The world's largest retailer, Wal-Mart (NYSE:WMT), is rapidly expanding into small stores and building strategies to contest smaller rivals that are luring away its customers. In doing so, two things that it is stressing are molding itself to changing customer requirements and using its resources more effectively and efficiently. The company has plans to open as many as 270-300 small format stores by the end of the year. Here's a lowdown on Wal-Mart's reasons for focusing on the 'small'.

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Wal-Mart Neighborhood Market in Winter Springs, Fla., Source: Wikimedia Commons

Customer traffic is shifting toward smaller stores
As per a Goldman Sachs research note, consumers are increasingly becoming fond of online shopping and smaller stores. Dollar stores, drug stores, and warehouse clubs are attracting more buyers than retailing giants like Wal-Mart and Target. Bill Simon, then Wal-Mart U.S. president and CEO, acknowledged in February that "customers' needs and expectations are changing. They want to shop when they want and how they want." With the rising cost of living, people like to avoid stocking stuff in big quantities, so it makes greater sense to buy from stores where they can avoid standing in long queues for a handful of items.

The smaller stores are located 'round the corner and are easily accessible. This saves the hassle of driving to supercenters and burning fuel. Doug McMillon, the current Wal-Mart CEO, says customers want the convenience of a quick shopping trip. No wonder then the so-called "narrow format" shops are thriving at the expense of big-box retailers.

Wal-Mart understands the changing requirements of its customers and that's why it's working on opening more of these smaller stores. Through them, it will be able to tap customers that want the smaller shopping experience.

Effective and efficient investing
In October 2013, Wal-Mart announced plans to open 120-150 small stores for fiscal year 2015, which it revised upward in February to 270-300, expanding its capital budget for the purpose. "We will accelerate growth of our Neighborhood Markets because of their strong returns, consistent comp sales performance and double-digit net sales increases," Simon had said in October. Typically, a supercenter's size is north of 180,000 square feet. In contrast, a Wal-Mart Neighborhood Market is about 40,000 square feet on average, and Wal-Mart Express is even smaller, at about 12,000 square feet. So, building 4.5 Neighborhood Market outlets or 15 Wal-Mart Express stores would be the same as building one supercenter, in terms of square feet.

Wal-Mart had 346 Neighborhood Markets and 20 Wal-Mart Express stores at the end of fiscal year 2014. In the current fiscal year, the company is on track to adding 180 to 200 Neighborhood Markets. The Express format had started as a 'three-market pilot' and its success has made the company open more such stores. The company plans to open 90 Wal-Mart Express stores in the fiscal year.

Simon had said, "This [focus on small stores] gives us the opportunity to build more stores for less money." Since these stores also function as pickup stations for products purchased online, Wal-Mart can expand its overall reach as a retailer through these store formats.

Comparable store sales of the small-format outlets have outpaced the retailer's mainstay big box numbers. During the quarter ended in July, while Wal-Mart's U.S. comp sales remained essentially flat (increase of 1.1%), comp sales for its Neighborhood Market (U.S.) went up by a decent 5.6% with traffic increasing 4.1%.

Testing new formats
Wal-Mart plans to experiment further with new concepts like Wal-Mart To Go. Having opened one at Bentonville, Ark., Wal-Mart's hometown, the format is a one-stop neighborhood store with a chic look. The "pilot" store opened in March, has a deli counter, a make-your-own milkshake station, and at the entrance there's a gas station. "It is very much a hybrid. I would consider it a food store that sells fuel," said Debra Layton, Wal-Mart's senior vice president of small formats. Though Layton says the company has no plans of expanding this format, she added, " ... however you never know, we test and learn all the time."

Foolish takeaway
Once upon a time Wal-Mart had revolutionalized the retail world with its big boxes, which remain its mainstay. However, it's crucial for the company to understand the pulse of its shoppers and if they are demanding smaller and more convenient store formats, the retailer has to align its expansion strategies accordingly. Otherwise it stands the risk of losing its customers to the mushrooming dollar stores. Thankfully Wal-Mart is aware of the changing trends, and it's focusing on building more small-format stores, which will give it the traction to compete with dollar stores.

ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.