For years, as leaders in many industries expanded abroad, retailers stayed at home. The exceptions were mostly European companies that had exhausted opportunities to grow in their relatively small domestic markets. As recently as 1996, foreign sales accounted for only 12 percent of the turnover of the world's top five retailers—a percentage far exceeded in industries as diverse as entertainment (34 percent), aerospace (35 percent), banking (48 percent), and petroleum refining (66 percent). Indeed, from 1990 to 1995, when other industries were sharply increasing the proportion of sales they transacted abroad, the mix of retailing stayed more or less unchanged.

But the business is now following the lead of other industries by globalizing, chiefly because of an expanding consumer arena, technological advances, deregulation, and the retailers' need to grow. The prime movers in this process, such as Carrefour, Wal-Mart, and Ahold, are helping to create new rules for retailers in general—expansion minded or not. When Wal-Mart, for example, bought two German retail chains within six months, it became the fourth-largest owner of hypermarkets in Germany and restructured the market there.

As global forces gather momentum and reshape the competitive environment, successful global players are going to create a "virtuous cycle" of self-reinforcing benefits that will give them the ability to redefine the economics of the retailing industry and, ultimately, to establish strategic control around the world.

A quick catch-up

Unlike companies in other industries, retailers have not been able to travel light: those seeking to establish new markets abroad must find suitable high-quality sites, develop distribution support systems, and deal with the complexities of local zoning regulations, tariffs, and quotas, as well as understand local tastes and manage local labor forces. Combine these difficulties with the intrinsic complexity of retailing—hundreds of stock-keeping units, rapid price changes, and the constant threat of product obsolescence—with the minimal incremental scale benefits retailers can achieve if they are already big, and it is clear why most US retailers have restricted their growth to North America and most of their European counterparts have stuck to Western Europe.

Nonetheless, rising incomes and improvements in infrastructure are enlarging consumer markets around the world and accelerating the convergence of consumer tastes. The Internet is making customers more accessible, while computers and videoconferencing are cutting the cost of doing business far from headquarters. At the same time, deregulation, the dismantling of trade barriers, and the single European currency are—albeit slowly—generating unprecedented levels of mergers-and-acquisitions activity among retailers in Asia, Europe, and North America.

While the barriers to globalization have fallen, so have the growth rates of retailers in the United States and Europe. Since retailers are already consolidating in their domestic and regional markets (Exhibit 1), the next step is to look farther afield, as Wal-Mart, Carrefour, and Ahold have already done.

Wal-Mart, based entirely in the United States until 1991, now has more than 700 stores in Canada, South America, Europe, and Asia—mostly gained through acquisitions. Carrefour, which has been playing the international game for upward of 30 years, built strong store networks across three continents. Ahold has bought businesses in more than ten countries in the past five years.

Not surprisingly, two of these three companies are European retailers that have gained cross-border experience on the Continent and now seek to apply their skills in more distant markets. Carrefour and Ahold want to integrate their operations more closely across national borders to cut costs and increase market capitalization. In the same way, many specialty retailers have also established solid cross-border positions by building and transferring global brands. Clothing chains like Gap and Zara are following in the footsteps of veteran cross-border operators, including IKEA, Hennes & Mauritz, and C&A.

Many specialty retailers have established their cross-border positions by building and transferring global brands

As these early movers have expanded their global presence, they have actuated the cycle of competitive advantage. Retailers can grow by increasing their access to consumers, talent, partners, or assets. Growth in scale permits them to achieve greater purchasing efficiency in sourcing, information technology (IT), and advertising. As scale efficiencies increase their operating margins, they can invest in the kind of expertise that would permit them, for example, to gather information about customers. The more retailers expand geographically, the more their profits swell, further increasing their ability to make investments to gain even more geographic reach and expertise and to upgrade their intangible assets, such as brands and talent. In short, those that have get more.

In other industries, leading businesses initiated the cycle early in their expansion efforts and were thus able to lock in these advantages when their industries started to globalize. Coca-Cola is the obvious example: because it expanded geographically and invested in customer access through a number of channels, it continues to accumulate advantages of scale and expertise. The company now claims half of the global soft-drinks market (against PepsiCo's 15 percent), has substantially lower cost-of-goods-sold and selling, general, and administrative (SG&A) expenses than PepsiCo, and specializes in the less asset-intensive parts of the value chain. This strategy permits the company to deepen its expertise in areas such as product development and branding.

Many retailers have failed to create a self-reinforcing virtuous cycle because they have not invested sufficiently in intangibles and have attempted to expand across borders in the traditional way—replicating domestic business systems and retaining full ownership, an approach that tends to be costly and slow to yield value. But as Ahold, Carrefour (Exhibit 2), and Wal-Mart have shown, retailers can succeed in new markets by investing in intangibles like IT, people, and unique skills and by entering into partnerships to gain rapid access.

Five ways to expand across borders

There is still enough time to build cross-border positions and local market defenses, because retailing will almost certainly continue to globalize more slowly than other industries. Yet the positions established by early movers and the accelerating movement of retail sales to the Internet make it important for retailers to act now.

The following five approaches, used successfully by early movers in retailing and other industries to expand geographically, hold the key to building the virtuous cycle of access, scale, and expertise.

1. Choose your sliver

Retailers have long recognized that they don't have to own all parts of the value chain to create profitable businesses, but few have pushed this "unbundling" as far as successful global companies do. Most retailers leave manufacturing to other companies; a few outsource logistics; and some franchise store operations. As the computer, auto, and oil industries have proved, a globalizing economy drives more and more companies to specialize in ever smaller business "slivers." In retailing, slivers could involve parts of the value chain (product development or branding, for instance), types of products (notably Amazon.com in books), or types of customers (such as DFS with Asian travelers).

In a globalizing environment, retailers will have to make more careful choices about which slivers to own, which to control without owning, and which to off-load entirely (Exhibit 3). The choice depends on cash flow and capital requirements, risk, competitive advantage, and the importance of a sliver to a company's retail proposition. Gap, for instance, owns most of its slivers—including product development, assortment planning, and branding—which create enormous value for the company and probably couldn't be executed more satisfactorily by any partner today. The company closely controls contract manufacturing. Carrefour owns its assortment-planning sliver, but it relies on its vendors to develop and brand most of the products it sells. Both Gap and Carrefour tend to own the store operations sliver. McDonald's, by contrast, sells it to franchisees because the company can do so without relinquishing control.

A retailer might make different choices in different market environments. As Promodès, for example, has expanded across Europe, the company has experimented with multiple ownership and operating structures, such as franchises, joint ventures, and wholly and partly owned subsidiaries. Ahold franchises only in its home market. IKEA and Marks & Spencer tend to own their stores in mature markets but to franchise, reducing risk, in emerging ones.

Retailers will have to decide whether owning or off-loading their slivers is more likely to enhance their access, scale, and expertise and hence to raise returns. The emergence of credible partners and third-party providers—such as Tibbett & Britten, Federal Express, and United Parcel Service in the logistics business—has begun to make the off-loading option more feasible.

2. Get comfortable partnering

Many retailers balk at the notion of forming joint ventures or other kinds of partnerships. But as the industry fragments into smaller slivers, these companies will have little choice but to entertain the idea if they want to endure and thrive.

Leading globalizers in other industries have shown how to enter partnerships without losing control of the business. Starbucks, for example, extends its brand at home and abroad through alliances with United Airlines, Barnes & Noble, Sazaby (a Japanese specialty retailer), and other partners (Exhibit 4). Internet companies—Amazon.com, for instance—are exerting themselves to build alliances with companies like LiveBid, Drugstore.com, and HomeGrocer.com to get leads, enhance their distribution systems, and build brand equity in new markets.

Many leading globalizers, such as Coca-Cola and Microsoft, have created new ownership systems and capital structures to control these alliances without maintaining majority interests in them. As retailers get better at managing relationships and as stronger local partners emerge, the trend to form cross-border partnerships will accelerate. Such partnerships will become tickets to the global game.

3. Invest in intangible assets

Now that financial capital is generally available across markets, the new source of competitive advantage—no less for local retailers than for globalizers intensifying competition in the local markets they enter—is intangible capital: brands, intellectual property, and talent, as well as networks of relationships and unique skills. All retailers will have to invest in building such assets to stay competitive.

Brands and reputation. A global platform is built on powerful brands. There are three requirements for creating a global brand. The first is a distinctive value proposition: benefits that appeal to consumers at a price they like. As retailers move from market to market, they must tailor their value propositions to address different consumer preferences, but without stretching their brands too far or destroying attractive profit formulas. Second, as branded manufacturers such as Nike and Polo Ralph Lauren have long recognized, strong brands should have clear personalities that are relevant to consumers and reinforced at every possible point of contact with them. Third, building a strong brand requires presence; the brand must be made totally visible in the marketplace. Traditionally, retailers have used their store networks to do this, but the emergence of the Internet and of global film, television, and magazine vehicles now makes it possible for them to do so more rapidly and efficiently.

Strong banner brands have made it easier for retailers with big-box formats, such as Carrefour and Wal-Mart, to form partnerships with local companies or to strengthen consumer franchises after local acquisitions. Such retailers are beginning to exploit their private-label brands as well. The Canadian grocer Loblaws, for instance, has built a significant international business exporting its President's Choice premium private label. Strong brands have also helped vertically integrated specialty retailers like The Body Shop and IKEA to penetrate new markets and to diversify into new categories and formats.

Some retailers have already begun to exploit technology, and others are now being forced to catch up

Proprietary technology, know-how, and tools. Software companies such as SAP and finance companies such as Citicorp have long exploited know-how and technology for competitive advantage. By contrast, average retailers invest only 1 to 3 percent of sales in IT and are therefore missing opportunities to improve customer access, to raise their service levels, and to develop critical global business efficiencies. Recently, however, some retailers have indeed begun to exploit technology and know-how, and other retailers are being forced to catch up. Carrefour now successfully exports tailored versions of its basic business model, including operations and accounting systems, across geographies. Wal-Mart uses technology to sustain its cost leadership in distribution and its superior inventory systems. And Lands' End uses "virtual models" to make it possible for customers to "try on" clothing over the World Wide Web.

People, talent, and skills. To support globalization efforts, retailers will have to develop their skills: managing partnerships, building global brands, renewing concepts, and managing people. Unfortunately, world-class talent in these areas is quite scarce, so most companies will have to build their talent pools in several stages. Upon entering a market, Promodès, for instance, creates a team of local retail experts and corporate "entrepreneurs" brought in from other markets. When the local operation has matured sufficiently, the company moves its entrepreneurial managers onward to newer markets, and the local team takes over the management of the store. Over time, such practices make people a true intangible asset and source of competitive advantage.

4. Keep expenses and capital requirements low

The physical complexity of retailing and local market conditions can drive up labor, rent, and overhead costs. Retailers should thus strive to be "expense and capital light." Kingfisher is rethinking its global business model and assortment to capture greater purchasing benefits from global sourcing and IT systems. Ahold has just centralized the finance functions of its US chains and expects to reap substantial savings across its North American operation. Statoil has cut its overhead costs as a result of organizing by concept across borders rather than by country.

Most specialty retailers have already managed to keep their need for capital relatively low by franchising or renting rather than owning stores. Other retailers as well might consider creating turnkey store operations that can be off-loaded to local partners, which would bear the capital costs of owning sites while reaping the benefits of worldwide branding and economies of scale. But retailers capable of generating very high sales per square foot might find that it still makes sense for them to own stores, at least if they can sustain a lower capital-to-sales ratio.

5. Exploit opportunities to arbitrage

Because the world's markets are not fully integrated, their factor costs vary. Many retailers already exploit some of the resulting arbitrage opportunities by sourcing goods from countries with low manufacturing costs and selling at a premium in mature markets. Over the next ten years, as markets integrate, retailers should exploit their remaining arbitrage opportunities to improve their cash flow and to finance their international growth.

Two types of opportunity are worth noting: value proposition arbitrage and cross-border arbitrage. In the first, a retailer "amortizes" a unique and proven concept by rolling it out across many markets, where it can fill a niche that local companies don't satisfy. McDonald's, The Body Shop, and IKEA have taken this approach. Cross-border arbitrage goes beyond sourcing to exploit factor differentials and scale. Some mail-order companies, for instance, benefit from high-price structures in markets such as Japan by selling goods there at local prices—without bearing the cost of a network of stores.

The fight for strategic control

Globalizing retailers can use these five approaches to launch a self-reinforcing cycle of benefits propelled by access, scale, and expertise. Off-loading low-return, asset-intensive slivers to partners while building world-class intangibles, for example, facilitates broader and quicker access to markets. Exploiting that access helps to build scale and yields larger margins, which can in turn be invested, among other things, in branding and product development expertise. Holding down expenses and capital requirements while exploiting arbitrage opportunities also creates efficiencies of scale, freeing capital that can be used to expand access and build expertise. Ultimately, retailers exploiting the virtuous cycle of access, scale, and expertise will lock in strong competitive advantages that will help them drive their own strategic destinies and shape the industry all over the world.

In global industries such as computers or aviation, a handful of players have exploited the virtuous cycle to make themselves stronger. Over time, they have acquired or taken significant market share from others, dramatically reshaping the structures of their industries. If Wal-Mart and Carrefour are any indication, retailing will not be different. For this reason, every retailer, whether it plans to stay at home or to venture abroad, must decide how to compete in a globalizing industry.

A tool called a strategic-control map, which plots the market-to-book ratios of companies (an indicator of performance) against their book values (an indicator of size), can help them make these decisions. Exhibit 5 is a strategic-control map of food and general-merchandise retailers. (We have also created a strategic-control map, not included with this article, for department and specialty stores, such as Gap.) A retailer's position shows how its market capitalization compares with that of competitors. Retailers with relatively high market capitalizations retain greater strategic control: they are better able to acquire other companies and to get access to the best assets and intangibles, such as relationships and talent. Control maps are divided into four quadrants: "incumbents" (lower left), "integrators" (lower right), "experts" (upper left), and "superleaguers"(upper right).

Incumbents, including Takashimaya, Saks Fifth Avenue, and Tokyu, have established positions in their home markets but lack the skills to play roles beyond their current territories. Holding by far the largest share of the market in the retailing industry, these companies typically know their home markets and customers well but are at risk to competitors entering from the outside. Indeed, the arrival of strong multinational retailers may eliminate long-standing local oligopolies. In Canada, Wal-Mart swallowed incumbent Woolco in 1994 and expanded it so aggressively that Wal-Mart took 40 percent of Canada's discount market (from other incumbents) while driving down industry margins by several points. Kmart collapsed in Canada within four years, and the remaining Canadian incumbents, such as Zellers, have had to rework their formats and economics to compete.

Integrators increase their market capitalizations by expanding their asset bases, usually through acquisitions of similar companies in adjacent geographical areas. Such companies include Tesco and Sainsbury's, as well as Federated Department Stores, which expanded to 500 outlets, from 200, in a single year by acquiring Macy's and Broadway Stores. The stronger integrators exploit their access and scale advantages, successfully integrating their operations so as to increase their absolute earnings and expand their geographic reach while eliminating potential rivals.

Experts tend to focus on particular slivers. Gap concentrates on the branding and merchandising slivers. Ahold emphasizes operations. Whole Foods Market focuses on a product sliver: organic groceries. Experts earn superior, indeed increasing, returns because they have strong intangibles and relatively low capital requirements. Moreover, as Gap takes advantage of its growth by investing in its brand, its brand equity increases, attracting more customers. The fact that growth itself tends to create more growth means that every brand investment is amortized over an ever-expanding revenue base. But although experts perform well, their relatively small size means that they often suffer from access and scale disadvantages, including the threat of a takeover.

The superleaguers have established virtuous cycles that allow them to get bigger and better, combining the strengths of integrators and experts. Few retailers have achieved superleaguer status, although Wal-Mart (Exhibit 6) and Carrefour have come close by building scale and unique intangible skills that will become increasingly difficult to imitate. Scale and skills are already helping these companies achieve global dominion over their sector.

After retailers understand their position on the strategic-control map, they can decide which expansion path best suits their aspirations, formats, and strengths. Relatively small and poorly performing retailers (in any format) occupying the incumbent quadrant should address their performance problems before embarking on any kind of effort to grow. When the basic performance of these companies improves, they should consider two strategies, either alone or in combination, to enhance their market capitalizations. One strategy involves moving toward the expert quadrant, either by building intangibles or off-loading the less attractive parts of the business, or both. The other is to become an integrator by expanding geographically, first within home markets and then farther afield, through acquisitions or organic growth.

Food and general-merchandise incumbents striving to improve their performance or to build scale are at particular risk of being acquired by others, especially if they compete in attractive markets with attractive sites. Oshawa Group (Canada), Giant Food (the United States), and Eldorado (Brazil) have all fallen to buyers that wanted to gain share in new markets overnight. Branded specialty retailers may be less vulnerable in this respect because much of their value to acquirers lies in their brands, not their sites.

By contrast, high-performing food or general-merchandise retailers should consider expanding into new markets through organic growth or acquisitions, thus moving toward the integrator and, eventually, the superleaguer quadrants. This path, at least today, may require the kind of capital that only scale and the leveraging of intangibles can provide. The challenge for retailers expanding organically will be to adapt their home market formats to new environments and to obtain access and skills from partners. Success in acquisitions hinges on the quick and effective transfer of skills to new businesses and on the ability to achieve synergies.

However, a retailer that already has superior intangibles in a particular sliver should pursue the expert expansion path and build on them—an approach that makes it possible to extract extraordinary returns from the capital base. Gap has moved north on its strategic-control map by drawing on its brand, product development, and marketing capabilities; Ahold has moved in the same direction through superior operating skills. The challenge for such retailers will be to find partners with strong complementary intangibles or ways of injecting the required intangibles into slivers that have been turned over to partners. McDonald's is among the few franchisers that have done this well.

As integrators build intangible skills and experts achieve global scale, superleaguers begin to emerge. These players are pressuring all retailers to respond to a new set of global rules—quickly.