Lone Star High Achiever

DAVID ORGEL

SAN ANTONIO — Ask anyone in the supermarket industry to name the best U.S. food retailers and virtually every short list will include the name H.E. Butt Grocery Co. It's a phenomenon that pleases H-E-B's executives but doesn't faze them.

It’s a phenomenon that pleases H-E-B’s executives but doesn’t faze them.

"We're flattered when people refer to our excellence," said Bob Loeffler, chief operating officer, in an interview with SN. "But if you asked anyone here if we achieve excellence, the answer would be no. We don't pat ourselves on the back. We're not satisfied about where we are. We run scared."

Supermarket News has named H-E-B the first recipient of the publication's annual Retail Excellence Award, which honors a retailer for outstanding performance in a number of aspects (see box, Page 16). H-E-B was chosen following an industry nomination process on SN's Web site, consultation with a wide variety of supermarket industry leaders and input from SN's editors. The profile of H-E-B in this issue includes interviews with a number of the chain's top executives and comments from others in the industry.

The overwhelming feedback about H-E-B, based here, is that it excels in almost every aspect of retailing. It's a master of local marketing and has a passion for food. A fierce competitor in a marketplace crowded with other supermarkets and alternate formats. A company that has figured out how to grow its territories despite operating in the same state for almost 100 years. A model for good relations with employees, suppliers and communities. A savvy practitioner of marketing and technology.

H-E-B manages to outperform in all these aspects of retailing — while "running scared." It operates in a state that is home to more Wal-Mart supercenters than any other (170 units, according to Wal-Mart). But H-E-B doesn't cower in front of Wal-Mart or any other competitors, said Neil Stern, senior partner with McMillan Doolittle, Chicago.

"H-E-B has the attitude that 'this is our market and we won't let anyone take anything from us.' They have a 'don't-mess-with-Texas' philosophy and view any incursion as a serious threat. They also want to play in all channels for customers, including mainstream H-E-B stores, Central Market for upscale customers and Hispanic stores. They have the right format for the right customers."

H-E-B is owned by the Butt family, including Chairman and Chief Executive Officer Charles Butt, who is actively involved in the company. The retailer posted 2002 sales of $9.8 billion, up from $8.9 billion in 2001, according to the company. H-E-B operates more than 300 stores across Texas and in northern Mexico and is now on an expansion drive in Houston and Mexico.

"There are 6 million people in Houston and 6 million people in all of the rest of H-E-B's markets combined," said Scott McClelland, president of H-E-B Houston/Central Market. "So Houston is a huge market."

H-E-B's earlier format for that market was H-E-B Pantry, stores of about 28,000 square feet with more limited assortments than today's larger prototype units. Now, H-E-B is phasing out many of those Pantry units in favor of its H-E-B conventional food and drug stores, which average 75,000 square feet. The company is opening nine H-E-B stores there this year, which will bring to 24 the total number of Houston food and drug stores. The company said it will expand its Houston distribution center in order to handle the larger stores.

"Not all the Pantry stores will be converted, but overall we are looking at changing to larger stores," McClelland said. Currently, there are 62 Pantry Foods stores remaining. Another expansion drive is taking place on the other side of the Mexican border. H-E-B has already opened 20 stores in northern Mexico since entering that market in 1997 and plans to double the number of stores within five years and open a 300,000-square-foot warehouse in 2004.

"We've worked in Mexico for a long time," said Loeffler, a 24-year H-E-B veteran who became COO earlier this year, succeeding Fully Clingman, who has retired from the company. "It began with Charles Butt's own deep interest in Mexico as a country and a neighbor. There's not a big difference between north Mexico and Texas, Mexican consumers know the H-E-B name. People have relatives on both side of the border. Mexico plays a hughe part in the daily life of Texas."

Launching and growing the Mexican stores was an extremely detailed and lenghty project that involved severn years of advance study, Loeffler said. Chain executives have worked diligently to import U.S. products into Mexico, including groceries and the chain's own-label milk, which was a departure from the shelf-stable milk many Mexicans are used to. H-E-B's commitment has impressed Mexican shoppers and competitors.

"The stores are doing every well," Loeffler said. "We've improved the lot of all consumers there by bringing stores with great standards, and our competitors have followed suit by improving their stores."

But H-E-B's road to Mexico hasn't been just a one-way street, Loeffler stressed. "We've learned about some categories from Mexico," he said. "General merchandise is more important in Mexican supermarkets than in U.S. supermarkets. We also have some good synergies with some high-quality Mexican suppliers who can supply both our Mexican and U.S. stores.

Loeffler noted that much of H-E-B's U.S. produce comes from Mexico, and the chain's own-brand diapers in Mexico and the U.S. are from a Mexican supplier.

CENTRAL MARKET CACHET

Despite H-E-B's efforts to expand in a number of markets, the retailer is usually known for quality rather than quantity of stores.

Its crowned jewel is the Central Market format, a store so exceptional that currently only seven of them exist. These stores now operate in Austin (two), Dallas, Fort Worth, Houston, Plano and San Antonio.

"Central Markets is a lifestyle," McClelland said. "We say that if you shop three times in a row you'll find a higher qulity of life with food.

Central Market still operates with the original vision from Charles Butt, who opened the first unit in 1994 in Austin. The idea was to create a store that excludes many basic supermarket grocery items in order to showcase extraordinay fresh foods and ingredients for cooking great meals. The traffic pattern through the 78,000 square-foot stores steers shoppers through a walkway of variety in prepared foods, produce, deli, seafood, bakery, meat and specialty groceries. Two of the most popular features are a cooking school and an upscale takeout restaurant called "Central Market Cafe on the Run."

The store further underlines the gourmet culture with a magazine called "Central Market Foodie." In the most recent issue, a letter from Stephen Butt, senior vice president of Central Market, states that Central Market is a place "with an audience of sophisticated home cooks with great knowledge and enthusiasm about the exciting trends happening in the culinary world." The magazine highlights special aspects of Central Market and alerts shoppers to special events, such as a "Tomato Mania" festival that spotlights 30 types of tomatoes. The latest issue profiles the managers of the cooking schools and their recommended recipes, including lamb's leaf lettuce salad with black truffles and goat cheese, artichoke and smoked ham strata.

The cooking schools feature classes by chefs and cookbook authors that address a myriad of shopper needs. For the ethnic-inspired, there are "Contemporary Latin Flavors," "Hands-On Sushi" and "Weekend Thai Potluck." Dieters might consider "Hecho en Mexico — Low Fat" or "Livin' La Vida Lo-Carb." For the romantically linked, there are "Hands-On Couples Cooking: an Entertaining Menu" and "Couples Cooking: Paella."

"We even have adults plan cooking school birthday parties in which friends take a class and then eat the meal together," McClelland said.

For those wanting upscale entrees, sides and deserts without the cooking effort, Central Market Cafe on the Run fills the need. A 40-foot full-service case houses salmon, lasagna, sliced flank steak, soups, a salad bar and a lot more. Seating is available. It's proof that H-E-B is one of the best food-service outlets in a supermarket industry that consistently faces stiff food-service competition.

Probably the biggest complaint about Central Market is that only seven of the stores exist. But other H-E-B stores are benefiting from the Central Market experience. Many have adopted a serpentine traffic pattern for the produce department that evokes the traffic flow through all of Central Market. Many H-E-B stores have also added Central Market Cafe on the Run outlets that are about 75% the size of their Central Market cousins.

"We won't build 40 Central Markets in each city, but we'd like to extend a popular feature like the cafe," McClelland said. "It can be somewhat tailored by neighborhood. It's an exciting growth vehicle."

About 15 H-E-B stores have "Cooking Connections" kiosks for demonstrating meal preparation — another example of the retailer's passion for food. Those kiosks are placed in the perishables department and include a stainless steel kitchen staffed by a culinary professional who cooks meals and educates customers. "Early in the week they focus on quick meals and later in the week they concentrate on entertaining meals," said Steve Harper, senior vice president, fresh merchandising, procurement and product development.

Ingredients for the meals are displayed near the Cooking Connections areas. The point of the demonstration is to emphasize how many easy and high-quality meals can be made from the ingredients available in the store.

"Over time, what's been lost is people's ability to cook, so we want to give people the know-how," McClelland said. "We're exposing people to different types of foods. This gets shoppers out of their comfort zone."

INNOVATIVE MARKETING TECHNIQUES

Behind much of H-E-B's success is innovative marketing of products and concepts.

A prime example is the chain's H-E-Buddy kids' private-label line, which was launched in May of last year and expanded earlier this year. Products include cinnamon and honey grahams, Animal Friends cookies, Dino Nuggets (frozen chicken nuggets), fruit snacks and cheese crackers. The H-E-Buddy character, a smiling grocery bag, appears on the packages. This line of products is further promoted through in-store events, one which featured face painting.

"Data shows that 66% of customers who shop with their kids buy items that weren't on their list," McClelland said. "Kids influence what's purchased in the store."

H-E-B's private labels are not just for kids, either. The retailer has a three-tier program for adults: "Central Market Own Brand" is the upscale line just being launched in H-E-B and Central Market stores. The H-E-B brand is the mainstream line; and Hill Country Fare is for entry-level price points.

A popular store ice cream brand is "Creamy Creations," which offers more than 60 flavors, including sherbet and yogurt. Flavors include Pecan Pie, introduced in August 2003, but the No. 1 item is Homemade Vanilla.

Another popular store-label program is "H-E-B Fully Cooked," a 208-item line of pre-cooked meats and other products that "reflects how Texans live," McClelland said.

Harper explained that the line of refrigerated and frozen products was created to solve a basic problem: "How can we make great food easier to prepare so it turns out great?"

Meredith Adler, managing director, Lehman Brothers, New York, said H-E-B rose to the challenge of its local market demographics. "You could argue that H-E-B is successful because it operates in such an interesting market, where there are a lot of low-income Hispanic customers who are very interested in high-quality food and perishables, which is an unusual combination for the rest of the country, which means they have to be able to do fresh well while at the same time be able to concentrate on low prices. What a learning experience for a company!"

One signature item is refrigerated fully cooked brisket. "We cook it for 18 hours because customers like the slow-cook method popular here," Harper said. "So, the goal is to enable them to have a great brisket more frequently than they would make it themselves." Customers re-therm the meat in a broiler pan for about an hour.

H-E-B also offers frozen, fully cooked items, such as burgers, that can be re-thermed in a microwave, an advantage if kids will be doing the preparation.

H-E-B executives talk a lot about private labels and other product attributes but not so much about price specials. That's because as an everyday-low-price operator the chain has removed the need for shoppers to scan the store brochure for the best prices. Instead, executives talk about value.

"We play an 'also' game," McClelland said. "We want low price, but also high quality."

Lisa Cartwright, managing director, Salomon Smith Barney, New York, said H-E-B "is not afraid to get very close to Wal-Mart on price. They are non-union, they have very strong market share and they kind of own the EDLP image in Texas even though Wal-Mart is there. In fact, even Wal-Mart has acknowledged that H-E-B is one of the most efficient distributors around."

Not that H-E-B avoids deals altogether. Its "Meal Deal" event, held every two weeks, enables shoppers to get free merchandise if they buy certain items. "For example, if you buy a fully cooked brisket you might get free items that revolve around a brisket meal," Harper explained.

LOCAL MARKETING LEADER

The fully cooked brisket is an obvious example of H-E-B's understanding of the needs of its marketing areas. "We make decisions locally, it's not corporate direction from San Antonio," McClelland said. "Some chains look at the average American and try to merchandise to that. We merchandise each store differently."

That practice comes into play when, say, the store is merchandising for Latinos in different markets such as Houston and San Antonio. "Houston Latinos are more on the immigrant side with a larger percentage from Central America and the Caribbean," McClelland said. "They have different eating habits from San Antonio Latinos, who are mostly Mexican and more acculturated. So in Houston you'd have more of an emphasis on black beans [Central American] as opposed to in San Antonio where you'd emphasize pinto beans [Mexican]."

H-E-B's employees, called partners by the chain, play a big role in local marketing. "Local marketing ideas come from our partners," McClelland said. "The partners live near the stores. They are built-in focus groups."

For instance, the chain recently opened a Houston store whose customer base is 25% Asian. Two partners working in that department are Vietnamese. Accordingly, one of the produce items stocked is durian, a fruit preferred by Vietnamese customers that comes from Thailand, South Korea and Laos.

RECOGNIZING 'PARTNERS'

"Our partners enjoy sharing authorship and they get a kick out of launching a new product," Harper said.

Store partners, in turn, get recognition for their efforts, including awards for various achievements. "We hold a Meat Expo and a Produce Expo, for instance, where we educate partners about the business and recognize them," Harper said. H-E-B employs more than 60,000 in Texas and Mexico, and many have long tenures, Harper said.

The chain is serious about partner training, including a course on diversity and another on the H-E-B culture called "Spirit of H-E-B," said Winell Herron, group vice president of public affairs and diversity.

The retailer's partners aren't the company's only link to its communities. H-E-B conducts an extensive community-service program that includes an annual donation of 5% of its pre-tax earnings to charities. That amount is in addition to the hours that partners devote to civic activities. (For a description of many of the chain's activities, see box on Page 26.)

H-E-B reserves the word partner for employees, but it seems that word is also appropriate for suppliers. "We look for long-term relations with suppliers, not transactional partnerships," Harper said. "We don't want one winning at the other's expense. We look for companies whose business strategies are aligned with ours, including low price on high-quality products.

"At our recent Produce Expo, I met a woman whose company has been doing business with our company for 72 years. That's five generations of farmers standing in the field to sell us cilantro and greens. We're in it for the long haul."

H-E-B's retail excellence is recognized by suppliers. In the most recent Power Ranking survey conducted by consultancy Cannondale Associates, suppliers ranked H-E-B No. 1 among supermarket retailers in clearest company strategy, best job of branding stores, best buying team and best supply chain, noted Don Stuart, partner at Cannondale.

H-E-B's most basic requirement is that suppliers have a 100% commitment to food safety, Harper stressed. H-E-B has an extensive quality assurance program with scientists and technologists. The chain audits supplier processes, including HAACP programs. The retailer recently opened a $3.5 million, 13,500-square-foot quality assurance lab in San Antonio which tests ground beef and produce sold at all of the chain's stores in Texas and Mexico.

TACTICAL USE OF TECHNOLOGY

Technology plays a big role in H-E-B's food-safety efforts and in many other aspects of the chain's operations. H-E-B has been cited as an industry leader in technology, but the company is characteristically humble about that praise.

"We've used technology some, but I've also admired the way others use it, such as Meijer, Wegmans and Publix," Loeffler said. "I wouldn't put us above them."

Loeffler, whose many previous roles at the company included chief information officer, described how H-E-B has employed technology to its advantage in recent decades. "We've been a good user of tactical technology," he said. "Over time, we've automated manual processes and received a payback."

In the 1970s, H-E-B was one of the first supermarket retailers making use of automated warehousing systems, he said. In the 1980s, the retailer installed a satellite network, which supported an ATM network and enabled e-mail and online access for stores. By the 1990s, "we moved more toward decision-support systems to help determine how categories perform and now much to produce," he said.

Today, H-E-B is excited about a number of industry initiatives, including the following areas with comments by Loeffler:

RFID: "We've been studying this closely. If we can have individually identifiable SKUs it will help in the supply chain and make it a different ball game."

LINUX: "Retailers in our industry should be interested in this free version of UNIX." Voice-Over Internet Protocol: "The application of this fast data network is for telephone use at a better cost structure."

Self-Checkout: "We've been experimenting with this concept in several stores. I would have thought it would have done best in neighborhoods with college students and other young people, but actually we are finding that everyone likes it. So, it may have a place." Anti-Shrink Efforts: "We have employed new technology to measure, monitor and control shrink."

Despite the advanced use of technology, H-E-B executives stress that technology is merely a means to support the chain's goals. It's one of the tools that figures in the drive to please shoppers.

"It isn't rocket science," Harper stressed. "We're just trying to understand our customers and meet their needs better than anyone else."

H-E-B's execution of that strategy has made it a model of retail excellence. The company is in the trenches each day doing whatever it takes to excel.

"Retailing gets down to the individual store, the individual location, my meat market vs. your meat market, my checker vs. your checker," Loeffler said. "It's a lot of different things: product, location, facility, knowing your customer. The retailer that does the most things right has the edge and wins."