WAL-MART EXAMPLE

ERM PLAN OUTLINE

AC 861 / 450

Introduction. Seeking Expansion in Urban Areas, Wal-Mart Stores Gets Cold Shoulder (Excerpts, 9/25/06 WSJ, by Kris Hudson & Gary McWilliams).

Cities like Boston might be the best hope for Wal-Mart Stores Inc. to grow in the U.S. For the retail giant, that's a problem. For years, Wal-Mart, of Bentonville, Ark., thrived in rural and suburban America where land was cheap and local governments didn't interfere. Now Wal-Mart is trying to break into the last areas of the country where it isn't dominant, and the going is tough.

Behind Wal-Mart's push into this inhospitable terrain is the onset of middle-age. The company reported a 9.5% increase in annual sales last year, falling short of the double-digit pace it set in nearly all of its 34-year history as a public company. Sales growth at stores open at least a year slowed to a 3.4% gain, far from their 10-year high of 9%, a record reached in 1999.

It faces this challenge both in the U.S. and abroad. Hit by stiff competition from cut-rate retailers, strong unions and labor restrictions, Wal-Mart recently withdrew from Germany after eight rough years, taking a $1 billion charge in the process. In China, Wal-Mart has only 64 stores, or one for every 20 million Chinese. Its expansion, which includes plans for another 18 to 20 stores this year, is subject to the whims of China's Communist Party.

Investors are skeptical whether Wal-Mart can continue to rely on U.S. expansion to sustain its growth. Wal-Mart dominates rural America, with 45% of its stores located in rural and semi-rural counties, according to market researcher ACNielsen. Yet sales gains at new stores, located mostly in urban areas, are lower this year than last, indicating that urban shoppers might be turning up their noses.

The bottom line: Must find a way to generate continuing growth, which will result in high stock prices, inexpensive sources of capital, and the time and resources required to solve its inevitable “middle-age” problems.

Strategic Objective (E 3.2, page 14). Wal-Mart's strategic objective is to remain the world's most efficient, low cost retailer of household items. It is illustrated by its ubiqitous “always low prices” slogan. Its greatest risk factor might be a change in consumer tastes; competition from some unforeseen source might also be a risk.

The bottom line: Must remain focused on low costs, low prices, and thus high volumes.

Operations Objective (E 3.2, page 15). Wal-Mart's operations objective is to maintain massive economies of scale and tiny inventories, thereby allowing it to charge low prices. Its greatest risk factor might be the obsolescence of its computer systems, allowing competitors to “leapfrog” it by employing superior technology.

The bottom line: Low costs must be achieved through technology and geography.

(Financial) Reporting (E 3.2, page 15). Wal-Mart's financial reporting objective is to maintain historical revenue growth rates in the face of saturated markets. It is illustrated by its global initiatives, particularly in high growth markets like China. Its greatest risk factor might be a decline in its stock price multiple as investors reclassify it as a “mature” firm.

The bottom line: A geographic diversification strategy can help lower costs and maintain growth.

(Legal) Compliance (E 3.2, page 15). Wal-Mart's legal compliance objective is to ensure that all employees worldwide respect labor and environmental laws. Its greatest risk factor might be a loss of control over employees in remote markets who “cut corners” in order to remain cost efficient.

The bottom line: Geographic growth into unfamiliar corners of the globe may lead to significant ethical and cultural challenges.

Internal Environment (E 2.7, page 10). Wal-Mart emphasizes the quality of its work force through a code of conduct that stresses teamwork, learning, professional competence and integrity, honesty, and independence of mind. Such qualities become progressively more difficult to instill and enforce in a work force that is growing rapidly across cultural boundaries.

The bottom line: We believe that our domestic culture is strong and reliable ... but will it translate globally?

Objective Setting (E 3.8, page 19). If high inventory turnover is the key to low costs, and if a high quality work force is the key to high sales volume, then a pair of suitable objectives may be (a) maintenance of a turnover ratio of at least 12 x per year in each of Wal-Mart's major business regions, and (b) maintenance of consumer confidence scores of at least 80% in each of these regions.

The bottom line: We also have concerns, globally and domestically, about our ability to track consumer perceptions regarding our culture.

Event Identification (E 4.1, page 22 and E 4.7, page 27). Let's select China expansion as the greatest risk factor, an issue that “cuts across” all objectives because: (a) Wal-Mart's knowledge of Chinese tastes is questionable, (b) its computer systems may be incompatible with those of Chinese suppliers, (c) it might be disappointed by its growth potential in China, and (d) language and cultural barriers might complicate its control and oversight activities. The greatest potential event and related impact (see E 4.1) might be the hiring of unqualified staff, resulting in higher costs and lower consumer confidence. The escalation trigger (see E 4.7) for these events might be a 10% decline in inventory turnover and a 10% decline in consumer survey scores.

And thus the following chart presents the plan. Please note that the “escalation trigger” is a 10% decline from any historical level. For instance, if consumer confidence soars to 90% and then slumps to 81%, a “risk response” (see below) may be triggered even though 81% exceeds the target of 80%.

The bottom line: Our greatest risk is hiring unqualified employees in China, leading to brand deterioration and declining turnover.

Risk Assessment (E 5.3, page 36). There is a low risk that extremely unqualified employees will fail to learn to use the inventory systems, resulting in frequent stock-outs of high demand items. There is a high risk that modestly unqualified employees will fail to keep track of the evolving tastes of consumers, resulting in modest declines in sales volume.

The bottom line: “Unqualified” is most likely a function of education and not of ethics.

Risk Response (E 6.1, page 55 and E 6.5, page 59). Avoiding China is not an option. Reducing risks through greater employee training might be an option, although it may prove expensive if labor shortages persist. Sharing the risk by hiring local Chinese retail management firms may prove expensive if the local firms “steal” proprietary techniques and technologies. And acceptance of risk through the absorption of cost is possible, given Wal-Mart's capital base, but it may lead to further declines in stock price. A cost benefit analysis may conclude that the most effective strategy is greater employee training, combined with limited absorption of cost.

And thus:

The bottom line: We'd love to fly every Chinese trainee to the US, but will need to make do with a “train the trainer” approach in China.

Control Activities (E 7.1, page 63). Wal-Mart should invest significant resources in creating a global pool of well trained employees. Such a pool would require annual training programs, job placement activities across regional areas, and a universal approach to personal and professional development. It may also be necessary to institute a common set of qualifications across all job functions worldwide, even though such activities run “against the grain” of a firm that has traditionally shunned costly bureaucracy.

The bottom line: Training is a “prevention” control; consumer surveys are “detection” controls.

Information and Communication (E 8.4, page 71 and E 8.15, page 81). Information must flow in BOTH directions between China and the US, as well as between Chinese management and Chinese workers. It may also be helpful to institute direct communications between workers in China and the US without managers serving as intermediaries. Such communications vehicles may include conference calls, email newsletters, chat rooms, and occasional face-to-face meetings.

And thus:

The bottom line: Trans-Pacific communication must flow in two directions: data to America and guidance to China.

Monitoring (E 9.1, page 85). Because employee competence is a critical success factor, management should review key indicators that are focused on independent evaluations of employee performance. Such evaluations may be completed by customers, vendors, and other constituents of the organization.

The bottom line: Rely on consumers (and perhaps other local stakeholders as well) to monitor employees.

Roles and Responsibilities (Applications, E 10.7, page 101). After comparing the benefits and costs of a risk committee against those of a chief risk officer, a composite “Office of Risk Management” is recommended for purposes of monitoring the China initiative. The approach is to emulate the roles and responsibilities of a chief risk officer, but to do so within an “office” format that can encompass activities in both America and China as a unifying mechanism.

The bottom line: An “office” of risk management may be awkward, but it is necessary to embrace the global diversity of the firm.

Limitations (pages 93 to 96). Although Wal-Mart has traditionally adjusted to risk management limitations by relying heavily on trustworthy long time employees, such individuals may be ill equipped to manage the type of social evolution that is likely to continue in China.

The bottom line: We may need to look for opportunities to insulate the parent company against such risks.

What To Do (page 97). We suggest the immediate formation of an Office of Risk Management in China, functioning closely with the local Human Resources function. The Office should immediately contact the following organizations:

The bottom line: Establish a risk management office in China first, and leverage existing company resources.