Challenges in retail Industry

In today’s turbulent retail world, successful executives are cultivating their businesses to ensure sustainable growth over the longer term. The issues they face are daunting. Exacting consumers who prefer services over goods, an almost endless array of customer choices, fierce competitors, pervasive use of the online channel and a complex global economy are just some of the factors keeping retailers focused on finding ways to sustain and grow their businesses in the years ahead.
The puzzle?
Manufacturers, suppliers and retailers need to extend product availability while maintaining complete integrity of the supply chain, and maximum operational efficiency.
The path to the solution?
It may appear dark and tangled, with a confusing array of emerging standards and technologies, and political, economic and competitive pressures.
The prize?
Substantial. Improved on-shelf availability that delights the consumer and benefits everyone all the way through the value train: inventory visibility and increased product turns, improved and more efficient handling, and a truly optimized supply chain.
Global Powers of Retailing Top 250 highlights:
Strong global economy drives Top 250 gains:
The strong global economy continued in fiscal 2006, the financial period covered in this year’s report on the world’s 250 largest retailers. In the US, the housing boom reached its peak, thereby allowing consumers to cash out the additional equity in their homes. This, in turn, stimulated consumer spending. On the other hand, inflation began to rear its head causing the US Federal Reserve to tighten monetary policy. Europe and Japan both witnessed an improvement in economic growth while inflation remained low.

The big emerging markets of China, India and Russia continued to experience robust economic growth. In China, consumer spending rose at a furious pace, thereby making the world’s third largest retail market very attractive to the world’s leading retailers. India, too, attracted increased attention. Still, government restrictions meant that global retailers had few opportunities in this burgeoning market. Instead, indigenous companies began to invest massively in modernization and expansion. Finally, Latin America was a mixed picture, with strong growth in Argentina, Chile, and Venezuela, but modest
growth in Brazil and Mexico.
Although the global economy has begun to show some signs of stress, fiscal 2005 proved to be another healthy year for the world’s leading retailers. Total retail sales for the Top 250 reached $3.01 trillion, up 6.0% from last year’s Top 250 total of $2.84 trillion. Year-over-year growth, based on this year’s list of companies only, proved even more robust, with an 8.8% increase over the group’s prior-year sales of $2.76 trillion.

However, not every company enjoyed strong growth. Forty nine retailers, or 20% of the group, experienced declining sales in fiscal 2006. Nearly half of these companies (24) are based in Europe. This was due, in large part, to a spate of demergers and divestituresIn today’s turbulent retail world, successful executives are cultivating their businesses to ensure sustainable growth over the longer term. The issues they face are daunting. Exacting consumers who prefer services over goods, an almost endless array of customer choices, fierce competitors, pervasive use of the online channel and a complex global economy are just some of the factors keeping retailers focused on finding ways to sustain and grow their businesses in the years ahead.
The puzzle?
Manufacturers, suppliers and retailers need to extend product availability while maintaining complete integrity of the supply chain, and maximum operational efficiency.
The path to the solution?
It may appear dark and tangled, with a confusing array of emerging standards and technologies, and political, economic and competitive pressures.
The prize?
Substantial. Improved on-shelf availability that delights the consumer and benefits everyone all the way through the value train: inventory visibility and increased product turns, improved and more efficient handling, and a truly optimized supply chain.
Global Powers of Retailing Top 250 highlights:
Strong global economy drives Top 250 gains:
The strong global economy continued in fiscal 2006, the financial period covered in this year’s report on the world’s 250 largest retailers. In the US, the housing boom reached its peak, thereby allowing consumers to cash out the additional equity in their homes. This, in turn, stimulated consumer spending. On the other hand, inflation began to rear its head causing the US Federal Reserve to tighten monetary policy. Europe and Japan both witnessed an improvement in economic growth while inflation remained low.

The big emerging markets of China, India and Russia continued to experience robust economic growth. In China, consumer spending rose at a furious pace, thereby making the world’s third largest retail market very attractive to the world’s leading retailers. India, too, attracted increased attention. Still, government restrictions meant that global retailers had few opportunities in this burgeoning market. Instead, indigenous companies began to invest massively in modernization and expansion. Finally, Latin America was a mixed picture, with strong growth in Argentina, Chile, and Venezuela, but modest
growth in Brazil and Mexico.
Although the global economy has begun to show some signs of stress, fiscal 2005 proved to be another healthy year for the world’s leading retailers. Total retail sales for the Top 250 reached $3.01 trillion, up 6.0% from last year’s Top 250 total of $2.84 trillion. Year-over-year growth, based on this year’s list of companies only, proved even more robust, with an 8.8% increase over the group’s prior-year sales of $2.76 trillion.

However, not every company enjoyed strong growth. Forty nine retailers, or 20% of the group, experienced declining sales in fiscal 2006. Nearly half of these companies (24) are based in Europe. This was due, in large part, to a spate of demergers and dive in the European market. Ahold, Axfood ITM, KarstadtQuelle, Littlewoods, and Modelo Continente, were among those who sold off significant operations in 2006. Deflation of goods prices also contributed to sales declines.
Consistent with this finding, the European companies as a group saw below average growth in 2006 as well as over the 2000-2006 periods, dragged down by France and the UK. Latin American retailers enjoyed the greatest growth, at double the Top 250 average.
The healthy gains in consumer spending translated into profitability improvements in 2006. Despite intensifying competition, enduring deflation, and value-seeking shoppers, the average profit margin for the 188 companies that disclosed their net income/loss figures was 3.5%. This compares favorably with last year’s Top 250 average of 2.7% and is a major improvement over the average profit margin in 2000 of 1.7%.
By geographic region, Latin American retailers were not only the fastest growing, but also the most profitable, with net income averaging 4.4% of sales, while Asia/Pacific retailers were the least profitable, on average. Among the “big five” retail economies, UK companies led the pack with a 5.5% average net profit margin. Germany, historically a low-margin market,
trailed the others with an average profit margin of just 2.0%. Of the companies that reported their results, only 15 retailers, or 8.0%, recorded a net loss in fiscal 2006. In 2004, 9.1% of the Top 250 companies had losses. In 2000, 18.5% were unprofitable.
Largest retailers gain more ground
The ten largest retailers continue to capture market share. These retail powerhouses (six US companies and four European companies) reported combined sales of $885 billion in fiscal 2006, or 29.4% of total Top 250 retail sales. This represents a robust 11.7% gain over their 2004 results, mostly as the result of continued strong organic growth.
Wal-Mart alone, with $312 billion in retail sales, accounted for more than 10% of the total. Despite difficulties abroad (failed German operation, exodus from South Korea) and a barrage of criticism at home, the world’s largest retailer continues to pull away from the rest of the pack. The industry Goliath is bigger than the second, third, fourth and fifth largest retailers combined. It is also bigger than the combined sales of the “smallest” 97 retailers on the Top 250 list!
Top 10 a relatively stable group
Wal-Mart has remained the undisputed leader in the retail world since Global Powers of Retailing was first published ten years ago. Actually, Wal-Mart assumed the position as the world’s largest retailer in 1990 and has held that position ever since. Carrefour has maintained the #2 spot for 6 consecutive years, having risen from #8 in 1996. Home Depot captured its current 3rd place ranking in 2002, rising rapidly over the preceding years.
Metro, #4 ten years ago, dropped to 6th place in 2001, before climbing back to the #4 spot in 2003. Tesco has seen a jump in the rankings similar to Home Depot. Currently at #5, Tesco ranked 18th in 1996. Sixth-place Kroger ascended the ranks from #13 ten years ago.
Target (formerly Dayton Hudson Corp.) climbed back into 7th place in 2005, surpassing Costco. Nevertheless, the chi-chi discounter has fallen back slightly from a 6th place high in fiscal 2002 following the sale of its Marshall Field’s and Mervyn’s department store divisions. Costco became a Top 10 retailer in 2002. Despite slipping one place to the #8 position behind
Target, Costco has risen 14 notches over the past ten years.
Sears and Kmart made return trips to the Top 10 in this year’s study as the combined entity Sears Holdings Corp., earning the 9th spot on the list. Sears, Roebuck & Co. was the world’s second largest retailer in 1996 and again in 1997. It then suffered a steady decline, bottoming out at #20 in 2004. Kmart, among the Top 10 until 2002, fell precipitously to #33 last year.
Rounding out the list, Schwarz Group has overtaken Aldi as the world’s biggest hard discount retailer, entering the Top 10 for the first time. The company rose from 11th place the year before. These two companies’ battle for a position among the Top 10 illustrates the growing importance of hard discounters in the global retail arena.
While the Top 10 retailers have been a fairly stable group over the past few years, a longer look back reminds us that the retail life cycle cannot be extended indefinitely without continuously adapting the business to changing market forces and competitive dynamics.
Ahold, ranked #3 just five short years ago and #9 last year, is no longer among the elite Top 10 as it continues to sell off operations around the world in an effort to reduce debt and focus on more stable markets closer to home. Whether the company’s restructuring is nearing completion or a break-up or merger of the company is imminent remains to be seen.
Albertsons LLC is all that remains of what was once the 2nd largest grocery chain in the US. As recently as five years ago, it was also the world’s 8th largest retailer. Pressured by shareholders to put itself up for sale, the company was sold to a consortium of investors in 2006.
Top 10 retailers by region
The Top 10 North American retailers are all US-based. All are among the top 20 retailers worldwide. The only significant change from last year’s list is the addition of Sears Holdings, which substitutes at #6 for 10th ranked Sears, Roebuck.
The Top 10 European retailers are based in 4 countries: France, Germany, UK and the Netherlands. All are among the top 25 retailers worldwide. Changes from last year’s list include Ahold’s fall from the 4th largest European retailer to #9 in this year’s study. ITM has fallen off the Top 10, having sold its German operations in 2005 to Edeka-Zentrale, which takes its place.
Seven of the Top 10 Asia/Pacific retailers are based in Japan. The largest, AEON, a diversified retailer operating a variety of formats, is #20 among the Top 250. The second-largest Asian retailer, Seven & I Holdings, is a new company established September 2005 by Ito-Yokado, Seven Eleven Japan, and Denny’s Japan. Hong-Kong-based AS Watson has also joined the Asia Top 10 this year as a result of numerous acquisitions. None of the Top 10 Asia/Pacific retailers is among the Top 10 retailers worldwide.
There are 9 retailers from Latin America among the Top 250, three of which are new to the Top 250 this year. The Latin American companies are based in Brazil, Mexico and Chile. All fall in the bottom half of the Top 250 list. Brazil-based Pão de Açucar, last year’s largest Latin American retailer, is now accounted for as part of France-based Casino’s international
operations.
The Africa/Middle East region has five companies among the Top 250. All are based in South Africa. Metcash Trading (Africa) has dropped from # 81 in 2004 to #230 in this year’s ranking, having sold its Australasian operations to Metcash Group.
Powerful forces drive globalization
Despite growing anti-globalization sentiment, globalization continues throughout the retail world. Slow growth in many mature markets and not-to-be-missed opportunities in emerging markets–particularly China, India and Russia–are powerful driving forces. In addition, global diversification is becoming increasingly important as a way to reduce economic, political and other risks.
On average, the Top 250 retailers conducted business in 5.9 countries in fiscal 2005. (This figure excludes Dell, Alticor (Amway), Avon and AAFES, whose global or near-global coverage would skew the average.) This same group operated in an average of 5.6 countries in 2004 and 5.0 countries in 2000.
Although international sales are becoming increasingly important to many large retailers’ growth strategies, foreign operations still account for only 14.4% of the Top 250 companies’ retail sales, on average, up 1.8 percentage points from 12.6% in 2005. Forty-three percent (107 retailers) have not yet ventured beyond their own borders. An additional 35 companies operate in just two–typically contiguous–countries, such as the US and Canada, Spain and Portugal, or Australia and New Zealand.
The biggest increases in share of sales from foreign operations have resulted from acquisitions, which enable retailers to enter new markets more rapidly than internal development.
Of the big 5 economies, Japan remains the most insular. Among Japanese Top 250 retailers, two-thirds operate only in Japan. Over half of the US-based companies (49 of 93 retailers) are single-country operators. Consistent with prior years, French and German retailers are the most international in scope, the result of anemic consumer spending, fierce competition, and a tough regulatory environment in their home markets.
Looking at the level of globalization by broad geographic region, European and African retailers dominate in terms of the degree to which they operate internationally. Faster growth in developing countries, largely in central and eastern Europe, beckons European retailers to look beyond their domestic
borders. The European firms in the Top 250 did business in an average of 9.9 countries in 2006. On average, these companies generated 28.1% of their sales from foreign operations. The 5 South African retailers on the Top 250 list operated in an average of 8.8 countries, primarily throughout the African continent. An average 13.0% of these companies’ sales are
generated outside their home countries.
Asian, Latin American, and North American retailers are the least likely to have foreign operations, although globalization is slowing accelerating. The US retailers on this year’s list operate in an average of 3.7 countries (excluding the “global” companies mentioned above). In 2000, these US companies operated in an average of three countries. Ten years ago (1996), the average was two countries.
Retailers contemplating global expansion opportunities should note the higher sales growth for companies with higher levels of globalization compared with those who have stayed closer to home. Average sales growth for single-country operators was 7.6% in 2006. For retailers operating in 10 or more countries, sales grew at double that rate. The difference in growth rates over the 2000-2007 period, while less pronounced, also favors the international retailer. A similar comparison can be made with the share of sales from retailers’ foreign operations. Those who derive 25% or more of their sales from outside their home market have grown at a far faster pace than those who do less than 25% of their business internationally.
US retailers continue to dominate
Although most US retailers are not major global players, US-based firms dominate the Top 250 list with 93 companies compared to 90 last year. These companies account for 37.2% of Top 250 retailers and 45.6% of top 250 retail sales volume. This represents a reversal of a trend that this study has noted over the past several years where the US share of both
measures was shrinking.
The 34 companies based in Japan are the second-largest group by country of origin. However, this is down significantly from 40 companies last year. On average, Japan’s retailers tend to be smaller, with their share of Top 250 companies almost double their share of sales.
By region, Latin America gained two companies, while Europe and Africa each gained one. Asia/Pacific experienced the only decline in share of Top 250 companies versus last year, with a loss of seven companies. To be among the
Top 250 largest retailers in the world required sales of at least $2.5 billion in fiscal 2005, up from last year’s $2.3 billion.
Specialty retailers swell the ranks
The majority of the Top 250 retailers are involved in the food sector, as has been the case since the inception of the Global Powers of Retailing reports. In fiscal 2006, 135 of the Top 250 retailers, or 54%, operated supermarket, hypermarket/supercenter/ superstore, cash & carry/warehouse club, hard discount and/or convenience store formats. However, the share of such companies is shrinking as more and more specialty concepts pursue international expansion and displace food retailers on the list. In fiscal
2000, 58% of the world’s largest retailers operated food-related formats. Ten years ago, that figure was 61%.
This trend points to a burgeoning middle class around the world with more disposable income to spend on apparel and home goods in addition to life’s basic necessities. This will give rise to more multi-national specialty retailers like H&M, Inditex, IKEA and Toys “R” Us. It also points to the globalization of fashion trends.
Companies whose dominant formats were specialty formats (apparel/ footwear, electronics, home improvement and “Other,” including sporting goods, furniture and home décor, toy and hobby shops, jewelry stores, etc.),
along with drug stores and convenience stores, performed much better than their food and general merchandise competitors. The “Diversified” group also reported solid sales and profits.
Diversification pays off
This year’s Global Powers of Retailing study also analyzed retail performance by dominant retail product sector. Companies were aggregated into four sectors: Fast-Moving Consumer Goods, Fashion Goods, Hardlines & Leisure Goods and, again, Diversified if none of the preceding three product sectors
accounted for at least 50% of sales.
Diversified retailers, operating formats across the food, apparel and hardgoods spectrum, enjoyed the strongest sales growth and profitability in 2005. Hardlines & Leisure Goods retailers also posted solid growth, although profit margins wereslimmer. Retailers of Fast-Moving Consumer Goods (essentially food, drug and mass merchandisers) are by far the largest group, with 133 companies. They are also the biggest. Eight of the world’s Top 10 largest retailers operate primarily food, drug and/or mass retail formats. This group performed somewhat below the average for the Top 250 as a whole. The Fashion Goods sector (retailers of apparel, footwear, jewelry, accessories and home textiles) was dragged down by relatively weak
department store results compared with the specialty stores.
These major retail sectors were also analyzed according to their level of globalization. This included the number of countries of operation as well as their share of sales from foreign operations. Not surprisingly, all four groups are becoming more global.
In 2006, the Fashion Goods retailers were doing business in 7.4 countries, on average, the highest among the four groups. As well, they had the biggest increase in number of countries from 2000 to 2006. While their foreign sales are relatively small by comparison, this will likely change as apparel demand grows rapidly in emerging retail markets. An international push is also underway among hardlines retailers. This is resulting in dramatic shifts in the competitive landscape as strong demand for homegoods propels the major consumer electronics and home improvement players into new markets.
The Fast-Moving Consumer Goods sector operates in the fewest number of countries, on average, although its share of foreign sales relative to the average number of countries in which these retailers do business is the highest. This is consistent with the fact that food, drug and mass retailers
tend to saturate a market before moving on to the next one. This is often accomplished by “buying” market share through acquisition of local players.
Analysis of market capitalization

This paper offers a useful ranking of retailers by size. Yet the size of a retailer is not a good predictor of future performance. Large size merely affirms that, at some point in the past, a particular retailer must have done
something right in order to grow so big. The market capitalization of a retailer, likewise, says something about past performance–even if quite recent–but not necessarily about the future. Yet can one draw any inferences about future performance by examining current financial information? The answer is yes–with many caveats. After all, if there existed a fool-proof way to predict winners, the shares of those companies
would instantly rise thereby cancelling out any opportunity to profit from the prediction. Instead, we can draw some general inferences about a company by examining its Q ratio.
What is the Q ratio?
The Q ratio is the ratio of a company’s market capitalization to value of its assets. If this ratio is greater than one, it means that the financial markets are valuing a company’s non-tangible assets such as brand equity, differentiation, innovation, first mover advantage, market dominance, customer loyalty, execution, and customer experience. A Q ratio of less than one indicates failure to generate value on the basis of non-tangible assets. Indeed, it indicates that the financial markets view a retailer’s strategy as unable to generate a sufficient return on physical assets.
Why is this useful?
Why is this of any importance? The reason is that, in an increasingly commoditized world, the best way that a retailer can generate positive margins is to clearly differentiate from competitors, convey information about its differences through branding, and maintain the freshness of its differences through innovation. In order to have any pricing power, retailers need to offer consumers a positive experience. The alternative is to offer
the same old experience and, consequently, compete principally on the basis of price (which many do). This is a recipe for margin destruction. Only the lowest cost leaders in a retail segment can compete on the basis of price. All others must do something else. Therefore, a high Q ratio indicates that the financial markets believe a retailer is doing the right things to succeed in
the current business environment. A Q ratio below one may indicate that the financial markets believe a retailer is failing to utilize its physical assets in a profitable manner.
One caveat, however. Some retailers are more asset intensive than others. Some lease stores rather than own stores. This fact can distort a Q ratio. Therefore, the Q ratio should be taken with a grain of salt.
Looking at the numbers
The Q ratio was calculated for the publicly traded retailers on this year’s list of the world’s top 250 retailers. Specifically, there are 167 companies for which a Q ratio was calculated. Using asset data from the most recent fiscal year and market capitalization data from Oct 2006, the average Q ratio for all companies on the list is 1.339. This compares with an average of
1.250 one year ago. Of the 167 companies on this year’s list, 84 have a Q ratio in excess of one. The remaining 83 companies have a Q ratio of less than one. Among the interesting highlights on the list are the following:
• When companies are ranked by market capitalization, the largest companies have a much higher average Q ratio than the smaller companies.
• When companies are ranked by five-year growth in market capitalization, the fastest growing companies have a much higher average Q ratio than those at the bottom of the list. This indicates that financial markets have confidence in those companies that have already achieved strong returns for
shareholders.
• Companies based in the US have the highest average Q ratio. Companies based in emerging markets also have strong Q ratios.







Global Powers of Retailing
2008
China
Does China have a normal economy? Rapid sustained growth may not be the norm for most countries, but it is certainly desirable. There are, however, other aspects of China’s economy that are neither normal nor desirable. Consider the structure of output. In most countries, investment represents somewhere between 20% and 35% of GDP. In China, it was roughly 44% of GDP in 2005, up from 34% in 2000. Of course strong investment is a good thing that leads to strong growth. But excessive investment creates problems, especially when it is driven by government plans rather than market forces. It leads to excess capacity, declining profit margins, and insolvency. Moreover, once government policy changes, the collapse of
investment down to a normal level could create serious transitional problems including a recession.
An especially abnormal aspect of China’s economy is the low level of consumer spending. Currently, it is just 41% of GDP, far lower than that of most countries (well above 50%). Meanwhile investment is at 44%. For investment to exceed consumer spending is almost unprecedented. In most economies, consumption is roughly double investment. The problem of low
consumer spending is that the economy is abnormally dependent
on relatively volatile investment and exports for growth, rather than more stable consumer spending. In addition, consumers are not fully reaping the rewards of strong growth.
Despite such high investment, gross savings is even higher at roughly 50% of GDP. This is due to several factors including a household savings rate of 30% of disposable income. Also, as mentioned earlier, private businesses in China are prone to retaining earnings rather than distributing profits to shareholders. This is because they require such funds to finance investment as capital markets are not especially open to private companies. State-run banks tend to lend mainly to state-owned enterprises.
It is the policy of China’s leaders to push the country away from growth based on exports toward growth based on domestic demand. The government recognizes that export growth is more vulnerable to volatility in the global economy. In addition, the government is keen to improve the living standards of greater numbers of Chinese households. Yet a successful transition
remains at risk due to China’s failure to radically reform its financial
sector. Moreover, the high level of consumer savings could retard domestic demand. This will probably not change barring an improvement in the country’s social safety net.
India
India’s economy continues to grow rapidly. In the first quarter of 2006, growth was 9.1%. The important question is whether this level of growth can be sustained. The answer depends on whether India’s stronger growth in recent years has been due to permanent structural changes in the economy, or due to cyclical and therefore ephemeral circumstances. First, some figures. By international standards, India’s growth has been quite strong since the mid-1980s. In the period 1988-1997 annual growth averaged 5.9%. In the period 1997-2002, it remained modest at 5.3%. Yet in 2002-2005, growth accelerated to 8.1%. This acceleration coincided with a huge level of investment in India’s information sector. Yet it is not clear to what extent that highly publicized investment made the difference. India’s farm sector had a strong harvest, and this may have been the principal cause of stronger growth. Three years does not make a trend. Only time will tell.
India has had a highly unusual growth model. In most poor countries, growth usually comes from low technology, labor intensive processes. In India, a disproportionate share of growth has come from high technology processes requiring skilled labor. In most poor countries, growth accelerates due to strong exports of manufactures. In India, service exports have played a key role. Finally, in most poor countries growth is accompanied by accelerated business investment. Yet in India consumer spending remains a very high share of GDP and is an important source of growth.
Is this model sustainable? Yes, growth will most likely remain strong. India’s economic reforms have improved the country’s prospects. Recent successes have caused foreign investors to take note and bring capital to the country. India’s vast ethnic diaspora has been pumping money and knowledge into the country as well. Moreover, the fact that India is not well integrated into the
global economy will actually be beneficial if the rest of the world should slow down. India’s growth is not especially dependent on the rest of the world.
There are, however, some factors that could threaten growth. First, the reform process has been hampered by political opposition within the coalition government. Privatization has been stalled and significant foreign investment in the critical distribution sector has not yet been permitted. Second, although the rise of China represents an opportunity for Indian
exporters of services, it also presents a challenge. China is becoming quite strong in IT-related services. India’s advantage in this arena could be gradually undermined.
Western Europe
Western Europe is at a difficult crossroads. Individual countries are finding it politically challenging to enact the kinds of reforms that might stimulate faster growth. In addition, the European Central Bank (ECB) faces conflicting demands. On the one hand, higher inflation countries such as Italy are experiencing real (inflation adjusted) currency appreciation versus the other countries of Europe due to higher inflation. The result is a loss of
export competitiveness. On the other hand, low inflation countries such as Germany and France are experiencing excessively high interest rates. The result for them is slow growth. The ECB has compromised with a policy of relatively high interest rates aimed at quelling inflation in those countries with an inflation problem. Yet this has harmed the low inflation countries. Thus, the euro experiment is not working as planned.
How could the euro project work better? Well, any region with a common currency requires several things to be successful. First, labor should be mobile. In Europe, while migration is permitted, it is culturally not feasible on a mass scale. Absent the euro, there would have been currency depreciation in some countries by now. Second, taxes and regulation should be limited. Consider the US. There, states compete for investment by
offering favorable tax and regulatory rules. In Europe, on the other hand, the EU offers harmonized regulation and requires that member states acquiesce. In addition, efforts at reform in individual countries have had dire consequences for politicians. Countries do not seem to compete for investment. Thus individual countries, lacking independent monetary policies, utilize few other policy levers to improve their economic performance.
One promising idea comes from Scandinavia where countries offer a compromise to resolve the tension between the nanny state and deregulation. In these countries, the nanny state has been retained in the form of heavy spending on education and infrastructure. Yet labor markets have been liberalized allowing for easier hiring and firing. Some see this model as the best future for Europe. One problem is that voters everywhere are divided about the appropriate role of government. Witness the recent close election experiences in the US, Italy, Germany and Mexico. What is the outlook for Western Europe? The answer is more of the same. While growth has accelerated lately, and is surprisingly strong in long dormant Germany, it will probably slow down in the coming year due to higher interest rates and a slowdown in the US.
Central and Eastern Europe
The new Central European members of the European Union are well positioned. They will enjoy the fruits of market access and will continue to experience growth at higher levels than in the West. Still, there are problems on the horizon. First, political support for the reform process is wilting as consumers suffer the frustration of unfulfilled expectations. After much progress on liberalization and fiscal rectitude, the possibility exists that this could be reversed in some countries. Second, these countries have worrisome demographics and no significant immigration as an offset. Indeed they continue to experience emigration, especially as the West is more accessible now. This could create problems in the future, both for government finances as well as for economic growth. For how, however, the consumer markets in these countries remain attractive.
Russia, too, offers opportunities in the form of high growth and relatively undeveloped retail markets. Yet there are concerns here as well. Demographics are poor and the population is actually declining as it ages. In addition, the high economic growth of recent years was largely the result of high oil prices. If this is reversed, growth could decline significantly. Finally,
political risk remains a factor as the government takes greater command of some sectors of the economy. Yet the consumer sector appears to be of little interest to the government.
United States
Is the US economic expansion on the verge of reversing? You wouldn't think so based on a number of economic indicators. The economy continues to grow, so much so that tax revenues have significantly exceeded expectations. Profits are very strong, even in the much derided manufacturing sector. This is due, in part, to the reduced costs associated with globalization. Employment growth has been healthy if not noteworthy and consumer spending has largely withstood the perils of higher energy prices.
Yet there are troubles on the horizon. Although personal income has been growing modestly, a continued skewing of income distribution has rendered lower to middle class households effectively poorer. Moreover, these consumers are the ones feeling the brunt of higher energy prices. It has been mostly the relatively affluent households that have kept spending growing. Yet their spending growth has been significantly in excess of their income growth. Now they face a problem in the form of a turnaround in the housing market.
The US housing market is finally showing signs of stress after a prolonged period of remarkable price increases. Housing prices in many markets appear to have peaked, inventories of unsold homes have increased, and turnover has declined. While a steep drop in prices is not likely, even a modest decline in prices will lead to a sizable decline in construction activity as well as home sales. More importantly, the end of housing price appreciation could have a profound impact on consumer willingness to spend. US households have relied on appreciating home prices to more than offset a decline in personal savings. Americans have felt wealthier and, therefore, more willing to spend. This has been especially true for relatively affluent Americans. Now the party appears to be coming to an end.
Is there anything happening that might offset the reversal of the housing boom? The answer is probably not. The pricking of the housing bubble was stimulated by an increase in short term interest rates designed to quell inflationary pressures. That rise, combined with a likely fiscal retrenchment by the federal government, will cause the economy to slow. The one factor that could stimulate growth is a likely decline in the value of the dollar. A lower dollar will stimulate exports by making them cheaper to foreigners. The problem is that the effects of a lower dollar will happen with a considerable lag–certainly not soon enough to offset the impact of higher interest rates, even if the dollar falls quickly.
One positive effect of a US slowdown would be to remove pressure from the global petroleum market. Oil prices will probably fall somewhat once markets become convinced that a US slowdown is underway. On the other hand, some part of the high price of oil has been due to perceived political risk in countries such as Russia, Venezuela, Nigeria, Iraq, and Iran. Predicting the path of such factors is nearly impossible.
Japan
Japan's economic recovery is underway. While it may never again achieve the fantastic growth rates of the 1980s, it will not return to the no-growth era of the past 15 years any time soon. If Japan had grown at a normal rate over that time, its people would be about 25% better off than they are today. There is, however, no point in bemoaning what might have been. The fact is that, having cleaned up the troubled banks, Japan is ready to invest and stop hoarding cash. In addition, Japan is poised to experience consumer-driven growth rather than relying almost solely on exports. Due to the aging of the population, consumers will rapidly cash out their savings, further driving down the personal savings rate. This increase in investment and decline in savings means that Japan’s huge current account surplus will decline–the counterpoint to a decline in the US current account deficit. Thus Japan's economic evolution will be a critical component in easing the global imbalance.
Today, it seems almost quaint to recall how Japan’s economic dynamism once threatened the confidence of Western companies. Governments responded with protectionism and threats of more. Japan no longer seems a threat. Yet Japan’s large, export-driven companies continue to perform well. Interestingly, the country's manufacturing production base continues to shift to other countries rendering Japan’s an increasingly service-driven economy. This is a natural evolution and could play an important role in reducing the cost of living in Japan.
Further economic reforms will also help reduce costs and stimulate more rapid productivity growth. There is considerable uncertainty on this point as the political costs of reform remain high. Still, Japan’s outlook seems better today than at any time in the last two decades.
Canada
Canada has benefited from the strength of the US economy. Now, with the prospect of a housing induced slowdown in the US, Canada is likely to experience a slowdown in export growth as a consequence. However, the consumer outlook in Canada remains strong. There are several reasons for this. First, Canada has not experienced a housing bubble, but has experienced an increase in housing prices that has not been reversed. The wealth effect of housing price gains should have a positive impact on consumer spending, Second, after-tax income has grown strongly, in part fueled by tax cuts at both the Federal and Provincial level. Finally, moderation in energy prices has put the brakes on interest rate increases. It will likely help to stabilize the currency as well.
Consequently, retailers can look forward to a good year in Canada. That may be one reason many foreign retailers are taking a renewed interest in Canada.
Latin America
Is Latin America moving toward the left? Not entirely. Some leftists remain free marketers (such as the leaders of Brazil and Chile) while some are socialists (Venezuela, Bolivia). And, of course, some rightists are hardly supporters of market economics. Labels don’t seem to mean much. What is clear is that opposition to market economics has gained some new and powerful voices. Still, the results of recent elections (Mexico, Peru) point to a nearly even split among voters about the appropriate choice of policies. There clearly remains considerable support for continuing on the path toward freer markets, especially from the rising middle class. Indeed the middle class probably provided the margin of victory for the PAN in Mexico. On the other hand, the rise of socialistic politicians means that even free market supporters will have to take steps to alleviate inequities. While the direction of policy is muddled, what is clear is that economic performance in the region has been disappointing.
Despite economic reforms during the past two decades, economic performance remains well behind that of Asia. The rise of China has been of particular concern in those countries where exports to the US have been of critical importance (Mexico, for example). On the other hand, the rise of China represents an opportunity to accelerate the export of commodities. Indeed commodity exporters have done well given the relatively high prices of commodities in the past few years. Witness the especially strong growth of Venezuela.
What can be expected in the next few years? First, commodity exporters could face a rude awakening if, following economic slowdowns in the US and perhaps China, commodity prices decline. Second, slow growth in the US will have a negative effect on overall exports from Latin America, thereby damaging growth. Finally, higher interest rates in the US could cause stress for Latin America’s borrowers. On the other hand, there is far more borrowing in local currency today than was the case in the past. Therefore, the risk of a financial crisis in the region is far lower than it would have been under similar circumstances twenty years ago.

The changing view of emerging markets
Although the global economy is riddled with substantial risks (imbalances, bubbles, and political problems), there is some good news that should not be ignored. It comes from the increased stability of emerging markets. Consider how the worldview of emerging markets has, well, evolved. China and India. That’s all anyone talks about these days. And while these two giants account for 40% of the world’s population, there are many other emerging markets which, combined, account for a sizable share of the world’s population and output. Moreover, these are important places to conduct business both in terms of producing goods and services as well as selling to local consumers and businesses.
The world has gone through a series of fads around emerging markets. Today, China and India attract attention to the exclusion of all others. Yet in the mid-1980s, the NICs (newly industrialized countries) were all the rage. These were Hong Kong, Singapore, Taiwan, and South Korea. Today, these four countries would hardly be classified as “emerging.” After all, Singapore’s per capita income is greater than that of most European countries.
The success of the NICs indicates that the attention back in the 1980s was warranted. Yet that success means you would no longer consider locating a textile factory in Hong Kong. In the 1990s, there were periodic fads around Latin America (first Mexico, then Brazil and Argentina), Southeast Asia (Thailand, Malaysia, Indonesia), and Central Europe (Poland, Czech Republic, Hungary). These countries attracted much investment in multiple sectors. Companies were attracted to economic liberalization, rapid growth, and skilled workforces.
Yet despite strong growth, these countries were at considerable risk. Each time emerging markets experienced strong growth and attracted the attention of the global investment community, something went wrong and investors were burned. High levels of foreign currency debt, low levels of foreign currency reserves, overvalued currencies, and poorly supervised financial institutions turned out to be a volatile combination. When global interest rates rose, crises ensued. Currencies were devalued, economies contracted, and global investors were burned. More importantly, ordinary people suffered as economies contracted and prices became volatile. Consider the experience of 1997-98 when a confluence of factors (high debt levels, inadequate reserves, poor banking supervision) led to sizable currency
devaluations and economic contractions in such disparate places as Southeast Asia, Latin America, and Russia.
Today, however, the risk of such turmoil is substantially lower. Many emerging countries are now able to borrow in their own currencies rather than in dollars and euros. Thus currency risk is lessened. Debt levels are far more manageable relative to exports. Moreover, many of these countries have built up sizable foreign currency reserves thus shielding themselves from attacks on their currencies. Thus the risk of sizable currency
movement is lessened. Finally, many emerging countries have improved their financial systems and set their exchange rates at more realistic levels. The result is that, although crises are not out of the question, they are less likely to happen.
On the other hand, the world’s second tier emerging markets (that is, all those other than China and India) face a serious challenge from the rise of China and India. Countries such as Mexico, Thailand, and Turkey are no longer the darlings of international investors. Instead, the seduction of China has attracted global companies in search of low cost suppliers.
Middle income countries, once the primary destination for such investments, must now redefine their roles. They must exploit their own competitive advantages. These could involve close proximity and access to end markets (Mexico, Poland), relatively high levels of skill and/or infrastructure (Malaysia, Czech Republic), or ability to service the commodity needs of the big emerging countries (Brazil, Argentina, Chile). The huge increase in China’s imports in recent years has actually been an engine of growth for some of these other emerging markets.

Eight new challenges facing global retailing
In today’s turbulent business world, the business issues facing successful retail executives are daunting. Exacting consumers who prefer services over goods, an endless array of customer choices, fierce competitors, pervasive use of the internet, and a complex global economy are just some of the factors keeping retailers focused on finding ways to sustain and grow their businesses. Traditional growth models focused on rolling out more stores and adding more SKUs no longer have the return on investment they once did. Yet despite the many challenges and pressures in today’s tough retail environment, a handful of retailers are significantly outperforming the market. As market forces compel retailers to revisit their growth strategies, the very largest retailers are thriving and so are some of the smallest. Those left in the vast middle are finding a very difficult environment for growth.
1)Value creation: a loss of consumer tailwinds
Over the last six-plus years, retail stocks have outperformed the S&P 500 by a stunning 135% in the US and by even bigger margins in Europe and Japan. Retail executives will point to superior strategy and execution as reason for this performance. What is more likely is that they were in the right place at the right time. Between 1996 and 2003, consumer spending as a share of GDP in the US rose from 66% to 70%, taking retail stocks up with them. In Europe and Japan, the consumer share of GDP has risen in recent years as well but to a less lofty share level in the high 50% range.
Prediction 1: Over the next five years, the share of economic growth in developed economies going to consumer spending will shrink as consumers retrench and government spending grows. The receding tide of consumer spending will take retail stocks down with it.
2)Cash rich, but investment challenged
Retailers across the globe have amassed an impressive hoard of cash. The problem is: only the very largest retailers seem to know what to do with it and even they seem to be struggling to get a favorable return on their investments. As a share of total assets, cash has soared over the past five years, following a similar pattern seen in other industries. As ranked by sales, cash hoards generally rise as business size declines. Part of the unwillingness to invest reflects growing CEO anxiety about the future. There certainly is no lack of things to worry about, including rising oil prices, worries over health and labor costs, new government regulations, concerns about consumer finances, political instability in the Middle East, fears of terrorism, and pandemics. Some of the cash windfall has been used to pay down debt as the financial leverage of the largest global retailers has fallen sharply. Some has been used to pay dividends. And yet, the shift to cash is hurting the financial performance of global retailers. Asset turnover (sales/assets) has slowed from 2.45 in 2000 to 2.17 in 2005, and return on net worth has fallen for the top 250 global retailers. Given the decline in these key metrics of financial performance, the dramatic rise in shareholder
value in the past five years simply cannot be sustained.
Prediction 2: Retailers will come under intense investor pressure to deploy their cash to improve asset turnover and shareholder value, resulting in more M&A activity, higher dividends, more debt reduction and more store openings.

3)Globalization backlash: sourcing comes home
Over the past 15 years, retailers have searched the globe to increase the uniqueness of their merchandise assortment and to keep costs down. In this pursuit retailers have greatly benefited by an expansion of free trade. As a result, China, Mexico, Brazil, India and even Vietnam are places that run large trade surpluses with the rest of the world that in the aggregate are no longer sustainable. Both Europe and Japan have also benefited from large trade surpluses with the US. These trade surpluses have enabled them to offset large deficits with other developing countries. If the US trade surpluses are lost, then the ability of Europe and Japan to buy from the rest of the world will also be limited.
Prediction 3: The combination of political and economic forces will increase the cost of, and reduce the access to, imports coming into the US, Japan and Europe. This will force retailers to search for higher-cost domestic sources.
4) Technology: The arrival of market transparency
In the past decade, consumer spending on information technology has skyrocketed and in country after country internet access has soared. In Europe, roughly 70% of all households have internet access. In Japan the number is slightly higher, in the US a bit lower. Those who are on the internet are younger, better educated and wealthier than their “unwired” countrymen. In some ways, consumers have reached a level of information parity with retailers. In the arms race between buyer and seller, the newest most mundane search technology is radically shifting the balance of power in favor of buyers. Before the internet, consumers had to go from seller to seller making inquiries, checking out different offers; in other words, they had to shop. The cost of search was real. Men were at a distinct disadvantage at this activity: Shopping is like forcing them to ask for the same set of directions, at least a couple of times.
Technology leveled the playing field for consumers in general by giving them access to information that once was only available to the largest businesses or the most adroit shoppers. In many ways, at least for those who are paying attention, Goggle has leveled the playing field by greatly increasing the transparency of the marketplace. The fear that the internet will turn branded products into commodities is potentially real for many product manufacturers.
Prediction 4: Information parity between consumers and retailers means that consumers will have more knowledge about products, pricing, features and product performance than sales associates employed by retailers, further reducing the value of and the need for retail workers who actually try to sell the consumer something.
Prediction 5: IT parity also means that more consumers will become retailers through auction sites or other means of electronically-facilitated commerce, taking market share from traditional retailers.
Prediction 6: IT-induced market transparency goes beyond pricing; it applies to every attribute of the brand mix. The use of child labor, environmentally unfriendly suppliers or other questionable activity can and will be unearthed by business hostile NGOs to discredit your brand and your business in the eyes of consumers.
5 )Digital business convergence: marketing to
the YouTube generation
Ten years ago there was a lot of talk about technological convergence. Your television and your computer would all become one seamless device. The technology has always been there to do this, but the application never really was–until now.
New YouTube statistics, as reported by Reuters, show explosive growth for the video sharing website. Launched in February 2005, YouTube now boasts:
• 60% of all videos watched online
• 100 million downloads a day
• 65,000 uploads a day (that’s 1,538 downloads per upload)
• 20 million unique users per month
• 29% of US online multimedia entertainment market
While much of the content on YouTube is amateurish, it is increasingly being used as a channel of communication to consumers. Music promoters were quick to use YouTube but were quickly followed by auto manufacturers like Nissan, sporting goods companies like Nike and other heavy advertisers.
At any one time, three to five of the top 100 most frequently watched videos will be ads. What makes YouTube different from television is its interactivity and the opportunity to engage in highly focused, viral and guerrilla marketing. Inundated with commercial messages, consumers have become ever more clever about filtering them out. Some of the more effective advertisements on YouTube are both entertaining and so subtle that it’s hard to even tell if they were meant to be advertisements.
By giving up the symbols of power, advertisers can make their audiences part of the message itself. Moreover, getting the customer involved with your message forces them to take some ownership for it. Breaking down the traditional boundaries between business and customer is the key to success in this new era of interactivity. YouTube is giving businesses more options on how to structure these relationships, and, in doing so, is providing for more effective ways of connecting to consumers and getting feedback from them.
Prediction 7: The success of online, on-demand video on sites like YouTube will lead to explosive growth in the use of this medium by traditional advertisers.
Prediction 8: The interactivity of video blogs will make them a tool used by NGOs and other activist groups to embarrass retail businesses they see as engaged in politically incorrect activities.
6) The changing face of the global consumer
and worker
Over the past 10 years, the age mix of the global population has been very favorable in keeping retail labor costs down and boosting retail spending. Over the next ten years, three significant changes will take place. First, the population in mature markets between the ages of 50 and 70 will explode, shifting consumer spending even further from goods and more toward experiences and services.
Second, relatively modest growth in the population between the ages of 20 and 35 will make it difficult to hire entry level workers while the decline in population between the ages of 35 and 50 will make holding on to middle and upper management challenging. In addition, the explosion in population over the age of 85 will draw societal resources toward health care and the maintenance of the elderly.
Finally, retailers in developing markets will have no such problems in finding a work force and consumers in the younger age cohorts. This demographic shift will produce developing economies that are more dynamic and risk taking and, as such, much faster growing than their developed world counterparts.
Prediction 9: Labor market demographics over the next decade will turn decidedly negative towards the retail business throughout most of the developed world, giving a boost to costs, and making hiring, training and retention critical to success.
Prediction 10: Consumer demographics over the next decade will turn decidedly negative towards the retail business, as consumer spending on services (travel, health care, etc.) ratchets up faster than does spending on goods.
Prediction 11: The shift in demographics points to faster retail growth in the developing world as the populations remain relatively young.
7 )A growing global middle class
While the middle class is shrinking or at best holding its own in the developed world, it is experiencing explosive growth in the developing world. The end of the cold war and the emergence of market-oriented governments in places like China, India and to a lesser degree in Latin America has created an explosion in wealth creation.
At the same time, markets create the one thing all retailers need: middle-class consumers. They also create inequality within countries. Even as the gap between rich and poor has increased, the size of the global middle class has exploded. In the past decade, the resurgence of the market has brought
about the dramatic growth of income in the newly developing parts of the world. From China to Eastern Europe, from Mexico to Malaysia, more households were added to the global middle class in the past ten years than in any time in history. By the next decade, the global middle class will approach 2 billion people. As a result, the next decade will be the decade of global retailing.
The growth in the global middle class has attracted the attention of global retailers. Among the 250 largest global retailers, 45 operate in 11 or more countries, up from just 5 such companies two years ago. The average number of companies of operation for this group is just over 7.
Prediction 12: Limited by mediocre growth prospects in the home markets, retailers in developed countries will increasingly turn to developing markets for growth.
8 )Lifestyle branding: searching for a multidimensional
bond
Unable to grow top line growth in existing mature business segments, more global retailers will take a page out of the Virgin Records play book and expand their businesses in other services and lines of trade. Getting brand permission from consumers is all about selling experiences, lifestyles, or solution, rather than products. Creating a brand experience, therefore, must begin with the consumer.
Successful retailers create strong brands that stand for something important to consumers—brands that speak to consumers in a way that is uniquely and explicitly relevant to their stage of life, self-image, culture, or specific shopping motivation. Building a business around a brand requires a clear definition of the brand and consistent delivery of the “brand promise.” Responsibility for the brand cannot be delegated to marketing alone. Ensuring an integrated brand experience–one that encompasses the entire customer experience–requires aligning the entire organization around the brand. Only then can a retailer truly leverage the power of the brand to drive sustained, profitable growth.
A good example of this is Starbucks, where customers get more than fine coffee–they get great service, first-rate music, and a comfortable and upbeat meeting place. Together, these elements create the Starbucks Experience. But Starbucks is becoming more than just a coffee company. Hear Music is the brand name of Starbucks’s retail music concept. Purchased by Starbucks in 2000, the Hear Music brand currently has three components: the music that each location plays and accompanying XM radio channel (XM 75); in-store CD sales, including Starbucks exclusives; and specially-branded Starbucks.
Hear Music retail stores. Now Starbucks plans to take its entertainment strategy to the next stage, films. Similar to its strategy in the music industry, the company seeks to become an innovator in the marketing and distribution of film.
New product launches contribute to Starbucks’s performance. Its retail stores offer a changing menu of seasonal flavored beverages. The company’s brand portfolio includes Tazo teas, Seattle’s Best Coffee, and Torrefazione Italia. These brands’ unique and innovative personalities allow Starbucks to appeal to a broad consumer base.
Prediction 13: In search of growth, more consumer businesses will expand into non-traditional product and service areas using the strength of their brand to expand their existing relationship with the consumer.