Help in a Headwind

If nothing else, the troubled U.S. economy figures to provide a rigid framework for the strategies and tactics of food retailers: Many initiatives will be defined by the economy, and some will be created by it. On the following pages are five ideas for supermarket operators to consider in what is shaping up to be a difficult year ahead.

INITIATIVE 1:
Provide Stable Pricing on Key Items

Faster than a speeding Prius, the supermarket industry has gone hybrid.

Though it was only a trickle five years ago, supermarkets have increasingly abandoned the seesaw of exclusive high-low pricing in favor of a “hybrid” strategy combining stable prices on some goods along with advertised specials. The trend, observers said, gained more converts in 2008 as a combination of a worsening economy and high gasoline prices made winners of stores that could serve shoppers looking to minimize the amount of shopping trips they made and still feel they could get their money's worth on a basket of groceries.

“The consumer in this economy, more than they have in the past, is looking at stability in terms of what they spend,” John Rand, director of retail insights for Management Ventures Inc., Cambridge, Mass., told SN. “In this environment, high-low doesn't give me, as a shopper, the assurance that my money is always well spent. If you take me out of that ad-driven price mentality and give me a sense that, across the wide market basket of items, you're competitive, and you give me the feeling that I'm not overspending routinely, I now feel more comfortable coming to your store.”

According to Rand, the numbers support not only the move to hybrid pricing strategies, but speak to their success. A long-term study of price models by MVI shows that in 2008, hybrid operators overtook high-low operators for the first time in share of total volume in the supermarket channel. Hybrid operators also perform better as a group, showing a 3.4% compound annual growth rate between 2005 and 2008, vs. high-low players, which grew by 0.2% in the same period.

MVI projects the trend will continue, with hybrid operators controlling more total volume than pure high-low players and showing stronger growth through 2013. What MVI refers to as EDP retailers — including pure EDLP operators and others not employing any high-low strategies — have also grown faster than pure high-low retailers since 2005 and are projected to grow even faster than both hybrids and pure high-low players over the next five years.

The current economic picture hasn't accelerated pricing movement as much as it has put a spotlight on retailers' price perception, said Mitchell Corwin, an analyst for Morningstar, Chicago. This has rewarded companies like Kroger, which have made an effort to improve their price image in recent years while upscale-leaning outlets like Whole Foods Market are seeing their comp sales drop.

“It's going to take time to shake that ‘whole paycheck’ image,” Corwin told SN. “And consumers are still tightening their belts. They will be less inclined to go to Whole Foods. I think they're in for a rough period.”

Rand points to the success of Kroger — which began slicing retails several years ago in an effort to stay within a range of Wal-Mart on staple items — as the biggest event in the move toward the hybrid model.

MVI calls Kroger's pricing strategy “KVI/Draft,” meaning that “known value items” are priced within a range of Wal-Mart, while the remainder of items — “the draft” — see more promotional activity and pricing swings.

Kroger's success in recent years attests to the veracity of its strategy, although the retailer has scars from its attempt to get there. Similarly, Ahold's largest U.S. banners, Stop & Shop and Giant-Landover, have undergone a lengthy transition to an everyday low price strategy, and have only now begun an orchestrated effort to communicate that to consumers. This, Rand insisted, is a key requirement to a successful pricing strategy.

“If I'm a retailer that moves to something other than pure high-low, and I start stressing stable prices or go all the way to EDLP, the message to the consumer has to change. You have to build into advertising and messaging the full-market-basket comparison,” he said. Successful EDLP players, he added, use their circulars to de-emphasize item-level pricing and create a message around the total market basket.
— Jon Springer

SALES AND GROWTH BY PRICING MODEL

In 2008, hybrid-price-model retailers overtook high-low operators for share of total volume in the grocery channel. Because the compound annual growth rate (CAGR) of high-low operators is lower than that of everyday price and hybrids, the gap will probably widen, according to a survey of around 100 retailers conducted by Management Ventures Inc., Cambridge, Mass.

SOURCE: Management Ventures Inc.

INITIATIVE 2:
Reduce Prices Without Losing Core Positioning

Unless the current recession lasts a lot longer than expected, Safeway, Pleasanton, Calif., feels it has the right formula for success.

In the company's annual investor conference this month, Steve Burd, chairman, president and chief executive officer, cited the cyclical nature of economic downturns in justifying the company's shift toward a more upscale offering.

“Some people on Wall Street have questioned whether we have the right strategy for a recession,” he said. “But recessions are temporary, and we believe you build a strategy to create long-term shareholder value, not to deal with a recession.”

Safeway devised its fresher, more upscale “lifestyle” format — which over the past few years has been rolled out to most of its stores — with the idea of differentiating from price-oriented competitors. Now that consumers have been pressured into bargain-hunting, however, Safeway is seeking to accommodate them without losing the strategic focus of its lifestyle makeovers.

In the analyst meeting, Burd noted that Safeway is planning aggressive price cuts in 2009 as it shifts more products toward EDLP, and financing these with a raft of cost-cutting strategies without sacrificing product quality or impairing the customer experience.

Jonathan Ziegler, senior analyst with Dutton Associates, El Dorado Hills, Calif., told SN in a recent interview that he applauds Safeway's effort to maintain its positioning.

“I know it's controversial today in the environment that we're in, because [Burd] has sort of moved the stores upscale,” he said. “I think people have criticized him for that, but they have short-term visions. He has differentiated his stores from being a commodity operation.”

Jon Hauptman, a partner at consulting firm Willard Bishop, Barrington, Ill., said there are several tools retailers can employ to improve their price image without risking their upmarket points of differentiation.

One of the best ways to accomplish this is through an expanded private-label offering, he explained.

“That includes not only maximizing assortments of national-brand-equivalent private label, but establishing or significantly increasing second-tier private label,” he said. “It provides shoppers options to trade down and save money while shopping an upmarket retailer. It's a great way to strengthen their price image without lowering their prices, because this is a variety issue, and more and more shoppers are looking to trade down, at least in some categories, in order to save money.”

Effective communication of price offers can also be a key element of a retailer's strategy, Hauptman said.

“Retailers can show shoppers how they can save money, through very clear and hard-hitting weekly circulars and store signage that highlights all the different ways you can save,” he said, noting especially the importance of pointing out specific savings. “In this day and age, we have to do the math for shoppers in order to get full credit for all discounts. That's not only doing the math for them on promotional shelf tags, which is important, but it's also important on endcap signage, so that a big endcap doesn't just say, ‘$1.99.’ It says ‘$1.99 — Save 79 cents.’ That sends a strong price message to shoppers who are just passing by the display.”

Increasingly, he said, supermarket operators are realizing that such price-focused messages can stand out without detracting from a retailer's decor package.

“We're not taking any of their upmarket elements away,” he said. “Instead, we're allowing retailers to retain their upmarket elements and show shoppers how they can afford them.”

A danger may exist for companies that stray too far from their core positioning, however.
— Mark Hamstra

INITIATIVE 3:
Leverage the New Real Estate Market

The downturn in the real estate market may offer some buying opportunities for retailers to either expand their operations more efficiently or eliminate some rent expenses.

In a recent conference call discussing Kroger Co.'s second-half financial results, Rodney McMullen, vice chairman, said the Cincinnati-based retailer was eyeing a few locations for those types of transactions.

“We are exploring some good opportunities to buy real estate we currently lease,” he said in the conference. “If those opportunities are realized, our capital expenditures and debt levels could increase. This would be offset by lower rent expense.”

He went on to explain that the company was looking at several “one-off” locations, where, for example, a seller might have a store in a location where Kroger was looking to expand. “When somebody has an asset to sell, especially if it's a store where we want to expand, it works out really well to buy that property and be able to expand the store,” he said.

Kroger owns about 43% of its 2,500 supermarkets and multi-department stores, according to its latest annual report. That compares with 41% for Pleasanton, Calif.-based Safeway, which said in its annual report that it “prefers ownership because it provides control and flexibility with respect to remodeling, expansions, closures and financing terms.”

For companies that have access to capital, a strategy favoring ownership seems to make sense, according to Bryan Hunt, managing director of high-yield research for Wachovia Securities, Charlotte, N.C. He cited Ingles Markets, Asheville, N.C., as an example of a company that might be able to take advantage of some real estate buying opportunities.

“In some cases, the companies can get the capital, but it's so expensive, it doesn't make any sense to acquire real estate,” he said. “But for a company like Ingles, they have access to capital in the asset-backed lending market at fairly favorable rates. Some companies may be able to buy property at borrowing rates that are less than the rent they are paying today.”

Hunt said he has noticed some quick-service restaurant franchisees that have recently begun pursing that strategy in light of the weak real estate market.

Terry S. Brown, chief executive officer of Columbia, S.C.-based Edens & Avant, a shopping center developer and property manager, said he hasn't seen many supermarket operators altering their traditional practices toward buying rather than leasing, but he noted that it might make sense for companies that have enough resources.

“Construction capital has dried up for real estate developers, so for supermarkets to do their own development and own their own store probably provides a high level of certainty as far as execution,” he said. “Some of those retailers are concerned about whether developers will be able to achieve the leasing [from other tenants] necessary to actually finance, develop and open new centers.”

Although supermarkets are expected to remain focused on remodeling rather than new-store development, the cost of land “is moderating,” and construction costs have gone down 5%-10% recently, possibly creating some opportunities for supermarkets.

Smaller-format stores in particular, Brown said, could benefit from either building their own sites or building small strip centers with a handful of smaller tenants.

“The grocers realize that their lease creates some value, and there's some sense that they'd like to capture as much of that as they possibly can.”
— Mark Hamstra

INITIATIVE 4:
Trim Costs, Watch Debt Levels and Curtail Cap-Ex

Just like many of their shoppers, supermarkets in 2009 are just going to have to do more on less.

A slow economy has made spending money hard to find, and investors have shunned companies with high debt loads, analysts said. Retailers, in turn, are curtailing their own capital investments, with some companies already announcing large year-over-year declines in budgets and others expected to adjust their plans in the months ahead.

“All across the landscape, capital expenditures are going to decline this year,” Mitchell Corwin, an analyst at Morningstar, Chicago, told SN. “There will be more focus on the balance sheets and on generating stronger cash flows and looking for ways to reduce costs so they are able to reinvest in price.”

Steve Burd, chief executive officer of Safeway, detailed a plan calling for precisely those measures earlier this month. While Burd placed the chain's spending slowdown in the context of aggressive earnings guidance, his call to spend $1.2 billion in capital expenditures in fiscal 2009 is a 25% reduction from fiscal 2008.

Ingles Markets, coming off its highest-spending year ever in fiscal 2008, said recently that it expected spending would drop by around 40% in 2009, citing reduced credit availability and a reduction in the number of projects it expects to build next year.

Brian Hunt, an analyst at Wachovia Securities, Charlotte, N.C., told SN in an interview that companies like Ingles, based in Asheville, N.C., will be well served to watch their expenses as debt approaches maturity dates. Stater Bros., the Colton, Calif.-based chain that recently completed a large new headquarters and distribution center, will likely rest its credit card next year as well, he added.

“Stater Bros. and Ingles were very ‘growthy’ when access to capital was a little more liquid, but now with liquidity in the market drying up, they have definitely dialed back cap-ex programs,” Hunt said. “Stater Bros. is coming off a major cap-ex program, and maybe for them it's lucky, and it's just a timing situation, but Ingles is definitely dialing back their cap-ex and managing their cap-ex based on what the availability of capital is.”

Ingles, which spent nearly $250 million last year, will spend around $150 million in the coming year. Hunt noted that Ingles has $350 million in notes that are callable this year and that mature in 2011, so it will want to avoid a “hiccup,” while looking to refinance.

“You don't want to go out and borrow a bunch of additional debt — you want to manage your debt levels when you are looking to refinance,” he said. “I think a lot of companies are looking at it the same way. They are trying to manage their short-term obligations and not get out over their skis and have a potential credit issue when borrowing rates are extremely high.”

At Safeway, spending is coming down after years of investing in remodels resulted in some 75% of the chain's stores getting on the lifestyle program. Burd mentioned the company has also become more efficient in its investments over time, doing some remodels today at 50% of the cost it had done previously.

According to Corwin, retailers will make choices that give them more bang for the buck.

“Every company will have to take a harder look at return on investment when they are building new stores or doing remodels, because in this environment it's harder to achieve the returns that they got in the past,” he said. “The criteria to spend money is going to be more stringent.”
— Jon Springer

INITIATIVE 5:
Take a Hands-On Approach to Helping Customers Save

As the economy has weakened, Stop & Shop, Quincy, Mass., believes it has found a way to let consumers know “that we're addressing the problem of rising food prices and suggesting ways they can be more savvy when they shop,” Andrea Astrachan, the chain's vice president, consumer affairs, told SN.

The communication vehicle is a series of “affordable food summits” Stop & Shop has been hosting since late summer in response to customer requests for help — meetings during which chain executives, local legislators, economists and community leaders discuss escalating prices and what can be done to get through the tough times, Astrachan explained. “The meetings give participants a true feeling of community — that we're all in this together and we all need to work through this together.”

Interest has been building as the economy has faltered, with the first meeting attracting only about 30 or 40 people, while the sixth one — at a store in Newington, Conn., in late October — had the largest turnout, with over 100 people.

“One of our goals is to assure customers that their concerns about rising costs are not being overlooked, so we've had six meetings so far to let people know what government is doing to help resolve some of the larger issues and what consumers can do to help themselves when they go shopping,” Astrachan said.

“We felt inviting local legislators to these sessions could help people get a third-party point of view about what's causing rising prices — separate from anything we might tell consumers — and what's being done about them,” she pointed out. “People are grateful to have the opportunity to talk to their legislators about what they are doing.”

The chain also includes representatives from local food banks to explain how consumers can deal with community hunger issues by making grocery donations, “as well as what they can do if they are in need of assistance themselves by using food banks or food stamps,” she said.

The meetings conclude with store tours to show shoppers how they can save money, “and people walk away from these sessions knowing not only how they can cut costs, but also where they can go to get help if they need it,” she explained.

Among shopping tips Astrachan offers during the store tours: suggestions that consumers buy more frozen fruits and vegetables “and buy fresh only to fill their needs for that week”; use eggs more often as a source of protein rather than relying solely on meat; and realize how store brands can save money — “up to $8 a meal on eggplant parmigiana, for example,” she noted.

“As we walk through the stores, many consumers tell us they never thought of some of the things we suggest, and other consumers share some of their own recipes, so it turns out to be a great way of learning how to save money,” Astrachan said.

Stop & Shop has already held summits at stores in Massachusetts, New York, New Jersey and Connecticut, using bag stuffers to publicize them, supplemented occasionally by communications from the participating legislators. Astrachan said additional summits will be held, though the company has not yet worked out a schedule for 2009.
— Elliot Zwiebach