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updated 8/22/2007 7:37:07 AM ET 2007-08-22T11:37:07

H. Lee Scott Jr., chief executive officer of Wal-Mart Stores, has been tirelessly upbeat in recent quarters even as the retailing giant has floundered through two of the most difficult years in its history. But last week Scott sounded downright glum as he reported financial results for the second quarter. He lowered the company's profit forecast for the rest of the year and made no effort to conceal his disappointment with its performance. "[This] was not what we expected of ourselves," he said.

Clearly, the brain trust in Bentonville is struggling to get the company back on track. Growth is faltering, with same-store sales inching up just 1.9 percent in 2006, the worst performance in the company's history. Several new initiatives to boost revenues have come up short, particularly an effort to move upscale into products like higher-end apparel and home goods. Wal-Mart's stock is hovering around its 52-week low. And some Wall Street analysts are already expressing doubt that Wal-Mart will be able to meet even the reduced earnings forecast it just provided. "Fourth-quarter expectations could be a stretch if merchandise missteps continue," says Adrianne Shapira, a retail analyst at Goldman Sachs.

How to fix the giant? To uncover fresh ideas, BusinessWeek decided to go to those managers who are closest to its customers. We spoke with a dozen managers at Wal-Mart stores across the country, some currently employed and others recently departed. A few declined to participate, citing the company's tight restrictions on talking to the press. But many wanted to talk. Some even felt more comfortable discussing the company's challenges with an outsider since their ideas aren't consistent with the corporate orthodoxy.

An insider's eye
These managers care deeply about the retailer. Clearly, the company's future is central to their lives and their professional prospects. Beyond that, they truly believe in what has long been the quintessential American success story. These managers have a wealth of knowledge gleaned from spending so much time at Wal-Mart. Those interviewed have more than 100 years of combined experience working at Wal-Mart Stores. Several quote regularly from founder Sam Walton's book "Made in America," including one current Missouri manager who cited Sam to make it clear he didn't always agree with his superiors in Bentonville: "There's only one boss: The customer."

There are plenty of radical ideas lurking in the minds of Wal-Mart's best and brightest. Many believe the company's relentless focus on whittling down costs — for products and workers — is beginning to have a negative impact on the overall operation. Others take issue with the command-and-control approach currently in vogue at headquarters. For example, Bentonville uses sophisticated computers to decide when to swap out certain products in stores, but they don't account for the gut instinct of managers on the ground. Mark Fisher, who managed the furniture department at the Wal-Mart in Moberly, Miss., says that can lead to big missteps. He cites the decision to replace a pair of $14.99 bookshelves that was a consistent best seller among college students with a higher-quality pair that cost $39.99. "[They] totally lost that entire segment of students," says Fisher, who worked at Wal-Mart for 11 years and now works at Party America, a party-supply store.

Many of the managers' ideas are just as simple, even obvious, if you spend time talking to customers and listening to what they want.

Take chocolate doughnuts. Freshly baked doughnuts and muffins don't make much money for stores, and managing an in-store bakery can be a hassle because it requires a more skilled staff and different hours. That's why headquarters has been cutting back on such operations. But talk to store managers and they shake their heads. The point, they say, is that chocolate doughnuts get people into a Wal-Mart, often every day. Then they buy other stuff — profitable stuff like a cup of coffee or a bottle of water.

Competitors such as Safeway and Kroger see the logic. That's why they're increasing their fresh bakery offerings just as Wal-Mart is cutting back. They're also starting to regain market share in key areas of the country.

A Wal-Mart spokesman declined to respond to specific questions raised by the managers' suggestions. He wrote in an e-mail: "We know that our store managers and associates are great ambassadors for the company and generate some of the best ideas for making our stores an even better place to shop and work."

Perhaps the most far-reaching advice from Wal-Mart's managers is that the penny-pinching approach at headquarters can prove pound-foolish at the store level. The company is notoriously and proudly tightfisted, in part because Sam Walton built the company by keeping costs low and passing the savings on to customers. But managers say the focus on costs, taken to extremes, can lead to broader errors. For example, while top brass wants to cut back on low- and no-margin products such as guns and live fish, managers say that has been a mistake in some cases.

Why? If you don't sell fish, it's difficult to sell the high-margin fish tanks and cleaning supplies that go with them. And if you don't sell guns, it's harder to sell all the extras people want with them. "The sundry items, from camouflage clothing, cleaning supplies for the weapons, ammunition, and the hunting kits, all have huge margins," says Fisher.

The same penny-pinching mentality has hurt the workforce — and by extension, managers say, the company's service. While many outsiders have criticized Wal-Mart for the wages and benefits it provides workers, what has received much less attention is how these policies are affecting Wal-Mart stores internally. Consider Wal-Mart's decision to transform its workforce to 40 percent part-timers, up from 25 percent to 30 percent now, to trim costs. Many store managers are finding it difficult to hire people under those conditions, especially because Wal-Mart requires part-timers to be available for different shifts from week to week. "There are many applicants for jobs, but they turn away when they hear it's part-time," says Carolyn Garland, a former manager who oversaw several departments during her 19 years at the Wal-Mart in East Ellijay, Ga. She says her store used to have around 200 employees three years ago and now has about 150.

Those kinds of cuts can take their toll. Daniel Jackson, who managed four Wal-Mart stores from Texas to Arizona for 12 years remembers a lesson he learned from the late Helen Walton, wife of founder Sam. She was embarrassed by the poor state of Wal-Mart's restrooms and told a group of managers: "If I walk into one more store where the bathrooms are not clean, I don't know what I will do." With that in mind, Jackson had at least two maintenance people on duty at all times, cleaning up spills, and making sure the bathrooms were clean. Today, his former Arizona store has one maintenance person during the day. "One person can't be expected to sweep up a store, mop spills, and also keep the bathrooms clean," Jackson says.

Customers have noticed. In February, in the University of Michigan's American Customer Satisfaction Index, Wal-Mart scored near the bottom in the discount-and-department-store category. Its score was 72, behind Costco Wholesale and Target, and 10 points lower than Wal-Mart's score in 1994.

Centralized decision-making
Wal-Mart's managers know this is a critical issue. Asked if there is any area he thinks needs the most improvement, Rick Scott, now manager of a Wal-Mart in Guymon, Okla., says: "There's always room for improvement, but the key one is customer service, from checking people out at the registers to making sure things are in stock to helping people find something at the store." Scott wouldn't elaborate when asked if he needs more staff.

More and more, Bentonville is calling shots that store managers used to handle. Point-of-sale data are analyzed and crunched at the Arkansas headquarters, spitting out results for what's selling and what's not, what to restock and what to pull from store shelves. Workers' schedules are determined at the home office to keep costs low when possible and to place the maximum number of people in the store at the busiest times of the day. There's even a central 800 number that workers at the 3,500-plus stores must call when they need time off for illness or other emergencies.

Wal-Mart uses centralization and sophisticated technology because it has worked so well in the past. As the largest retailer in the world, Wal-Mart had long been able to spot consumer trends before its rivals and adjust its merchandising accordingly. The approach is particularly well suited to CEO Scott, who came up through the logistics side of the business and is considered a master of efficiency and operations.

But managers say Bentonville may now be pushing the command-and-control approach too far. Many managers say their operations would run better if they had more flexibility to handle all sorts of issues, from employee scheduling to restocking store shelves. Garland, the manager from East Ellijay, Ga., says when her store started using the point of sale system to automatically order cosmetics, it was a direct hit to cosmetic sales. That's because cosmetics are a frequent target of shoplifters, given their small size. Since stolen cosmetics never show up as sold, they never get replaced on the shelves under the new system, so customers looking to buy end up disappointed.

Previously, Garland says, she would place special orders to refill any cosmetics items that were down to their last two packages in the aisles, which she checked several times a day. "Taking away the option from the department manager to order products for customers was a mistake," says Garland, who left Wal-Mart in February. "That ordering system worked well in some other departments, like domestics, where you sold large items, like pillows and rugs or furniture, but was a disaster here."

When in Oklahoma...
Nowhere were the shortcomings of the centralized approach more apparent than in Wal-Mart's recent effort to move upscale in several product categories. The initiative began two years ago, after company research found that affluent people with annual incomes over $75,000 were shopping at Wal-Mart for basics like paper towels and detergent. In short order, the company took out an eight-page ad insert in magazine to promote a new fashion line, sponsored a fashion show in New York's Times Square, and started pushing clothing that managers say they knew wouldn't sell in their stores. "We're rural America," says Scott Thompson, a store manager at a Wal-Mart in Guthrie, Okla. "In the heartland, we're rather conservative, and we don't think in any extremes."

Wal-Mart has since pulled back on its upscale push, acknowledging the difficulties. Scott, in an interview with BusinessWeek earlier this year, said the company had moved "too far, too fast."

The company's top officials often trumpet their adaptability and explain that merchandise is tailored for what they call "the store of the community." But Jackson says that flexibility is limited. He says there are six general formats that headquarters will try to fit the stores into—rural, urban, upscale, African American, Hispanic and inner city. But Jackson says rural Texas is very different from rural Montana. And a Hispanic store in El Paso is very different from one in Albuquerque because El Paso will have shoppers from Mexico who are looking to buy American goods to take back to Mexico, while Hispanics in Albuquerque are more likely to be looking for ethnic supplies. "You cannot have each store fit into six cookie-cutter ideologies," says Jackson. "Listen to each manager, because they know their customer."

Wal-Mart has shown an impressive ability to adapt during its rapid growth over the past few decades. Now it may need its most radical overhaul yet to keep Wal-Mart the world-beater its managers still believe it is.

In Fairhope, Ala., soft-spoken Kevin Smith runs a different kind of store for the company. It's a brand-new supercenter, but one that was modified to appease town residents who had protested Wal-Mart's entry into the retirement community. The store's exterior was designed to resemble a row of village shops, and more than 500 trees were planted outside, along with landscaping to match its locality. In addition, the store was built with an environmentally friendly design, with skylights and energy-efficient lighting. In the month since its opening, the store has become a hit with both lower-income customers and those who splurge on organic meats and eggs. Smith has run two stores previously, and now he's all for dramatic change. "We can't sit still and grow stagnant," he says. "Nothing ventured, nothing gained."

Copyright © 2012 Bloomberg L.P. All rights reserved.

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