TRADER JOE'S SHIP SHAPE

ELLIOT ZWIEBACH

Trader Joe's time is now.

As it marks its 50th year of operation, Trader Joe's Market is a format precisely in tune with what large numbers of consumers are looking for, according to industry observers: a small box with an edited assortment of high-quality foods that creates in-store excitement and avoids the sameness of conventional supermarkets with a variety of unique private brands and sharp pricing.

Remaining ahead of the times is the challenge it faces going forward, they indicated.

“Trader Joe's has been ahead of the mainstream for years,” Art Turock, a Kirkland, Wash.-based consultant, told SN. “Its capacity for developing great and unique private-label lines was noticeably ahead of the national food chains and the industry standard, and the concept of sacrificing square footage for an assortment geared to specific communities was also ahead of its time, but right on the mark for today.”

The chain knows its customer well, he said, and understands that many food shoppers want an edited assortment rather than what he described as a “confusing” variety.

Founded by Joe Coulombe in 1958 as a convenience store chain called Pronto Markets, the company changed its name to Trader Joe's and began adding a more eclectic product mix in 1967. It has been owned since 1979 by a German-based trust administered on behalf of Theo Albrecht — the same trust that owns Aldi.

Inside its nautically themed stores, inventory is limited to about 3,500 SKUs, fresh offerings are pared to a minimum and in-store service departments like delis and bakeries are non-existent. The chain cut its teeth in trend-forward California — it is based in Monrovia, near Los Angeles — where its quirky merchandising was readily accepted, analysts pointed out.

Today, it operates 310 stores in 23 states and the District of Columbia, with stores concentrated on both coasts and across the northern tier of the U.S. Annual sales are estimated at more than $6.6 billion — an average of $21.3 million per unit — with overall revenues climbing at an annual rate of approximately 15%.

Trader Joe's comparable-store sales are growing about 10% a year, according to Neil Stern, senior partner in Chicago-based consulting firm McMillan Doolittle.

Another analyst, Jim Hertel of Willard Bishop, Barrington, Ill., estimated that 60% of the chain's growth comes from the 20 to 30 new units Trader Joe's opens each year, and 40% comes from existing stores.

Stores average about 10,500 square feet — with some newer units approaching 12,000 to 15,000 square feet, observers said, yielding sales per square foot above $2,000. That's more than triple the conventional industry average and more than double the $950-per-square-foot average at Whole Foods.

“The stores are small, but they use vertical space extremely well,” Jonathan Ziegler, a Santa Barbara, Calif.-based analyst with Dutton Associates, El Dorado Hills, Calif., told SN. “And while inventory is limited, everything they carry works for them.”

Stern estimated Trader Joe's gross margins range from the low to mid-20s, compared with 28% at conventional supermarkets, which have a higher mix of perishables. Margins on private brands, he estimated, are about 25% to 30%, compared with 35% at conventional supermarkets; margins on national brands are in the teens to low 20s, compared with 28% at conventional supermarkets.

Trader Joe's is able to operate on thinner gross margins “because it's so efficient in how it does business,” Ziegler said.

“While it may not have the gross margin of a store that sells a lot of fresh prepared foods, its operating costs are certainly lower.”

CULT FOLLOWING

One of Trader Joe's key strengths is “its ability to fill a niche no one else is in and to create such a unique position in the marketplace that no one else could hope to replicate it,” said Patricia Edwards, a Seattle-based analyst with Wentworth, Hauser & Violich, San Francisco.

“As a result, people crave Trader Joe's,” she said.

One industry observer characterized Trader Joe's as “an upscale food store with down-to-earth prices.”

Much of its ability to keep pricing down-to-earth stems from its reliance on private brands, which make up an estimated 80% of the product mix.

“As a consumer, I think Trader Joe's greatest strength is definitely the uniqueness of its product offering,” Turock told SN. “When you want to find something that's different and unusual — and something of good quality — that's the place to go. And everything tastes good.”

Hertel described the chain as having a “sense of whimsy and adventure in its marketing,” which includes its unusual Fearless Flyer advertising vehicle and such in-store flourishes as hand-painted signs with a humorous bent.

“Trader Joe's is a fun place to shop, and the food is great, too,” he said.

Stern noted the cult-like status Trader Joe's has for many of its customers.

“Many shoppers become advocates for the company,” he said. “They may go there for only three or four items that they can't get anywhere else, but they end up buying many more than that.”

The store-level employees also add to the “fun” of the shopping experience, Stern pointed out.

“They tend to be very laid-back, with their Hawaiian shirts and relaxed attitudes,” he said. “It often feels like a mom-and-pop store rather than a big chain, with employees being given a lot of freedom to do their own thing.

“And when they interact with customers, you don't feel you're dealing with robots, but with individual, knowing human beings.”

Hertel agrees: “There's a sense that working at Trader Joe's is not just a job. The stores are really about what sells, and that's reflected in the workforce, which is knowledgeable about the origin of the foods and how they're prepared — they accurately reflect the enthusiasm of the customers.”

Ziegler pointed out that Trader Joe's also does a good job using sampling to encourage new-product trial — many stores have some cooking equipment behind a small counter where products are heated up and displayed for tastings.

“It has the right-size stores, the right mix of unique and traditional merchandise, a good mix of private-label products and very friendly employees who always make you feel good to be there,” he said. “And with its broad assortment of private brands, it doesn't have to compete with the major chains on price because there's hardly any product overlap.”

Trader Joe's is certainly not the first operator to rely so heavily on private brands, Ziegler pointed out, “but most others have tried it with knockoffs of existing brands, whereas Trader Joe's develops more unique items.”

Trader Joe's strength is its pricing, “driven by the perceived quality, which creates sharp values,” said Andrew Wolf, a Richmond, Va.-based analyst with BB&T Capital Markets.

“Its approach is higher-end products at a discount, and it works.”

Turock said Trader Joe's does a good job with prepared foods in its frozen and refrigerated sections.

“There are other companies with better or more upscale offerings or with larger assortments, but what Trader Joe's offers works very well for the fill-in shopper who can't do all her shopping there,” he explained.

Stern said he believes Trader Joe's is comfortable being a destination for fill-in trips.

“It's a secondary shop in people's lives — they think of going to the supermarket first and then doing fill-in shopping at Trader Joe's to buy specific items they can't get elsewhere.”

He cited research indicating that Trader Joe's ranks considerably higher than any other secondary choice he's ever seen, with approximately 55% of shoppers naming it as their second choice after a chain supermarket.

“Most retailers strive to be primary destinations, but you can't build your business being something you're not, and with such strong sales per square foot, it's hard to argue with anything Trader Joe's is doing,” Stern said.

CHALLENGES AHEAD

For a company that's generally been ahead of its time, the next few years may create some of Trader Joe's biggest challenges, Mike Griswold, a Boise, Idaho-based consultant for AMR Research, Boston, told SN.

“The challenge for Trader Joe's is that its unique niche may no longer be a niche,” he said. “The heavy emphasis on own brand, organics and a quality name are no longer such strong points of differentiation as they used to be, now that many other retailers are getting more involved with private brands and organics, and boosting the quality of their name.”

Now that Tesco's Fresh & Easy banner has gained a foothold in the U.S., and other food retailers, including Safeway and Wal-Mart Stores, are experimenting with small-format locations, Trader's Joe's 10,000-square-foot box is also no longer unique, Griswold pointed out.

“Trader Joe's might want to reexamine its economic model and see if it could squeeze even more costs out of the supply chain in a smaller unit,” he suggested. “It might consider offering more national brands, particularly in stores in more urban settings, where the lack of consistency in what products are available from week to week could be more frustrating to shoppers.”

Stern said he believes store size may be creeping up as Trader Joe's finds more products to sell. It may also be changing its approach to real estate, he added.

“Historically, it's had a very rigid philosophy that allows it to spend only so much and no more on real estate, which means it's been willing to take tertiary, out-of-the-way locations where costs are cheaper,” he said. “But after seeing the results at the store it opened in 2006 in New York City, I think it might be willing to consider paying more because the volume can be astounding.

“Trader Joe's took a second-floor location at a store here in Chicago, in the very desirable Lincoln Park area, and that store is doing so well that they've probably realized they could be doing three times the volume at ground level. So they may be looking at real estate more strategically and deciding it may be worth paying more for prime locations.”

Ziegler suggested Trader Joe's might consider opening slightly larger stores, “which would allow room for more fresh prepared meals. It would also mean it could do a better job with bakery in terms of offering more freshly baked goods rather than relying simply on packaged products.”

For Hertel, boosting store size would be a tricky proposition: “Trader Joe's footprint has the benefit of shop-ability so I'm not really sure it needs to be larger — especially given the incredible productivity and sales per square foot it enjoys.”

But the chain could benefit from mixing things up a bit more, he suggested.

“To maintain excitement and be top-of-mind for shoppers, a store needs to offer new items, and Trader Joe's certainly does that,” Hertel said. “But beyond simply culling out the bottom sellers, perhaps it could raise the bar a little and be more strategic in its product offering by taking a seasonal approach to some of the core items in order to manage the assortment more for excitement.

Turock said he thinks the chain could actually evolve in the other direction, developing an even smaller format designed for urban areas.

He also suggested that Trader Joe's could consider expanding its perishables offering, especially as the health benefits of fresh fruits and vegetables become more apparent to an aging population.

“Within three to five years I think you'll see much more shelf space devoted to produce at Trader's Joe's,” Turock said.

Historically, Trader Joe's has merchandised a bare-bones perishables offering, which analysts said has helped minimize labor costs.

“The stores aren't designed for the kind of labor-intensive departments that an upgraded produce section would be,” Ziegler said. “So while an improvement in perishables is certainly an opportunity for Trader Joe's, it doesn't really fit within its paradigm.”

Wolf offered a similar assessment. “Fresh produce is not the business Trader Joe's is in. It operates a more basic business in perishables, with the same kind of limited assortment of fast movers it offers across the entire store, and since it has a winner on its hands, it has no reason to change.”

He said he believes Trader Joe's is slowly “growing its bandwidth” to encompass more customers from different income groups. “Demand is expanding, and so is the number of middle- to lower-income shoppers, and Trader Joe's is well positioned for that, with an offer that is very relevant.”

Hertel said it might be time for Trader Joe's to make a more aggressive push to capture more low-income and rural customers, and to reconsider its historic target audience — “possibly through expansion into more rural areas or, if it can't do that, maybe striking up third-party distribution agreements in areas where it doesn't intend to open stores but where it sees selling opportunities.”

Edwards told SN she believes the ability to change with the times is embedded in Trader Joe's corporate culture, “and while I don't believe it has to change its DNA, it does have to continue to evolve by keeping its finger on the pulse of the market. It's always done a great job merchandising to where the consumer is going, and I expect that to continue.”

80%
Private-label share of Trader Joe's product mix

Source: Analyst estimates