03/05/2014 05:10 EST | Updated 05/06/2014 05:59 EDT

The Dangerous Mistake U.S. Retailers Make in Canada

More than a mere few US retailers assume that expanding into Canada, because of its relatively small population (the population of California alone, at about 38 million, is larger than Canada's roughly 35 million), is akin to expanding into just another state. Making this assumption -- blindsided by the admittedly vast similarities across all walks of life -- is downright dangerous.

The rate of US retailers setting up shop in Canada has been intensifying as of late. Canadian consumers generally embrace American brands. Yet the road for U.S. retail chains expanding north of the border is not always rosy. If pursued too aggressively, it often turns rough, sometimes disastrous.

While Canada and the US share an intertwined economy, to successfully expand into the Canadian market, US retailers need to understand Canadian consumers and key business factors affecting retailing: because when in Rome, do as the Romans do.

The know-how of US businesses in what it takes to successfully expand into Canada is far from uniform. Many US retailers quickly get tangled in the strong consumer currents that lurks underneath the seemingly calm waters. They soon discover that expanding into Canada is no walk in the park. Large and sophisticated US retailers fail in fundamental aspects of their expansion strategies. Among the most recent large scale forays north of the border, Target Corp. hit a wall with higher than expected expansion costs and significantly lower than expected sales, having set up operations in well over 100 former Zellers stores in just under one year.

Companies opting for a slower, more methodical, strategy, first testing the waters and gradually adapting to the business and consumer environments, stand a far better chance. The recent expansions of Crate and Barrel and Lowe's, with a slow but solid year-over-year store growth in the initial phase, are examples.

Doing business in Canada can be very profitable. BMO Capital Markets reports that Canadian retail sales are equivalent to US sales on a per capita basis. Canada has higher sales per square foot than in the US. And Canada only has 14 square feet of shopping-floor area per capita, compared with 23 square feet in the US.

More than a mere few US retailers assume that expanding into Canada, because of its relatively small population (the population of California alone, at about 38 million, is larger than Canada's roughly 35 million), is akin to expanding into just another state. Making this assumption - blindsided by the admittedly vast similarities across all walks of life -- is downright dangerous. Such companies cross the border at their own peril.

A smart entry strategy was deployed several weeks ago by Signet Jewelers Ltd.'s acquisition of Zale Corporation, which owns among others, the Peoples Jewellers and Mappins brands in Canada: expansion through merger or by taking over an existing successful Canadian chain.

Similarly, Limited Brands Inc., the owner of the Victoria's Secret lingerie brand, paved the way for a successful expansion in recent years by taking over the Canadian La Senza chain, which was not in competition with its higher-end boutiques and provided it with a significant access to real estate in shopping centres.

Being taken over by a Canadian company, akin to a reverse takeover of sorts, is another promising strategy. Last fall, Canadian department store Hudson's Bay Co. announced its buyout of US's Saks Fifth Avenue.

Over the past several decades, some US retailers have gone on to thrive in Canada's retail landscape, such as retail giants Home Depot Inc., Staples, Costco, Wal-Mart and Starbucks. But it was not all smooth riding. Not all brands or business models will make it in Canada, even if owned by the same retail chain, no matter how sophisticated. Wal-Mart, which first arrived on the Canadian scene by taking over Woolco in 1994, continues expanding its general and supercentre stores, but closed down its Sam's Club stores a few years ago, unable to compete with Costco, which had set up shop in Canada earlier.

Two key obstacles are at the heart of the problem: the cost of doing business in Canada, which is significantly higher than in the US, and consumer preferences, which have their differences and nuances.

First, the cost of labour is generally higher. Minimum wages are higher in Canadian provinces, coupled with a higher taxation burden.

Second, supply of retail real estate is far more limited than in the US and its cost is higher. Real estate commercial vacancy rates in Canada are at historic lows. Increase in the real estate supply is limited, particularly in the core centres.

Third, moving goods across the border further increases costs. Ours is a vast country spread over enormous territory. Bringing inventory into Canada, dealing with customs and managing the inventory across the land requires significant resources, and reconfigured logistical channels. It may be no wonder that Zappos closed down its Canadian e-commerce operations as a result of customs and other cross-border logistical constraints.

Fourth, the legal regulatory framework is different. Canada is a foreign country. Among the many legal differences, for example, are language, labeling and many other regulatory requirements, all of which add to costs.

In the franchise context, which more than a few retailers use for all or portions of their business models, legal requirements and implications are significant. Provincial franchise disclosure laws, currently in Ontario, Alberta, Manitoba, New Brunswick, and Prince Edward Island (with British Columbia on the way), require that all 'material facts' relating to the franchise company or the proposed franchise purchase be disclosed. A material fact is defined broadly as any information about the franchise company or the proposed investment that would be expected to affect a reasonable franchisee operator's decision to make the purchase, or the price that he or she is willing to invest in the proposed franchise.

Material facts include all of the factors outlined earlier in this article -- all these have to be legally disclosed to potential franchisee operators. Often, they are not adequately disclosed, creating legal disputes of significant proportions and financial consequences for the franchise company expanding into Canada and its franchisee-operators.

Sixth, consumer tastes and trends are different. While major Canadian shopping centres may seem to the untrained eye not much different from their US counterparts, significant differences in consumer patterns and preferences are alive and well.

Knowing the right product mix and maintaining adequate supplies of it has proven to be a challenge for US retailers.

Canada's economy is comprised of regional commercial centres that are far apart, and to some extent, independent of one another. Some of Canada's population hubs are immensely multi-cultural; others are less so. Consumer differences are sometimes driven by the four seasons experienced in most Canadian cities, and the generally colder weather.

Heritage plays a role here. Queen Elizabeth's Canadian representative is charged with, among other functions, promoting Canadian national identity. Lawyers robe in court (but, thank goodness, do not wear wigs). And Canada's Harry Rosen Inc. is recognized as a leader in men's retail fashion worldwide.

In sum, Canadians are different from our US cousins. But more so, like our US cousins, we are an immensely proud nation.

US Retailers must appreciate this complex dynamic and the nuances in Canadian society and the business landscape. They need to adapt their brands and product offerings accordingly.

One would think that with the gigantic ongoing advances in "big data" business analytics, retailers have the means to develop a sense of Canadian consumers' shopping patterns and preference for their product categories, before actually planting foot here. US retailers need to accept the need to make significant changes to their operations. Their expansion strategies should be marked by a contemplative strategy of crawling before walking; certainly not hitting the ground running.