer, a provider of state-of-the-art technology and a global organization with a foot in developing countries--and only then would it stand a real chance.

The first part of that equation is unlikely, says Ander. "You have to ask yourself who would have an interest in merging," he says. The retailers doing well, like Target (nyse: TGT - news - people ) and Costco (nasdaq: COST - news - people ), aren't really interested in a merger with a smaller player, which would guarantee them more headaches than profits, at least for the ramping-up period. "And the ones who could benefit from a merger, like Kmart, well, it's hard for them to find a partner," he adds.

Still, if the three amigos succeed in Mexico, some big U.S. players might be convinced to give a troika some thought.