Wharton Marketing 2

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ApproAches for retAilers

Vol. 2

http://executiveeducation.wharton.upenn.edu http://knowledge.wharton.upenn.edu

WhArton onMarketing


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Wharton on Marketing Approaches for Retailers, Vol.

With internet sales rising and virtual storefronts expanding into consumers

homes, how should retailers plan forand promoteonline shopping? And, arethe ground rules the same as bricks-and-mortar shopping, or would it be smartto adjust pricing according to who is shopping online and when? These are someof the newer issues that retail marketing executives are facing, along with anincreasing awareness of the importance of maintaining customer satisfaction inthe virtual and nonvirtual storefront and the value of customer loyalty programs.Meanwhile, bargain retailers like Wal-Mart, facing saturation in their targetmarket, are looking for ways to grow by appealing to upscale shoppers. Thefollowing articles from Knowledge@Wharton take a look at whats in store for

retail marketing.

Approaches for Retailers


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Cant Find That Dress on the Rack? Retailers Are Pushing More Shoppers to the Web 4

Shoppers with tastes or sizes that fall outside the mainstream may have more trouble finding what they wantin stores as retailers attempt to shift low-volume items to Internet sales. According to Wharton faculty andindustry analysts, retailers are paring back in-store selections in order to save inventory handling costs as wellas precious floor space. The strategy, however, has its drawbacks.

What Consumersand RetailersShould Know About Dynamic Pricing 7According to a recent study, 64 percent of consumers who shop on the Internet do not know that it islegal for an online store to charge different people different prices at the same time of day. Yet dynamicpricing is not new. Retailers have been using it for years in ways that benefit not just themselves but alsotheir customers. The challenge is to establish dynamic pricing in ways that lead to profitability rather thanprice wars.

The Lowdown on Customer Loyalty Programs: Which Are the Most 10Effective and Why?When making a purchase, a consumer has a choice between using frequent-flier miles, cash, or somecombination thereof. Which will she choose? And whats the best way to motivate the customer to participatein a frequent-flier program? Wharton Marketing Professor Xavier Drze and Joseph C. Nunes of the Universityof Southern California have spent several years studying how customer loyalty programs can be structured togenerate the most revenue for companies offering them.

Beware of Dissatisfied Consumers: They Like To Blab 14When consumers have a bad shopping experience, they are likely to spread the wordnot to the storemanager or salesperson, but to friends, family, and colleagues. Overall, if 100 people have a bad experience,a retailer stands to lose between 32 and 36 current or potential customers. These are some of theconclusions of The Retail Customer Dissatisfaction Study 2006 , conducted by The Jay H. Baker RetailingInitiative at Wharton and The Verde Group, a Toronto consulting firm. The biggest source of consumerdissatisfaction? Parking lots.

Wal-Mart: Is There a Downside to Going Upscale? 17After saturating its target market of bargain-hunting consumers, Wal-Mart is ratcheting up its low-pricestrategy to appeal to more upscale shoppers by expanding its merchandise lines to include organic foods,better wines, high-end consumer electronics, and new fashion-oriented apparel. Its an approach that carriessome riskincluding new challenges for its legendary supply-chain systemsay Wharton faculty and analysts,but the move is dictated by intense competition and the lack of other opportunities for growth.

Contents

007 University of Pennsylvania Wharton Executive Education Knowledge@Wharton


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shoppers With tastes, or sizes, that falloutside the mainstream may have moretrouble finding what they want in stores asretailers attempt to shift low-volume items toInternet sales.

According to Wharton faculty and industryanalysts, retailers are paring back in-storeselections of odd sizes or offbeat colors inorder to save inventory handling costs as wellas precious floor space. At the same time,stores are trying to coax shoppers looking forlow-selling merchandise to special order thoseitems or buy them through the ret ailers web

sites. The merchandise is then shipped directlyto customers homes.

Retailers have always feared operationalproblems leading to stockouts (items and/orsizes that are out of stock) and lost sales. Now,stores are generating intentional stockoutsbecause they have the opportunity to capturelost sales through the Internet. Slow-movingitems can be efficiently sold using the website, but not the stores. So when the customercomes into the store and wants an item thatis a slow-seller, he or she can get redirected,says Grard Cachon, Wharton professor ofoperations and information management.

Items with few takers can clog a retail supplychain, add cost to the distribution system,waste expensive retail square footage, and,ultimately, lead to costly markdowns.

As retail operations have expanded into mega-stores across the country and the world, ahandful of losers in the merchandise mix ateach location can grow into a big problem, says

Cachon. When theres so much variety and youhave an item that sells maybe four or five timesa year, millions of those items can add up tosubstantial amount of sales. You can effectivelysell those items through a consolidatedwarehouse, but you cant put them in hundredsof Best Buys.

Wharton Marketing Professor Barbara Kahn saysretailers who intentionally dont stock some

items still run the risk of turning off individualshoppers. She notes also that because retailerscan offer a better assortment of merchandisethrough the Internet, consumers benefit overall.From the single consumer point of view, theone who wants the odd size, this is not thebest approach: It would obviously be preferableto have the item right there, says Kahn. Butif you think of the portfolio of consumers, thenits a different story. I would imagine the savvyretailers are maximizing their floor space toappeal to their best, high-value, loyal customersrather than catering to every taste, but at thesame time they are servicing those one-offtransactions by facilitat ing the online purchase.

Getting the Tangible ExperienceDaniel Corsten, a former visiting professor

at Wharton who now teaches at the LondonBusiness School, says hes not convinced thenew strategy of pushing in-store customers tothe Internet will work. What happens is t hestore turns an impulse buy into rational buying.You come into the store and you want to buysomething, but it is not there. You realize youwere intrigued about buying [the item], but nowyou have to rationalize it. You ask, Do I really

Cant Find That Dress on the Rack? RetailersAre Pushing More Shoppers to the Web


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want it? This breaks the purchasing process. Allof a sudden you think twice.

The new strategy stems from retailers desireto consolidate in-store operations with Internetsales, which now account for 10 percent to 15percent of revenue, says Corsten. He warns thatwhile retailers are wise to give the Internet moreattention, the two channels do not necessarily

appeal to all customers. People go to a storebecause they like going to a store. They alreadychose not to go to the Internet, says Corsten.If I go to the Internet and make a purchase, Imhappy. If I go to the shop and make a purchase,Im happy. But if Im being shifted from the storeto the Internet, then my purchasing processchanges. Yes, I get the full assortment virtually,but I wanted the tangible experience.

According to Corsten, retailers that do not stocka full assortment of items risk losing directsales, but also sales of complementary items.A retailer choosing to pass on carrying certainsizes of jeans will also lose sales of belts andtops to the customers who wear those sizes.

Strategically, he says, if all stores sold only thebest sellers, all retailers would begin to lookalike. Retailers would lose their competitiveadvantage, and customers would then shop onlyfor the cheapest price or at the closest store.

In order to identify customers who have notfound what they are looking forbecause its

not thereand then convince those shoppers tospecial order or buy over the Internet, requiressophisticated, well-trained salespeople, headds. Finding great st aff is always critical, hesays. And a knowledgeable staff is expensive.

Serguei Netessine, Wharton operations andinformation management professor, saysWharton research has found that out-of-stocksare more of a problem than retailers think.Computer records often indicate an item isin the store, but if the customer cant find it,or its in a storage area or was shoplifted, theshopper leaves with the impression the store isout of stock.

According to Netessine, retailers typicallybelieve their in-stock rate is 95 percent to 98percent, but when customers are surveyed,they report the rate to be 75 percent to 80percent. Its only half the story to have theitem in stock, he says. The other half is to

make sure the customer is able to f ind it.Research indicates the most important factor indetermining whether customers are able to findan item is having knowledgeable employees onthe shop floor that can locate it, he adds.

Finding the Size 13 ShoeKevin Freeland, president of Optimal Advantage,

a Minneapolis retail consulting firm and aWharton guest lecturer in operations andinformation management, agrees that the trendtoward shifting marginal sales to the Internetincreases overall consumer selection.

Earlier in his career, he worked in inventorymanagement at Payless Shoe Source, wherethe average store was just 2,400 square feet.Even in the late 1980s and early 1990s, thechains inventory was undergoing triage asmanagers eliminated low-selling size 12s and13s from their assortment. Back then, hesays, the customer had no alternative. Thesalesperson would have said, We dont carrysize 13, and the person would have gonehome disappointed. There has always beenrationalization in the retail store. The significantdifference is that today theres an alternativeway to purchase those items.

Michael Zisman, a Wharton guest lecturer andmanaging director of operations at InternetCapital Group, says this emerging retail strategywould never have been possible without the

rise of FedEx and UPS to carry out the finalphase of the distribution process. He notes thatstores have different policies about shippingpayments. Many offer free shipping if thecustomer orders the item while they are still inthe store. Internet shoppers usually must pay.

Zisman says shipping costs are no longer abarrier to consumers who are willing to spendsome money in order to save time. Consumersare also now comfortable with ordering overthe Internet, he adds. People are acclimated to

using the Internet now. If a store doesnt havewhat you want in stock, youre not insulted,whereas 10 years ago you would have said, Illgo somewhere else.

To make distribution more efficient, newcompanies are springing up to carry theinventory and ship it, according to Zisman, whois a director of Vcommerce, an Arizona firm thathandles logistics for retailers. These companies,


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he says, can take on the responsibility forcarrying inventory and reduce the time it sits onretailers books.

He argues that the shift toward more-efficientinventory handling could invigorate the overalleconomy, citing February 2006 U.S. Censusfigures showing that retail sales make up abouta third of the nations $12 trillion economy.

Retail goods inventory is about $472 billion. Ata carrying cost of 30 percent, this representsa real cost of $150 billion, or 3.75 percent ofsales. The economy cant run with that sort ofinefficiency. If the whole economy can reduceits investment in inventory, everybody wins.

Beyond the logistics implications of shiftingin-stores sales to the Internet, there are somemarketing boons to planned scarcity. Zismansays he recently skipped a trip to his localcomputer store on a Saturday to purchase aLynksys router from Dell online. The deliverywas shipped by Dell on Monday and wasinstalled and working on Tuesday, leaving Dellwith very little cost of carrying the inventory.

On top of that, 2 days later, Zisman receivedan e-mail advertising a sale on PCs from Dell,which had now acquired his e-mail address andother marketing information. Zisman pointsout that Dell took no brand or credit risk in thetransaction and faced only a slight risk that hewould return the item.

Pushing the Quick BuyAccording to Netessine, some retailers, like theSpanish retail chain Zara, keep inventory low tomake the most of scant retail space but alsoas a marketing strategy. Quick inventory turnsencourage shoppers who might be waffling on apurchase to buy or risk losing out completely. Ifyou have low inventory and update fashions veryquickly, then the customers know that whenthey come into the store, whatever they see isnot going to be there tomorrow, says Netessine.

The strategy helps the retailer in two ways, hesuggests. First, it prevents consumers fromwaiting for an end-of-season sale to buy theitemat a lower profit margin for the store.Second, it encourages more frequent storevisits by customers who dont want to missout on new merchandise. Once they are in thestore, theres a chance they will buy.

William Cody, managing director of WhartonsJay H. Baker Retailing Initiative, says someretailers are attempting to pare down in-storeinventory to maintain a clean, boutique look.Stores that are crammed with merchandisesend a signal to consumers that clearance salesare soon to follow. The old retail adage was,Pack it high and let it fly, says Cody. Butthats a d iscount mentalit y.

Many clothing stores, he adds, are followingZaras lead and trimming back what they carryon the floor. Apparel retailers are moving awayfrom racks and racks of clothing to a cleanerpresentation of the merchandise. It moves thestore away from a discounter image. Thatsimportant to give more price credibilit y.

The approach may work for Zara or otherfashion-oriented retailers with the technologicalcapability to turn merchandise quickly, Netessinesays. The strategy might not work so well with agrocery chain selling a basic item, like detergent.If you go to the store and just want to buydetergent, you are more interested in thedetergent being in stock than some new andimproved version, he says. With clothing, oftenyou dont go in with a specific product in mind.So it will be easier to subst itute. Cody addsthat grocery stock-outs could also damage the

retailers relationship with its partnering vendors.

Corsten agrees that shifting low-volume salesto the Internet may be more effective for someitems, such as electronics, which are standardbrands, or appliances, which would be delivereddays later anyway. But for apparel and moreimpulse-driven decisions, the push to limitinventory might backfire. He says research onconsumer reactions to items that are out ofstock shows that people are willing to switchstores or come back for planned purchases forhigh-involvement items such as cosmeticsor hygiene products. For low-involvementproducts and impulse purchases, they maysimply not make the extra effortand the saleis lost for good.

Coaxing shoppers from store aisles to theInternet might work for many items, he adds,but it will definitely take the magic out of theshopping experience .

Retailers Internet sales now accountfor 10 percent to 15 percent of revenue.


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007 University of Pennsylvania Wharton Executive Education Knowledge@Wharton 7

a study released in 2005 by the AnnenbergPublic Policy Center of the University ofPennsylvania was provocatively entitled Opento Exploitation: American Shoppers Online andOffline. It concluded that American consumersare vulnerable to subtle forms of exploitationby marketers.

Much of the study, which was based on atelephone survey of 1,500 adults, focusedon privacy issues dealing with the collectionof information about consumers. But it alsoexamined peoples knowledge of pricing.It found, for example, that 64 percent of

respondents who had recently used theInternet did not know that it is legal for anonline store to charge different people differentprices at the same t ime of day. In addition, 71percent did not know that it is legal for bricks-and-mortar stores to do the same thing.

Is this type of pricing, known as dynamicpricing, underhanded or unethical? No, accordingto faculty members in Whartons Marketingdepartment. They say such pricingalso calledtargeted pricing, flexible pricing, tailored pricing,

or, to use the phrase employed in the Annenbergstudy, discriminatory pricingis customary,an essential tool for companies, and oftenbeneficial to individual customers and societyas a whole. Does dynamic pricing sometimesupset consumers? Research shows that peopledo get disturbed if they learn that they paidmore than someone else for the same item. Butthat happens because they often do not knowmuch about the factors that go into a companysdecision to set prices, are reluctant to ask for alower price, or find bargaining distasteful. And,of course, the people who get bargains are notat all likely to be disappointed or feel exploited.

Dynamic pr icing has a lways been with us,says Wharton Marketing Professor PeterFader. Think of the classic hagglers in themarket of a Middle East bazaar. People willpay very different prices for the same bolt offabric. This is more the norm in transactionsthan fixed pricing. Fixed pricing is a much

later phenomenon, and its an artificial one.Companies must engage in flexible pricingpractices in order to honor their responsibilitiesto their shareholders. If retailers charge a flat,low price to make everyone happy, theyreleaving a lot of money on the table.

There is nothing really new here, agreesWharton Marketing Professor Z. John Zhang.The only thing new is that the Internet hasgiven companies so many different ways toset prices and adjust prices. Notes StephenJ. Hoch, chairman of Whartons Marketingdepartment: People are exposed to dynamic

pricing all the time. Do they understand[everything about it]? No. But they understandsenior citizen discounts and student discounts.

To be sure, not all pricing strategies arepermissible. Collusion by competitors in anindustry to fix prices violates the law, as doesthe use of race or gender to target customersfor different prices or other discriminatorytreatment. In addition, if retailers use dynamicpricing in such a way that it angers customers,they can erode customer loyalty, spark abacklash, and lose business. But dynamicpricing is common. Different customers in anautomobile showroom at the same momentcan end up purchasing the same vehicle with

the same extras for wildly divergent prices,depending on their knowledge of the carbusiness and their negotiating skills. People withpoor credit histories may pay higher interestrates to the same credit card company thanpeople with stellar credit scores. If you are ahighly profitable customer, a telephone companymay offer you $50 to switch to their services,but it may offer only $20 to your less profitable

What Consumersand RetailersShouldKnow About Dynamic Pricing

Sixty-four percent of surveyedInternet users did not know that itis legal for an online store to chargedifferent people different prices at thesame time of day.


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neighbor for switching. And who has not sat onan airplane wondering whether the passenger inthe next seat paid a lot less for her ticket, eventhough she bought it on the same day?

Or consider the vacationer who, on a hot day atthe beach, decides that he wants a cold beer.He can walk one block north to the luxury hotelalong the boardwalk and pay $5 for a bottle. Or

he can head one block south to a corner bar andpay $2. Its the same beer, but people wouldntbe at all offended to pay $5 at one place and $2at the other, Fader says. People understandthis. These are business issues more than legalor e thical ones.

The Internet has given online retailerstremendous opportunities to collect dataon customer behavior and target people fordifferent prices for the same merchandise.Website operators not only know what itemscustomers put into their shopping basketsbut what items they remove before checkingout. Retailers can monitor behavior for longperiods of time and figure out what webpages customers visit, which items theylook at, and which products make particularcustomers happy. Online merchants also cantell if someone is a serious or casual shopper.Nonpurchase visits to a site may tell theretailer as much about customers as thosevisits when they fill up their shopping carts.

But precisely how retailers should tailor their

prices based on customer behavior is notalways readily apparent or predictable. Forexample, should frequent customers always beoffered better prices or more frequent discountsthan those customers who are not as loyal?

Theres not an obvious answer, Fader explains.You can make two good arguments. If youre afrequent customer, maybe retailers should chargeyou more because they have you locked in andcan rely on you for your business. Or maybethey reward your loyalty and charge you less. Ifa retailer makes the wrong decision, they canlose a good customer and leave money on thetable. Retailers have to look at not just how oftenany given customer has been to the websitebut when they visited, what they bought, andwhether their transactions were high margin.There are no simple rules of thumb. Retailersmight be better off picking a few customers andgiving them a special price today. Companiestend to be uncreative in the way they approach

these questions. They look for black-and-whiteanswers rather than nibbling at the edges.

Indeed, says Fader, there will be times whencompanies make bad decisions and chargetoo much, tick people off, and lose them ascustomers. But that, he says, is the beautyof a free market. If a company does dynamicpricing badly, theyre going to lose customers

and get beaten to a pulp.

Forget Big BrotherIt also is important for consumers not toconjure up images of Big Brother-style retailersdoing all in their power to take advantage ofthem, according to Hoch. Even though retailershave the ability to collect tons of information,many do not bother to gather it at all, andothers are inept at using it effectively. Theresa lot of data you can collect about onlineclicking behavior, he explains. Most onlinemerchants dont collect that information anddont analyze it. The assumption is that thesecompanies actually are very effective at all ofthese different practices. Theyre not .

There are occasions, too, when flexible pricingdoes not work in the best interests of the firm.If you are the only firm in the marketplace andhave a near-monopoly, or if your competitorsare slow in reacting to what you do, you havepricing power, notes Zhang. You know somecustomers are willing to pay more for your

product, and some will pay less. So its goodfor you to charge different prices to differentpeople based on their willingness to pay. Thishas been shown in many studies.

If, on the other hand, a marketplace is crowdedwith many competitors, dynamic pricing may bea mistake because it can lead to a price war anderode profit margins, Zhang says. If everybodyhas pricing flexibility and uses that flexibility,theyre all going to bid for every customer inthe marketplace, and competition is going to

intensify. This is not necessarily good for thefirm. In such an environment, the company thatstands the best chance of emerging the victorwill be one with a large loyal following, goodquality products , and a good brand image.

There are occasions when flexible pricing canbenefit society, Zhang adds. Pharmaceuticalcompanies can sell drugs at lower prices topoorer people who need them because they


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charge higher prices to those with the meansto pay more. If a drug company can set onlyone price for every customer in the market,that price will be low relative to those who areprice insensitive and can afford to pay moreand too high for those who cannot afford to paymuch at all. But if a drug company engages indiscounting, it can charge less to those whocannot afford to pay much. As a result, the

company can expand its market, and societycan benefit in a number of ways. More peopleare going to use the drugs, and the profitabilityof the firm is going to increase, allowingthe company to conduct more research anddevelopment and turn out more drugs. Thatswhy no economist will ever say that we shouldban price discr imination, Zhang states.

Transparent Price DiscriminationMarketing Professor Lisa Bolton has conductedresearch examining perceptions of price fairnessand found that people use three referencepoints to determine what price they feel is fairfor any given product: what the product costin the past, what competitors charge for theproduct, and the costs associated with a product.

Bolton found that most people simply misunder-stand the many factors that companies considerin setting prices. Consumers underestimate,for instance, the impact that inflation has oncompanies costs. When they compare pricesacross competitors, consumers often feel that

all merchants should simply charge the sameprice for the same item, not taking into accountthe possibility that the department store acrossthe street may charge higher prices because itscosts of doing business are higher. Moreover,consumers too often focus on the cost of thephysical materials required to make a productand neglect other manufacturing costs.

According to Bolton: People will say, Its just acotton T-shirt, how can you charge that much?Or they say of a drug, Its just a little pill, whydoes it cost so much?

By and large, consumers also feel thatpromotional costs for products and services areunfair and that the salaries of senior executivesare unfair too. The bottom line, says Bolton,is there is a general perception that prices areunfair. Researchers dont understand well enoughhow consumers perceive the marketplace, whatwe call marketplace metacognition. People livein a capitalistic society and believe in the free-

market system, and yet they dont seem to beknowledgeable about it.

Marketing Professor Jagmohan S. Raju sayscompanies can engage in flexible pricing ina way that minimizes customers potentialantagonism: They can be more open about whatthey are doing. Companies are recognizingits important to be fair, and customers arebecoming more knowledgeable about what isgoing on with pricing. They want things to bemore transparent. Transparency does not meannot charging different prices; it means companiesbeing open about their strategies. Companieswant to make sure their existing customers arehappy, and their prices have to be in line withthat goal. There is a recognition that customersare more knowledgeable about prices and cantalk to each other about prices. This does notmean that companies cannot charge differentprices, however. I think they can still do that.

Most observers agree that consumers willhave to become accustomed to flexible pricingbecause it is here to stay. Fader says the

companies, offline and online, that will benefitmost from dynamic pricing will be those thatconduct frequent experiments with pricingstrategiescontinually charging higher and lowerprices to different people, offering coupons,discounts, and other incentivesto see whichwork best at improving the consumers shoppingexperience and increasing revenue and profit.

A lot of learning comes by experiment ing,Fader notes. Companies that know whatexperiments to run and read and act on theresults are going to get richly rewarded. Imlooking for the time when we have electronicprice tags on shelves in stores instead of bits ofpaper so that retailers can change prices duringthe course of the day or even as customer X iswalking down the aisle. Companies will try it,and some will do it stupidly. But some will do itwell and find ways to keep customers locked inand keep revenue flowing in.

The Internet has given online retailerstremendous opportunities to collectdata on customer behavior and targetpeople for different prices for thesame merchandise.


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10 Wharton on Marketing Approaches for Retailers, Vol.

When making a purchase, a consumer hasa choice between using frequent-flier miles,cash, or some combination thereof. Which willhe or she choose? Another consumer has anopportunity to participate in a special programto get a free car wash after paying for a certainnumber of washes. Whats the best way forthe car-wash owner to motivate the customerto participate?

Such questions are serious business for airlines,hotel chains, credit-card companies, and othercorporations that offer loyalty programs tocustomers. Wharton Marketing Professor Xavier

Drze and Joseph C. Nunes of the Universityof Southern Californias Marshall School ofBusiness have spent several years studyingthese programs and have reached a number ofconclusions as to how they can be structured togenerate the most revenue for companies thatoffer them.

Loyalty programs have been around for morethan 100 years and are experiencing anenormous resurgence, according to Nunes.Frequent-flier programs are among the best

knownAmerican Airlines is credited withlaunching the first in 1981but companiesbegan trying to win the hearts and minds ofcustomers long before that. One of the earlyefforts to encourage customer loyalty was theS&H Green Stamps program, which began inthe 1930s. Consumers received tiny stampswhen they made purchases from participatingmerchants, glued them onto pages of booklets,and redeemed them for products when theaccumulated stampsa form of alternativecurrencyhad attained a certain value.

Trading stamps of all kinds are often seen asthe first alternative currency to be awarded toencourage repeat purchases, Nunes notes .They were initially awarded to customerswho paid with cash instead of credit in the1800s but evolved into something given outwith purchases. After World War II, dozens ofcompanies began trying to outdo each other,offering double, triple, and ultimately quadruple

stamps. The escalation ultimately led to thestamps demise. By the mid-60s, supermarketsstarted offering straight discounts instead to cutout the middleman.

According to Jupiter Research, more than 75percent of consumers today have at least oneloyalty card, and the number of people withtwo or more is estimated to be one-third of theshopping population. Surveys by information-technology analysts Gartne r, ForresterResearch, and META Group suggest the data-for-dollars explosion is showing no signs ofletting up anytime soon. According to Gartneranalyst Adam Sarner, U.S. companies spentmore than $1.2 billion on customer loyaltyprograms in 2003.

Drze and Nunes became interested in loyaltyprograms after suspecting that many of themwere not performing as well as they could forthe corporations promoting them. There area lot of ineffective programs out there, Drzesays. To distinguish a good one from a badone you have to understand how they motivatepeople. There hasnt been that much researchon the underlying principles that make a loyalty

The Lowdown on Customer Loyalty Programs:Which Are the Most Effective and Why


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program work or not work for a firm. We felt thatwas a significant gap that needed to be filled.

Dollars and MilesIn a paper entitled Using Combined-CurrencyPrices to Lower Consumers Perceived Cost,Drze and Nunes examine the different kinds ofcurrencies that consumers can accumulate and

spend, such as frequent-flyer miles and hoteland credit-card rewards points. As consumersare increasingly able to pay for a variety ofgoods and services using a combinationof reward currencies and real money, howthey respond to what Drze and Nunes callcombined-currency transactions has becomeimportant to marketers.

In their paper, Drze and Nunes present amathematical proof that outlines the conditionsunder which a price delineated in multiplecurrencies (for instance, $39 plus 16,000 miles)can be superior to a standard, single-currencyprice (where a person pays either $189 or25,000 miles but not a combination of the two).

In the paper, published in 2004 in the Journal of

Marketing Research , Drze and Nunes say thereare two ways that combined-currency pricingcan bring in more revenue for a company: suchpricing can either lower the psychological orperceived cost associated with the pricingscheme or raise the amount of revenuecollected given a perceived cost.

For example, a consumer may be indifferent asto whether he spends $500 or 25,000 mileson an airline ticket, but prefers paying $400plus 5,000 miles rather than paying either ofthe single-currency alternatives. At $0.02 permile, the combined-currency price brings in theequivalent revenue to the airline, yet inflicts asmaller psychological cost to the consumer, theresearchers write.

It is important to note, they add, that thisconsumers preference for the combined-currency price indicates that each mile or dollarspent is not valued equally. The perceived cost

of paying more dollars and/or miles increasesas the payment in that currency increases.As a result, it will be best for a company tocharge a combined-currency price for, say, anairline ticket when two conditions exist: theconsumer does not value each unit withina currency equally, and the perceived costfunction for one of the currencies is said to beconvex. Convexity means, for example, that

25,000 miles appears to be worth more to theconsumer than twice as much as 12,500. Why?Twenty-five thousand miles will get you a freeround-trip ticket within the United States, while12,500 miles might only get you an upgrade,says Drze.

The authors reached their conclusions aftersurveying three groups of travelers and havingthem evaluate and make choices among pricesissued in single and combined currencies. Theauthors say their research is the first to explore

how consumers evaluate transactions involvingcombined-currency prices.

You would think that if people were offeredmoney and miles, they would always take themoney, but a lot of people want the milesinstead, Drze says. Their feeling is, Moneyis only money; and if I take money insteadof miles, Ill just use the money to pay a bill.Theres nothing special about paying a bill. Butwhen they take frequent-flier miles as a rewardinstead of cash, they will use them to t ake tripsand that gives them memories. That makesthe miles special. The airlines consider theirprograms aspirational as fliers earmark theirmiles for special trips. Theres a lot going onpsychologically when it comes to taking milesor some other kind of rewards points. Peopledont consider miles or points to be the samething as money.

Artificial AdvancementIn another paper, The Endowed ProgressEffect: How Artificial Advancement IncreasesEffort, Nunes and Drze outline howcompanies can structure certain rewardsprograms to make them more attractiveto customers and, hence, more profitable.Endowed progress means that people who areprovided with artificial advancement toward agoal show greater persistence towards reachingthe goal than they otherwise would. By artificialadvancement, a company advances a customer

Loyalty programs have beenaround for more than 100 years

and are experiencing an enormousresurgence.


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toward a goal while simultaneously moving thegoal further away, so that the task requirementsand the reward remain unchanged.

For example, a company could improve arewards program that requires eight purchasesin order to earn a specific r eward by revampingit so that the program requires 10 purchases,but with two awarded upon enrollment. Both

programs require eight purchases and providethe same reward, but customers are moreapt to complete the programand completeit soonerif they are given a head st art,according to the paper, which was published inthe Journal of Consumer Research . The authorsdemonstrated this through an experimentinvolving 300 customers of a car wash whoreceived loyalty cards and whose subsequentvisits to the car wash were tracked.

By converting a task requiring eight steps intoa task requiring 10 steps, but with two alreadycomplete, the task is reframed as one that hasbeen undertaken and incomplete rather than

not yet begun, according to the study. Thisincreases the likelihood of task completion anddecreases completion time.

In addition to the study of the behavior of the carwash customers, Drze and Nunes conductedfour other studies of consumers for their paperon the endowed progress effect. They found,first, that as people progress toward a goal,their effort will increase and thus completiontime will decrease. Endowed progress, whichprovides artificial advancement towards the goal,exacerbates this effect. Second, the researcherslearned that persistence depends on relativeprogress made by a person, not on the amountof reward points or miles that would be lost byfailing to continue.

Third, when the endowed progress is issuedin points rather than purchases, both theendowment and the return that customersobtain for their efforts appear more significant;

and, thus, customers will exert more effort.Finally, Nunes and Drze learned that theendowed progress effect is more likely tooperate when consumers are provided witha reason for the endowment, even if thatreason is specioussuch as, Our company isconsidering a rewards program; would you liketo participate?

Programs on the IncreaseLoyalty programs continue to grow. EvenNeutrogena is planning to roll one out, andthe NBA [National Basketball Association]is looking at st arting one, too, says Nunes.Loyalty programs used to be used chiefly inservice businesses like credit cards, hotels,and airlines. Those businesses with inventoriesof perishable products or services, like hotelrooms and seats on planes, had little costs andlots to gain from getting into this. Credit cardsjust used miles as a payback: you collect 3percent from vendors and give 1 percent back.But now, to remain competitive, all kinds ofcompanies are doing it. Heck, Maxwell Housecoffee has its own program where consumersearn House Points with each can they buy.

Nunes says some consumers get excited aboutamassing points even if the points have nocurrency value. Yahoo Answers, a question-and-answer site run by Yahoo, gives pointsto users who answer questions and rate thequestions and answers of others, he says.

You cant exchange these points for real-worldgoods and services, yet people still spendenormous amounts of time accumulating themjust to beat others in a list of top point-gettersor simply to compete with themselves.

Loyalty programs can be quite effective. Ina study, Exploiting the Installed Base UsingCross-Merchandising and Category DestinationPrograms, that Drze conducted with WhartonMarketing Professor Stephen Hoch, a babyclub loyalty program increased sales of baby

products by 25 percent on average over a 6-month period. It did that by increasing thenumber of transactions with baby products. Italso increased the amounts purchased in eachtransaction and boosted store traffic by 5 percent.

But Nunes points out that the long-term impactof loyalty programs is not yet completelyunderstood. For instance, an online studyby Maritz, a market research and consumer

As consumers are increasingly ableto pay for a variety of goods andservices using a combination of reward currencies and real money,how they respond has becomeimportant to marketers.


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loyalty program consulting and implementationcompany, found that members of programsspend more. But it was unknown whetherthe program drives spending or whether bigspenders are just more prone to join programsand get rewards for their spending. Nunessuspects the latter and worries that somefirms are simply bidding for the best customersby offering them bigger and better rewards.

Loyalty programs, he adds, need to bedesigned to offer differentiated products andservices to customers based on their purchasingpatterns and profitability. If these programs aresimply based on quantity discounts or paying forpatronage, they will not endure.

Drze and Nunes are continuing their researchinto loyalty programs. Among other issues,they are currently exploring the use andeffectiveness of statusgold cards, platinumcards, and the likein loyalty programs. Alot of loyalty programs endow customers withstatus, which they earn through purchases orother actions, Nunes explains. Our researchis looking into how stratifying customers andendowing some with status makes them feeldifferent and thus behave differently.

The researchers have just begun investigatingthe topic. But from what they have discoveredso far, it appears that assigning a customerto a categorysuch as gold st atusmay putthem in the top 5 percent of all customers,but it does not necessarily make the customerfeel special. It turns out that gold customersfeel much more distinctive and apt to spendmore if they know that there is another class

of peoplethose endowed with silverstatus, for instancebelow them. This paperis tentatively entitled A Cut Above: Exclusivityand Sta tus in Consumer Loyalty Programs.

If you go back 10 or 15 years, a gold card wasreally special, Drze says. Today, if you donthave a platinum card, which confers greaterstatus than gold, youre nobody. The interestingthing is that what has evolved over time isthat more and more customers need st atus.Marketers need to find ways to separate oneclass of customer from another.


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its c old and rainy, and the parking lotoutside the store is packed, except for a spotway out in the corner. The shopper pulls up,only to find a shopping cart blocking the space.Inside, the store is jammed. The digital camerasare hard to find, and its impossible to knowwhy one costs $150 and another $300. The twomodels that are on sale are out of stock, andit takes a clerk 5 minutes to bring another onefrom the back of the store. At checkout, the lineis stalled while those on either side are flowingsmoothly. Finally, when the customer reachesthe cashier, he is told his $25-off coupon is notvalid until the next day.

Wharton Marketing Professor Stephen J. Hoch,who suffered through this scenario first handduring a recent shopping trip, says customers arebound to talk about these kinds of experiences.And, according to new Wharton research, suchword-of-mouth communication should be a bigcause of concern to retailers.

Results of The Retail Customer DissatisfactionStudy 2006 conducted by The Jay H. BakerRetailing Initiative at Wharton and The VerdeGroup, a Toronto consulting firm, in the weeksbefore and after Christmas 2005show thatonly 6 percent of shoppers who experienced aproblem with a ret ailer contacted the company,but 31 percent went on to tell friends, family, orcolleagues what happened. Of those, 8 percenttold one person, another 8 percent told twopeople, but 6 percent told six or more people.Even though these shoppers dont share theirpain with the store, they do share their painwith other people, apparently quite a few otherpeople, says Hoch.

Overall, if 100 people have a bad experience,a retailer stands to lose between 32 and 36current or potential customers, according tothe study.

The complaints have an even greater impact onshoppers who were not directly involved as thestory spreads and is embellished, researchersfound. Almost half of those surveyed, 48percent, reported that they have avoided a store

in the past because of someone elses negativeexperience. For those who had encountereda problem themselves, 33 percent said theywould definitely not or probably not return.This storytelling has even more impact on thepeople the story is told to than the people whotold the stor y, says Hoch. The data is based ona survey of 1,186 shoppers.

Those surveyed were asked to discuss theirmost recent shopping experience. Half saidthey had at least one problem. On average,survey respondents reported experiencingthree problems on the shopping trip, duringwhich they spent an average of $163. The topthree categories of merchandise purchasedwere clothing, 23 percent; groceries, 16percent; and electronics, 12 percent.

Paula Courtney, president of The VerdeGroup, says the exponential power ofnegative word-of-mouth lies in the natureof stor ytelling. As people tell the stor y, thenegat ivity is embellished and grows, shesays. For example, the first time the story istold, it might be about a customer servicerepresentative who was rude. By the timethe third or fourth person hears the story, thecustomer service representative becomesverbally abusive. To make a story worth

Beware of Dissatisfied Consumers:They Like to Blab


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telling, there has to be some entertainmentvalue, a shock value, says Cour tney. Stor y-telling hurts ret ailers and entert ains consumers.

Why dont shoppers confront the retailerdirectly? If they were boiling mad, they wouldcomplain to the management during the storevisit or maybe after, but they dont do thatvery often, says Hoch. Some people figure

its going to happen again, and they cant doanything about it. They are resigned to it. Butthe main reason they dont complain is itstoo difficult to go out of their way to deal withevery service slight.

Indeed, the survey showed that 46 percent ofthose who had a problem expect they woulddefinitely or probably experience the sameproblem in the future.

Jammed Parking Lots, Crammed

Merchandise RacksParking was a major source of aggravation forshoppers, according to the survey. It toppedthe list of problems, with 40 percent of thosesurveyed reporting dissatisfaction in theparking lot.

According to William Cody, managing directorof the Baker Initiative, parking problems set thestage for customers to arrive angry, whichcan make them more likely to have a troubledshopping experience. Most retailers, he says,

dont consider the parking lot to be part oftheir operations, but he advises them to takea closer look at their landlords managementof parking problems and try to come up withcreative solutions.

He notes that during the Christmas sellingseason, one mall in New Jersey hired peopleto wave flagsindicating available parkingspotsat shoppers circling to find space. Evenif this doesnt speed up the parking process,Cody says the presence of the flag waversmight provide some psychological comfort to

shoppers by signaling that the stores were atleast attempting to address their concerns.

In addition to parking problems, shopperssurveyed complained that it took a long time forthem to be waited on (24 percent) or to pay (33percent). Shoppers who had to wait for servicecomplained about it to 2.1 other people, onaverage, and those who had to wait a long time

to pay told an average of 1.4 people.

Customers time has become an importantpart of the ret ail value equation, along withprice, merchandising, and other traditionalcomponents of the industry, according toCourtney. Retailers havent caught up to thephenomenon that consumers have no time.Time is a rare and precious thing . Yet becausethe Internet allows shoppers to buy around theclock, there is more pressure on retailers torespect their customers time. The Internethas erased all the boundaries that existed withshopping in terms of when you can shop.

Courtney told about her own experience buyinga briefcase in an airport shop in Philadelphia.She used her mobile phone to call her husbandin Toronto and ask him to go online to researchthe brand. He discovered that the same model,which was on sale for $475 in the airport, wasavailable online for $230. Courtney used theinformation to negotiate a 50-percent reductionin price at the airport store. We are muchsavvier shoppers , she says. We have no time,

and we dont want to overpayall the morereason retailers have to worry.

Meanwhile, she adds, ret ailers continue tofocus on merchandise, jamming stores withinventory that overwhelms customers and cutsinto the time they have to shop. Accordingto the sur vey, shoppers are likely to tell 2.5people, on average, about their inability to findan item because the store was cluttered withmerchandise. Retailers are putting as manyjeans and shirts out as they can get on the

racks. In the end, she points out, ret ailers willwind up reducing the price on merchandise tomake up for the negative experience, erodingtheir profit margins.

Gatherers vs. GrazersAccording to Hoch, the survey shows someslight differences in attitudes among shopperswho were reporting their experiences at a mass

Customers time has becomean important part of the retailvalue equation, along with price,merchandising, and other traditional

components of the industry.


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merchant versus a specialty store. Peoplewho are in a specialty store are more in thepleasure-seeking experience, while peoplegoing to a mass merchant are on a miss ion.

He notes the study did not find hugedifferences in the attitudes of male and femaleshoppers, although men were more likely tocomplain. Its clear that males are hunters and

gatherers and females are grazers and gleaners.When the male is frustrated in his attempt toget the task accomplished, he is more likely tobe irritated. Females are more interested in thecustomer ser vice interact ion.

Cody says retailers historically have paid a greatdeal of attention to how to satisfy the customerbut have not been too interested in finding outwhat makes them dissatisfied. In retail, itshard to focus on the dissatisfied because yourcustomers are anonymous, unlike a direct salesor business-to-business model. Wal-Mart has100 million shoppers a week, so its hard to do.Historically it has focused more on product andexperience as a way to create satisfaction.

And despite the value in learning aboutconsumer gripes, retailers have resisted asking

their customers what they do wrong for fearof stirring up negative thoughts, Courtneyadds. They have been reluctant to presentconsumers with a laundry list of things theymay have experienced because it would turnpeople off.

Retailers, Cody suggests, need to find waysto get customers to share complaints withmanagement, not friends and family. One wayis for retailers to ask customers to check abox on their credit card slip indicating they hada problem at the store. Retailers could thenattempt to follow up or give the customer aphone number or web address to make theircomplaints directly. If nothing else, he says, itwould give the customer a chance to blow offsteam. That could prevent them from spoutingoff to others who might then embellish theexperience and make matters that much worsefor the retailer.

Courtney recommends that retailers paycloser attention to recruitment and hiring offront-line sales people and other workers withdirect customer contact. The least-trained,lowest-paid people are the ones you put infront of your customers, particularly during theChristmas season.

As for Hoch, good cheer goes a long way

for retailers at any time of year, he says.Retailers that are responsive and friendly aremore likely to smooth over issues than thosethat dont try to be as friendly as possible.Maybe something as simple as a greeter atthe beginning of the store or at the end wouldhelp. Some people say the personal touchdoesnt matter, but I disagree.

Consumers, too, can take steps to head offdissatisfying shopping trips, adds Courtney. First,they should take their complaints directly to theretailer. Dont we all, as consumers, benefitfrom telling the company? she asks. Werecommend that the first thing is to complain tothe person closest to the problem. If someone isrude, confront that person. Or if you dont wantto do that , take it to the store manager.

Customers should never escalate the problem,she cautions. We encourage complaining,not yelling. It never pays to be abusive as acustomer. You might just be escorted to the doorif there is an emotional experience. If somethinghas made you very upset, dont do anything

about it unt il you can let your emotions pass.She suggests consumers go back the next dayor make contact by telephone or in writing.Be as factual as possible. It lends credibility toyour story and makes you not sound like a crazylunatic. In addition, consumers should shoparound and not return to stores where they hada bad experience. The erosion of business isthe only way to wake up retailers, to get themfocused on the customers experience.

Finally, if a ret ailer refuses to respond to

dissatisfied customers, shoppers should feelfree to spread the word. If all else fails, we doencourage you to tell all your friends and family.Dont tell five people, te ll 35 people, saysCourtney. Retailers need to know that if theydont listen, it will hurt their bottom line.

If 100 people have a bad experience, aretailer stands to lose between 32 and36 current or potential customers.


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after saturating its target market ofworking class, bargain-hunting consumers, Wal-Mart is ratcheting up its low-price strategy toappeal to more upscale shoppers by expandingits merchandise lines to include organic foods,better wines, high-end consumer electronics,and new fashion-oriented apparel. Its anapproach that carries some risk, say Whartonfaculty and analysts, but that is dictated byintense competition and the lack of otheropportunities for growth.

The changes come as Wal-Martthe worldslargest retailer with annual sales of more than

$300 billionhas struggled with slowing growthand rocky transitions internationally as well asinto urban areas of the northeastern UnitedStates. In a speech at the companys annualmeeting this month, Wal-Mart chief executiveLee Scott outlined elements of the strategyand quoted Wal-Mart founder Sam Walton: Youcant just keep doing what works one time.Everything around you is always changing. Tosucceed, s tay out in front of that change.

Wooing the Baby BoomersAccording to Wharton Marketing ProfessorXavier Drze, now that Wal-Mart has conqueredthe value end of retailing, its options arelimited. They are going upscale. Its the onlychoice available, he says. They have expandedto the point where they cant expand in the U.S.anymore. If you cant grow by reaching morepeople, you have to grow by selling moreandmore expensive[merchandise].

Approximately 80 percent of American shoppersnow visit a Wal-Mart store at least once a year,and more than 170 million consumers aroundthe world shop at a Wal-Mart store each week.In addition, the company has expanded to 6,100stores in 70 countries. Wal-Mart is sending asignal that they are about more than price, saysWharton Marketing Professor David Bell. Theyhave played price. Now they want to play qualityand broaden their image. It will be interesting tosee whether people believe it .

The new strategy will help Wal-Mart competeagainst Target, its chief discount-chain rival,adds Wharton Marketing Professor John Zhang.Target is doing well. Customers perceiveit as more trendy and higher-end. Wal-Martnow is forced to move to the high end to lookmore like Target instead of jus t looking cheap.Demographics are also driving the changes atWal-Mart, which traditionally has had the mostappeal to young families. The chain is making aneffort to woo the nations 70 million aging babyboomers, according to Zhang. These are thecustomers with more spending power. You haveto figure out a way to follow them and satisfy

thei r needs .

The new higher-end products will be sprinkledthroughout Wal-Marts core offerings and arenot likely to alienate the companys establishedbase, suggests Wharton Marketing ProfessorStephen Hoch, who says he sees no reason forthe initiative to fail. Target has been successfulat going slightly above where Wal-Mart is. Wal-Mart may not be perfectly associated with atrading-up image, but my guess is they canbuy brands that have that panache as well asanybody else, or even better.

Of course there is always a chance Wal-Mart

could jeopardize its current position by aspiringto move up the customer ladder, Drze notes,comparing the situation to regional airlines thatdo well in their niche, then expand nationally,but ultimately fail because they have lost theircompetitive edge. The question for Wal-Martis, if they sell high-end [goods], is there acompetitive edge to that? Or will it make themjust another retailer? Thats the risk.

Wal-Mart: Is There a Downside to Going Upscale?

Approximately 80 percent of American shoppers visit a Wal-Martstore at least once a year, and morethan 170 million consumers aroundthe world shop at a Wal-Mart storeeach week.


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In March, Wal-Mart opened an experimentalstore in Plano, TX, an affluent area where theaverage income of $140,000 is triple that of thetypical Wal-Mart shopper, according to marketresearch firm Information Resources, Inc., (IRI).The store carries 2,000 premium items, includingmeat, cheese, wine, and fresh produce, notavailable in typical Wal-Mart supercenters.

In a report to clients, Bank of America analystDavid Strasser says Wal-Marts shift up theprice continuum is already showing results.For several years, the chains sales growth wasled by food and consumables, while generalmerchandise was weak. Strasser analyzed salesof consumer electronics at 1,300 stores wherehigher-end merchandise, particularly flat-paneltelevisions, was introduced last year. For the firsttime in 4 years, consumer electronics became anongrocery category to contribute growth to theoverall sales mix at U.S. Wal-Mart stores.

Strasser also points to sales of the chainsnew, more upscale private-label clothing line,Metro 7which have been so strong that thecompany has had trouble keeping items instockand its line of 400-thread-count sheets,which have recently been selling out and areanother symbol of Wal-Marts move up theluxury continuum.

Even within the food and beverage category,Wal-Mart is changing its menu, most notablywith new lines of organic foods, fresh produce,and top-shelf wines and liquor. William Cody,managing director of Whartons Jay H. BakerRetailing Initiative, says Wal-Marts expansionin wine represents a departure from thechains cultural roots in Bentonville, AR, wherefounder Walton shied away from selling alcohol.According to Cody, changing federal regulationsover the distribution of alcohol may open upnew opportunities for Wal-Mart, Costco, andother national retailers. Recent federal courtcases have overturned statutes written at theend of Prohibition that gives states control overalcohol distribution.

Adjusting to Organics and OtherInnovationsOrganics represent a new, growing categoryof demand for all retailers and is expected toexperience double-digit growth through 2010,according to an IRI report issued in May that

states: Wal-Mart has been relatively slow toenter the fray, given a potential disconnect withits core lower-income consumer.

The $15 billion organic foods market representsjust 2 percent of overall U.S. food and beveragesales but is growing at a rate of 20 percent ayear, compared to 2 percent to 4 percent fornonorganic groceries, according to the Organic

Trade Association. The opportunity for theconsumer is tha t Wal-Mart can hypotheticallyoffer organics at a lower price, but thatsassuming unlimited access to the supply, saysCody. Can they position themselves as thelow-price leader in organics? Possibly, but itsmore a way to bring in new customers whobuy organics.

Moving into organic foods will create newchallenges for Wal-Marts legendary supply-chain system, adds Serguei Netessine, Whartonprofessor or operations and informationmanagement. Coming into organic foods issomewhat tricky, especially for someone as bigas Wal-Mart. While Wal-Marts typical supplymodel is to push vendors into a centralizeddistribution system, the wholesale organicfoods market is made up of many smallsuppliers selling perishable goods that requirecomplicated handling. Its essentially hopelessand meaningless to try to centralize distribution.You have to change the distribution systemsomehow to go back to the model in whichsuppliers supplied direct ly to the nearest store.

Without major industrial-scale supplyoperations, Netessine says he doubts Wal-Marts claim that it can substantially reducethe price of organic foods. Still, hes notcounting Wal-Mart out just yet. They will haveto adjus t, he says. People incorrectly thinkof Wal-Mart as only supplying cheap goodsto people on a budget. If you look at Wal-Mart merchandise, the list includes gold anddiamonds and expensive electronics. Whereverthere is some demand for something, even

expensive items, Wal-Mart tries to come in.Every time, they have to adjust the supply chainfor different merchandise, but for organic food[this adjustment] seems especia lly tricky.

Another new innovation Wal-Mart executives arepromoting is walk-in medical clinics, operatedby outside firms like RediClinic, a healthcarestartup created by America Online founderSteve Case. Wal-Mart leases space at 11 stores


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to pilot clinics and has said it may increase thatnumber to 50 by the end of this year.

According to Cody, the clinics fall more in linewith Wal-Marts traditional consumer base,and while they may not be profit centersthemselves, the clinics could help boostpharmacy sales or simply draw more shoppersinto Wal-Mart stores.

Morris Cohen, Wharton professor of operationsand information management, suggests thehealthcare clinics will get leverage from Wal-Marts real estate clout. However, they posenew issues of supply-chain managementspecific to services, as opposed to productinventory, where Wal-Mart is viewed as themaster. It makes a lot of sense that Wal-Mart should be providing services in carefullyselected convenient locations where you canshare some of the overhead of the store, hesays, noting that the chain already has opticaland pharmacy services. Why not manicures?

Cohen explains the challenges of operating aservice supply chain center around consistencyand quality. A service is consumed as it is

produced, unlike a product that can sit on ashelf and come out of a box when the customerwants it. So often the quality rests on thedependability of the front-line people deliveringthe service. Consistent ser vice, for example,requires companies to maintain excess capacityfor times when they are not busy in order tomeet customer needs when they arise, saysCohen. Its still matching supply and demand,but the knobs you have to turn are d ifferent.

The clinics may also f it into Wal-Marts push topresent itself as a kinder company, particularlyafter unions generated reports showing thatWal-Mart employees lacking health insurancecoverage are among the top users of state andfederal-financed Medicaid programs. CEO Scotthas said that 30 percent to 40 percent of thosevisiting the Wal-Mart clinics are uninsured, whilesurveys indicate that if those people had notbeen able to come to the clinic, 20 to 40 percentwould have sought expensive emergency room

care. Another 10 percent to 20 percent wouldhave gone without treatment.

Hoch points out that Wal-Mart is taking othersteps to improve its appeal to shoppers,including new image-oriented advertising and amajor initiative to operate with greater sensitivityto the environment. I do think they are engagedin more outward-reaching public relations efforts

to burnish their image, such as feel-good ads,he says. They need to constantly evolve.

Successes and Setbacks AbroadMeanwhile, Wal-Marts international expansion,which is an earlier attempt at generating growthbeyond the companys well-established base,continues to have both successes and setbacks.In March, Wal-Mart raised its stake to acontrolling 51 percent share in Central AmericanRetail Holding Co., with 375 supermarkets inGuatemala, El Salvador, Honduras, Nicaragua,and Costa Rica. In May, it pulled out of SouthKorea, where it had 16 stores.

Wal-Mart officials have indicated that India,where government reforms lifting restrictionson foreign ownership of retail operations areunderway, could be a major t arget marketfor the company. Meanwhile, Wal-Mart isexpanding rapidly in China, where, Zhang says,there are a large number of value-consciouscustomers and where infrastructure andlogistics will play an important role. Wal-Mart

has the advantage [in this area]. I sense thecompany probably wil l do well.

Wal-Mart has had some success in Britain afterstumbling in Germany, says Hoch. In Japan,after struggling for years, Wal-Mart severalmonths ago took a controlling stake in thecountrys fifth-largest retailer, Seiyu Group. Thecompany operates more than 400 supermarketand general merchandise stores in that country.You win some and you lose some, Hoch says.Each individual global market has its own setof issues. Wal-Mart has been successful inNorth America, including Canada and Mexico,and will continue to look for opportunities. Thecompany is designed to grow. If it cant grow,its in trouble.

Moving into organic foods willcreate new challenges for Wal-Martslegendary supply-chain system.

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