Target International Expansion

Analysis of Canadian Expansion

12/3/2010

Table of Contents
Introduction .................................................................................................................................................. 4 Why Expand? ............................................................................................................................................ 4 Targets Existing International Experience................................................................................................ 5 Canada: A country To Expand Into............................................................................................................ 6 Expand into Toronto Area First: ............................................................................................................ 7 Canadian Retail Sector .............................................................................................................................. 7 Canadian Ethos ......................................................................................................................................... 7 Consumers Shopping Demands and Preferences ..................................................................................... 7 Competitors Already Internationalized .................................................................................................... 8 International Learning Experience ............................................................................................................ 9 Economies of Scale ................................................................................................................................... 9 Foreign Investment Climate in Canada ......................................................................................................... 9 Canadian FDI Breakup ............................................................................................................................. 10 Canadian Economys FDI Attractiveness ................................................................................................. 10 Other Attractive Factors of Canadian Economy ..................................................................................... 11 Retail Environment in Canada. 13 Retail Market Structure 13 Competitors. 15 Infrastructure. 17 Workforce. 17 Selecting an Entry Mode. 18 Acquire Zeller's.. 19 Political Risk. 20 Business Risk 22 Risk Management 24 Implementation 26 Non Financial Investments 27 Financial Investments 28 Page 2 of 48

Control Mechanisms &Milestones.. 29 Performance Metrics. 30 Exit Strategy. 30 References ................................................................................................................................................ 333 Appendix ..................................................................................................................................................... 34 Exhibit 1: Target Stores in U.S. (Green Rectangles showing areas closer to Canada). ........................... 34 Exhibit 2: Target Key Financial Figures Growth Rate Change ................................................................. 37 Exhibit 3: Target Key Financial Figures Growth Rates............................................................................. 35 Exhibit 4: Target Key Financials ............................................................................................................ 38 Exhibit 5: Target Sales Growth Relative to Store Size Growth ................................................................ 36 Exhibit 6: Country Portfolio Analysis Adjusted for Distance for Fast-Food Restaurants ...................... 37 Exhibit 7: Increasingly More Corporate Profits are coming internationally ........................................ 37 Exhibit 8: Expected Target Canadas Key Financial Figures Growth Rates ............................................. 38 Exhibit 9: Expected Target Canada Growth Chart .................................................................................. 38 Exhibit 10: State of Foreign Direct Investment in Canada ..................................................................... 39 Exhibit 11: Sources of Foreign Direct Investment in Canada ................................................................ 39 Exhibit 12: Foreign Direct Investment Breakup in Canada by Major Industry ...................................... 40 Exhibit 13: Foreign Direct Investment Breakup in Canada by Selected Industry .................................. 40 Exhibit 14: US and Canada Key Indices Comparison ............................................................................. 41 Exhibit 15: Canadian Retail Sector Snapshot (2009) ............................................................................ 41 Exhibit 16: Some Components of Canadian Culture ............................................................................. 42 Exhibit 17: Comparison of Canadian Economy Growth vs. its Peers..................................................... 42 Exhibit 17: Canada GDP Growth Rates vs. Other G-7 Countries ........................................................... 43 Exhibit 18: Corporate Taxes in Canada compared to Other G-7 countries ........................................... 43 Exhibit 19: Zellers (Hudson Bay) Financials Small Snap Shot................................................................. 44 Exhibit 20: Zellers (Hudson Bay) Financials Chart ................................................................................... 44 Exhibit 21: Retail Sector, Year Over Year Growth...44 Exhibit 22: Retail Sector, Operating Profits 44 Exhibit 23: Canadas Working-Age People by Mother Tongue. 45 Exhibit 24: Frankel and Ross Measuring the Impact of Distance. 46

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Introduction
Target is one of the major retailers in U.S. It started in 1902 as Dayton Dry Goods Company and opened its first Target store in 1962 in Minneapolis area. Since then it has opened 1740 stores (Exhibit 1); at a record pace of 21% per annum. It has become the second largest retailer in U.S. with annual sales of $63 billion dollars (Exhibit 4). Target is a discount merchandiser and follows a best cost strategy to compete with retail giant Wal-Mart whose annual revenues exceed $300 billion dollars. Wal-Mart is a low cost leader and it is impossible to compete against Wal-Mart just on the basis of low prices. Hence Target offers slightly higher niche products than Wal-Mart at the best cost. Best cost strategies are most difficult to implement with Target being one of the successful exceptions. Why Expand? One of the significant facts we noticed about Targets past 5 year financials is that the growth rates for revenues, profits, net profit, gross profit and revenues per square foot has been slowing down. The growth is still there but it has been slower in recent years (Exhibit 2 & 3). The retail saturation in American retail segment and the infamous recession of 2008 have been the major factors for the slow down. There is a high probability that Target has reached to a saturation point in terms of future growth in America and new growth in U.S. will be increasingly difficult in challenging economic environments. The evidence of saturation is suggested by the fact that the growth rate of new square footage has gone down from 8% to 4%. As per Raymond Vernons Product Life-Cycles theory the wealth and size of U.S. market gave Target strong incentive to develop unique upbeat charming retailing concept. As Targets retailing concept has matured and Target finds harder to grow in U.S., it is right time for Target to look outside for future growth where it can apply its distinctive competency to win share in international markets. Page 4 of 48

The other key factor with Target is that its growth depends on how fast it is able to add new stores. Its revenue growth for period 2004 to 2009 has been 6.89%, and correspondingly Target has grown its retail footprint at the rate of 7.05% (Exhibit 4 and 5). This is very clear from the fact that the average sales per store have grown only by 0.96% in past five years. Target is a discount chain and it works at low margin of 3.5% to 5%. The relatively low margin forces Target to keep increasing volume of sales as each dollar earned bring in few more pennies. Even if the value chain is made incrementally more efficient, Target is not going to increase its net profits much. And the fact of the matter is that since Target is venturing into selling more groceries and perishables, it is forced to increase different types of distribution centers. The average number of stores per store has been decreasing from 52.32 to 45.89, which only shows increasing overhead, and one of the causes for net profits not to keep pace with revenue growth. The only avenue to increase profits is to expand at same rate of 8% to have a steady growth rate of 6% to 7%. And we have earlier seen since U.S. retail market is saturating, it requires Target to look outside of U.S. for expansion. The stock market has rewarded Target richly for its growth, and Target has commitment to continue with its growth rate because it owes fiduciary duty to its shareholders to succeed beyond their expectations. Targets Existing International Experience

At this point, we want to assert that Target is not new to international trade. It already sources the products it sells from different countries from its subsidiary Target Sourcing Services (TSS). TSS is responsible for importing the right quality merchandise at the right prices for Target stores, and has staff all over the world. Since 2005, Target has been running back office operations in India, to lower its office support costs. Target Indias sole task is to assist Target to run its value-chain efficiently, and develop new and efficient merchandising concepts. Thus Target is not new to running international business, and to the challenges international operations poses. Page 5 of 48

Canada: A country To Expand Into We have found Canada to be an excellent expansion destination, and to be very attractive for variety of reasons. When we looked at the country portfolio analysis just for fast food restaurants our eyes were startled. The biggest circle on the portfolio analysis diagram belongs to Canada (Exhibit 6) and it indicated that Canada was closest to US in many ways . This analysis made adjustments for cultural similarity, geographically closeness (Exhibit 1) and trade agreement participation. Indeed this is the case. Both U.S. and Canada are biggest trade partners in the world, share big portion of their borders and signatories to NAFTA. And in fact many Target stores are close to Canadian border and frequently visited by Canadian shoppers. Economically Canada and U.S. are similar. Both are categorized as developed countries and have around 80% of population living in urban centers with at least 75% working in service sectors. The income levels do not differ that much. U.S.s per capita annual income of $43,730 is little higher than Canadas $ 39,010 (Exhibit 14). The prosperity levels indicated by penetration of telephone, computers, and televisions all indicate that the residents of both countries have a very high standard of life. Many of the cultural traits such as Thanksgiving dinner, Success through hard work, Santa Claus and Easter Bunny are cultural norms found in both countries (Exhibit 16) . Geographically Canada and U.S. are very close and share same weather elements. It is easy to see that in both countries consumers have similar tastes and demands because of geography, economics and culture. Hence it becomes very easy for Target to extend into Canada. If Target chooses to open few stores in Toronto and Vancouver metropolitan areas it can do it easy, since these regions are close to its existing distribution centers in New York and Washington states (Exhibit 1). And merchandise as we saw will not be problem because the consumers in these four areas share same tastes and have same demands. Moreover the consumers across both countries watch same sports, movies, and television shows. Thus Target can use almost same amount of the advertising dollars to run marketing campaigns in both countries.

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Expand into Toronto Area First:

Toronto and its suburbs is one of the largest concentrations of population in Canada. Within 1day drive or 1 hour flight time of Toronto 22 million people with an economic value of $550 billion reside :. This area is the fifth largest market in North America and twelfth largest in the world. A company like Target will ill afford to ignore one of the largest consumer markets. Canadian Retail Sector Canadas annual revenues in retail sector are $403 billion in Canadian dollars. 46% of these revenues come from chain stores and 30% of Canadian GDP comes from retail sector (Exhibit 15). Retail sector employees 11.2% of Canadians, and uses 227,200 locations to push its wares to its customers. There is a strong retail environment in Canada and Target does not need to educate its potential consumers about its offerings. Consumer education is big issue in many countries of the world and international companies spend time and money to educate and train consumers about the products which these consumers do not know about. Canadian Ethos

Canada is well known across the world for its social welfare programs and Canadians take immense pride in it. And Targets policy of donating 5% of profits for social causes matches beautifully with Canadian ethos. Such policy will resonate with Canadian consumers and will make Target a likable place to shop for these consumers. Consumers Shopping Demands and Preferences

Consumers in Canada covet U.S. shopping experience. Target, with its racks of dirt-cheap designer duds, has big following among border-hopping Canadian customers. Their experiences is well summarized by Maureen Atkinson, a senior partner at J.C. Williams Group, a Toronto-based retail Page 7 of 48

consulting firm, "If someone goes to Target and then comes back to Canada and shops at Zellers or WalMart they aren't as happy, They become more demanding, less satisfied.". There is a window of opportunity for Target to fill the gap in the Canadian retail market and to cash retail envy Canadian Consumers feel. In a recent survey it was found that both U.S. and Canadian consumers had similar financial perceptions but Canadian consumers were less reactionary. 29% of Canadians did not cut back versus 19% of U.S. shoppers. It was also discovered that Canadians are more avid shoppers, and visit variety of shopping venues at higher frequency than U.S. consumers; a trend which will benefit Target. Canadian consumers also report higher participation in loyalty programs; 64% versus 51% for US. Targets new 5% discount program on purchases made on Target credit card will surely attract majority of Canadian consumers. Competitors Already Internationalized

Majority of U.S. firms are having more share of their revenues from international markets (Exhibit 7). One of the Targets online retail competitors Amazon.com has 48% of its revenues coming from outside of U.S. . Knickerbockers theory tells us that a competitor firm who enters internationally first might use profits from overseas to subsidize prices in home country to wean way business from its existing competitors. Secondly, for Targets chief competitor Wal-Mart Canada is its sixth largest market. Wal-Mart Canadas annual sales are approximately $15 billion which happens to be 4% of Wal-Marts total global sales. Wal-Mart derives its $15 billion of revenues from 317 Canadian stores including 89 Supercentres. Thus it is imperative for Target not to overlook its competitors and fall far behind in penetrating international markets.

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International Learning Experience

We saw that how Canada being close to U.S. gives an excellent chance to Target to start internationally. Since it can start with few stores close to its existing distribution centers, Canada opens a low risk door for international expansion and wonderful opportunity to learn and master global trade practices and challenges global trade creates. Economies of Scale

We saw that Target works with low margins it makes necessary for Target to constantly ramp its sales volume. Thus going international will open bigger markets for Target and economies of scale will work to help lower costs. Target is also big in private label and economies of scale will benefit more in Targets very lucrative private label products.

Foreign Investment Climate in Canada

Canada has been very attractive destination for international foreign direct investment (FDI). We have learned that historically most FDI has been directed to the developed nations of the world as firms based in advanced countries invested in each others market. And FDI in Canada proves same. Among all G-7 countries Canada ranks on top in FDI as percentage of GDP, which happens to be 30% in 2006 for Canada (Exhibit 10). The FDI as percentage of GDP has been climbing in Canada showing Canada as remarkable attractive FDI destination. Among all the countries who invest in Canada, U.S. is in the top with $288 billion dollars of FDI. U.S. contributes 57.6% of total foreign investments in Canada (Exhibit 11) .

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Canadian FDI Breakup

In Canada 41.1% of all FDI is invested in Finance, Insurance and Energy sectors (Exhibit 12). Canada is bestowed with lot of natural resources. Its principle export is energy in form of gas and oil, and it makes up 20% of $389 Billion dollars of total Canadian exports. We saw earlier that service sector is 68.6% of Canadian economy. And service sector needs strong presence of financial and insurance institutions. Looking at these factors makes it clear why most of the FDI in Canada has been in these three sectors. And when we look at the foreign ownership in Canada by selected industry we observe that in retail industry 20.9% ownership is through FDI (Exhibit 13) and on average across all industries FDIs share in investments is 21.1%. The current amount of foreign investment demonstrates that Canada is an attractive investment destination. The amount of FDI ownership in retail sector should take away nervousness from Target as others have already demonstrated FDI in retail. Canadian Economys FDI Attractiveness

Honorable Peter Van Loan the Canadian Minister of International Trades own words makes clear the stance Canadian government has taken with regards to FDI in Canada. We offer one of the most attractive and low-risk business destinations in the world. Our rich diversity, spirit of innovation and excellent business conditions are key drivers of our economy. The advantages and opportunities that Canada offers are countless: Lowest taxes on new business investment in the G7 Lowest debt-to-GDP ratio in the G7 Fastest economic growth in the G7 for 2011, according to the International Monetary Fund Worlds soundest banking system, according to the World Economic Forum Page 10 of 48

A tariff-free zone for manufacturers by 2015 The highest proportion of post-secondary graduates in the OECD High quality of life A commitment to the rule of law and a strong justice system"

Attributes, such as lowest taxes, fastest G-7 economic growth, stable polity, lowest G-7 debt-toGDP ratio, high quality of life, and strong law enforcement, make Canada a strong candidate for any FDI considerations. These are the very qualities corporations are looking in foreign countries to make commitments for FDI investments. Moreover in 2009, Canada became first country in the G20 to become tariff-free zone for manufactures after elimination of over 1,500 tariffs on manufacturing inputs and machinery and equipment. The foreign investors compliment Canadian government well for Canadas high skilled workforce and enviable quality of life which makes Canada a place to do business and succeed. Canadas economy has been one of the most resilient globally during the recent downturn. Canadas GDP, is worlds 11th largest, and for the decade 2000-2010 its GDP has averaged growth of 1.7% well above the U.S., the U.K., France, Germany and Italy (Exhibit 17). As per IMF, Canadian economy is forecasted to grow at the rate of 2.6% for 2010 and 3.6% for 2011, well above the other G-7 countries growth rates (Exhibit 18). For foreign investors, therefore, Canada offers a large and growing market with high-growth sectors of activity at a time when most other advanced economies are looking at uncertainty over the short-to-medium term. Other Attractive Factors of Canadian Economy

There are few other commendable things about Canadian economy which makes it the destination for FDI. Canada has the lowest payroll taxes among all G-7 countries and by 2012 the Canadas federal corporate income tax will fall from 18% in 2010 to 15%. The new rate will be less than half of the top

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U.S. federal marginal corporate income tax rate and lowest in the G-7 countries. Canada also allows faster depreciation for assets, an attractive proposition for capital investment. Recent years have been marked by world-wide bank failures and collapses. But no Canadian bank or insurer has gone bankrupt. Four of the Canadian banks are among North Americas top 10 banks, measured by assets. The Canadian government runs budget surplus which stands for something when other G-7 countries are running multi-billion dollar deficits. A stable banking system and budget surplus indicates that the Canadian consumers shopping power will stay intact and will not fluctuate, a quality deemed by those selling consumer goods. As per World Bank in 2010 Canada has the lowest number of procedures required to establish new business among G-7 and OECD countries. Among real estate process all over the world Canadian real estate prices are most competitive. Canada allows full repatriation of investment earnings and with balance of trade with U.S. in Canadas favor repatriation of earnings back to U.S. will not be a problem. The latest Competitive Alternatives 2010, KPMGs guide to international business costs, found that Canada leads the G7 in low business costs, with an overall cost advantage of 5.0% over the U.S. Among the countries in KPMGs study, Canada has: The lowest R&D costs in the G7, with a 12.9% advantage over the U.S.; The second-lowest labor costs (after Mexico); The third-lowest facility lease costs (after Mexico and the U.S.); The lowest electricity costs; and The second-lowest tax costs (after the Netherlands).

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Thus it becomes a no brainer for Target to invest in Canada. The economy of Canada is doing excellent and is most stable. Canada has least barriers on flow of goods and money across the border. It citizenry makes attractive potential customers for Target.

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Retail Environment in Canada

Canadas economic strength lies in the diversity and vitality of its natural-resource industries that supply the world with ore, oil and gas, lumber, and other commodities. The retail sector is a vital part of Canada's economy and society. The Canadian retail industry is primarily engaged is selling consumer goods and related services through stores to the general public. Large retail firms also tend to operate their own warehouse facilities and, in some instances, have manufacturing operations for the production of private-label goods. Retail Market structure

The retail market structure has changed considerably in recent years. A number of large nonCanadian retailers (mainly from the United States) have established a significant presence in Canada, bringing with them new approaches to doing business, such as use of the big box retail format, everyday low pricing, and advanced logistic systems. Several Canadian retailers are transforming themselves to compete successfully with these large newcomers, while in some sectors, local independent retailers have disappeared altogether. In the short term, Canadian consumers have benefited from the lower prices and added convenience associated with the changed retail market structure, but, at the same time, the retail environment has become more homogenous and concentrated.

The Canadian retail market has been evolving rapidly since the last decade. The most significant development of the last decade has been the emergence of big box stores. In the first study on this issue by Statistics Canada, Genest-Laplante identified three unique categories of big box stores in Canada and quantified the growth(in market share) of these new formats. The first category is supermarkets, with Page 14 of 48

groceries as the main products, and a minimum store size of 50 000 sq. ft. Second are specialty stores retailers focusing on specific types of consumer goods, such as sporting goods, electronics, toys, drugs and clothing, with a minimum size of between 5000 and 20 000 sq. ft. (depending on the type of goods sold). Finally, there are general merchandise stores with a minimum of 90 000 sq. ft. Since 1989, these three categories have steadily taken a greater share of Canadian consumer sales in their respective markets.

The direct contribution of retail trade to the economy was $74.2B in 2009, representing 6.2 percent of Canada's gross domestic product (GDP). The rate of Canada's retail sector GDP growth was 34 percent faster than the U.S. retail sector and 96 percent greater than the Canadian economy between 2004 and 2008.5 Retail employment grew 2.4 percent per year from 2002 to 2009 while employing 2.0 million people, or 11.9 percent of the total working population in 2009. Through its investments in information and communication technologies (ICT), commercial infrastructure, and logistics and transportation services, the retail sector has significantly affected other sectors of the economy.

After a prolonged period of growth, Canadian retail sector sales decreased in the last quarter of 2008 and through the first three quarters of 2009 (Exhibit 21). The impact of the economic downturn on sales of the Canadian retail sector varied more among the economic regions of the country than on a product line basis. The Alberta and British Columbia retail sectors had the largest percentage sales decline amongst the Canadian provinces during the economic downturn.

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The economic downturn affected the sales of each retail trade group differently. Home furnishing stores, furniture stores, home electronics and appliance stores, and home centers and hardware stores experienced some of the largest yearoveryear sales decreases through the first three quarters of 2009. Meanwhile, the sales growth of supermarkets, pharmacies and personal care stores, and department stores and general merchandise stores remained positive throughout the downturn on a yearoveryear basis.

Although retail sales have decreased during the economic downturn, the sector has remained consistently profitable (Exhibit 22) in part due to better control of global sourcing activities and responsiveness to changes in consumer demand. Also, retailers are moving beyond operational improvements based solely on measuring averages. Managing and controlling the variability in their operations especially regarding their supply chain is driving their profit margin.

Although the Canadian retail sector experienced negative annual growth over four quarters due to the economic downturn, its growth has consistently outpaced the U.S. retail sector over the past several years. In addition, the sales of the Canadian retail sector were less affected by the global economic crisis than that of the U.S. retail sector.

Competitors
The Canadian retail market is dominated by foreign retailers. A number of retailers (Best Buy, Old Navy, Home Depot, Wal-Mart, and Staples) from United States have established a significant presence in Canada, bringing with them new approaches to doing business, such as use of the big box Page 16 of 48

retail format, everyday low pricing, and advanced logistic systems. Several Canadian retailers are transforming themselves to compete successfully with these large newcomers, while in some sectors; local independent retailers have disappeared altogether.

The bulk of total foreign retail sales in Canada (approximately 75 percent) are attributable to firms based in the U.S., with most of the rest coming from firms in the United Kingdom (Simmons and Kamikihara). In fact, the umber of U.S. retail chains operating in Canada increased from 10 in 1985 to 185 in 2003. As of early 2009, 11 of the top 20 retailers in Canada (measured in terms of retail sales) were U.S.-owned.

Wal-Mart entered Canada in 1994 with the acquisition of 122 Woolco stores, and in eight short years, it has easily surpassed the Hudson Bay Co.and its Zellers chain to become Canada's number one retailer. Wal-Mart effectively controls 38 percent of the Canadian department store market. Before WalMart's arrival, Canada's retailers mainly operated according to a variable high low pricing model, using weekly fliers, loss leaders and specials to attract consumers. However, to compete against Wal-Mart and one another, Canadian discount and traditional department stores are borrowing some of the U.S. giant's tactics, including everyday low pricing. For example, it was reported in 2003 that approximately 35 percent of Sears Canada's sales are based on everyday low pricing, a substantial departure from its historical method of using frequent markdowns to attract customers. The same source reported that Zellers has responded by moving a larger share of its inventory to an everyday low pricing system. The end result is that it appears Canadian consumers are benefiting from consistently lower prices due to the introduction and widespread use of everyday low pricing in the retail marketplace.

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Infrastructural Facilities

Canadas infrastructural facilities are one of the best in the world. Canada offers thoroughly modern transportation (Air/Rail/Road/Sea) and telecommunication infrastructures, and easy access to global supply networks, which makes Canadas business climate second to none. Canada has a true integrated rail network running coast to coast, which is run by two national railroads, allowing for the seamless movement of goods across the country without switching carriers. Canadian Nationals acquisition of the Illinois Central railroad back in 1998 resulted in the only truly continental railroad one that stretches from Halifax in the east to Prince Rupert in the West and from New Orleans in the South to Canadas Northwest Territories. Canadas major cities are well connected through its state of the art National Highways and air.

Canada's technology infrastructure is very advanced and ranks second, only behind the U.S. of all G-7 countries and continue to rank above or very close to the U.S. in terms of the number of internet users and internet hosts per 1,000 inhabitants. The Canadian Government is committed to make Canada the most connected Government to its citizens and make available high-speed broadband access to Canadians in all communities. The economic policies of the Canadian Government are focused on making Canada a world leader in the new global economy. Workforce

Canada has a skilled and motivated work force, and continues to attract some of the brightest minds from around the world, thanks to its business-friendly immigration policy for qualified immigrants. According to the Organization for Economic Co-operation and Development (OECD), Canada leads higher education achievement. Canada ranks fourth among member countries of OECD for its high

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school completion rates. Canada ranks first in the OECD for its college completion rates, and ranks seventh for its university completion rates. More than half of all Canadians between the ages of 25 and 35 have received postsecondary education, either at the university, college, or technical level. Its engineering, business, and management schools also rank highly.

Canada is a multi-cultural country, and its workforce is reflective of that. One in every five Canadians has a mother tongue other than English or French. That is close to 6.5 million people. Both Asian and European languages are spoken extensively in Canada (See Exhibit 23). This diversity is an asset to foreign investors. Business looking for global skillets, will find Canadas ethnically diverse workforce very familiar with different business cultures.

Selecting an Entry Mode

The preferable entry mode for Target is to establish wholly owned subsidiary by acquiring an existing enterprise in Canadian market. By acquiring an established enterprise, Target can rapidly build its presence in the Canadian market. Acquisition helps Target to preempt the competition. Acquisition is usually less risky than greenfield venture. When a firm makes an acquisition, it buys a set of assets that are producing a known revenue and profit scream. In contrast, the revenue and profit stream that a greenfiled venture might generate is uncertain because it does not yet exist. When a firm makes an acquisition in Canadian market is also gives Target not only acquires a set of tangible assets, such as real estate, logistic systems, customer service systems, and so on, but it also acquires valuable intangible assets including immediate access to markets and managers local knowledge of the business environment in Canada. Page 19 of 48

Acquire Zellers

Zellers Inc. is Canada's second-largest chain of mass merchandise discount stores, started in 1931 by Walter P. Zeller, the company discount department store chain with about 280 stores across Canada. Zellers stores carry a variety of items, from apparel to groceries and furniture. Zellers is headquartered in the city of Brampton, Ontario, near Toronto, and is a subsidiary of Hudson's Bay Company ("HBC"). In recent years, Zellers has been moving slowly away from the discount department store model, and has introduced better quality merchandise and different customer service concepts. New and remodeled Zellers stores are often compared to those of Target Corporation in the United States.

Zellers operates stores from St. John's, Newfoundland and Labrador, to Prince Rupert, British Columbia, and employs over 35,000 people. The average store size is 94,000 square feet. Zellers Select stores are designed for smaller markets with populations under 25,000, with stores averaging 45,000 square feet.

Almost every Zellers location in the English-speaking provinces features a pharmacy and an in-store restaurant, the 1950s themed Zellers Family Diner. The chain has been busy renovating and expanding its stores to its new larger format (typically 100,000 square feet) to better compete with supercenters operated by rival Wal-Mart Canada. These stores typically feature a hair salon, refrigerated groceries, major appliances, mattresses, and expanded electronics and cosmetics departments.

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In the past several years, Zellers has made a notable push to drive sales through use of exclusive, private label merchandise. In a strategy similar to Target's, Zellers sells Big Star, Cherokee, Sportek, "Stuff by Duff", Homestyles, Hunt Club, Midtown, Nest by House & Home, Wabasso "Design Ideas", Alfred Sung Home, Truly, MarketSquare, Beaumark, Home Studio, and many other labels that can only be found in their stores in Canada. Private brands now represent over 30% of Zellers sales.

By acquiring Zellers provides Target right tools to compete with rival Wal-Mart Canada. This acquisition will provide Target with a revenue stream of $5 to $6 billion Canadian dollars a year (See Exhibit 19 and 20). At the same time it will also face challenges, in changing the culture of the organization and may experience high employee turnover.

Political Risk Relative to Targets decision to expand via Foreign Direct Investment in Canada; we need to review the issues of political risk. By definition, Political risk is comprised of any political force that imparts dramatic changes in a countrys environment whereby impacting profit and other metrics of success for businesses. Such political forces can be doled out in countries where there is evidence of social unrest as in the example Sub-Saharan Africa or where fanatical, political regimes are at work as in the examples of Pol Pot, Idi Amin and Hugo Chavez. As Target moves to increase market share, they must pay particular attention to an FDI path of least resistance. Over the past decade, the spread of democracy has improved the fertile landscape for FDI ventures but as for the political distance between the US and Canadaits hard to beat. First off, retail consumer goods are less sensitive to such distance where as
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products like precious metals, electricity and other various commodities (ie sugar, Textiles, coffee) are highly sensitive to preferential trade agreements. The following is an excerpt from the US State Department website: Canada is a constitutional monarchy with a federal system, a parliamentary government, and a democratic tradition dating from the late 18th century. The Charter of Rights and Freedoms, enacted in 1982, guarantees basic individual and group rights (US Dept of State 2010) . It is clear to see that Canada doesnt run the same Two Party political system as found in the US; however, the tradition of democracy is clearly a commonality which fosters a positive atmosphere for commerce and also reduces many of the necessary controls that would need to be implemented when entering a Totalitarian/command style environment. Target should consider a guarded approach to entering the province of Qubec however. Qubecs national sovereignty has waned in the past decade; however, culture and identity still make up the centerpiece of the provinces politics. Many Quebecers wish for secession from Canada however they enjoy the benefits of confederation.

The relationship between the United States and Canada is the closest and most extensive in the world. It is reflected in the staggering volume of bilateral trade--the equivalent of $1.6 billion a day in goods--as well as in people-to-people contact. About 300,000 people cross the border every day.(US Dept of State 2010) Based on CAGE Theory, Frankel and Rose predict exponential changes to international trade due to many of the current conditions found between the US and Canada (Polity, Regional Trading Bloc, Common Language, Common Border, Access to Ocean) See Exhibit 24.

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An important factor to note concerning NAFTA is that trade between the US and Canada has grown over 265% since 1994. This can be interpreted as a positive aspect shared by both countries whereby further solidifying their relationship

Historically speaking, the US and Canada comprise one of the largest investment relationships in the world. It comes as no surprise that Canadas largest foreign investor is the US. Statistics Canada reports that at the end of 2007, the stock of U.S. foreign direct investment in Canada was $289 billion or about 59% of total foreign direct investment in Canada. (USDS 2010) Based on this evidence, Targets decision to operate in Canada carries little political risk while offering a nurturing environment in which to thrive. Concerning the laws of Canada, Criminal law, and Civil Law are based on the common law system of England which is the underpinning for the United States legal system. Conversely, Quebec utilizes a civil code that is derived from the French legal system. This evidence clearly illustrates yet again there are many commonalities between the US and Canada with exception of Qubec. Business Risk The definition of business risk is as follows: Probability of loss inherent in a firm's operations and environment (such as competition and adverse economic conditions) that may impair its ability to provide returns on investment. Business risk plus the financial risk arising from use of debt (borrowed capital and/or trade credit) equal total corporate risk.(Business Dictionary.com) As with any Foreign Direct Investment you will carry business risk mainly in the form of investment failure based on a collapsed FDI venture. Corporations must tie up capital when
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embarking on FDI no matter if its a joint venture of a full-blown Greenfield approach. Mitigating all risk is not possible; however steps may be taken to reduce certain risks. In comparison to FDI expansion overseas, growth in Canada costs far less and carries fewer logistical risks. Yet, some of the significant challenges that face Canadian FDI are the, vast distances between major Canadian cities and other aspects of bilingual labeling and marketing. Target has looked at a variety of FDI approaches relative to expansion in Canada. Initially, they planned a launch of 5-6 stores across select provinces in Canada. They have worked with real estate developers to determine locations for maximum impact as in the example of the Greater Toronto Area which is home to 22 million people. The following excerpt is from Target CEO, Doug Steinhafel: "As we approach each of these growth opportunities, Target will apply the same rigorous financial discipline that we have applied historically, ensuring a returns-based approach and the prudent use of capital"(Target.com, 2010). The strategic behavior of competing firms can force one another to find the same resources. The eased barriers to entry due to NAFTA compounds the competitive climate whereby increasing the likelihood that others will join Target in a fight for market share. As Target grapples for greater market share in the retail consumer goods sector, they will cross paths an old rival, WalMart who, with 317 stores across Canada, has been servicing Canadians for more than 15 years. Other related competition native to Canada is Hudson's Bay Co(HBC). Their substantial presence is delivered under the Zellers and The Bay chains. Relative to Wal-Mart, Target is not a First Mover by expanding into Canada. Wal-Mart being the first mover has now sold its brand to Canadians for over 15 years and has created a brand loyalty. Wal-Mart also carries the distinct advantage of running the most efficient and technologically enhanced distribution

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centers in North America. These ingredients can pose a daunting risk as Target will initially be utilizing its distribution centers in the US to feed Canadian stores. One concern is that the layout of Super Target and Target Greatland stores accommodates the sale of groceries. Distribution centers located in the United States are ill-equipped to service fresh produce, seafood as well as various meats and dairy for the Canadian market. There are also legal and governmental issues that obstruct Targets ability to import certain food groups into Canada. For example, Meats, Dairy, and poultry must be approved by the Canadian Food Inspection Agency. This said, the expansion effort will need to increase to include the building of distribution centers in Canada that are sourcing food stuffs locally to Canada. Said efforts increase scale of entry and tie up greater capital, therefore, greater exposure if the venture doesnt tender a return on investment. Lastly, exchange rate fluctuation can have an impact on the FDI process. Targets plan is to roll out its half dozen stores mid decade is a long enough timeline to see a great deal of flux in the US/Canadian dollar exchange. Budgeting has to take into account a possible weakening of the US dollar otherwise the project might not be sufficiently funded come time of launch. Risk Mitigation Target has elected to avoid FDI in such countries that exemplify the ideals of totalitarian or collective rule and command economies. China, as an example, may offer inexpensive factory labor however; they lack the infrastructure to transport retail goods around the country. By choosing Canada, Target has opted for democracy and a market economy. According to Ghemawats statement about Wal-Mart in Canada; Target in Canada will virtually be a carbon copy of Target in the United States. (Ghemawat, 2001)

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As for the mitigation of business risk; Target could look to acquire Zellers stores to reduce the time involved in launching a full scale Greenfield FDI. Zellers infrastructure is in place for seamless operational startup. A polycentric staffing policy could help reduce cultural myopia as well as reduce the costs of value creation. Although, after an incubation period, a more preferable geocentric staffing approach would foster greater growth for host and home country managers. One of the possible downsides to this acquisition is the reduced square footage of retail space in Zellers stores. Lack of footprint may present an operational problem when reformatting the stores to match the space hungry, Target motif. The acquisition of Zellers however, would come with distribution centers that could feed the grocery sector of Target. Additionally, given the opportunity, Target may want to enter into a joint venture with HBC/Zellers as many mergers and acquisitions fail due to overpayment, The Hubris hypothesis, where top managers overestimate theyre ability to generate value to the firm. Risk can also be mitigated via proper screening and auditing. The choice of strategy should fall between a Global Standardization and Transnational Strategy. To clarify this, many of the goods sold at Target stores within the United States would easily be salable in Canada under the standardization approach, however, products requiring French labeling or metrics would need to be localized. There is also a significantly larger Indian population in Canada that would respond to greater localization of products, hence there will be a mix of standard and local products. Concerning the pressures for cost reduction, the retail consumer goods market is lead by the largest corporation in the world. As a competitor of WalMart, Target must look to expand in efforts to create a greater bargaining force with is suppliers. The domino effect would then lead to more robust order volumes where suppliers could take further advantage of Economies of Scale and drive prices lower. Within this notion is
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Knickerbockers theory of Multipoint competition. Target is following one of its largest competitors to Canada in order to stave off Wal-Mart capturing an insurmountable market share.

Implementation Dominic Barton, Principle Director of McKinsey and Co. states Opportunities come up when available. Prepare your board on the basics. (McKinsey, 2010) Relative to Target, this statement is quite apropos. The initial plan for Targets FDI was to launch five to six stores across Canada, mid Decade. As it turns out, HBC is in season to divest itself of their consumer retail business unit, Zellers. Zellers Inc. is Canada's second-largest chain of mass merchandise discount stores, with 276 locations in communities across Canada. (hbc.com) Rumors within the past few years pointed to a possible takeover of Zellers. Jerry Zucker had purchased Zellers taking that option off of the table, however, after his untimely death in 2008, the retailer was spun off to NRDC Equity partners in July of 2008. The economic downturn has weighed heavily on NRDC as they also own the retailer Lord and Taylor. This said, Zellers is right for acquisition yet again. Target has alluded to the fact that it may be another three years before they are positioned to enter Canada so during the interim they will be focused on improving the stores in the United States. Target plans to invest $1 billion (U.S.) renovating 340 stores, adding more groceries to its general merchandise as hard-pressed consumers continue to buy staple goods.(Flavelle, 2010) As Target bides their time, playing a wait and see approach, they will be focused on building 10 new stores in existing U.S. markets during 2010. This is a stark decrease from the 58 stores built in 2009 and 91 stores in 2008. Plans are also in the works for opening smaller store formats within the next 2 years.

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Looking at the current retail landscape in Canada, Wal-Mart, with its 317 stores across Canada generates $15 billion and NRDC Equity(Zellers) generates roughly $6 Billion annually. This said, the entire retail market is $400 Billion and leaves enough room for Target to penetrate and draw discerning customers away from the likes of Wal-Mart. Based on this opportunity Target must first gain approval by way of The Foreign Investment Review of 1973. The law deals with acquisitions of control of Canadian businesses. The review was necessary for all acquisitions and for every establishment of a new business in Canada by foreign-controlled entities above a certain size. (Business Highbeam.com) The initial FDI plan by Target was of an incremental approach, requiring a capital investment considerably less than the magnitude of a near 300 store takeover complete with distribution centers. Target would undoubtedly finance FDI expansion with a combination of debt and equity. Non Financial Investments Concerning Non Financial investments, Target has certainly reviewed the overall climate conditions of Canada and with the possible acquisition of Zellers, many of the stores will need to be upgraded to perform as LEAD certified buildings. Said green activities will result in environmental preservation which on the outset isnt a financially sound project, however, should add to show corporate social responsibility. Target will also generate non financial investments by way of government regulations. As stated earlier, review boards will be assembled to review and generate proposals for the Foreign Investment Review Board. Customer satisfaction is another key area of non investment due to the following reasons: Canada has long had a love/hate relationship with foreign direct investment (FDI). FDI brings

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economic activity and jobs but conjures up fears of foreign takeovers, especially by the United States. Foreign firms operating in Canada are more innovative and productive than their Canadian counterparts, and they pay higher wages. (business.highbeam.com ) Lastly, employee motivation is a non-investment to ponder. Target has a rich tradition of creating a team atmosphere. That said, with any acquisition and especially one in another country, corporations must invest money into team-building programs to foster the proper spirit and work to reshape the culture of those acquired.

Financial Investments Naturally the monetary investment in this particular FDI relates to any costs of Greenfield, acquisition or joint venture, but also the front end research to support the decision to initiate FDI. Given the likelihood that Target would implement a Geocentric staffing approach, the costs to transfer managers to and from Canada would greatly increase expenses over Polycentric approach. The benefits would be realized by way of solid cross cultural literacy. Marketing campaigns geared specifically for the Canadian audience as well as funding the peripheral expenses in logistics, supply chain management and other related operating software integration will be a source of additional financial investment.

Control Mechanisms

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Based on the buying psyche of Canadian shoppers, the concern arises that strong loyalty programs are used by retailers. The affect of these programs usually creates higher switching costs for customers to change their patronage preferences. Target currently implements controls to measure the performance of all aspects of their retail offering. From a customer aspect, data mining through reward cards and the Target Visa help forecast demand as well as create loyalty via switching costs. From the operational side, incentives will be paid to managers of the FDI subsidiaries based on performance metrics. Certainly, ethical behavior on the part of expatriate managers has to be strictly monitored therefore the appointment of an ethics officer and the adoption of a code of ethics are the mainstays of principled business in this era. Incentivizing moral courage and ethical behavior and sanctioning immoral conduct is routine practice for many multinational enterprises. Finally, Target Canada will need to enforce strict guidelines relative to the dissemination of prescription drugs as they cannot be shipped to customers in the United States. Federal regulations prohibit the sale of prescription drugs to US residents from outside the country; however, these laws are broken on a routine basis. Milestones We need to develop two criteria based on either a smaller scale Greenfield launch or the capital intensive acquisition with Zellers stores. With the initial plan of launching 5-6 stores through Greenfield FDI by mid decade, we would expect a 3 year plan to fully integrate the Target culture via geocentric staffing policies. Based on this smaller scale approach, reserve monies would be available to inject into further expansion stores after a sufficient break-in period. This break-in period of 3-5 years would indicate whether or not to continue further expansion in Canada. The acquisition of Zellers would accelerate the penetration of the Canadian market immediately. As Target would be acquiring the culture of Zellers they would implement a 90
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day milestone to make fast broad changes to the Zellers business. Implementation of TQM methods such as Lean and Six Sigma would help reduce waste, capture Voice of the Customer and increase operational efficiencies. After 18 months we implement an alignment program to start the integration of Targets culture, however, we would anticipate a time frame of 5 years to fully integrate the culture. Once again a geocentric staffing policy would assist in these efforts and combat against the effects of an ethnocentric, Phillips - Dutch Mafia staffing policy. In the span of 10 years we look to Target to surpass $8 Billion Canadian in sales Performance Metrics We base our metrics on calculating per capita earnings and population rates. In the United States, the Population is 301 million people. The per capita income is $43,730. Target sales are $63 Billion, therefore, per capita income of $43,730 generates Target sales of $209.30 in the US. We can then apply this metric to Canada. Canadian per capita income is $39010 which can then be divided by the US per capita income $43,730 to generate $186.71. The resulting per capita income, divided by the Canadian population of 32.6 million people will net $6.08 Billion in projected revenues. If the spend increased by 50% the Target stores in Canada could generate roughly $9 Billion. To generate even the original projection of $6 billion, Target would need to operate approximately 200 stores at $25 million each. If the Zellers opportunity is presented, Target will be best suited to strike a deal in order to meet the above performance metrics. Exit Strategy Having the foresight to arrange for a possible exit to your FDI plan is prudent. As stated earlier, the financial risk is based on the inability to achieve the return on investment. Target will endorse plans to exit based on the following criteria:
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Insufficient demand Political and Economic instability Fixed costs outweighing sales revenue

The initial stopgap measures to shore up the balance sheet would be to scale back stores through divestment and re-concentrate same store sales, whereby eliminating capital exposure where possible. If efforts to strengthen the financial position arent assisting, or the political and economic climates become insurmountable, Target must further liquidate more assets such as distribution centers and more stores until exit is complete. No firm is immune to adverse market or political conditions.

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References
1. Hill, Charles W. L. Global Business Today. Boston: McGraw-Hill Irwin, 2009. Print. 2. "2009 Shopping Habits Report." ICSC.org. International Council of Shopping Centers, Dec. 2009. Web. 3 Dec. 2010. <http://www.icsc.org/web/RecessionBooklet_lores.pdf>. 3. Plunkett, Jack W. "Hudson's Bay Company." Plunkett's Retail Industry Almanac 2007: the Only Comprehensive Guide to the Retail Industry. Houston, TX: Plunkett Research, 2006. Print. 4. Lamb, Charles W. MKTG. Toronto: Nelson Education, 2009. Print. 5. Intini, John. "We Want Target." Macleans.ca - Canada News, World News, Politics, Business, Culture, Health, Environment, Education. Macleans.ca, 6 Aug. 2007. Web. 3 Nov. 2010. <http://www.macleans.ca/business/economy/article.jsp?content=20070806_108088_108088>. 6. Invest Toronto Home. INVEST IN CANADA BUREAU: Foreign Affairs and International Trade Canada, Jan.-Feb. 2010. Web. 25 Nov. 2010. <http://www.investtoronto.ca/InvestAssets/PDF/Reports/invest-in-canada-flagship-report2010.pdf>. 7. Holden, Michael. "Overview of Canadian Foreign Direct Investment." Library of Parliament, Canada. Parliamentary Information and Research Service, Library of Parliament, Canada, 17 June 2008. Web. 15 Nov. 2010. <http://www2.parl.gc.ca/Content/LOP/ResearchPublications/prb0833-e.pdf>. 8. "Target Annual Reports: 2009." Target: Investors: Annual Report 2009. Target Corporation, 12 Mar. 2010. Web. 03 Nov. 2010. <http://sites.target.com/site/en/company/page.jsp?contentId=WCMP04-045295>.

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9. Pocket World in Figures. London: Economist, 2009. Print.

10. "Cashing in on Canada: Four Ways to Profit - Big - From the World's "Safest Economy" - Money Morning." Investment News: Money Morning - Only the News You Can Profit From. 18 Sept. 2019. Web. 03 Nov. 2010. <http://moneymorning.com/2010/09/18/canada-4/>.

11. Pankaj Ghemawat. Distance Still Matters: The Hard Reality of Global Expansion. Harvard Business Review. Sep 01, 2001. Print.

12. Fisher, Daniel. "Owning Emerging Markets The Smart Way - Forbes.com." Forbes.com Business News, Financial News, Stock Market Analysis, Technology & Global Headline News. Forbes, 20 Nov. 2010. Web. 30 Nov. 2010. <http://www.forbes.com/forbes/2010/1206/investment-guide-emerging-markets-brics-brazilsmart-markets.html>. 13. "State of Retail" The Canadian Report, 2010. <http://www.ic.gc.ca/eic/site/retra-comde.nsf/vwapj/qn00001_eng.pdf/$file/qn00001_eng.pdf>. 14. Steele, Christopher. The Logistics Advantages North of the U.S. Border, Apr. 2010 <http://www.locationcanada.com/CanadaLogisticsInfrastructure/apr10/logistics-advantage-northborder9325.shtml> 15. Zellers History < http://www.hbc.com/hbcheritage/history/> 16. http://www.state.gov/ 17. http://www.businessdictionary.com/definition/business-risk.html#ixzz16s1ZRQeh 18. http://www.target.com 19. http://www.hbc.com/storelocator 20. Global Forces Shaping the Future of Business and Society, 2010, https://www.mckinseyquarterly.com/Global_forces_shaping_the_future_of_business_and_society _2701 21. Flavelle, D, January 2010, Cheap-Chic Retailer Target Coming To Canada, http://www.thestar.com/article/754191 Page 34 of 48

22. http://business.highbeam.com/603/article-1G1-57797032/impact-government-policies-

foreign-direct-investment

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Appendix
Exhibit 1: Target Stores in U.S. (Green Rectangles showing areas closer to Canada).

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Exhibit 2: Target Key Financial Figures Growth Rate Change

Exhibit 3: Target Key Financial Figures Growth Rates

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Exhibit 4: Target Key Financials

Exhibit 5: Target Sales Growth Relative to Store Size Growth

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Exhibit 6: Country Portfolio Analysis Adjusted for Distance for Fast-Food Restaurants

Exhibit 7: Increasingly More Corporate Profits are coming internationally

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Exhibit 8: Expected Target Canadas Key Financial Figures Growth Rates

Exhibit 9: Expected Target Canada Growth Chart

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Exhibit 10: State of Foreign Direct Investment in Canada

Exhibit 11: Sources of Foreign Direct Investment in Canada

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Exhibit 12: Foreign Direct Investment Breakup in Canada by Major Industry

Exhibit 13: Foreign Direct Investment Breakup in Canada by Selected Industry

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Exhibit 14: US and Canada Key Indices Comparison

Exhibit 15: Canadian Retail Sector Snapshot (2009)

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Exhibit 16: Some Components of Canadian Culture

Exhibit 17: Comparison of Canadian Economy Growth vs. its Peers

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Exhibit 17: Canada GDP Growth Rates vs. Other G-7 Countries

Exhibit 18: Corporate Taxes in Canada compared to Other G-7 countries

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Exhibit 19: Zellers (Hudson Bay) Financials Small Snap Shot

Exhibit 20: Zellers (Hudson Bay) Financials Chart

Exhibit 21: Retail sector year-over-year growth

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Exhibit 22: Retail Sector Operating Profits

Exhibit 23: Canadas Working-Age People by Mother Tongue

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Exhibit 24: Frankel and Ross Measuring the Impact of Distance

Distance Attribute Change in International Trade(%) Income level(1%) 0.7 Economic Size(1%) 0.8 Physical Distance(1%) -1.1 Physical Size(1%) -0.2 Access to Ocean 50 Common Border 80 Common Language 200 Trade Agreement 330 Colony-Colonizer 900 Common Colonizer 190 Common Polity 300 Common Currency 340 Exhibit 24 (Ghemawat 2001)

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