TAKING AIM AT GROCERY

ELLIOT ZWIEBACH

The next big threat to traditional supermarkets could come from SuperTarget, some industry observers told SN — assuming it's able to get a handle on self-distribution while expanding and upgrading its perishables offerings.

Others said Target faces even more challenges in its battle for grocery market share, citing problems with consumer price perceptions; issues with adjacencies and traffic flow at store level; and an inability to localize food offerings.

All agree, however, that after operating in the shadow of Wal-Mart Supercenters for more than a decade, Minneapolis-based Target Corp. is firmly committed to growing the role of food in all its stores, particularly at its massive SuperTarget stores, which include a full grocery offering.

Target operates nearly 1,600 stores, of which 210 are SuperTargets, accounting for an estimated 19% of the chain's total sales — approximately $12.3 billion out of 2007 volume of $63.4 billion, according to industry sources.

SuperTargets average 175,000 square feet — with prototypes of 160,000 square feet and 190,000 square feet in 22 states — with the largest penetration in Texas (42), Florida (33) and Minnesota (23). The stores devote 35% to 40% of floor space to grocery items, with consumables and commodities accounting for about 33% of sales, up from 30% in 2005, compared with 47% of sales at Wal-Mart, observers said.

The company, which began opening SuperTargets in 1995, has been ramping up the growth of that format for the last few years. After opening 22 locations in 2005, 19 in 2006 and 33 in 2007, Target plans to open 40 more units this year, 44 in 2009 and 48 in 2010 — representing approximately 25% to 40% of unit growth, compared with 15% to 25% over the past three years, industry sources said.

Target's increasing emphasis on expanding its grocery offering could prove troublesome for some supermarkets, observers said, because the successful moves that traditional supermarket operators have made to differentiate themselves to deal with the price threat posed by Wal-Mart could be thwarted by a more focused expansion of SuperTarget, which itself uses a superior ambience and a better quality of merchandise to differentiate its stores from Wal-Mart's.

“As Target moves more aggressively to expand food, it's going to pose a more direct threat to most supermarkets because its approach to food gets right into the industry's underwear,” Howard Davidowitz, chairman of Davidowitz & Associates, a New York-based retail and investment banking firm, told SN.

“Most supermarkets have found ways to adjust to the Wal-Mart phenomenon so they could grow sales and earnings without having to match Wal-Mart pricing. But Target won't do food like Wal-Mart.

“It will do it its own way, with better quality, better assortments, better service and better lighting, which will provide more direct competition to what supermarkets have been doing to confront Wal-Mart. And with a significant footprint, a gigantic platform and unlimited capital to grow, Target will be a very significant threat.”

Davidowitz said he expects Target to have a stronger impact on the conventional food business — not only from a more rapid expansion of SuperTargets but also as the result of greater penetration of food items in conventional Target and Target Greatland stores.

David Heupel, an analyst with Thrivent Financial in Minneapolis, also said he believes SuperTarget could pose a serious challenge to conventional supermarkets. “Target certainly adds a different twist to the equation because it's competing on more of a quality level than Wal-Mart,” he said. “The big problem for supermarkets is that consumers who are not looking solely for low prices are more likely to be persuaded to shop at a SuperTarget [than a Wal-Mart] because the quality it offers may be as good as what they can get at a supermarket.”

Though a SuperTarget is unlikely to have a service meat counter, he said, it makes up for that with high-end product.

“For a special occasion, you could spend $40 for a steak and a Maine lobster at SuperTarget and have a surf-and-turf dinner that's up to the quality of what you can get at any supermarket,” Heupel said.

Room For Improvement

One retailer who competes with SuperTarget gave the stores high marks for product quality — his only criticism involved the layout in the grocery area.

“The way that side of the store is laid out is not as efficient as on the dry goods side,” he told SN. “The flow of traffic from point to point is very jumpy.”

The retailer said the quality of perishables at SuperTarget is generally better than it is at Wal-Mart, “and it's on a par with most conventional supermarkets. In fact, the overall quality of food is a major draw. So if SuperTarget can maintain its operations at that level and improve its layout, it could be a real threat to some supermarkets.”

Deborah Weinswig, an analyst for Citigroup, New York, agreed that SuperTarget still has some adjustments to make on adjacencies in the food section. “There is still room to improve cross-shopping opportunities,” she said.

However, she said she believes the stores do a good job in perishables, particularly in the area of prepared foods. “That's one area where Target definitely outdoes Wal-Mart,” she said.

Food is one of the chain's fastest-growing segments, Jim Hertel, managing partner at Willard Bishop Consulting, Barrington, Ill., pointed out, “and probably a steadier source of sales growth than anything else.”

However, he said he views SuperTarget as “more of a potential threat right now that could become a kinetic threat as it begins rolling out new stores more aggressively.”

Hertel said a consumer's decision whether to shop at a SuperTarget or a conventional supermarket would likely fall in Target's favor because of the one-stop-shopping opportunities. “The tipping point for a shopper to sacrifice a positive supermarket experience in favor of a discount store is usually a price differential of 10%,” Hertel said, “and given that SuperTarget is within that range and that the shopping experience there is closer to that of a supermarket, that's a potent combination.”

Asked what conventional supermarkets would have to do to meet the challenge posed by SuperTarget, Hertel replied, “They would have to turn to other elements in the value equation and move toward increased service or more in-store personalization to satisfy and delight shoppers. Basically, supermarkets would have to raise their game.”

Supermarkets will find a way to compete “because they are smarter and better than SuperTarget and higher up the learning curve, and they will be the drivers of that curve while Target will remain a follower,” said George Rosenbaum, co-founder of Leo J. Shapiro & Associates, a Chicago-based marketing research firm.

He said he isn't certain about the potential threat SuperTarget might pose for supermarkets, based on research his firm conducted late last year that indicated consumers have a low opinion of SuperTarget's food offerings.

“Although consumers said the shopping environment at Target is more customer-friendly than at Wal-Mart, in terms of ease of use and a more comfortable atmosphere, they see a big gap between its general merchandise offerings and food, and at this point, while its handling of general merchandise and soft goods reflect department store breeding, Target falls much lower on the curve in terms of food, especially in the area of fresh.

“Even if Target is able to overcome what consumers perceive as its glaring problems in fresh food, it will still be a follower behind supermarkets,” Rosenbaum said.

A Positive Impression

Since last fall, SuperTarget has deliberately sought to make a more positive impression when it opens a new store, Patricia Edwards, a Seattle-based analyst with Wentworth, Hauser & Violich, San Francisco, said, “by being extra sharp on food prices, especially in the first 60 days, while stacking produce higher and carrying more stock than usual so there's a bountiful smorgasbord of fresh food.”

Even as Target expands its food know-how and grows its abilities to do a better job of merchandising, Weinswig said she doubts SuperTarget will ever be as big a threat to supermarkets as Wal-Mart is, “because it's not as big a draw, with less frequency of visits — only three a month for Target, compared with eight a month for Wal-Mart.”

Edwards said the company is ramping up SuperTarget expansion “because it believes it has the opportunity to make a statement about its value proposition to customers.”

“It wants to drive frequency of visits, and having consumables is the way to do that. The company believes that if it can make a positive impression by adding freshness to its value proposition, then it has a good chance of retaining a consumer as a regular shopper at its stores.”

But with only 210 locations, Edwards said she considers SuperTarget a threat only on a local basis. “To be a significant threat industrywide will take years,” she noted, “but it could be a big threat on a regional basis. As it expands, Target should concentrate SuperTarget openings to leverage its strength from region to region.”

Heupel said he's confident Target's growth plans for food will keep the company on track. “Wal-Mart is obviously way farther along than Target in grocery merchandising, but I like Target's prospects,” he said.

“Target tends to be very careful in choosing real estate sites,” Weinswig said, “and while it might be more beneficial to backfill and concentrate its efforts in specific areas of the country, Target feels it's more important to have the right store in the right location rather than to look for density within a given market.”

It's doubtful SuperTarget will ever come close to the 2,500 supercenter locations Wal-Mart operates, Weinswig told SN, because Target's appeal is aimed at a more affluent customer.

But Target is growing the SuperTarget format more aggressively because it understands the ability of that type of store to increase the frequency of visits, she said.

“Profits on the food side are lower than what Target is used to, and that may have inhibited more rapid expansion in the past,” Weinswig explained. “Given the fact Target started as a department store company, it's taken awhile to change its thinking and then process those changes. But it's beginning to accept the fact that food is a more complex business than discount store merchandising and that it requires more localization of offerings and faster turns — though it's still using a third party to supply food, which makes that business less profitable.”

Toward Self-Delivery

That could change now that Target is gearing up to handle more of its own distribution, starting later this year with the scheduled opening of its first perishables distribution center in Lake City, Fla., with a second perishables facility reportedly set for next year in Cedar Rapids, Iowa, observers said.

Target anticipates opening an average of one perishables facility a year over the next 10 years, Weinswig said, which should enable it to broaden its fresh assortments and merchandise more local items while increasing gross margins, maintaining better in-stock levels and boosting store productivity.

Speaking with analysts during a conference call last month, Target President Gregg Steinhafel said the company expects to handle perishables and grocery distribution completely on its own “within a time frame earlier than four or five years.”

Until then, he said, “we will have a hybrid network where we are dependent on our own facilities and on Supervalu and C&S [Wholesale Grocers].”

Asserting greater control of the food component in its supply chain will enable Target “[to] improve our food margins, manage freshness better and enable continued rapid growth of our own brand in our food assortment,” Steinhafel said.

It also will provide Target with opportunities to improve gross margins.

Based on its experience distributing groceries from its general merchandise warehouses, “we are experiencing the levels of gross-margin upside that we anticipated when we made the additional capital investment in our own facilities,” Steinhafel said, “so we are seeing the right kinds of offsets to make the economics work.”

Steinhafel said Target expects to convert at least two more Supervalu distribution centers to Target-owned grocery facilities, with one due to open in early 2009 and another to open later in the year. Sources told SN the first facility is located in Fort Worth, Texas, and the second is in Phoenix.

Target has been self-distributing dry groceries through its general merchandise warehouses for several years as a customer of Supervalu, its corporate neighbor in Minneapolis. As it begins opening its own perishables and grocery centers, it will continue to leverage that relationship, Weinswig said, with Target owning the buildings and inventories, and Supervalu overseeing the logistics “until Target gets itself up and running on its own,” she indicated.

According to Heupel, Target has been slow to move into self-distribution “because it knows it must be very efficient before doing it corporate-wide, but I believe it will get there.”

Davidowitz said Target has not seemed to be as committed to expanding the SuperTarget format as Wal-Mart has been with its supercenters. But with the decision to operate its own distribution facilities, “Watch out!” he declared, “because when Target does something, it usually does it very well — and it rarely fails.”

As SuperTarget expands, one advantage it will be able to build on is the private-label lines Target has already developed in the grocery area, observers pointed out.

Chief among its private-label food brands is Archer Farms, a line of more than 2,000 premium groceries and fresh baked goods. Other brands include Market Pantry, encompassing staple foods at prices below national brands; Sutton & Dodge, a line of Angus beef; Wine Cube, a line of boxed wines; and Choxie, a line of premium chocolates.

“Target is a genius when it comes to branding and marketing,” Davidowitz told SN. “It has always strived to create its own brands throughout the store and to make sure those brands connote quality and differentiation, and it's been able to bring techniques it learned in apparel and hard goods to food, with all brands standing for quality.

“After all, this is Tar-zhay, not Wal-Mart,” he said.

“The strength of corporate brands is one area Wal-Mart is lacking,” Hertel said. “Target builds brands rather than simply offering products, and that drives shopper loyalty.

“If Target can continue to create demand for its private-label lines and offer superior pricing on commodity items, that's a powerful combination.”

Weinswig said the success of Target's private-label program “is probably greater than the company expected. And it has the ability to offer items with good opening price points as well as top-quality lines for more affluent customers.”

Edwards said the private-label brand assortment is a plus for Target “because consumers who shop at a lot of different stores are used to seeing unique brands in each one, so if they recognize the brands they can get only at SuperTarget are of good quality and have a good value proposition, that can only help strengthen the stores.”

Rosenbaum offered a different view. “Most people who shop at Target also shop at Wal-Mart, and private label doesn't resolve the problem consumers have expressed that food at Target, especially perishables, is seen as inferior to general merchandise. That isn't going to change very much until Target gets higher on the learning curve of how to run a food store and gradually becomes more competitive with supermarkets in the minds of consumers.”

According to his company's research, consumers don't think Target's prices are as low or as competitive as conventional supermarkets, Rosenbaum pointed out.

“They don't believe Wal-Mart or SuperTarget run food stores as well as most major supermarket operators. But given the economic pressures consumers face today, including the high cost of fuel, Wal-Mart Supercenters and SuperTargets have an advantage over supermarkets because they provide a one-stop-shopping experience that enables consumers to forgive them for their relatively inferior food operations,” Rosenbaum told SN.

Price perception is a part of its image Target is trying to improve, Weinswig said. Although Target formats are typically priced 10% to 15% below supermarkets on food and within 1% to 3% of Wal-Mart, “the company has had issues communicating its low prices to customers,” she explained, with focus groups indicating most competitors, including supermarkets, are priced lower on consumables.

“Target management is focused on narrowing that price-gap image, spending more time on research and understanding why customers are not buying certain categories in the store,” Weinswig indicated.

According to Heupel, Target is competitive with Wal-Mart on core goods, “and on a full basket, price levels will be fairly close. And if there's much variance, Target will typically react.”

Edwards agreed. “If Wal-Mart is lower than Target on an item that really drives traffic, Target will drop its price,” she said.

“The reality is that its prices are right in line with the competition, but there's a perception prices are 5% to 10% higher.”

With inflation becoming a growing concern, Target will be faced more and more with the question of whether to raise prices or hold the line and take a hit, Heupel pointed out, “and going forward, I would expect Target to be more reactive, with Wal-Mart leading prices up and Target following them.”

Davidowitz said SuperTarget is unlikely to convert many Wal-Mart customers. “Wal-Mart describes its customers as 150 million Americans with average annual incomes of $40,000 to $44,000. Those people are solidly Wal-Mart customers, and Target's strategy doesn't address them,” he said.

“Who it addresses is the other 150 million consumers who shop at traditional food stores and don't mind paying a little more for quality perishables. That's the Target customer.”