IF YOU [CAN AFFORD TO] BUILD IT

Cost inflation: It's not just for groceries and gas any more.

For the past year and a half, supermarkets have been coping with rising food costs, but for longer than that they have also been dealing with double-digit hikes on some of the materials they need to build and remodel their stores as well. Some observers estimate that costs are rising as much as 1% per month.

Although there are some signs that the high costs are leveling off or even pulling back slightly, supermarket companies have had to be proactive in their planning and engineering in order to stay within their capital expenditure budgets and achieve adequate returns on their investments. In addition, the construction boom in China is projected to continue to pressure supplies and keep material prices high.

Some operators have reprioritized their lists of store remodels and put some projects on hold, while others are scaling back on the scope of some remodels in an effort to compensate for double-digit cost increases for such items as concrete and prefabricated steel.

“There are some companies out there that are cutting their list of planned remodels in half,” said Tim Morrison, an architect with Little Diversified Architectural Consulting in Charlotte, N.C. “All of the supermarket companies that we work with have a cap-ex budget for the whole year. At one point in time, they might think they can do ‘X’ number of supermarkets with that budget, but what is happening is that over time they are having to scrutinize their project list. They are starting to say, ‘Some of these stores that we would like to remodel, we are going to put on hold, and those that definitely will get a return on investment, let's go ahead and do those now, even if it costs us more money.’

“But the stores that are marginal — they are putting those on hold.”

Among those retailers that have delayed some remodels due to high construction costs is Publix Super Markets, Lakeland, Fla., a spokeswoman told SN. Although rising costs and supply shortages have not impacted Publix's new-store development plans, they have delayed some projects.

“We also look at purchasing supplies in bulk whenever possible to help mitigate the rising costs,” said Maria Brous, the Publix spokeswoman.

When Piggly Wiggly Carolina began planning its newest location in Myrtle Beach, S.C., an experimental prototype that features small refrigeration units scattered throughout the store and a series of short gondolas arranged by food type, the original goal was to find a way to design the store as cheaply as possible.

“We reduced their overall box costs by 20%,” said Joel McCreary of McCreary Snow Architects, Columbia, S.C., although he declined to discuss details of the project.

Julie Dugas of GHA Design Studios (formerly Marco Retail), Northville, Mich., which worked on the store's design, said Piggly Wiggly came to Marco about two years ago seeking to get the total cost down on the construction budget for the store.

“They had seen an increase of almost 20% in one year in construction costs, and said they have to do something about that,” she said.

She said Piggly Wiggly worked with McCreary Snow to reduce its steel costs through engineering and to reduce other costs in the mechanical systems and through the use of alternative building materials.

Some aspects of the store required more investment than a typical supermarket might, however, because of the unusual layout of the refrigeration systems.

“In order to meet the concept needs of that store, they felt it was important to spend those extra dollars,” Dugas explained.

Harvey Gutman, president and founder, Brookside Advisors, Marlboro, N.J., and a former Pathmark Stores executive, said supermarkets should stick to their plans regardless of fluctuations in construction costs. In the last few years, as costs have risen in double digits, supermarket construction specialists have become more proactive in the costing process, he explained.

“New store builds and for that matter strategic renovations are strategic decisions, and they shouldn't be significantly affected by the cyclicality of construction costs,” he told SN. “However, that doesn't mean that one can ignore what has been going on for the last three or four years with construction costs. I think what smart operators did during that time was to value-engineer their projects where possible, get more involved in the costing and bidding process, and use the Internet for auctions [to buy used equipment and other supplies], where possible. That's something that's new, and it's something that's helped save money.”

PARING BACK ON REMODELS

As reported in SN last month, the three biggest traditional supermarket operators — Kroger, Safeway and Supervalu — have continued to emphasize remodels rather than new-store construction in their capital expenditure allocations. The three are also projecting a slight decline in cap-ex as a percentage of total sales despite maintaining their remodeling pace, a possible indication that construction costs are leveling off. Only a handful of operators — including Publix, Whole Foods, Harris Teeter, Trader Joe's and Aldi — are planning significant expansion through new-store development.

The most recent survey of store development by Food Marketing Institute, Arlington, Va., indicated that overall, supermarket operators had begun paring back on remodels in recent years, down from 4.5% of stores in 2005 to 3.7% of stores in 2006.

The high cost of construction has forced retailers “to make more careful decisions about building new stores and scoping and selecting remodels,” according to the report, called “Facts About Store Development 2007.”

“While some simply have scaled back their building and remodeling activity, others are finding ways around the problem,” the report stated.

Among the solutions cited in the report are finding alternate materials, bidding out projects to numerous companies and planning better.

Rising construction costs were cited as the single most important factor influencing store-development activity, with respondents rating it a 3.8 on a scale of 1 to 5, followed by rising energy costs, with a rating of 3.5.

Companies are moving ahead with development plans, “but with increased caution,” the report said.

“With excellent sales and profit numbers across the industry, the reasons for this decline likely reside with the external business environment more so than internal factors,” the report concluded.

For the first time in five years, the report showed that the construction of retrofit stores in 2006 outpaced new-store construction, with retrofits accounting for 60.6% of new stores, vs. 39.4% built from the ground up. In prior years, retrofits accounted for about 30% to 40% of new stores, compared with 60% to 70% of new stores that were built from the ground up.

The report noted that overall construction costs leveled off in 2006, after several years of increases. Retailers cited an average cost per square foot of $142.42 for the construction of a new store in 2006, down slightly from $146.70 in 2005. The cost to retrofit an existing store was less than half that amount, at $53 per square foot.

Equipment costs, often the largest component of construction, totaled $60 per square foot for newly build stores and $35 for retrofits.

The increased costs also lengthened the time retailers estimated it would take to reach break-even, from 12 months for conventional supermarkets in 2005 to 15 months in 2006.

BUYING AHEAD

Piggly Wiggly was not alone in seeking to take costs out of the construction process. Other supermarkets — especially independent operators and smaller, privately owned chains — have been taking a wide range of measures to compensate for rising material costs while still investing in some necessary upgrades to their stores.

Some supermarkets have been buying some of the more expensive construction materials, like prefabricated steel, ahead of anticipated cost increases, even though their needs for the location might change over time and force them to reshape some of the pieces, store designers told SN.

They also have been turning more and more to refurbished equipment, several observers said, even for use in the construction of new stores.

And some supermarket operators are increasingly using equipment longer than they had planned, as they cut back the scale of their remodels to only include changes that impact the most visible parts of the store.

“We are seeing that some supermarkets might change the scope of their remodels,” said Morrison of Little. “So in lieu of going through and changing out a lot of equipment, they will choose only those areas that are front and center, like the service cases — those areas that are really going to make maximum impact to the customer.

“So what might have been planned as a comprehensive remodel might instead become a floor and lighting remodel,” he said. “These are things that customers actually notice — they notice lighting and they notice flooring first.

“Sometimes you are going to see owners focus on the ‘lipstick’ elements of the decor, such as painting, instead of tearing down bulkheads and building anew.”

Through the first five months of 2008, Morrison said the cost for reinforcing steel has increased by about 41%, electrical conduit by 28%, copper wire by 18% and installed roofing by 10%. That doesn't even include massive price increases in diesel fuel — up 45% year-to-date — and gasoline, which also contribute to higher costs for construction.

To stay ahead of anticipated increases in costs for some of those basic construction materials, some operators are placing their material orders for new-store construction earlier in the process than they typically would, according to Jason Loucks, another architect at Little.

“Some of them are actually expediting components of the construction a little early, so that they are getting their deal packages together quicker because of the increases in costs that we're seeing,” he told SN. “They are getting a pre-order in for prefabricated steel, and they can get a reduced cost because the projection is showing nothing but going up.”

He said the strategy of pre-ordering steel shapes such as support beams can be cost-effective even if the plans change, because it can cost the retailers less to reshape the steel than it would have if they had waited until later in the project and cost of the material had risen.

“Every minute you wait, the costs just keep going up,” Loucks said. “A lot of the owners we are seeing right now are willing to take that risk just to get that cheaper deal.”

The rising costs of some building materials — and the cost to transport them to the site — also have made local sourcing a more attractive option for some retailers, he said. Local sourcing is also one component of LEED (Leadership in Energy and Environmental Design) certification, making “green” construction techniques a more viable option for some retailers (see Page 39 for more on this topic).

DOING MORE WITH LESS

Dugas of GHA said she's seen some retailers scale back on the extent of their remodels, opting to forgo a complete refurbishing of some stores to preserve more of the existing structural elements.

“Sometimes they don't gut it to do a remodel — that's one way some have been saving money,” she said. “They just deal with existing architecture and do as little physical construction to the space as possible.”

Another strategy has been to cut back on the use of drywall material, either leaving exposed block or dry walling the walls up to a certain point, and then painting the rest to blend into the ceiling. Using drop ceilings also can help cut drywall costs, she explained.

“Especially in a lot of these spaces when you've got exposed ceiling, with 18-36 feet exposed, to put drywall up there is a huge expense that people don't have to spend.”

She said she also encourages retail clients to think about allocating their investments more strategically throughout the store.

“We like to say, ‘If you have $100 to spend on 100 square feet, you don't want to spend $1 on each square foot — it might be more impactful to spend a larger chunk of that on an area that might get noticed, and cut costs someplace else,’” she said. “The clients that we work with are being really careful about focusing their dollars on where they get the most impact, and letting go of things that they thought they had to do, like putting all kinds of things up in the exposed areas to entertain the customer.

“We are saying to focus on good merchandising and good lighting, and on the experience the customers have with the employees.”

To make more efficient use of retailers' investment dollars, Dugas said she has been seeking to get involved earlier and earlier in some clients' projects, rather than being called in after many of the decisions on construction have already been made. In one instance, she said a Midwestern supermarket operator was planning to rebuild the entire vestibule to make room for cart storage, but instead came up with an alternative design that saved money on construction and provided a suitable alternative for cart storage.

“The earlier we can be involved in the process, the better,” she said. “In the end, that's what's saving the real dollars.”

She also noted that manufacturers have responded to the pressure on retailers by coming out with more attractive fixtures that are more affordable.

“They are coming out with better and better looking things, and the price points are getting more and more reasonable, for things that look expensive,” she said. “We are always looking for that surprising thing that looks like a million bucks but doesn't cost that much.”

Bob Gorland, vice president in the Harrisburg, Pa., office of retail consulting firm Matthew P. Casey & Associates, Clark, N.J., told SN that he's seen an increasing number of retailers making use of refurbished equipment, or refurbishing equipment themselves.

“There are some independents that are working through wholesalers or brokers to find equipment packages from stores that have closed, like the hundreds of Winn-Dixies that have closed,” he said, citing one independent that equipped an entire new store using equipment from a shuttered Winn-Dixie.

Others are sprucing up their existing equipment with fresh paint and new bumper guards in lieu of replacing it, he explained.

“In many cases, this equipment is able to last 15 years or so, but sometimes people were trashing it after seven or eight years,” he said. “Now they are seeing if they can keep it longer or maybe switch it to another store.”

He also suggested that replacing the facade alone can generate a strong sales bump at some stores. And at some locations, negotiating with the landlord to make improvements to an entire shopping center could be just as important to the overall return on investment for the supermarket anchor.

He counseled against expanding poorly performing stores, a strategy he said he has seen fail repeatedly in the marketplace.

“You take a store that's 45,000 total square feet and doing $200,000 to $250,000 per week in sales — that store doesn't need to be expanded to 55,000 square feet,” he said. That store needs to have a four-walls remodel, because it is not space-productive. A 45,000-square-foot store is easily built to do $400,000 per week or more in sales.

“You can take a profitable store and make it unprofitable, because it didn't pick up enough sales from the addition.”

There are some recent indications that construction costs could be leveling off, however. In a discussion with analysts following its annual meeting this month, Wal-Mart Stores, Bentonville, Ark., noted that the slowdown in the housing market could be easing the pressures on costs. The company said its capital expenditures for the year would be at the low end of previous guidance, in part because the slowdown in the housing market has eased demand.

“On the question on construction costs, we are seeing some relief, even with the cost of asphalt-based products and commodities going up,” the company said.

FACTORS INFLUENCING
SUPERMARKET DEVELOPMENT

(ON A SCALE OF 1 TO 5)

1%

Rate of construction cost increases per month.
Source: Little Diversified Architectural Consulting

CONSTRUCTION MATERIALS INFLATION

(% CHANGE IN LAST 3 YEARS)