Surviving the Meltdown

Supermarkets weathered an economic meltdown in 2008 as consumers cut back on spending, amid rising costs for food and fuel.

As shoppers' sensitivity to pricing became more acute, retailers were forced to fight through inflation to offer deals on everyday items and to expand their private-label portfolios. Many companies reported strong sales of their own brands, even among their more upscale offerings.

A credit crisis emerged in the second half of the year, as a result of the complex real estate implosion that dragged down investment banks, slowing down the pace of mergers and acquisitions. The Fresh Market, based in Greensboro, N.C., went in search of investment capital and was unable to find it, and most of the deals that took place were relatively small, in-market transactions.

Tesco's U.S. invasion, which began in late 2007, continued in stops and starts this year as the British company rolled out its Fresh & Easy small-format store in the Southwest. Although traditional supermarkets reported little impact from the new chain, the concept of operating out of a smaller box — Tesco's U.S. stores measure about 10,000 square feet — did capture the interest of several operators.

Among those companies that dipped their toes in the waters of small-store formats were Wal-Mart, Schnucks, Hy-Vee, Safeway, Giant Eagle and Supervalu.

Consumers, Retailers React to Pricing Pressures

THE COMBINATION OF food-price inflation and economic pressure on consumers drove changes in shopping patterns in 2008.

“There's a new consumer out there,” Jack Brown, chairman and chief executive officer of Stater Bros. Markets, San Bernardino, Calif., told SN in July — “one who will buy products wherever they can get the best price. They may buy some items at a gas station or a drug store — with no loyalty to the supermarket where they have done most of their shopping for years — because of the economic strictures they're feeling.”

As food and gas prices rose, retailers reported that consumers increasingly traded down to less expensive products, including private labels, and shoppers appeared to be making fewer trips.

It wasn't just inflation but the speed at which it accelerated that created problems, David Dillon, chairman and CEO of Kroger Co., Cincinnati, said during a conference call earlier this month.

“When inflation occurs quickly or is a much higher number, both of which occurred [this year], then it starts to chip away at being a net positive and makes it harder [to deal with]. Lay that on top of an economy that went south in a hurry, and I think this year has been, for all of us, one for the record books.”

Supermarkets, however, proved they were much more resilient in the downturn than apparel retailers and department stores, which had among the worst sales performances in decades. The split was evident at big-box food retailers like Costco, BJ's, Target and Wal-Mart, which all reported strong food sales during the year, but some softness in discretionary items.

Dollar stores reaped the benefits of consumers' frugality, as some shoppers appeared to “trade out” of traditional stores and into cheaper formats.

The trend toward more at-home dining might have helped compensate for the shift, however, as supermarkets enhanced and marketed their meal solutions alternatives.

But with inflation hovering anywhere from 2% to 6% and, occasionally, more throughout the year, retailers were constantly on edge — hoping for a drop in supplier prices but absorbing inflationary increases as long as they could and then ultimately passing along all price increases.

Inflation caused problems for retailers who, like Stop & Shop, Quincy, Mass., were trying to change their price image, as John Rishton, CEO of Brussels-based Ahold, said in an earnings call in May.

“Previously, if we had a price of $10 and the new price was $8, customers could clearly see that we reduced prices and improved the value of our offering,” he explained. “But in an inflationary environment, a price that goes from $10 to $11 doesn't sound too impressive, even if our competitors have increased prices far more.”

In late July, several major chains, including Safeway, Supervalu, Delhaize and Costco, revised their financial outlooks downward within days of each other, citing the weak consumer putting pressure on margins.

The situation appeared to be particularly frustrating to Christian Haub, executive chairman of A&P, Montvale, N.J., who said in a speech in September, “I don't think there is any use to believe there is upside when everyone around you is giving earnings warnings. We will not withstand all of these pressures unscathed.”

-- Elliot Zwiebach

Small Stores Get Attention, Mixed Results

LET'S GET SMALL.

From upscale shops designed for tight urban spaces, to limited-assortment arrangements curtailing space as a cost-saver, to fresh takes on the “express” format, retailers were big on going small during 2008.

Chains that announced and/or debuted new small-format stores during the year included Wal-Mart, Schnucks, Hy-Vee, Safeway, Giant Eagle and Supervalu. While many retailers were careful to describe their new vehicles as tests or pilot stores, the sheer volume of them indicated the supermarket industry believes there can be a place for the small format within their brand portfolio — if only a small one.

News that Wal-Mart would develop a small format, Marketside, arrived in January, and by October the first locations of the so-called “Small-Mart” were open and competing in the Phoenix area with local Fresh & Easy stores that had only recently been debuted by Tesco.

Marketside was described by one observer in SN as a “conventional grocery store shrunk down,” featuring name-brand dry groceries. That contrasts with Tesco's private-label-heavy offering. Both stores appear poised to capture busy families needing prepared meals on the run.

Safeway in May also began testing the express-store format by converting an older Vons location in Long Beach, Calif., to a new format called The Market. Steve Burd, chief executive officer of Safeway, said in a recent presentation that the store performance was “good, but not great,” and that Safeway planned to open two additional small stores in 2009 to further test the concept.

Analysts at SN's roundtable this summer expressed some skepticism around the express format, noting that in addition to challenging economic hurdles, Tesco's model appeared in need of considerable tinkering with its merchandising pizzazz and neighborhood focus. A better opportunity for small-store expansion, one analyst argued, was the hard-discount format.

“When you realize there are more than 15,000 dollar stores in the U.S. and only about 2,200 hard-discount stores targeting the much bigger retail food market, it's very clear there could be 6,000, 7,000 or 8,000 hard-discount stores in the U.S. ultimately,” the analyst, John Heinbockel of Goldman Sachs, said, adding that even segment leaders Save-A-Lot and Aldi are growing too slowly.

Some supermarket operators appeared to have gotten that message by debuting their own takes on the small discount box by year-end, including Hy-Vee's Heartland Pantry and Giant Eagle's Valu King. Those stores, which opened within weeks of one another in Nebraska and Ohio, respectively, each use limited space to feature private-label items, including Topco's natural/organic brands, along with special-buy national brands and limited service departments.

Supervalu's Jewel-Osco chain in September debuted Urban Fresh by Jewel, a well-appointed, 16,000-square-foot store in a trendy Chicago neighborhood that features about 6,000 SKUs, with an emphasis on beer and wine, cheeses and fresh goods. Schnuck Markets, in the meantime, said it would build its own version of a small, upscale box in a newly developing urban project in its home city of St. Louis.

-- Jon Springer

Credit Crisis Slows Dealmaking

SUPERMARKET MERGERS and acquisitions for the most part went the way of the credit markets in 2008: They slowed to a trickle, then nearly froze solid.

It was hardly a coincidence. M&A activity until this year, observers noted, was sparked by easy access to the credit markets and subsequent activity led by private-equity firms.

Tighter credit knocked private equity almost completely out of the game this year except as sellers: Albertsons LLC was party to the year's biggest single deal — a sale of 49 Albertsons stores in Florida to Publix Super Markets. Albertsons LLC was the private-equity-backed buyer of leftover properties from the Supervalu takeover of Albertsons Inc.

While observers in a March article in SN predicted the exit of private equity would eventually bring asking prices down to a level where strategic mergers could make a comeback, that day hadn't come by mid-December. Deals materialized only in isolation during 2008 and mainly consisted of small in-market deals, where local competitors swapped stores or regional chains bolted on volume in small chunks.

A rough deal-making climate — and the declining economy that led to it — might have been best illustrated by The Fresh Market's failure to secure expansion capital. The Greensboro, N.C.-based retailer said in April it had retained Goldman Sachs to assist in a search for outside investors, only to pull the chain off the market by August. Sources told SN that investors valued the company far below what it was hoping to get, noting that its sales pace had slowed along with the economy.

In a year with few big deals, Publix's purchase of 49 Albertsons stores in Florida, announced in June, would prove to be the biggest splash. The $500 million buy resolved long-standing questions around what would happen with Albertsons LLC's business in Florida. The year before, the group, led by Cerberus Capital Management, spun off 160 stores in Northern California. Its shrinking footprint allowed it to consolidate divisions this year.

The deal provided Publix, Florida's largest supermarket operator, with greater market share, flexibility in replacement sites and in some cases the ability introduce its specialty GreenWise format. Analysts considered it an aggressive move that denied competitors Winn-Dixie or Sweetbay a shot at the stores, though there were no public confirmations of a bidding war.

In a series of smaller deals throughout the year, buyers concentrated on massaging area market shares by absorbing smaller competitors and, in some cases, selling those stores where they were weaker. Homeland Stores, a division of Kansas City, Kan.-based Associated Wholesale Grocers, in January purchased 26 stores belonging to United Supermarkets of Oklahoma, based in Altus, and in December acquired five stores from Williams Discount Foods, based in Oklahoma City. The latter group included some former Albertsons assets spun off from Albertsons LLC in 2007.

Elsewhere in the Midwest, employee-owned Harps Foods, Springdale, Ark., purchased the eight-store Wallace & Owens chain with stores in Missouri and Arkansas.

Houchens Industries, Bowling Green, Ky., in February added seven Cincinnati-area Save-A-Lot stores to its portfolio and in May took over Buehler Foods, a 22-store operator based in Jasper, Ind.

Spartan Stores continued its roll-up of distribution customers in Michigan when, in August, it acquired Flint-based VG's Food and Pharmacy for $85 million. Officials of VG's, a second-generation family-run business, told SN it considered only Spartan when it decided to sell, citing a long relationship with the Grand Rapids distributor.

In the Northeast, the shrinking Penn Traffic chain provided purchase opportunities for Price Chopper (two stores) and Gerrity's Supermarkets (one store). Ahold's resurgent Stop & Shop chain also took two Massachusetts stores from a supplier, C&S Wholesale Grocers, formerly operating as Grand Union and Ro-Jack's stores.

And in New York, Bethpage-based King Kullen expanded from its Long Island base by buying former A&P and Pathmark stores on Staten Island that were ordered to be divested as part of the A&P-Pathmark merger.

On the West Coast, the biggest deal was a transaction between Hispanic-focused operators: Bodega Latina purchased seven California stores from Mexico's Grupo Gigante.

Delhaize was active overseas, buying the 34-store Plus-Hallas chain in Greece in January and a 14-store chain based in Romania, La Fourmi, in April.

Some supermarkets this year invested in outside businesses, while others spun off nonfood holdings. Spartan completed cutting its ties with The Pharm drug chain, selling it to Rite-Aid, while Hy-Vee spun off its in-house advertising agency. Kroger bought a stake in The Little Clinic, an in-store wellness chain.

-- Jon Springer

Fresh & Easy Slows Expansion

TESCO HAD GREAT expectations in 2008 for Fresh & Easy Neighborhood Markets, the small-format chain of 10,000-square-foot stores it launched on the West Coast in November 2007.

The United Kingdom-based company had originally projected 200 stores by the end of its fiscal year in late February 2009. However, it lowered those expectations twice during the year and ended 2008 with 106 units, with an estimated 20 more likely to open by late February.

As of mid-December, Fresh & Easy had 54 locations in California, 27 in Arizona and 25 in Nevada — with little impact on most supermarket competitors, industry observers told SN.

The first slowdown in expansion plans came in March, when Fresh & Easy said it would take a three-month hiatus after opening 61 stores in five months, to “kick the tires, smooth out any wrinkles and make some improvements that customers have asked for.”

When it resumed store openings in July, Fresh & Easy featured more promotional pricing; more shelf labels calling attention to featured items or making price comparisons with competitors; a broader selection of private-label and national-brand items; and warmer colors in its decor.

Fresh & Easy opened approximately 40 more stores before announcing in November that it was slowing expansion plans again. “In the current economic environment, we've decided to keep expanding at the same rate we have been,” Simon Uwins, chief marketing officer here, told SN — a rate of about two new stores a week.

The slowdown will affect the chain's plans to expand next year into Northern California — a move that's been postponed indefinitely while the company's second distribution center, in Stockton, Calif., is built. Although construction is already under way, “We're not quite sure when it will open,” Uwins said.

When Tesco reported financial results for the first half, which ended Aug. 23, Fresh & Easy had lost $106.8 million on sales of $135 million during its first 10 months of operation, with average sales of $11 per square foot per week.

Speaking in late November, Sir Terry Leahy, chief executive officer, said several stores “have now moved strongly into [comparable-store sales] growth” and that overall performance “continues to be pleasing.” Once the U.S. economy bounces back, he added, “We'll be able to step up our rate of growth.”

-- Elliot Zwiebach

Whole Foods Faces FTC, Weak Consumer

THE NATION'S LEADING retailer of natural and organic foods got squeezed like an overripe banana in 2008.

Whole Foods Market, which for years outpaced the supermarket industry in terms of sales growth, stock performance and merchandising innovation, suddenly found itself battling to retain customers in a difficult economy and squirming under the microscope of the antitrust authorities at the Federal Trade Commission.

Although Whole Foods successfully completed its acquisition of Wild Oats Markets last year, and appeared to have thwarted the FTC's attempt to block the deal, the FTC pressed on with its case this year. In July, a three-judge panel ruled that a lower court erred in its assessment of the merger, paving the way for a new ruling that could force Whole Foods to sell off some assets, antitrust experts said.

Meanwhile, the FTC also proceeded on a separate track to pursue an administrative hearing to undo the deal. That hearing is scheduled to begin in February.

The company's battle with the FTC took place amid a weakening consumer environment for Whole Foods' upscale offering.

In August, Whole Foods reported the lowest comparable-store sales gain in its 28-year history — 2.6% — for the third quarter. The company suspended the dividend on its battered stock and said it would cut some capital spending.

“It's reasonable to conclude the deceleration is primarily due to the economy,” John Mackey, the company's chairman and chief executive officer, said in a conference call discussing results for the period.

In November, Whole Foods sold a 17% stake in the company to Los Angeles-based Leonard Green & Partners, raising $425 million for store development.

Fourth-quarter comp-store sales slowed to a mere 0.4%, and the forecast for the early going in 2009 was not favorable.

-- Mark Hamstra

The Year in Technology: Strides and Setbacks

PRACTICALLY EVERY FOOD retailer did something green — that is, energy-saving or environmentally friendly — in 2008, whether it was introducing reusable grocery bags, selling biodiesel fuel, installing LED lights in perishables cases, testing a secondary loop refrigeration system, or harvesting the sun through skylights and solar panels.

One environmental issue that all food retailers have in common is the phaseout of ozone-depleting R-22 refrigerant that will begin in 2010, when production and import of HCFC refrigerants will be allowed only for equipment manufactured before 2010. Retailers are developing R-22 reclamation strategies to ensure that they have enough of the refrigerant to service legacy equipment. They are also beginning to replace R-22 with HFC refrigerants that don't harm the ozone layer, such as R-422D and R-404A.

On the in-store technology side, the biggest news of the year occurred on March 17 when Hannaford Bros., Scarborough, Maine, announced that a data breach at the checkout lanes of its stores had exposed 4.2 million credit and debit cards to fraudulent misuse. About 1,800 cases of actual card fraud were linked to the breach. Since then, the chain has spent millions on security upgrades that go well beyond what is required by the PCI (Payment Card Industry) Data Security Standard, to which Hannaford said it was in compliance. Hannaford is still dealing with lawsuits stemming from the breach.

In another big in-store development, two days after the Hannaford announcement, Pay By Touch, San Francisco, terminated its biometric payment technology at about 400 supermarkets. Pay By Touch had appeared to be building support for biometric payment, in which a shopper's finger-scan linked to a credit or debit account paid for purchases at the POS; full rollouts took place at Piggly Wiggly Carolina and two Supervalu divisions — Jewel-Osco (204 stores) and Cub Food (75 locations) — as well as at several independents.

The industry did make some strides in retail systems during 2008, especially in the evolution of the GS1 DataBar — smaller in size than the UPC code but capable of storing more information. In the loose produce arena, a growing number of suppliers are putting stickers on fruits and vegetables that bear both the traditional price lookup (PLU) code and a 14-digit DataBar. This year, CPG manufacturers began issuing interim “hybrid” coupons that include both the traditional UPC-A bar code and a data-rich version of the DataBar.

-- Michael Garry