Bulking Up

ELLIOT ZWIEBACH

Sam's Club appears to be operating on firm footing as it marks its 25th anniversary this month, with a more settled management team directing its primary focus on small-business members, industry observers told SN.

Sam's — a division of Wal-Mart Stores, Bentonville, Ark. — is the largest of the three warehouse clubs operating in the U.S. in terms of store numbers and is generally regarded as having the lowest prices in the club industry.

Yet, it finds itself in second place in total revenues behind Costco Wholesale Corp., Issaquah, Wash., with few prospects for overtaking it. But with a few tweaks here and there, observers said they believe Sam's can strengthen its position and further improve its operations.

The slumping economy should help, Sam's executives told SN.

“We believe economic pressures can create value, and the club can save members money,” Greg Johnston, executive vice president of operations, told SN. “We want to be relevant and necessary for people today, and with everything that's going on with the economy, Sam's can definitely help them save money.”

In fact, the club industry outperformed retail overall during the second half of last year, he pointed out, “as more people turned to the club format because of the values we offer.”

Sharon Orlopp, vice president of Sam's people division, said the company plans to stress a value message to reassure existing members — using basket comparisons at the warehouse level “to make sure our members recognize the value of buying in bulk.”

“Sam's is focused on quality and price,” said Susan Koehler, senior manager of corporate communications, “and because those concerns are so topical, you'll see a lot of that message during the anniversary this year.”

That message could be effective, observers said.

“Anytime the economy drops as it has, the consumer is more likely to trade down to a club, where prices per ounce are more attractive than at a supermarket,” Deborah Weinswig, an analyst with Citigroup, New York, told SN.

Chuck Cerankosky, an analyst with FTN Midwest, Cleveland, said the food offering should help Sam's attract more members during the economic malaise, “because when the economy softens, clubs do well with consumables, though they may see a drop-off in some discretionary spending on bigger ‘wow’ items.”

Food and sundries account for about half the space at Sam's, whose clubs average 135,000 square feet, though the allocation has grown over the last few years as the company has expanded its fresh selections, Johnston pointed out, “and that's what's really driving repeat traffic.”

Keeping Up With Costco

Costco passed Sam's in sales totals in 2005 and has continued to widen the gap. Last year, Costco's sales at 385 U.S. clubs were $50.5 billion (80% of its total sales base of $63.1 billion), compared with $44 billion at the 593 Sam's locations (18% of Wal-Mart's total volume of $239.5 billion).

Business members account for slightly less than half of the total club membership but slightly more than half of total revenues, Koehler told SN.

“Business members spend more per visit,” she pointed out. “Sam's started as a business to help small businesses succeed, and we've evolved into a company that helps business members shop for their business and personal needs while also helping families save money on their needs by buying in bulk.”

“We consider Sam's a relationship business,” Orlopp said. “We want to get to know the specific needs of all our members, especially the small-business members.”

Sam's has continued to lose ground to Costco in terms of market share, with 42% of all U.S. club business (down from 44% a year ago), compared with 49% at Costco (up from 47% a year ago); the other 9% is done by BJ's Wholesale Club, Natick, Mass., a regional operator on the East Coast.

On a sales-per-square-foot basis, Sam's averages $556 while Costco is doing $998, according to estimates by TNS Retail Forward, and it's unlikely Sam's will catch or pass Costco during the next five years, said Sandy Skrovan, senior vice president of TNS Retail Forward, which is based in Columbus, Ohio.

“Costco is continuing to pull away from Sam's and BJ's, and both are likely to work harder to protect their share of sales,” she said.

The two chains attract different demographic groups.

Orlopp told SN the average annual income of Sam's members is $62,000 to $65,000; observers said the average annual income of Costco members is in the $95,000 to $125,000 range.

“The Sam's member is more mid- to lower-income,” said Jim Hertel, managing partner at Willard Bishop, Barrington, Ill., “and with Sam's catering to that demographic, the average transaction size and the average spend per member is about one-third smaller than at Costco.”

Simple competition is also impacting Sam's negatively, observers said.

According to Patti Edwards, a Seattle-based analyst with Wentworth, Hauser & Violich, San Francisco, most of Sam's strength is in the Southeast, “and that's an area that's been hard hit by the economy. And with Costco moving into the Midwest in the last five years, Sam's is facing more competition for the membership club dollar in that region as well.”

For Cerankosky, the warehouse locations each company chooses is often a determining factor in its sales levels. “Costco is actively seeking out triple-A locations for new warehouses, with no hesitancy to pay up for a site if it feels the traffic will be there, and as a result it's purchased some very expensive locations and produced extraordinarily high volumes,” he said.

“Sam's, on the other hand, seems to be more satisfied with lower-cost locations that may be a few blocks farther from the off-ramp, which results in lower volumes.”

Where Sam's and Costco go head-to-head, said Jim Degen, president of JM Degen & Co., Templeton, Calif., Costco is usually the winner. “As Costco has moved more into Sam's territory — in Illinois and Texas, for example — people are lining up to join Costco,” he said.

Hertel said Sams's will need to manage its assortments better as direct competition with Costco occurs more often. “As Sam's moves into more metropolitan, urban and suburban locations instead of strictly rural ones, the challenge will be meeting the needs of a more upscale member base location by location,” he pointed out.

Weinswig said Sam's is trying to keep pace by doing a better job of localizing its merchandising to fit each warehouse. “I wouldn't say they're upscaling the offering so much as they are tailoring it on a store-by-store basis,” she explained.

Cerankosky offered a similar opinion. “With its focus on the small operator, it's been able to tailor its offerings to local needs, which is a winning approach. And that high-volume business customer is also coming back to fill his personal shopping needs.”

Sam's has warehouses in all but two states — Oregon and Vermont — “and we'd like to go into those states if we can find the right situation and make it happen,” Johnston told SN.

Observers told SN they expect Sam's to open about 25 new warehouses a year, roughly half of which will be relocations or expansions. Cerankosky said he anticipates Sam's is likely to grow more aggressively in Canada, where it operates only six warehouses.

Sam's also operates 70 clubs in Mexico, 15 in Brazil, nine in Puerto Rico and three in China.

TNS Retail Forward said it expects Sam's to increase sales an average of 6.2% a year over the next four years — to $48 billion this year, $50 billion in 2009, $53 billion in 2010 and $56 billion in 2011.

Sam's comparable-store sales last year, excluding fuel, were up 4.2%, compared with 2.8% in 2006.

“When you look at the results, especially in the second half of 2007, you can see we had strong increases in overall basket sizes, and business members were a big part of that,” Koehler said.

The relationship between Sam's and Wal-Mart is one of the club's greatest assets, Degen said, “because it gives Sam's the ability to source some products through Wal-Mart. At one time, they were totally separate buying organizations, but they merged some processes four or five years ago so they could take advantage of Wal-Mart's buying power and its relationship with big vendors.”

Although Sam's works closely with Wal-Mart whenever possible, they are very definitely two separate entities, Koehler pointed out.

“We carry fewer items — between 4,000 and 5,000 SKUs — and lower price points than supercenters, and our members' annual incomes tend to be higher [than those of Wal-Mart customers], which enables us to offer more ‘affordable luxuries’ than a supercenter.”

Tweaking the Food Offering

Consumables, including food and sundries, account for about 60% of Sam's sales.

“As long as the economy is suffering, Sam's should continue to count on food as a draw,” Edwards of Wentworth, Hauser & Violich said. “When the economy turns and things get better, food can continue to be a draw — as long as Sam's keeps up with changes in the industry as they evolve.”

In basic consumables, Sam's has the lowest prices among the club competitors, Skrovan said, although she pointed out that Sam's food offering is largely geared toward the foodservice trade. However, she said Sam's is working to fine-tune its food offerings by incorporating more unique and specialty items, such as gourmet wines and cheeses during the holidays, and by testing prepared-meal items at its Fayetteville, Ark., club and then launching the most successful ones as grab-and-go offerings at other locations.

Johnston told SN Sam's is giving more space to fresh merchandise, particularly home-meal replacement items, “where we're able to provide good values for people looking to save time. The price per person of our prepared meals provides a great value.”

Sam's is also becoming more consumer-friendly in its grocery offerings, moving away from exclusive reliance on large institutional sizes to more smaller-sized packages in multi-packs “where it makes sense for consumers and businesses,” Johnston added.

Sam's is also expanding its offering of fresh baked goods, he said.

Edwards told SN she believes home-meal replacement could play a key role in Sam's success over the next few years. “That's an area of the food business that's evolving, and if Sam's is willing to keep up with what's going on in the industry, it could reap significant benefits,” she explained.

Weinswig of Citigroup said she also sees prepared foods as an area for growth. “Sam's has been very under-penetrated in prepared foods,” she explained, “so there are still huge opportunities there, coming off such a small base.”

Jim Degen, president of JM Degen & Co., Templeton, Calif., said Sam's is doing a good job going after foodservice customers, including caterers and small restaurants, to drum up business for its food offerings as well as equipment and supplies — “something Costco has not done quite as aggressively, and that's paying off for Sam's.”

Degen said he believes Sam's focus on the foodservice area will get sharper, particularly as it puts more emphasis on the quality of its meats.

Meat is a category where Costco enjoys a great reputation, while Sam's reputation has been lacking a bit, he pointed out. But as Sam's adds more Prime and Choice selections and improves the packaging, it should be able to use meat to build sales, he said.

In most perishables areas, Sam's has tended to offer a larger assortment than Costco at a little lower price, Degen said. “But Sam's is trying to cut back and narrow the focus on the number of SKUs in perishables so it can do a better job on a few items that will drive the business,” he pointed out.

Weinswig said the biggest improvement Sam's has made on the food side involves produce. “It's been increasing the quality and upscaling the assortment a bit, even if that means a slightly higher price point,” she said.

Edwards offered “one small gripe” about Sam's food operation: the lack of theater. “You don't smell the baked goods, you don't see people cutting meat and you don't see people prepping the prepared meals as you do at Costco. But the customer is different at Sam's from Costco, so that sense of theater may not be as important.”

Sam's Clubs offer consumer products under the Member's Mark label and foodservice items under the Bakers & Chefs brand. Private brands account for approximately 10% of the merchandise mix, according to TNS Retail Forward.

Sam's Clubs do not carry either Sam's Choice or Great Value — Wal-Mart's private-label lines — “to avoid confusion,” Johnston said. “We want to differentiate ourselves from Wal-Mart and create our own value,” he explained.

Hertel of Willard Bishop said he believes Sam's could benefit from expanding its private-label offerings. “Sam's has relationships with national suppliers with whom it could work collaboratively to develop new private-label items on an attractive cost basis,” he explained.

“Sam's already has good private brands, though it has been underscoring the value proposition with national-brand suppliers. But we're in a time when the potential value of stronger private brands may become more important.”

Another challenge for Sam's is its advertising, Degen said.

Sam's ad budget is substantial, he indicated, “without generating very positive results. Right now, TV ads promote Sam's Club and a few key items, but they don't say why someone should become a Sam's member rather than shopping at a Target. There's nothing that differentiates Sam's in the ads in terms of merchandising or private label.”

What Sam's needs to do in its ads is to focus on foodservice, with particular attention to quality perishables, and to stay on strategy, Degen said. “If it did that and built its reputation through differentiation, that's something it could advertise.”

Weinswig suggested Sam's should reduce its advertising budget and invest more money in in-store events for various business segments. “Those have been very effective in establishing Sam's as the headquarters for all kinds of small businesses, and they should continue to do more of that rather than spending money on advertising,” she said.

Sam's fuel stations are an added plus that draw traffic during a period of high gas prices, Skrovan of TNS Retail Forward pointed out.

“Gas is cheaper at Sam's because it owns its own stations and can better control costs. In a survey [taken before gas prices began rising], a third of Sam's members said they would renew their membership just to get the discount on gasoline.”

Getting New Members

Edwards noted, however, that Sam's hasn't done as well as it had hoped recently in attracting new members, “possibly because of competition and because some potential members might be feeling squeezed, and the prospect of buying in bulk can be daunting.”

Sam's believes it can convince more people to join, Johnston said, citing results of a survey in which 37% of Sam's business members said they save more than $1,000 per year shopping at the club, while 70% said they make up their annual membership fee on purchases every month.

Hertel of Willard Bishop said the time may be right for Sam's “to get creative with membership fees — to come up with ways to allocate the fee over time, so not all of it is due up front — to make it easier for people in pinched economic circumstances to commit to a Sam's membership.”

Sam's also could benefit from an increased emphasis on food, “especially during this period of food price inflation,” he said.

“With both food and fuel prices up, Sam's target customer is likely to feel more of a pinch, and it might be a good time for Sam's to consider widening the gulf between itself and supermarkets in terms of food prices while holding tight on margins,” Hertel said.

Weinswig of Citigroup said she likes Sam's focus on the small-business customer, “but even that customer can be incentivized to buy more with more-exciting merchandising and more treasure-hunt programs.

“In addition, Sam's has really established itself as the low-price leader among clubs, and it will not be undersold, but it has not emphasized that point strongly enough. If it could get that message across more powerfully, it would be a great way to drive member loyalty and boost sales.”

According to Edwards of Wentworth, Hauser & Violich, “Sam's has been moving toward featuring more upscale offerings over the last few years as its demographics have moved up a little, and it ought to continue to work to refine that concept, though it doesn't need to move upscale to the same extent as Costco, because Costco's member base is coming from a higher income level.”

Degen said Sam's needs to continue to focus on broadening its customer base. “It's done a good job the last few years raising shopper frequency, due in large part to its focus on business members,” he said, “and in the last year it's been directing more of its member strategy toward women in higher-income households, and the company indicates that has been working.”

Cerankosky of FTN Midwest said the company could benefit from a bit more consistency in its merchandising strategy. “While Sam's has certainly cut back on the number of changes in direction it was making a few years ago, it's still not as consistent as Costco.”

Sam's and Wal-Mart buyers go to market together, Weinswig said, to get a better cost of goods on some items, but they buy differently.

“While they used to buy basically the same merchandise for both companies, Sam's has moved away from that because it understands that household incomes of its members are higher than that of Wal-Mart customers, who fall in the $40,000 range, so they can look for better quality more than just for price.”

Wal-Mart said last year it has no plans to sell Sam's, though it did not rule out the possibility of spinning the company off at some point.

Edwards said a spin-off might be difficult “because Sam's systems are so intertwined with Wal-Mart's that it may be too hard to extricate.”

“We're always looking to do the right thing to increase shareholder value, and a spin-off has been discussed in the past,” Johnston said. “The decision for now is that Sam's will remain a Wal-Mart division, because management believes that's the best thing for right now.”