Small Wonder

JON SPRINGER

With industry attention turned these days toward retailers that are casting their lines into the possibilities of the express-store format, it's easy to overlook the fact that Kroger has been swimming in the small-store waters for decades.

The Cincinnati-based retailer — best known for large, combination grocery stores and even larger Marketplace superstores — quietly operates nearly 800 convenience stores across the country. And while c-stores account for only a small gulp of Kroger's annual revenue, it's not an insignificant one: The division produced sales of about $3 billion for the company last year. That's about the size of a regional grocery chain, and makes Kroger one of the largest players in a fragmented c-store industry.

More important, observers say, experience in the c-store industry has provided Kroger with the knowledge behind its burgeoning supermarket-fuel business, a launching pad for successful private brands like Turkey Hill, and an understanding of what drives the convenience shopping trip. That helps Kroger better compete with the emerging express-store concept, and better defend itself against competitors like dollar stores and supercenters, despite sharp distinctions between those various formats.

Kroger's know-how in food, marketing and distribution in turn is growing its c-stores through an emphasis on proprietary products and centralization, and through sharing in innovations like loyalty marketing and integrated discount programs. The chain recently rebranded its five c-store banners in an effort to unify them, and more recently appointed an official with responsibility for “bridging” its convenience and supermarket formats.

Finally, the c-store division is providing Kroger with a canvas for format experimentation. In Greensburg, Kan., the company is at work on a grocery/convenience hybrid store set to open next year. And at a Tom Thumb store in Florida, Kroger is making a success of an unusual fusing of a convenience store and a pharmacy.

“The unsung small star in Kroger's store galaxy has been its convenience and gas division,” said Burt P. Flickinger III, managing partner of Strategic Resource Group, New York.

Kroger officials declined to comment for this article.

Long History, New Look

Kroger's association with convenience stores is a long one and closely associated with the Dillons grocery chain in Kansas, from which Kroger's current chief executive officer, David Dillon, emerged.

Dick Dillon — a cousin of David Dillon's father — developed the company's first convenience store in 1960, calling it Kwik Shop. The store was designed to combine “the time-saving and personalized service of a small store with supermarket efficiency in management, inventory control and merchandising,” according to a company history. In many ways, the c-store division continues to serve that purpose for Kroger.

Dillons had expanded Kwik Shop into Nebraska and Iowa by the late 1960s. In 1970, it acquired Quik Stop, a similarly misspelled Northern California-based chain. Following Kroger's acquisition of Dillons in 1983, the c-stores continued to operate under Dillon Cos., a fully owned subsidiary. That group further expanded with the purchase of Tom Thumb in Florida and Turkey Hill in Pennsylvania in 1985; Colorado-based Loaf 'N Jug in 1986; and Wyoming-based Mini Mart in 1987. Mini Mart and Loaf 'N Jug were subsequently merged, and more recently their stores were rebranded under the Loaf 'N Jug name.

More than 20 years of operating the convenience divisions as separate entities came to a close in recent years as Kroger endeavored to unite its banners under common programs and imaging. A new logo, first introduced in 2004, shows a stylized shape of the United States set within a diamond with colorful backgrounds. The logo serves not only to identify the stores, whose names appear in similar type alongside the new symbol, but also a corporate gasoline brand.

The new look gradually spread across Kroger's divisions as part of renovations and new store openings. Along with the new logo came branding of various departments inside the stores: Coffee Central and Soda Central denote those offers with common signs throughout the chain. In some stores, a foodservice department offering items like breakfast sandwiches, pizza, burgers, subs and burritos is branded as the Real Time Café.

The re-imaging of Kroger's convenience stores helps create efficiencies, makes the brand distinct from competitors, and presents consumers with a consistent brand message, observers said. It's an effort that is fairly unusual in the c-store industry.

“Convenience stores have traditionally been a more merchandising-driven channel, where the focus has been on the buy and on logistics and efficiencies. Now, in a market where there's more competition than ever, there's a growing realization that a marketing orientation is necessary,” David Bishop, managing partner of Balvor LLC, a sales and marketing consulting firm based in Barrington, Ill., told SN. “For Kroger, the idea of unifying divisions under one national brand makes a lot of sense to leverage their skill and maximize equity in the brand.”

Not the Same Business

“Historically, supermarkets running c-stores have been an odd duck,” said Neil Stern, senior partner at McMillan Doolittle, a Chicago-based consultancy. “On the surface it makes sense, but the practicality of it made it a difficult business.”

Differences between the convenience and grocery channels extend not only to product offerings, store sizes and locations but also to issues with distribution, Stern explained. “There's just not a lot of synergy there.”

While some supermarket operators such as Giant Eagle have a growing c-store business, and others, like Ingles Markets, have begun to add c-stores to complement their gasoline offerings, still others are getting out of the business completely. Marsh Supermarkets recently spun off its Village Pantry business to a separate entity, and before that Ahold sold off its Wilson Farms c-store subsidiary. And earlier this year, Albertsons LLC said it would sell 72 fuel centers in six states to Valero Energy, a San Antonio-based gas company, as part of a decision to focus on its core grocery and pharmacy strengths. Valero now operates those businesses under its Corner Store banner.

Supermarkets that intend to play in the convenience field have to be prepared to do so completely, Steve Montgomery, president of b2b Solutions, a Lake Forest, Ill., consulting company, told SN. Many, he said, failed to make the commitment to the product offering that consumers demand.

“The problem most supermarkets had, in my opinion, was that they looked at the fuel offering out front as just another checkout,” Montgomery said. “If you're not selling cigarettes in packs and in cartons, and moist tobacco, and other things you find in a convenience store, then you're not really in the convenience-store business.”

Kroger's experience in the convenience format is a big advantage here, observers said.

“Kroger understands the gasoline business more quickly and more comprehensively than the [grocery] competition,” said Stern. “Like any business, gasoline has its complexities, and Kroger's been at it for a long time, so they're better able to leverage that knowledge than others.”

C-Store Struggles and Solutions

Consumers aren't the only ones who have been cheering falling gasoline prices in recent weeks. They're joined by gasoline retailers, which over the past two years have seen sales rocket — and profits retract — as the prices at the pump have spun to record-high levels.

In 2002, when motor fuel prices averaged less than $1.50 a gallon, retail margins at the pump averaged around 9%, according to figures provided by Bishop. In 2008, when average prices exceeded $3.25 per gallon, margins contracted to around 4%.

Credit-card interchange fees provide another hit on top of that, Bishop added. These charges — which retailers pay banks that issue credit cards — are based on transaction size and not volume. Rising prices increase the impact of these fees on retailers' net profits even without selling more gas.

Kroger said its convenience store division generated around 70% of its dollar sales from gasoline in 2007. That's pretty typical in the industry, and the reason why c-store operators — Kroger included — are looking for other means of driving profits through those stores.

“The high contribution of gas on a dollar sales basis is a bit of albatross around the neck of the convenience store industry,” Bishop explained. “It drives down the profitability of the one business you are most dependent upon. That's the motivation that many in the industry have focused on: The need to move off motor fuel as a sustainable profit center.”

That's where food — as part of an improved in-store offering — enters the convenience business.

“Foodservice is something people looked at, because it's a growth area of the business, and because it has a higher margin than any packaged good in the store, and because it fits the model of serving customers on the go,” Bishop explained.

Kroger can exercise advantages here, sources said. Its effort to improve offerings and polish the brand image of its c-stores can help create a sales mix and a profit contribution better able to withstand wild swings in profitability from its gasoline business. Kroger's private-label program — a small part of which spills into the c-store offering — and a traditional association with the food business also helps its credibility in food relative to competitors with their heritage in gasoline.

Turkey Hill, the Pennsylvania convenience store chain that grew from a dairy of the same name, is among leaders in this development, sources said. Turkey Hill's ice cream and milk are considered strong brands in their own right, and its branded iced tea is the largest-selling in the convenience channel, sources said. Bishop estimates private-brand sales account for only 3% of all sales at convenience stores, vs. penetration levels of 17% or more in the grocery channel, indicating there is plenty of room to develop such offerings, even if the process is only beginning.

“The problem many convenience store operators have had is that consumers see them as gas stations that sell food, not convenient stores that happen to sell gas,” Bishop said. “But that's an evolutionary shift that's still happening.”

'All Kinds of Possibilities'

In an interview with SN earlier this year, Dillon of Kroger acknowledged that the c-store channel in general had to overcome consumer perceptions about high prices and low-quality food. The challenge at Kroger, he added, was to find ways to provide the “convenience” the channel promises.

“The word ‘convenience’ store is supposed to mean convenient to the customer, but I'm afraid over the years it's come to mean not-very-fresh product and very high prices,” Dillon said. “We have fought that tendency in our own c-store group, and I think over time we'll continue to look at that. I think it is a vehicle that over time will help us focus on the convenience aspect.”

Finding new interpretations of convenience — and integrating the convenience store into Kroger's overall array of shopping vehicles in the market — appear to be the company's other strategic priorities.

“These stores can be very complementary as Kroger defends its sales and market share, and can be a good defensive move against dollar stores” due to their size, according to Flickinger. “Also, as consumers have less time and less disposable income to drive greater distances, Kroger can use c-stores and supermarkets together to get more out of weekly shoppers, and to turn Wal-Mart and Super Target shoppers from weekly shoppers into biweekly or monthly shoppers.”

“From a customer standpoint, we really are trying to have [an offering] where a customer can engage with us in multiple formats,” Rodney McMullen, Kroger's vice chairman, remarked in an earnings call last year. “We believe that that's most effective. So we are really looking at all of [our formats] together rather than each one individually.”

This blueprint is coming to life in places like Kansas, where Kroger has used the combination of Dillons supermarkets, Dillons Marketplace superstores and Kwik Shop convenience stores to capture all manner of shopping trips. Consumers there can shop at Kwik Shop using their Dillons loyalty card, and participate in gas-rewards programs both there and at Dillons.

Kroger is also using its convenience stores as places to test new concepts. In rural Greensburg, Kan., where a 2007 tornado wiped out the only grocery store (Dillons) and the only convenience store (Kwik Shop) in town, Kroger is rebuilding both in an 8,000-square-foot “hybrid” store combining both concepts. According to reports, the prototype, set to open early next year, will include immediate-consumption items like fountain drinks and snacks along with traditional grocery staples like fresh produce, meat, dairy, frozen goods and a fuel center.

“We continually tinker with what we do inside our smaller formats,” Michael Schlotman, Kroger's chief financial officer, said during a presentation earlier this year. “And we have a lot of markets where our convenience stores overlap with our supermarkets. So there are all kinds of interesting possibilities that could be there, as we continue to tinker with the convenience stores.”

The chain early last year debuted a Kroger-branded pharmacy within a Tom Thumb convenience store in Pensacola, Fla. “It's exceeding our expectations per script count, and it's now up to the point where it's making money, only a few months into the process,” Schlotman said about the concept in the same talk last spring.

These innovations were nearly lost amid the attention given to new “express” stores rolled out over the last year by Tesco, Wal-Mart and others. Experts say these stores — around 10,000 square feet and specializing in prepared take-home meals — have more significant differences than similarities to c-stores. But the jury is out on how things may evolve.

“Could Kroger come up with a different animal based on their understanding of small stores? Yes. I think everybody is still trying to figure out what these stores are going to look like over the long haul,” said Stern.

Montgomery notes that the concepts have sharply distinct niches, with convenience marketing around the idea of refreshment, whereas other food stores emphasize replenishment. “I don't see Tesco's Fresh & Easy having any impact at all on convenience stores,” he said. “They seem more competitive to grocery stores and Whole Foods.”

Bishop said he suspects express stores will need to maintain a disassociation with gasoline. Giant Eagle Express, a pilot express store opened last year by Giant Eagle, sits on a lot adjacent to a gas offering and has not been expanded upon, he noted. “It could mean that the association with motor fuel can put a drag on the ability to move into fresh.”

For Kroger, an expansion of c-stores, particularly where it already operates supermarkets, seems a safer bet than expansion into the express format, Flickinger speculated. Oil companies fleeing the c-store business in favor of refining and other lines of business could spark this movement, he added.

Bishop said he sees Kroger continuing to expand store size and offerings within the stores, and also developing a tighter connection with customers through its marketing capabilities.

“Kroger's stores, not unlike the rest of the c-store industry, will continue to grow, not only in square footage but in lot size, allowing greater ingress and egress,” he predicted. “You'll see a trend toward reaching consumers in off-site communications, whether it's freestanding ad inserts and radio spots in prime drive time, or by using their loyalty card. They will link that to proprietary products and fresh food offerings, which will be more expansive than a traditional c-store due to their heritage in the food retailing business.”