In Canada, U.S. retailers can be their own worst enemy

March 13, 2014: 10:18 AM ET

Target's recent missteps provide an important lesson for retailers going into Canada for the first time: American brand awareness can be both a blessing and a curse.

By Caroline Fairchild, reporter


FORTUNE -- For decades, Canada has remained a top choice for U.S. retailers looking to open stores abroad. Our neighbors to the north speak the same language and run a similar government, making expansion relatively straightforward. They have a similar appetite for shopping, too, as evidenced by the 1.25 million trips shopping Canadians made into the U.S. in 2012.

In fact, the similarities between the two markets gave Canada a nickname: The "51st state of retailing," says Sandy Silva, a fashion and beauty director with market research firm NPD Group.

But nickname aside, Canada recently became a high-profile stumbling ground for Target (TGT), the second-largest U.S. discount retailer. No one was more excited about Target entering Canada than the Canadians themselves, says Antony Karabus, a retail advisor who has consulted numerous companies looking to expand into Canada. But the company launched more than 120 Canadian stores last year only to stumble, hard. In February, it reported a nearly $1 billion loss from its Canadian operations, making major headlines in both countries. Canadians busted down the doors when the stores first opened, but now the chain is having a hard time getting them to come back at all, says Karabus.

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So what went wrong? As more U.S. retail giants ready their Canadian entrance -- both Nordstrom and Saks are launching in Canada this fall -- Target's experience offers some valuable lessons, perhaps the overriding one being that Canada is not as simple a market as many U.S. retailers believe it to be.

For example, big U.S. retailers often assume their big-name and built-in brand awareness will give them a natural assist. But the more nuanced reality is that Canadian familiarity with U.S. brands can hurt retailers just as much as it can help them. Well-traveled Canadian shoppers have grown quite accustomed to the American shopping experience in the U.S. -- and they expect an identical experience when U.S. retailers open up in their backyard. But that task is nearly impossible for most large American retailers facing larger costs, less retail space available to open stores, and a vastly different competitive landscape when they enter Canada.

What's more, because Canadian shoppers cross the border so often, Canadian retailers are not only competing with other established retailers in the area, but against their own U.S. storefronts as well, says Savvas Kotsopoulos, a retail services lawyer for Canadian firm Miller Thomson. "You have to recreate the U.S. experience in Canada. You can't just offer the 'light' version," he says. "Canadians know the products and service they can get in the U.S., and the expectation is that they are going to get that experience recreated in Canada."

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Karabus agrees that a failure to replicate the American shopping experience is exactly what hurt Target. Cross-border shopping is "almost like religion" to Canadians, he explains, so they immediately noticed when Target's prices were higher due to increased labor, transportation, and tariff costs. Locals were also turned off by the real estate Target acquired from Canadian discount retailer Zeller's -- stores that are smaller than Targets in the U.S., which resulted in underwhelming product assortments. Target also faced problems getting the brands Canadians were craving into its stores and higher expenses with its supply chain because of Canada's sheer size and spread-out population. The country is home to roughly 35 million people, similar to the population of California, but Canada is more than twice the size of the Golden State. That means the retailer has to deal with more transportation logistics and costs to get product out to the dispersed population.

These issues could have been avoided if Target had tested its model out with a few stores before expanding so rapidly, says Karabus. "The lesson for retailers here is not to open so much all at once," explains Karabus. "It is really hard here. It is not the same, and it is not so easy." Target spokesperson Eric Hausman said it made "more sense" for Target to open up more than 120 stores in a year than a handful at a time. But Hausman acknowledged that the large push of stores in such a short period of time has led to some initial inventory and pricing challenges. Still, executives are confident they will be able to fix it to bring the full "Target shopping experience" to Canada, claims Hausman.

Nordstrom (JWN) may not have learned from Target's experience specifically, but it's taking a very different tack. Starting this fall, the luxury retailer known for its customer service plans to slowly enter the country with just six stores over the next four years. Chief financial officer Mike Koppel explains that the retailer was meticulous about picking the right locations for its stores and hopes to build out the company's presence once it gets to know the Canadian shopper. "While it is geographically not far, it is a lot more complicated [than expanding in the U.S.]," says Koppel. "We want to make sure we are going with our best foot forward and understand other retailers and find the right real estate."

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To be sure, the luxury retailer is also competing in a vastly different market than Target. The Canadian luxury market is a mere fraction of the U.S. luxury market and has few players. Yet a strong base of affluent Canadian shoppers means there is more room for Nordstrom to enter and grow the space than Target had when it decided to compete in Canada's saturated discount market.

But replicating the American shopping experience in Canada will be just as critical to Nordstrom's success as it would be for Target or any U.S. retailer, says Maureen Atkinson, a senior retail advisor with Canadian-based J.C. Williams Group. Without the right product assortment and pricing, Nordstrom could eventually battle the same issues that Target is facing now. "If somebody has a great affinity to the brand and the brand is based on the American experience, that becomes a huge negative if the retailer doesn't match that experience," says Atkinson.

In January, Saks -- recently acquired by Canadian retailer Hudson's Bay -- announced that it, too, would be setting up shop up north, with plans for a 150,000 square-foot space in Toronto by 2015. Similar to its competitor, Saks is pursuing a slow expansion into the country.

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Luckily for both companies, analysts claim Canadians will be less sensitive to inevitable price increases over U.S. merchandise due to higher taxes in the luxury goods sector than they were with Target's discount merchandise. With limited options for higher-end shopping, locals will be willing to pay more for the convenience of having more luxury shopping options nearby, says Atkinson.

Yet even for retailers who follow all these steps and replicate their U.S. stores perfectly and get everything right, the best U.S. retailers can still underperform. Perry Caicco, an equity analyst at the Canadian Imperial Bank Of Commerce, points out that shoppers, regardless of nationality, do a vastly different type of shopping when they are on vacation than when they are at home, he explains. Just because Canadians are big shoppers at Target, Nordstrom, and Saks when they visit the U.S. doesn't mean those patterns will necessarily duplicate themselves once they have weekly access to the stores.

Instead, to truly be successful, he says, U.S. retailers must blend what Canadians have grown to love about American brands with what locals need in their home market as well. And others agree. "We are not the 51st state -- we are a distinct country," says NPD's Silva. "Canadians are really loyal to their stores and shopping preferences. A new U.S. retailer really has to take the time to get to know the differences in the Canadian marketplace before coming in."

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