Wal-Mart (NYSE:WMT) has faltered time and again in the high-potential China market. From food scandals to accounting discrepancies to falling sales, the problems have come thick and fast. Among Wal-Mart's international markets, China is second only to Mexico in terms of square footage, but even after 18 years  of operations in China, the country contributes only about 2% to Wal-Mart's total revenues.  

A recent Bloomberg report said that "cracks in the foundation of Wal-Mart's retail business in China have been developing for years." It noted how the retail giant has reversed its stance from calling China one of its best markets for many years to conceding that performance in China was among the worst in its big markets. Where does this leave the China promise for Wal-Mart investors?

Here's an update on what's happening on the mainland before Wal-Mart reports earnings in February.

Supercenter China

Walmart Supercenter in China. Image source: Wal-Mart investor relations.

Planning and compliance issues
On the planning side, Wal-Mart hasn't quite understood what Chinese buyers want. The chain's low prices, which have been a roaring success in all other parts of the planet, have failed to woo discerning Chinese buyers. The result has been that the locals do not identify with the company. Chinese consumers have written off Wal-Mart with the argument that it sells cheap by compromising on quality.

When it comes to compliance, Wal-Mart has been hit by food safety issues a number of times in the past in China, decelerating its growth in the process. In 2011, the company was blamed for passing off non-organic food as organic food items. More recently, in early 2014, Wal-Mart's "Five Spice" donkey meat was found to have fox DNA. The retailer then recalled the meat and apologized to its customers. The food scandals have hit Wal-Mart's image in such a way that there is an overwhelming feeling in China that Wal-Mart follows different standards for the country.

Compliance has gone wrong in accounting, too. In December, Bloomberg reported Wal-Mart had accepted that there were pricing and inventory discrepancy in its Chinese operations in 2011. The faulty practices reportedly included marking up goods to inflate profits, booking fictitious sales, and more.

Currently, Wal-Mart is on a mission to remedy past wrongs and build leaner and more transparent operations. It's shuffled many executives, announced 250 job cuts in marketing and merchandising, and plans to close 15-30 stores over the next year and half in China, while expanding store count overall. The company is trying to improve people's perception by doubling expenditure on compliance to $49 million over the next three years. While these are steps in the right direction, it's giving precious time to competitors to catch up.

Market pressures
Wal-Mart has about 400 stores in China, and according to researcher Euromonitor International, it has the third largest market share in the country after Sun Art Retail Group and China Resources Enterprise. But, Wal-Mart's sales in China are dwindling, with a 2.3% drop in comps and a 0.8% decrease in total sales in the third quarter over the same period the previous year.

CNN Money attributes this to rising competition from local players, moderating economic growth in the country, a suspicious attitude toward foreign companies amid several big scandals, the ongoing austerity campaign by the government, and new laws.

The Chinese government under President Xi Jinping has been running an austerity campaign since late 2012 to curb excessive consumption by government officials. While the exercise is primarily a headwind for the luxury market, general retailers like Wal-Mart are being affected, too.

The CNN article refers to a survey where "60% of companies told the American Chamber of Commerce that they felt less welcome in China than in the past." It also mentions Daniel Wright, CEO of advisory firm GreenPoint Group, saying that China is reducing the preferential treatment it once doled out to foreign companies.

Way ahead
Falling sales are never good news, and the dip is doubly bad when it happens in a market as lucrative as China, with a population of over 1 billion with increasing urbanization. Wal-Mart can't afford to ignore the country's potential.

CEO Doug McMillon acknowledged this on a recent visit to the Mainland. He told Caixin Online that China is "a priority market for us." So, apart from straightening out compliance issues, the company also plans to take the store count in China to 480 by the end of 2016, from 405 at the end of the 2014 fiscal year.

E-commerce is a bright spot. Wal-Mart's e-commerce portal for China, Yihaodian, saw 40% traffic growth in the third quarter, and its anniversary sales in July jumped over 50% versus the year prior. Yihaodian has nearly 90 million registered users and last year it doubled its offerings to around 8 million items. Though Wal-Mart doesn't break out its online China sales, according to Internet Retailer, the figure was around $1.907 billion in 2013.

The expansion, closures, executive shuffles, and increased compliance point to just one thing: China is an essential part of Wal-Mart's long-term plans. However, in view of the current challenges, investors could keep a cautious stance until Wal-Mart reports a pickup in sales in the county.

ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.