ESCALATING GAS PRICES BURN RETAILERS AT BOTH ENDS

SN Staff / Reporting by Elliot Zwiebach and Mark Hamstra

Rising fuel prices are threatening to clog the economy's engine and are forcing some food distributors to adjust their marketing strategies and delivery operations, industry executives told SN last week.

Although earlier this year some supermarket operators reported that consumers had perhaps adjusted to high gas prices, this summer prices have spiked to the highest they have been in 20 years, when adjusted for inflation, according to the Energy Information Administration.

In addition to putting a damper on consumer spending, the rising cost of fuel also may be impacting retailers' transportation costs, forcing some to alter their delivery strategies. Data released last week by the U.S. Department of Labor indicated that rising fuel costs are also affecting product-price inflation, and some food retailers have said they are starting to see their costs for some products rise.

"We believe rising fuel costs have had the biggest impact on consumers and their shopping habits," Gary Phillips, president and chief executive officer, Associated Wholesale Grocers, Kansas City, Kan., told SN. "The average family has a set amount of spendable income, and with the huge increase in fuel costs, they have been forced to cut back on spending in other areas."

Wal-Mart Stores, Bentonville, Ark., the nation's largest retailer, last week issued some cautionary statements about the impact of gas prices both on consumer spending and on operating costs, while BJ's Wholesale Club, Natick, Mass., said rising fuel costs were cutting margins at its own on-site gas pumps.

"It's clearly going to be a headwind, for everybody from manufacturers to distributors to retailers," said Jason Whitmer, analyst, FTN Midwest Research, Cleveland. "What I'm most concerned about is how it impacts overall sales demand. Fuel is still a major wrinkle in the end-market landscape."

Steve Smith, president and CEO of K-VA-T Food Stores, Abingdon, Va., when asked about the status of gas prices in his area, reflected the mood of many of those contacted by SN when he replied, "Too damn high!"

Prices at K-VA-T's Gas & Go fuel centers were approaching $2.50 a gallon, "and I've got to believe that's forcing some consumers to pinch their grocery purchases," he said. "In talking with consumers -- particularly older consumers on fixed incomes or dependent on Social Security -- they're saying they've had to cut back on grocery purchases."

Smith said K-VA-T has tried to accommodate these customers by focusing ads on lower-priced products -- ground beef instead of ground round, for example.

Smith said K-VA-T will still try to appeal to affluent shoppers, but is also trying "to make consumers with less disposable incomes say, 'wow,"' including more emphasis on private label.

"Sales have been good this year, but had gas not continued to move upward, I believe sales could have been stronger," he said.

CUTTING DISTRIBUTION COSTS

Retailers and wholesalers may be feeling the biggest impact of rising fuel costs in their trucking fleets.

Operators told SN they have been examining ways to trim costs from their distribution operations via such initiatives as encouraging fewer deliveries and maximizing truckloads.

Bob Spengler, president and chief operating officer, Save Mart Supermarkets, Modesto, Calif., said the company is "looking at every means we can come up with to cut our logistics and transportation costs," including altering its delivery scheduling.

"At Save Mart we've always prided ourselves on being able to have a truck at every store five or six days a week, but now we're trying to determine if that makes economic sense," he said. "The cost of running our own trucking fleet up and down the highway has risen to $2.60 per mile, compared with $1.70 a mile five years ago, and we have not imposed any freight increase in our trucking operation. But we can't afford to absorb those increased costs indefinitely, and the only way to get them back is to raise retail prices or be more efficient. Raising retails is the last thing we want to do, but we can't afford to let costs keep creeping up and not do anything about it."

Phillips of AWG said his company is "looking at every aspect of transportation to minimize the impact" of rising fuel costs.

"We use computerized routing of our outbound trucks to minimize the miles we drive; we try to get maximum cubes on the loads, and our retailers work with us to reduce the number of deliveries they need," he said.

He also said the wholesaler ships as much product as possible directly to its members from the manufacturers' plants, bypassing its own warehouses.

Phillips also said he's noticed an increase in the number of direct-store delivery vendors who have begun routing their products through AWG's warehouses to cut their fuel costs.

"We believe there will be even more consolidation of DSD items as the high cost of fuel forces a reduction in the number of smaller trucks on the street," he said.

Rod Van Bebber, senior vice president, distribution, Unified Western Grocers, the Los Angeles-based member-owned cooperative, told SN the company has seen gas prices in the last week rise 14.5 cents in Southern California to $2.98 per gallon and 6 cents in Northern California to $3.04 per gallon. Unified for the past 18 months has used environmentally controlled diesel, which is more expensive, he noted.

"We burn in excess of 3 million gallons of fuel a year, so every penny increase in gas prices costs us $30,000 that must be passed on or taken off the bottom line," he said.

Unified has had a fuel surcharge based on cubic volume per order in place for several years, he said.

"As freight expenses from vendors increase, we pass those costs of goods to our members, and we assume they pass those increases on to the consumer," Van Bebber explained.

He said Unified might have to reconsider the surcharge if fuel prices continue to escalate.

"The idea of surcharges was they could be rolled back as fuel prices declined, but it's becoming more apparent that fuel will never return to its former levels, so distributors like us may have to adjust our base rates."

He said he expects Unified to continue to try to control costs by utilizing such measures as routing trucks more efficiently, eliminating unnecessary routes, reducing idling time or boosting spending to keep its equipment in better shape.

Smith of K-VA-T said he also looks for ways to cut expenses as fuel costs rise.

"We try to make sure a 53-foot truck has 53 feet of groceries in it, not 48, to maximize capacity," he said.

He also said he encourages stores to get by with four deliveries per week instead of five.

"We'd rather send out 1,500 cases on four trucks than 1,200 cases on five trucks, and between the logistics people and those at the store, we've seen some improvements," he said.

Some regional operators, including Stater Bros., Colton, Calif., and Giant Eagle, Pittsburgh, told SN they have not had to pass on fuel-cost increases to their customers yet.

PRODUCT INFLATION

Some retailers said they have started to see product-cost increases from manufacturers as higher fuel costs have driven up their expenses as well.

Last week the federal government reported that consumer prices rose 0.5% in July, including a 0.2% increase in food prices. Energy prices were up 3.8%, and prices for petroleum-based products were up 6.1%.

"Our costs of goods are increasing in direct proportion to fuel costs," said Phillips of AWG. "Here, too, we minimize the effect by procuring the product in vendors' largest weight brackets and lowest cost brackets."

Smith of K-VA-T said his company has been seeing cost increases of 20 cents to 30 cents per case for national-brand items and for store brands. He said the company can't always pass the cost increases on to consumers, although it usually tries to do so.

K-VA-T has also formed a task force of store and district managers and facilities personnel to develop best practices and reinforce conservation of plastic products, including plastic wraps used at the stores. The chain is also encouraging baggers to make better use of the space in each plastic bag when they're packing customers' groceries, Smith said.

Bob Hermanns, president and chief executive officer of Associated Grocers, Seattle, said fuel costs are continuing to push up the price of commodities like produce and meat, where product shipments are priced by the load. He's also seeing price increases from some manufacturers of dry products.

AG has a fuel surcharge that varies monthly, depending on fluctuations in the fuel situation, he said.

"The price of perishables is calculated into the price at which we ship goods, but if a branded manufacturer raises his costs, then that raises our costs, so while we're not increasing our charge, the cost of goods is going up," Hermanns explained.

Jack Brown, chairman, president and CEO of Stater Bros., said the company has been notified by some manufacturers that they may impose a fuel surcharge at some later point, "and if that happens, it will be reflected in the cost of goods." So far, however, he said the company has not had to raise retail prices.

POTENTIAL POSITIVES

Retailers and analysts said there are some potential positives for retailers in the rising costs of fuel, including their ability to lure customers with relatively low prices for gasoline at their own stores.

"Some of the retailers that are getting smart about marketing fuel are going to be able to attract those price-sensitive customers with discounts," said Whitmer of FTN Midwest Research. "The price sensitivity per gallon on gas is far greater than the sensitivity on milk or anything else in the store. If they can effectively market that and cross merchandise it within the stores, it's going to be a big opportunity for food retailers who operate a lot of fuel centers."

Frank Badillo, a senior economist with Retail Forward, Columbus, Ohio, noted that the impact of high fuel prices seems to be limited to low-income shoppers.

"I think it mostly affects those retailers that target those down-market consumers," he told SN. "At the same time, retailing is going to continue to benefit from job growth and growth in incomes, but I think you will see a lot of impact focused on retailers like Wal-Mart."

He noted that although consumer confidence has been strong and employment has been growing, job creation has been skewed toward the upper-income levels, and low-wage earners have been more hard-hit by job transfers overseas.

Fuel costs could stabilize in the fall, he added. "I see the pressures easing, and that should help in the coming months."

Some retailers aren't so sure, however.

"We do not expect gasoline prices to decline nearly as fast as they went up," said Phillips of AWG, "and we think the effect of high prices will continue to impact retail."