Sober Wal-Mart launches drive into tricky area: Liquor

Thanks to Carrie for finding this article :-)

By Deborah Ball and Ann Zimmerman, The Wall Street Journal

Two years ago, Wal-Mart Stores Inc. held a series of meetings with the world's top liquor makers at its alcohol-free headquarters in the middle of a dry county. The subject, say several people who were there: What did Wal-Mart need to do to sell more vodka, whiskey and rum?

The results of those meetings are now starting to hit store shelves. In a move partially meant to spur flagging growth at stores open more than a year, Wal-Mart is pushing into hard liquor, one of the rare product categories where the world's largest retailer is very small.

Using its classic strategy that has transformed how Americans buy everything from bread to diapers, Wal-Mart is likely to shake up the booze business with its low prices, carefully chosen products, big displays and fast deliveries. The push is changing how Wal-Mart lays out some stores and influencing where it builds some new ones. Meanwhile, liquor stores and distributors are anxiously watching to see how the giant's moves will affect them.

Wal-Mart has picked a prime partner. The Bentonville, Ark., company has teamed up with Diageo PLC, the world's biggest liquor company, much as it works with Procter & Gamble Co. and Kellogg Co. Together, Wal-Mart and Diageo are developing new merchandising and products. They have come up with a new plan for a select number of Wal-Marts that triples the shelf space dedicated to spirits.

"We're putting hard liquor in our stores where we can," says John Westling, Wal-Mart's senior vice president for nonperishable food. "This is an area where we are focused on growing sales."

But selling more alcohol raises complicated issues for a company that presents itself as a folksy all-American enterprise and an arbiter of social mores. In addition to banning risque magazines from its stores and selling sanitized versions of CDs with controversial song lyrics, Wal-Mart forbids alcohol consumption on company property and at company events. When Wal-Mart executives put business meals on expense accounts, they must personally pay for any alcoholic drinks. Some store managers have balked at the effort to promote liquor sales, citing local sensitivities.

Groups such as Mothers Against Drunk Driving question whether busy supermarkets can police liquor sales as adequately as stores that sell alcohol only. Wal-Mart says it requires its salespeople to request ID of anyone who appears to be under 27 and that its training is adequate.

Wal-Mart is also finding that selling booze is a lot harder than selling toilet paper. Twenty-four states allow supermarkets to sell hard liquor, but restrictive rules make it practical for large chains to get into the business in only about 17 of them, liquor-industry experts say. Even among those 17, Byzantine laws regulate selling hours and tough rules for getting a liquor license are common. In some cases, stores must close off aisles or sections during hours when alcohol sales aren't permitted.

The campaign is forcing Wal-Mart to bend some of its most firmly held business tenets. Everywhere it sells alcohol, state laws require Wal-Mart to buy through distributors, a layer it typically eliminates to squeeze costs. And because Wal-Mart forbids alcohol consumption at its home office, sometimes its buyers must jump through extra hoops to test the merchandise they bring into the store.

Wal-Mart's push into alcohol is part of its ambition to be a one-stop store catering to almost all of its customers' needs from coast to coast. The company began selling groceries in a big way only about 10 years ago. For years, Wal-Mart's stores were concentrated in the Midwest and South where many states don't allow supermarkets to sell spirits. As it began competing more directly with grocers who sell hard liquor, it realized it needed to stay competitive. Costco Wholesale Corp. and some other rivals are well ahead of Wal-Mart in the liquor department.

The company also recently has struggled with narrowing profit increases and slowing sales gains at its stores open more than a year. Selling booze should help: Even at a discount, hard liquor carries a large profit margin and is growing faster than beer and wine.

Yesterday, Wal-Mart reported fiscal second-quarter net profit of $2.81 billion, up 5.8 percent from a year ago, its smallest gain in nearly four years. The company posted $76.81 billion in sales, a 10 percent increase over last year. Same-store sales increased 3.5 percent for the period.

In 4 p.m. New York Stock Exchange composite trading, shares of Wal-Mart fell $1.53, or 3.1 percent, to $47.57. The company's shares are down about 10 percent since the beginning of the year, compared with a 1 percent rise for the Standard & Poor's 500.

Wal-Mart has sold beer and wine as well as limited amounts of hard liquor for years. Alcohol sales accounted for about $1 billion out of the company's $285 billion in sales for the fiscal year ended Jan. 31. Wal-Mart executives have privately said the retailer aims to quintuple alcohol sales to $5 billion in the next five years, according to several spirits executives, who were briefed on its plans.

Mr. Westling, the Wal-Mart executive responsible for alcohol products, says the company doesn't have a specific sales target for liquor. Wal-Mart declined to make other executives available to comment for this article, citing the sensitivity of the project.

Some major liquor manufacturers are eager to get their products into Wal-Marts as they look for new ways to boost sales. "Retailers are very important to Diageo and to our plans for sustainable, profitable growth," says Diageo Chief Executive Paul Walsh, in a written reply to questions.

Executives from Diageo, which recently expanded its office in Bentonville to 13 people from just a handful, say they started lobbying Wal-Mart to sell their brands such as Johnnie Walker Scotch and Smirnoff vodka in about 2001. Diageo had recently acquired U.S. spirits group Seagram Co., lifting its share of the $48 billion U.S. liquor market to 23 percent. Last year, Wal-Mart named Diageo its first "category captain" for spirits, its term for the coveted position it designates to one supplier in each area. The captain helps Wal-Mart shape plans for a specific range of products.

Wal-Mart buyers, in turn, started giving the spirits maker advice on new products. While the retailer routinely helps food and beverage companies come up with new products, it had never done so in hard liquor.

Early last year, during a visit to Diageo's U.S. headquarters in Stamford, Conn., some senior Wal-Mart buyers and top Diageo marketing executives toured a local supermarket, Diageo executives say. They spotted a milk drink with dulce de leche, a caramel-like flavor that has spread in recent years to ice cream, candies and other desserts. The Wal-Mart buyers urged Diageo to come up with a dulce de leche spirit, something Diageo hadn't considered, Diageo executives say.

Within months, Diageo designed a dulce de leche liqueur it named Caraluna. Wal-Mart pushed Diageo to work quickly to have it ready to test during the critical Christmas shopping season and agreed to a trial in its Arizona stores. Diageo invented a nonalcoholic whipped topping version of Caraluna that it served on ladyfingers in the liquor aisle so shoppers could sample the flavor of the new liqueur.

Diageo managers are now tweaking Caraluna, which it renamed Dulseda for trademark reasons, in preparation for a national rollout.

When Wal-Mart opened a new store in Pineville, Mo., last January, it borrowed a well-worn trick from the liquor industry: planting a liquor store just over the border of a state or county with restrictive booze laws. Shoppers from Wal-Mart's hometown of Bentonville often make the 10-mile drive to Pineville to stock up on liquor. The new store, featuring a separate 5,000-square-foot section selling 750 milliliter bottles of Johnnie Walker Black Label and Hennessy cognac for less than $29, has been a success, Wal-Mart has told suppliers. By contrast, a nearby independent liquor store, Hilltop Liquor & Tobacco Store, was recently selling the same size bottles of those two brands for about $35 and $34, respectively.

"We would not have enough space in that store, if we hadn't built a separate liquor department," says Mr. Westling of Wal-Mart. "We are looking at our other stores where we are running out of stock quickly in spirits and trying to find where we can get more space from."

Encouraged by the Pineville experience, Wal-Mart recently asked Diageo executives to scout out other similar sites. Wal-Mart has started to include liquor in the prime end-of-aisle spot reserved for special promotions, rotating it with beer and wine. It plans to close a Sam's Club in a town just south of Bentonville because it couldn't secure a liquor license. It will reopen the store several miles away in Fayetteville, where the company recently secured a license.

Wal-Mart is making other adjustments to meet liquor-sale requirements in various states as it struggles to catch up to competitors with large liquor sections. In Florida, it has gotten around a law restricting the sale of liquor in grocery stores by walling off the liquor department and building a separate entrance in some of its new stores.

"If they wanted to pull consumers from their competitors, they had to have bigger spirits departments," says Mark Kyle, international customer director of Allied Domecq PLC, which was recently acquired by Pernod Ricard SA and Fortune Brands Inc.

As with other Wal-Mart expansions, the push into booze is scaring some small retailers. To gird against big-box retailers such as Costco and Wal-Mart, Tom Williams, owner of a liquor store in Waltham, Mass., joined with 12 other stores to form a business group that pools its resources to do joint marketing and promotions. "Look what they've done to other categories -- independent pharmacies, optical shops. They've crushed them," Mr. Williams says of Wal-Mart.

Some distributors are also nervous that Wal-Mart could squeeze the profit margins they have long enjoyed because of heavy state regulations. After the repeal of Prohibition, the states established what is called a "three-tier system" that requires the makers of alcohol to use a middle man, or distributor, to sell to bars and stores. The goal of the system was to help in regulating the industry and to prevent the large manufacturers from having too much power over mom-and-pop retailers.

Wal-Mart's entrance into the business could help spur changes already taking place in the distribution business. Over the past few years, Glazer's Wholesale Distributors, the No. 3 liquor distributor in the U.S., has invested in computer software, including some that is compatible with Wal-Mart's systems, to compile inventory and sales data faster, enabling it to restock shelves at individual stores more quickly. While Wal-Mart still must place orders with each Glazer distributor in individual states, Glazer has appointed one manager to run interference should problems crop up with pricing or late deliveries.

Wal-Mart's move comes amid challenges to distributors' role in controlling the sale of alcohol. Earlier this year, the Supreme Court ruled that states could no longer ban the direct sale of wine across state lines. And a closely watched Costco lawsuit challenges a Washington state law requiring retailers to buy wine from a distributor rather than directly from a manufacturer. But liquor industry officials say any significant changes to the sale of hard liquor as a result of these cases would likely be years away.

Wal-Mart's corporate culture, which has long eschewed alcohol, complicates the company's hard-liquor ambitions. It bans the consumption of alcohol at all corporate events -- including a recent barbecue where Diageo won a vendor-of-the-year award. In recent months, Wal-Mart has, for the first time, allowed spirits makers, including Diageo, to display but not open their products at Wal-Mart events such as its big semiannual vendor meetings, say spirits executives who were present at one of the meetings.

Because Wal-Mart executives aren't allowed to drink on company premises, spirits manufacturers sometimes book hotel rooms in Bentonville or take executives to the few local members-only clubs that have liquor licenses to sample products.

Bob MacNevin, head of national accounts for Pernod Ricard, says that when his team flies to Bentonville for meetings with Wal-Mart, they make special arrangements. The executives ship sample bottles of Jameson Irish whiskey and Wild Turkey bourbon to their hotel ahead of time because they can't buy their brands locally. Oftentimes, they leave Arkansas with the bottles unopened. "They are very, very careful," he says.

Unlike many rival grocery chains, Wal-Mart prohibits alcohol ads in its monthly circular and doesn't permit spirits promotions outside the liquor aisle, blocking cross-promotions with food or glassware, for example.

Even when Bentonville headquarters approves a liquor display, some Wal-Mart store managers decline to install it. This is allowed, under Wal-Mart's policy of letting local store managers have some say in adjusting their merchandise and marketing for local taste. To combat that, liquor makers are instructing their distributors to meet with individual Wal-Mart store managers to show them sales data to argue that selling spirits helps overall sales.

"We have held Wal-Mart 101 presentations with our distributors," says Allied Domecq's Mr. Kyle. "We pull the numbers and show them the opportunities."