A&P'S FOOD BASICS AND FRESH MARKET

Jon Springer

MONTVALE, N.J. -- Call it a high-low strategy of supermarket store design.

The future of A&P here lies in two new store concepts that, if executed properly, will generate better returns on capital than conventional supermarkets, observers said. The retailer has begun the process of converting its fleet to either the perishables-oriented Fresh Market concept, or the hard-discount Food Basics model. Though there remains a long way to go, both in the concepts themselves and in the funding of the conversions, observers said the changes demonstrate A&P's recognition that its attempt to reverse its fortunes will be anything but conventional.

"By going from one extreme to another, you're removing yourself from being an also-ran," Matt Casey, founder of site-selection firm Matthew P. Casey & Associates, Clark, N.J., told SN. "I'd consider conventional A&Ps today as an also-ran. There's nothing special about them. They can't set themselves apart from the Pathmarks, ShopRites and Foodtowns of the world. Other than the convenience of a location, there's no special reason to go to an A&P."

The retailer is hoping to change that through format evolution. Thus far, 20 of A&P's U.S. stores have been converted to the Fresh Market concept, which is designed to improve sales, traffic and profitability by boosting the mix of higher-margin perishables as a percent of sales.

According to Perry Caicco, an analyst for CIBC World Markets, Toronto, such stores attempt to derive 30% to 40% of their sales from perishables -- about double the amount of conventional U.S. supermarkets. Better margins from those perishable sales (around 35%, vs. less than 30% at a typical supermarket) can ratchet up annual returns on invested capital from around 14% for conventional stores to 25%.

"The overall store gross profit percent is about the same as a conventional supermarket because the key is investing in grocery as the perishable penetration climbs," Caicco explained. "As you sell more fruits and vegetables, you lower the price of Tide and Coke. It makes the whole offer much more compelling."

A&P declined comment for this article, and its Fresh Market stores in the United States are less than a year old. However, in conference calls, the retailer has indicated it is very happy with the performance of its fresh stores.

"If you take an A&P that's doing $300,000 a week and upgrade it and add customer service and upscale product presentations and it winds up doing $600,000 a week, you're going to be thrilled," Richard Kochensperger, a professor of food marketing at St. Joseph's University, Philadelphia, told SN. "I hear that a few of the stores they have converted so far are doing quite well."

Challenges remain with the Fresh Market concept. The stores are expensive to build or convert. Cost is a concern for A&P, which is losing money in the United States. Analysts expect the retailer may sell one or more of its divisions to pay down debt and fund the ongoing makeover in its core Northeast markets.

"When you think of A&P, you have to think of it in three sets: the discount box store; the new fresh store; and hundreds of old conventional stores that haven't gone to a new concept yet because they don't have the capital for it," Caicco said. "Theoretically, I think they know where they're going, which is to a [financially] healthier place, but they have a long way to go."

Executing the concept successfully over the long term is another concern, some said, noting A&P historically has encountered difficulty translating its ideas into profits. "A&P's history is full of inspirational new initiatives that oftentimes don't work for a variety of reasons," Burt P. Flickinger III, managing director of Strategic Resource Group, New York, told SN.

There are some indications that A&P is looking to revise its approach to its discount Food Basics stores, which haven't met with the same success in the United States as they have in Canada, where they originated, sources said. According to Flickinger, the Canadian Food Basics stores have the advantage of a head start in the discount format and fewer price competitors. Yet, that's changing as Loblaw and Sobeys are getting more aggressive with their own discount boxes.

In the United States, A&P operates 25 Food Basics locations in New York, New Jersey, Ohio and Michigan, according to A&P's Web site. Nearly all are converted from conventional stores. The first U.S. units opened in late 2001.

Executed properly, the hard discount store "brings a phenomenal return on invested capital," said Caicco. Theoretically, such stores succeed through lower costs in labor, advertising and design, while generating better margins through an increased ratio of private label and perishables than conventional stores.

However, return on capital -- which can be as high as 78%, according to estimates by Caicco -- takes longer to achieve in discount formats than in typical supermarkets. That's because the former advertises less and tends to have lower brand recognition. "You might hear Food Basics isn't doing well, but you have to remember these things take a long time to mature. A store can start as low as $7 a foot [in weekly sales], climb to $8 or $8.50 in year one, $9.50 to $10 in year two, then head to $11 to $12 in year three," he said. "They look modest at first, but that's typically how it goes."

While some U.S. retailers -- such as Supervalu, which operates Save-a-Lot; and Albrecht, which operates Aldi -- have been hugely successful with a discount format, other companies have tried and failed, Flickinger noted.

One issue that would-be discounters have encountered is getting the labor scheduled properly. "If you're trying to keep labor at 5% of sales, it can be difficult to get labor efficiently coordinated when the trucks get in. Keeping the shelves stocked can also be difficult," Flickinger noted. "Another possible outcome of tight labor is what reportedly happened to A&P when authorities in Michigan found widespread rodent infestation at one store. The way the consumer looks at it, that's not an issue unique to one store. It's all stores."

Christian Haub, A&P's chief operating officer, has said the company will convert conventional stores to Food Basics "where appropriate," which observers interpreted as those with low volume and that can be converted with the blessing of labor unions. Sources said unions generally have been approving of special contracts for converted discount stores that otherwise might close.

"If you have an A&P that's doing $100,000 a week and sucking air, a change to a Food Basics that can do $300,000 weekly will obviously generate a better return," Kochensperger said. "But it's not going to be the right solution for a store already doing $350,000 to $400,000 a week."

While A&P fights to reinvent itself behind store concepts that skew both upscale and down, Kochensperger said the strategy makes sense given stratification of incomes in the United States. "I believe we're becoming a bi-modal society," he said. "The rich are getting richer, and more people are dropping out of the middle class and into what I call the struggling class. If I'm a retailer, I'd think I better go upscale or downscale, or both, as A&P is trying. I think the strategy has merit."