ACE OF CLUBS 2004-09-13 (2)

MARK HAMSTRA

NATICK, Mass. -- BJ's Wholesale Club has always been in a category of its own.

The smallest of the three major membership club chains, BJ's was founded by a company previously known as Zayre Corp. 20 years ago. It has evolved and grown at its own pace -- sometimes following in the footsteps of its rivals and other times stepping out ahead.

Although its stores' aisles are stacked high, warehouse-style, with bulk packages of groceries, the company, based here, has long been more consumer-oriented and more food-oriented than the other warehouse chains. It garners about 75% of its memberships from individuals. Lately, it has been refining that mission by improving its perishables and taking other measures to target supermarket customers specifically.

It operates 151 stores from Maine to Florida, generating an average of $45 million in sales per store, including $49.3 million at its larger clubs and about $24 million at its smaller facilities.

Food and sundries accounted for about 70% of the $6.6 billion in sales BJ's tallied last year. BJ's estimated that its best members spend about $500 per year on groceries in its stores and another $1,500 at supermarkets.

While Issaquah, Wash.-based Costco Wholesale, the largest of the club chains in terms of sales, and Bentonville, Ark.-based Sam's Club, the largest of the three in terms of number of stores, grew to become national players through acquisition, BJ's has largely stuck to its strategy of concentrating its presence along the East Coast, with the exception of a failed foray into the Chicago market in the late 1980s.

New Concept

The latest development in its business plan is not so much a radical change in strategy as it is a throwback to the original strategy of the club stores: serving small businesses. Last month, the company unveiled its blueprint for a new banner called ProFoods that will serve small food-service operators exclusively. The first two outlets are slated to open later this year in New York City.

At about half the size of traditional BJ's stores, ProFoods will be located in industrial areas, seeking to provide restaurant supplies for small food-service operators in what it described as an $80 billion niche. Profit margins are expected to be better than those of BJ's traditional clubs, and average order sizes are anticipated to be about $350, the company said in a recent conference call with analysts discussing its second-quarter results.

"The concept will leverage BJ's expertise and logistics, merchandising, operations and financial controls," said Michael Wedge, president and chief executive officer, during the conference call. "The business model for ProFoods is built on merchandised margins that are slightly higher than a wholesale club, free memberships, and a broad merchandise assortment to support one-stop shopping in this category."

BJ's executives declined to comment for this article.

Deborah Weinswig, analyst, Citigroup Smith Barney, New York, said in a research note that BJ's should be able to leverage its existing infrastructure in rolling out the new format. She likened the ProFoods concept to that of Los Angeles-based Smart & Final, which is a non-membership, food-oriented, club-style concept that also positions itself to capture professional food-service customers. She pointed out, however, that Smart & Final's operating margin in 2003 was 2.2%, which was slightly lower than BJ's 2003 operating margin of 2.5%.

"ProFoods could be a nice complement to BJ's core business," said Bruce Prescott, retail analyst, Management Ventures, Cambridge, Mass. "The second format can allow BJ's to enter markets like the New York metro area, where the availability and price of prime retail real estate are barriers to a traditional club format. The ProFoods concept can work in a less ideal location like an industrial park. And by catering to the small-business shopper, it gives the traditional BJ's business a little more liberty to polarize toward the retail member."

EVOLVING AS A FOOD RETAILER

The launch of ProFoods marks another in a series of food merchandising changes the company has introduced through its history as it has focused on becoming a full-service grocery destination at its traditional clubs.

In 1990, with 58 stores in the company, BJ's began introducing in-store meat departments and bakeries, after saying for years that such departments were too cost-intensive. Before then, the company's perishable food offerings were limited to about 35 produce items, 70 frozen products and 70 to 80 items in the diary and deli departments, according to a 1989 article in SN.

Last year, the company began rolling out smaller packaging, which it calls "life sizes," in several perishable departments, including seafood, dairy, meat and bakery, to appeal to smaller households. It began adding rotisserie chicken and deli departments with slicers.

It also ramped up its private-label program, introducing a line of premium prepared foods under the Wellesley Farms label. At the end of 2003, store brands like Wellesley Farms and Rozzano Authentic Italian Foods accounted for 6.5% of BJ's total annual sales, up from 5% the year before, the company said.

In addition, the company began using half-pallets in some newer stores that allow it to merchandise more stockkeeping units in the same amount of space. It is expanding its offering to include up to 7,500 SKUs per store.

In May of this year, the company tapped a supermarket industry veteran, former A&P divisional president Karen Stout, as executive vice president of merchandising.

Soon afterwards, the chain rolled out self-distribution of produce to 31 stores in the Southeast, a move analysts said would help BJ's be more competitive in perishables, an area where it previously had lagged behind other retail formats selling food.

"Fresh produce is an area where they've not kept up with the rest of the clubs," said Chuck Cerankosky, analyst, McDonald Investments, Cleveland. "They've had a good meat operation, a good bakery, and they've developed a good seafood operation, but produce has been lacking."

He said the company expects to offer fresher products at better prices, while reducing its own costs.

A recent visit to a BJ's in New Jersey revealed a relatively small area for fresh produce -- about 24 feet of a reach-in cooler, plus a few displays of melons and apples. The store had nearly 100 doors of frozen foods -- mostly bulk packages containing items like prepared appetizers and multipacks of one-pound bags of frozen corn.

The meat case was extensive and included mostly bulk, family-style packaging. Adjacent to the meat case, the company had a special display of shrimp on ice and another of "cheeses of the world."

The bakery offered oversized muffins, cakes decorated to order, and bulk packs of bread (two loaves to a bag).

At a few of the the endcaps of the grocery aisles, the store had small televisions playing promotions for beauty care and home-cleaning products. Cross merchandising of toys with cereal in the grocery aisles was another notable feature in the store.

On the Attack

The changes have come as the chain has repeatedly said it is going on the attack in an effort to take market share from supermarkets.

"Supermarkets are certainly in our crosshairs, when we look at less efficient forms of retail," Wedge said in a recent conference call. "We all know that's a business model under tremendous pressure. The model itself has inefficient logistics, and it's just not an efficient model of food distribution today.

"So we love to compete against supermarkets, but we're also looking to take share from other forms of retail, whether it's chain drug stores, category killers, any of the other categories where we know that we have, as probably the lowest cost in all of retailing, a better way to get the consumers the product at the absolute lowest price."

While BJ's has always sought to differentiate itself from the other clubs by focusing more on consumers, in many ways it has evolved in sync with the rest of the club industry.

"When I first encountered clubs in the 1980s, they really seemed to be going after food-service operators and small convenience customers," said Cerankosky. "They were going after resale customers to a large degree.

"Then the model moved toward capitalizing on the business owner, who may be more affluent, and you started seeing a lot more general merchandise get into the mix."

The first club stores actually opened in 1976, eight years before BJ's opened its first club in Medford, Mass.

While the other club stores long restricted their membership to small business owners, BJ's soon began openly courting traditional consumers.

"We're not looking for people with particular affiliations," said Herbert J. Zarkin, president, BJ's Wholesale Club, in a 1993 interview with Club News, a former sister publication to SN. "If you have $25 and you are breathing, you can join BJ's."

BJ's also differed from the other clubs at the time (in addition to Costco and Sam's Club, there was Pace and Price) in that it shunned private labels. At its stores, which then stretched from Washington, D.C., to New England, the company offered only name brands.

"We do not want to be in the private-label business," Zarkin said in the 1993 interview. "We feel very strongly about name-brand product. It's very important that we carry the No.1 brand in a category, be it food or nonfood."

The company continues to emphasize the most popular brands, although now it has become much more accepting of private-label merchandise.

"At the end of the day, I think the similarities between Sam's and BJ's and Costco are much greater than their differences," said Cerankosky. "They all want that member to make a big-ticket discretionary purchase. In the most simplistic sense, the model is to get the member in for the great buy on consumables, and hopefully every once in a while they walk out with a several-hundred-dollar discretionary purchase."

The margins aren't necessarily higher on the big-ticket merchandise, he explained, but the gross-profit dollars are.

"If you're making roughly 10% gross margin on oranges and cereal and aspirin, that's all well and good. But it's a lot more fun to get 10% gross margin on a $1,500 Yerf Dog go-cart, which I saw in BJ's this past summer, or 10% on a $1,500 computer or a $3,000 piece of jewelry."

A Sound Model

Cerankosky said he thinks the warehouse club format is "probably the toughest threat for conventional food retailers to defend against."

He said the warehouse clubs are often more convenient and offer a higher quality level than supercenters, which in turn attracts more affluent consumers.

"If the clubs are getting a bigger portion of the discretionary dollar because they offer big-pack grocery merchandise in addition to the high price-point treasure hunt merchandise, I think that's a winning combination that's tough to beat," he said.

BJ's business model revolves around its lower cost structure, aided by a reduced SKU count, a nonunion labor force and an efficient distribution network that leverages a network of cross-docking warehouses.

The company's decision to concentrate its stores in more affluent, highly populated East Coast markets also has helped keep its costs in check, analysts said.

"BJ's doesn't really have the capabilities to expand outside its current market and is hence necessarily concentrating on expanding in existing markets," said Prescott of Management Ventures. "While this is resulting in some cannibalization of its own stores in the Northeast, saturating its markets isn't necessarily a bad thing as it strengthens the BJ's brand. There are also significant efficiencies in distribution and marketing associated with a concentrated market presence that strengthen BJ's business model and solidify its market share."

BJ's has long been the frequent target of takeover reports. For at least 10 years, Costco has been reported to have been interested in acquiring the company. Just last year, reports surfaced that Wal-Mart was seeking to add BJ's to its Sam's Club empire.

Cerankosky said he didn't think such mergers would be likely to occur, despite the instant strength in the Northeast that such an acquisition would provide.

"I would be more inclined to think it would be another retailer looking to get into upscale discounting," he said. "I don't think Costco or Sam's would be likely acquirers."

The company remains committed to its strategy of growing at about a 10% pace per year, mostly by filling in existing markets.

"We want to be very intelligent about expansion," Wedge said in a recent conference call. "We are not going to grow just for the sake of making a number. We've been criticized in the past for going to a lot of different places at the same time. Our focus today is to build out markets, be the No. 1 or the No. 2 in every market that we service."