BENTONVILLE, Ark. -- Neighborhood Markets is a format with considerable untapped potential whose expansion Wal-Mart Stores could decide to accelerate at any time, industry observers told SN.
However, with returns at Neighborhood Markets viable but lower than those at supercenters or warehouse clubs, they said Wal-Mart is more likely to continue to expand the format on a gradual basis, as it has for the last 10 years, while pushing the operating boundaries beyond the Southeast into a handful of Western markets.
"On the one hand, Wal-Mart would probably like to roll out bunches of these stores," Bill Bishop, principal at Willard Bishop Consulting, Barrington, Ill., said. "But on the other hand, I'm not sure the Neighborhood Markets are as profitable as supercenters or clubs. So it's unlikely they would want to roll them out as quickly."
According to Mark Miller, an analyst with William Blair & Co., Chicago, the return on investment at Neighborhood Markets is running ahead of the capital Wal-Mart is spending. "So it's a viable format," he said. "But the returns on supercenters are higher, and Wal-Mart wouldn't want to find itself in a situation where it opens a Neighborhood Market at a particular location today, and then decides it should have been a supercenter."
Another consideration slowing the spread of Neighborhood Markets is management talent, Miller pointed out. "There are only so many qualified produce managers or pharmacists available. If Wal-Mart moves them into a Neighborhood Market, they're not available to work at a supercenter," he said.
Wal-Mart officials declined comment for this story.
A Good Tool to Have
Speaking at the company's annual meeting here last fall, Tom Schoewe, executive vice president and chief financial officer, said, "Do we have less interest in Neighborhood Markets? Not at all. In the last couple of years, we've learned that Neighborhood Markets are really a good tool to have in our arsenal, and we're getting a good return on them.
"But we've learned we can put supercenters closer to each other -- three to five miles apart -- and the financial returns are much greater with supercenters than with Neighborhood Markets."
Neighborhood Market, a conventional food-and-drug format with a drive-through pharmacy window, was introduced in 1998 to serve as a fill-in between Wal-Mart supercenters and Sam's Clubs. It was intended to give consumers a variety of choices among Wal-Mart formats. Over the past seven years, Wal-Mart has opened 85 Neighborhood Markets, with plans for 25 to 30 more this year.
Neighborhood Markets operate in 21 markets in 13 states: Arkansas (Little Rock, Fort Smith and the northwest part of the state); Oklahoma (Tulsa and Oklahoma City); Texas (Dallas, Houston and Fort Worth); Alabama (Birmingham and Mobile); Florida (Tampa, Orlando and Melbourne); Memphis, Tenn.; Louisville, Ky.; Indianapolis; Evansville, Ill.; Kansas City; Salt Lake City; Phoenix; and Las Vegas.
According to Pam Kohn, senior vice president, Neighborhood Markets, "We're going to continue to strengthen our presence in these markets, and we'll be popping up in a few new markets as well."
The Neighborhood Market business model has not changed, Kohn told SN. "Wal-Mart's strategy is to focus on supercenters as a primary growth vehicle, and then, after supercenters are established in an area, Neighborhood Markets offer added convenience."
Neighborhood Markets run 40,000 square feet to 50,000 square feet, with observers putting sales per unit close to $300,000 a week, though they said sales range anywhere from $175,000 a week to $400,000 or more. As a group, the 85 stores account for sales of roughly $25.5 billion annually, or approximately 1% of Wal-Mart's 2004 total of $256 billion, according to industry estimates.
Kohn did not discuss store volumes but noted the company's current Neighborhood Market prototype is actually shrinking -- to just over 39,000 square feet.
"As we've gotten better at thinking like our customer, we've been able to combine departments such as photo processing and customer service," she said. "But don't let the size reduction fool you -- we've accomplished that while also adding new services like the bakery, which we combined with the existing deli."
She said Wal-Mart's goal was to give the stores a market feel. "If you look around, you'll see warm colors throughout the building. For example, we've put in colored concrete floors that allow fixtures to melt into the background while helping to highlight the merchandise, and we've designed the perishables sections to accentuate the product by using lighting that really brings out the color, texture and freshness of the product."
Kohn said Neighborhood Markets will continue to evolve and change. "Our prototype is always a work in progress," she told SN. "We design our stores for each particular market to offer a natural flow to a typical shopping trip, and given the diversity of markets that we're now serving, we want our stores to reflect the feel of the community in both look and product offering.
"Our architecture team is doing a great job helping us with the first part of that, and our merchants and operators are doing an excellent job on the second half of that equation."
The goal is to get better with each store, Kohn explained. "When we opened the first Neighborhood Market in 1998, it looked a lot like a standard Wal-Mart of the time. Since then, we've really focused on the theme of convenience -- trying to think every step along the way like a grocery store customer.
"We also focus on efficiency, and we've gotten better at that by using more durable materials. We now use metal plates to protect the walls leading to the stockroom, for example, whereas previously we had to do frequent resurfacing and refurbishing.
"There's also better efficiency in pallet positioning. We have placed pallets on the sales floor for items with high-volume turnover such as gallon water, charcoal and large bags of dog food."
The slow, steady growth of Neighborhood Markets has been dwarfed by the rapid growth of Wal-Mart supercenters, with nearly 1,700 stores opened since 1988, and another 250 or more scheduled to open this year.
When Wal-Mart initially announced the Neighborhood Market concept, many industry analysts anticipated a rapid expansion that could impact retail operators all across the country.
"When Neighborhood Markets were first unveiled, more supermarkets were like Neighborhood Markets, with conventional formats and fewer amenities," Bishop noted. "Since then, many stores have installed more innovations and novelties, which isn't what Wal-Mart is trying to do.
"Neighborhood Markets is a 1990s-based supermarket. That's what Wal-Mart wants it to be.
"It's a pretty good supermarket that delivers the variety in 45,000 square feet that you can get in a 60,000 to 70,000-square-foot supermarket, plus a pharmacy and an expanded health and beauty care assortment. There's a lot pushed into that small store."
Whether or not Wal-Mart moves forward with Neighborhood Markets may depend on how committed it chooses to remain to the food business, Bishop said. "It went into the food business 20 years ago because it saw opportunities there, but it's not unrealistic to think that at some point, a combination of slower growth and lower profitability might prompt Wal-Mart to move and grow in some other business altogether."
Jeff Green, a retail feasibility consultant based in Mill Valley, Calif., also said Wal-Mart is deliberately keeping the Neighborhood Market format very basic rather than trendy "because that's the way it wants it to be. Just as the name implies, it wants those locations to be neighborhood stores, something that's convenient and low-priced."
According to Gary Giblen, senior vice president and director of research for C L King Associates, New York, Wal-Mart is continuing to tinker with the stores' approach to merchandising to keep the format very basic. "It's trying to determine how good Neighborhood Markets need to be in perishables, without destroying the simplicity of the format or its low-price positioning. [These are] the same issues Food Lion struggled with for years before going in the other direction.
"Wal-Mart wants to keep perishables and service in the Neighborhood Markets as basic as possible without making the stores less appealing to customers who want to be able to do their complete shopping at one location."
Waiting for a Rollout
Industry observers said they are not sure if, or when, Wal-Mart might decide to roll out Neighborhood Markets more aggressively.
"Obviously, Wal-Mart has struggled a bit with the format. But I've got to believe it's more a matter of trying to understand how the Neighborhood Market brand complements and competes with Wal-Mart supercenters and Sam's Clubs," Green told SN.
"Wal-Mart has pretty much decided on the size of the stores, but it's still tweaking what it puts into them to understand what happens when it adds or removes stockkeeping units and how that affects sales at its other formats, to understand better how each one competes with and complements the others, rather than trying to fit in with existing competition because Wal-Mart knows it can beat anyone in the market on price."
It could be three to five years before Wal-Mart makes a big move with Neighborhood Markets, Green said, "after the last wave of fill-ins with supercenters in the central U.S. occurs," he explained. "Wal-Mart has a strong record with supercenters, and it wants to take the time to learn more about the Neighborhood Market concept before moving forward."
Bob Gorland, vice president for the Harrisburg, Pa., office of Matthew P. Casey & Associates, Clark, N.J. -- consultants specializing in supermarket site selection and feasibility studies -- said Wal-Mart is likely to continue to roll out Neighborhood Markets gradually for a few more years.
"Wal-Mart will eventually reach a point where it begins reducing the number of supercenter openings and increases the number of Neighborhood Market openings," he said. "But Wal-Mart tends to be very tactical and methodical in how it does things. So any upturn in the number of Neighborhood Markets would be slow and steady, rather than a sudden spurt."
Retail Forward, the Columbus, Ohio-based research firm, said Neighborhood Market's time may not come until at least 2010. "Neighborhood Market expansion will continue to take a backseat [to supercenters] until the time is right," the firm said in a report, when Wal-Mart slows down supercenter expansion "[and] as today's generation of baby boomers become less mobile, making it more difficult to navigate a big-box supercenter."
Miller said it could be 10 to 15 years before Wal-Mart decides to expand Neighborhood Markets more aggressively. "The company's growth strategy is pretty well set for the next five years as it continues to convert discount stores to supercenters. So it could be 10 or 15 years before it decides if it wants to focus on Neighborhood Markets," he said.
Jonathan Ziegler, principal in PUPS Investment Management, Santa Barbara, Calif., said he believes Neighborhood Markets remain more of a long-term opportunity for Wal-Mart. "It's focused its energies on supercenters because it realizes the return on investment is a lot higher for those stores, and that it can put them closer together without cannibalizing, while taking advantage of the opportunity to sell more high-margin general merchandise. Neighborhood Markets don't have the mix of products that generates the margins of a supercenter. So their time has not yet come."
Of those interviewed by SN, only Giblen said he believes a more aggressive rollout of Neighborhood Markets is imminent, indicating it could happen at any time. "With ongoing weakness among more conventional players, Wal-Mart could be emboldened to make a more powerful onslaught with Neighborhood Markets as soon as next year," he said.
Pricing vs. Supercenters
According to Bishop, the primary appeal of Neighborhood Markets is the pricing, "which is very close to that of supercenters, but in a store that's one-third the size. It's also clean and utilitarian, with a very streamlined look."
Gorland said pricing at Neighborhood Markets tends to be a little higher than at Wal-Mart supercenters, "to make up for the lower amount of nonfoods, though it's still lower overall than most other retailers. If a competitor charges $3.99 for a box of cereal, the supercenter may have it for $2.99, while a Neighborhood Market might charge $3.35."
That's certainly been the case in Utah, where some consumers have been disappointed by the pricing at the three Neighborhood Markets in the Salt Lake City area, Steve Reich, vice president of marketing for Associated Food Stores, Salt Lake City, told SN.
In an area where Wal-Mart supercenters control a 20% market share, "consumers went into the Neighborhood Markets with the expectation that pricing would be like that of a supercenter, but the price points are higher," Reich said. "People here have big families, so they're very price-conscious. Word got out very quickly that Neighborhood Markets don't have the same prices as supercenters."
As a result, Neighborhood Markets "haven't taken off here," Reich said, estimating per-store volume at $150,000 a week.
That definitely isn't the reaction Wal-Mart is looking for. According to Green, the Wal-Mart connection was supposed to create a built-in consumer appeal for the Neighborhood Markets format. "People identify with the Wal-Mart name, and that establishes an automatic bond," he said. "In addition, it's a format where customers can cherry-pick staples, and know it will be convenient and cheap."
Gorland said he believes Neighborhood Markets may pose a greater threat to drug stores than to supermarkets "because of the drive-through pharmacies and the expanded HBC lines, plus the fact there's more pricing consistency, with lower HBC pricing than a supercenter."
The fact that Neighborhood Markets may take some sales from nearby supercenters is not a concern for Wal-Mart, he added. "Wal-Mart doesn't mind a certain amount of cannibalization," he said.
New Markets
According to Miller, Wal-Mart is continuing to learn how to do a better job with the Neighborhood Market format, particularly as it picks up ideas from its international operations. "Like McDonald's, the flow or learning continues to move from the U.S. to the rest of the world, and then back to the U.S. Though I'd say Wal-Mart is probably 20 years behind McDonald's in that process."
One area in which Wal-Mart has picked up knowledge from abroad is operating stores in urban areas -- a learning tool that will come in handy as it expands Neighborhood Markets into more urban areas, Miller said.
Observers differed on the viability of Neighborhood Markets in different geographies and demographics.
Green said he believes Neighborhood Markets stand a greater chance for success in the central United States than on either coast. "Shopping habits are different in the middle of the country. Price tends to be more important there than quality or service," he said.
Ziegler and Giblen said they see no limits to expanding the format anywhere in the United States.
Expansion will definitely not be limited to the central United States, Ziegler said. "That's been an appropriate expansion area early on because that's where Wal-Mart's expertise is. But over the long term, Neighborhood Markets could be a fairly powerful vehicle in areas like Southern California, including locations in communities where supercenters have been turned down by voters or local governments."
According to Giblen, "Neighborhood Markets cut their eyeteeth in some of those central areas of the U.S., but now they're ready to tackle bigger guns in places like California or New England.
"Wal-Mart can sandwich them in within any built-out area because they require less space than a supercenter or a regular supermarket," he explained. "That's the beauty of the Neighborhood Market format, that it can go into areas between supercenters while drawing on the total economies fostered by supercenters. Neighborhood Markets not only fill in a marketing area, but they also leverage off the distribution, regional supervision and advertising umbrella of other Wal-Mart stores in an area."
David Livingston, managing partner at DJL Research Co., Pewaukee, Wis., said he expects Wal-Mart to use Neighborhood Markets as fill-in locations in areas "where there's less real estate available, or where big-box zoning restrictions keep supercenters out."
Livingston said the primary target areas for expansion of Neighborhood Markets are the densely populated urban areas south of Interstate 70, which runs from Columbus, Ohio, through Indianapolis, St. Louis and Kansas City to Denver. "That's Wal-Mart country," he said. "Anything north of I-70 is the rust belt, a more union-oriented area," he noted.
However, Wal-Mart is moving beyond those confines, Livingston said, pointing to Neighborhood Markets that already operate in the Phoenix area and in Las Vegas, and the planned expansion of the format to Albuquerque, N.M.
Gorland said he sees broad expansion possibilities for Neighborhood Markets. Initially, the stores have grown in a semi-circle around Bentonville, stretching from Florida to Texas, "an area that is less unionized and closer to Wal-Mart's core store base and logistical support facilities," he noted.
"But could it open Neighborhood Markets outside that arena? Of course! Wal-Mart can do whatever it wants."
WAL-MART'S NEIGHBORHOOD MARKETS carry all the basic offerings of a larger, traditional supermarket, but without some of the amenities that conventional stores have added in recent years. Pricing is generally lower than traditional supermarkets in the area, although slightly higher than supercenters, observers said. The average size of Neighborhood Markets has been dropping, from 43,000 square feet in the early years to under 40,000 square feet today. The stores emphasize convenience, as the "Grab It & Go" section pictured top left illustrates. Customers in a hurry can pay by the "honor system" for coffee, pastries and newspapers.
Neighborhood Market Openings
2005
Jan. 19
Phoenix
Dallas
Bedford, Texas
Las Vegas [3 stores]
North Las Vegas
Jan. 31
Melbourne, Fla. [2 stores]
2004
Jan. 14
Mesa, Ariz. [2 stores]
The Village, Okla.
Baton Rouge, La.
March 3
Layton, Utah
Evansville, Ind.
March 31
Tampa, Fla.
May 5
Tampa, Fla.
July 7
Oklahoma City
Indianapolis
July 14
Tallahassee, Fla.
Aug. 11
Indianapolis [2 stores]
St. Mathews, Ky.
Sept. 1
Mesa, Ariz.
2003
Jan. 15
El Paso, Texas
Oviedo, Fla.
Dallas
Allen, Texas
West Valley City, Utah
Center Point, Ala.
Mobile, Ala.
Jan. 29
Houston
Dallas
Tulsa, Okla.
March 5
Richardson, Texas
April 2
Jordan, Utah
May 7
Memphis, Tenn.
July 2
Fort Worth, Texas
Aug. 6
Draper, Utah
South Ogden, Utah
Winter Springs, Fla.
Oct. 8
Nashville, Tenn.
Oct. 22
Overland Park, Kan. [2 stores]
Jeffersontown, Ky.
2002
Jan. 9
Rogers, Ark.
Jan. 30
Broken Arrow, Okla.
Cyprus, Texas
Houston (2 stores)
May 8
Dallas
Pantego, Texas
July 10
Houston
Aug. 7
Houston
Oct. 9
Rockwell, Texas
Bartlett, Tenn.
2001
April 4
Keller, Texas
June 6
Richardson, Texas
Tulsa, Okla.
July 4
Lewisville, Texas
Aug. 8
Tulsa, Okla.
Houston
Oct. 9
Rockwall, Texas
Bartlett, Tenn.
Memphis, Tenn.
Source: www.walmartstores.com
* Since 2001. Wal-Mart Stores opened 19 Neighborhood Markets from 1998 to 2000 in Arkansas, Texas and Oklahoma, but information on those locations was not available.
