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SHANGHAI, Mar 24 (Reuters) Wal-Mart Stores Inc. and other foreign retailers in China are looking westward for the next round of store expansion as the government sweetens incentives to invest in the underdeveloped central regions.

Multinationals are already well-established in Chinese coastal cities such as Shanghai, where competition is fierce. Analysts say the stage is now set for another battle over second-tier, inland cities as retailers race to build name recognition among brand-loyal consumers.

Retail consultants list some 60 cities that are ripe for development. The first retailer to reach each one gains a major edge because they can build a following among local consumers before competitors can muscle in.

Foreign retailers are eager to expand in China to get their share of a $240 billion retail market with an average growth rate of more than 10 per cent in recent years. Most of their focus so far has been on the large, wealthy cities on the eastern coast.

Now, China is promoting investment in its interior regions through a series of incentives including tax breaks, and it is building up the infrastructure to meet growing demand.

The moves come at a good time for Wal-Mart, the world's biggest retailer, which is set for a major China expansion of its own.

Wal-Mart Asia CEO Joe Hatfield told Reuters on Sunday that the retailer is planning to hire 150,000 people in China over the next five years -- five times what it currently employs here.

Wal-Mart has 56 stores in China, with revenues of more than $1 billion, a tiny portion of its global sales of $312 billion for the most recent fiscal year.

With his hair slicked back and a cigarette in his hand, Hatfield does not look like the typical Wal-Mart executive. He doesn't speak Mandarin, although he has lived in China for more than 11 years and was Wal-Mart's first employee here.

Hatfield certainly thinks like growth-hungry Wal-Mart, and has learned enough to be sold on this market. He believes that in 20 years, Wal-Mart's China operations could rival its U.S. business, where it has more than 3,700 stores.

UNCHARTED TERRITORY But moving into smaller markets will not be easy, and analysts say it will be a key test of whether Wal-Mart has learned from early missteps here.

The retailer, which opened its first China stores a decade ago, has been slow to expand in China and still trails rivals such as Carrefour.

Carrefour, the world's second-largest retailer, has 78 supermarkets here, and its 2005 revenues were more than double Wal-Mart's.

Local players such as Wumart Stores Inc. also have their eyes on the smaller cities. Wumart said last month that it is considering expanding outside of its stronghold in the Beijing area into second- or third-tier cities.

Wal-Mart and its competitors will have to repeat many of the steps they have taken in the major cities. That means negotiating with local governments, building supplier relationships and, most importantly, earning the trust of local consumers.

''It's almost as if they're going to a new country,'' said Heng Sheau Jing, senior research analyst with Euromonitor International in Shanghai.

Wal-Mart is already taking some small steps inland. It recently opened stores in smaller cities such as Yuxi in Yunnan province, and Yueyang in Hunan province.

The retailer has encountered a few snags. Hatfield said the government would not allow Wal-Mart to transport certain products across provincial borders, particularly if they compete with items sold at local stores.

As a result, Wal-Mart has struggled to replicate the efficiency of its vaunted U.S. logistics system, which relies on more than 100 distribution centres to get goods to stores quickly and cheaply.

Wal-Mart hopes to have five distribution centres in China within the next 3 years.

OPPOSITE STRATEGIES Wal-Mart and Carrefour adopted different strategies in China when they first arrived in the mid-1990s.

Carrefour opened new stores quickly, and designed different formats to gain access to both large and small cities, according to research from consulting firm Kurt Salmon Associates.

Wal-Mart took it slowly, opening only two stores in the southern city of Shenzhen and studying them closely before venturing north.

Critics say that when Wal-Mart first arrived, it tried to impose U.S. operating methods that didn't always work well here. As a result, the company came across as arrogant, and had trouble dealing with some local suppliers and governments.

For example, they said Wal-Mart would reject deliveries if they were late -- a practice that angered suppliers in major cities where traffic congestion is a constant problem.

''Wal-Mart thought they were so powerful that no one had negotiating power over them. They were wrong,'' said Hainan Mu, general manager and senior consultant with SunLand Consulting in Shanghai.

Competitors such as Carrefour have managed to grow faster in China because they learned how to work with the local governments, and quickly picked up on which domestic brands sold best in a particular market.

That's a recurring theme for Wal-Mart, which has also found itself trailing Carrefour in places such as Brazil. Wal-Mart seems to be learning from its mistakes, however.

''It's a work in progress,'' Wal-Mart's Hatfield said in a recent Reuters interview. ''You make adjustments. You keep reinventing yourself every day.'' That flexibility will be a key quality as Wal-Mart expands into new markets in China. The retailer is training new managers now, and hiring merchandise buyers around the country to establish relationships with local suppliers.

''China is not one country. Not everyone buys the same way,'' said Stephen Dixon, Kurt Salmon's regional director for Greater China.

REUTERS SD SSC1451

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