MIDWESTERN MAINSTAY

ELLIOT ZWIEBACH

WEST DES MOINES, Iowa -- For Hy-Vee, the best of times is now.

"At 75 years, the company is stronger, more vibrant, faster-growing and healthier than it's ever been," Ron Pearson, chairman, told SN in an interview at the company's headquarters here. "Our assets are newer, our employees are more motivated, sales are growing faster and the bottom line is better.

"In today's retail supermarket world, a lot of people are not very healthy, but we truly are because we've targeted a variety of lifestyle needs and integrated them into our stores. We've been able to look ahead five to 10 years and figure out what customers will want, and as a profitable company, we've plowed money back to build those lifestyle approaches into our stores. And when you combine that with employee ownership and the autonomy our store personnel have, everything clicks.

"Autonomy and employee ownership are two of the biggest keys to our success and why we are growing at a rapid rate and having our best years right now. When the employees own the company, you try harder, you're more productive, you care more and you work toward success."

Ric Jurgens, president and chief executive officer, echoed Pearson's remarks. "Being employee-owned creates a dedication to the company that many other retail chains don't have," he told SN. "It's that autonomous involvement by employees that helps us grow the business, plus a willingness on our part to try to tailor stores to a wide array of customer needs."

Asked to explain how Hy-Vee has been able to survive for 75 years, Jurgens replied, "A company is not about formats and buildings. A company is not a thing. It's a collection of people working together to deliver goods, and that's what makes it successful.

"For 75 years, Hy-Vee has had the best people, and the people we have working with us today are the best we've ever had."

Hy-Vee operates 221 stores, encompassing 195 supermarkets and 26 drug stores in seven states. From its beginning in Beaconsfield, Iowa, in 1930, Hy-Vee has become a regional powerhouse -- moving into Missouri in 1933, Minnesota in 1969, South Dakota in 1975, Nebraska in 1977, Kansas in 1988 and Illinois in 1989 -- operating within a 400-mile radius of its headquarters here, in an area bigger than the state of Texas, Jurgens pointed out.

Sales for the year that ended Oct. 1 rose nearly 6.5% to $4.95 billion, compared with last year's $4.65 billion, Pearson said, and earnings climbed 4.8%, on top of last year's 5.6% increase and the prior year's 3.9%.

The Next 75 Years

With Hy-Vee's fortunes on an upswing, the executives said they see no reason why the company shouldn't continue moving in a positive direction. "We never think short-range," Jurgens said, "and we make every decision in hopes of celebrating our 150th anniversary."

As it moves into its second 75-year cycle, Hy-Vee's goals include:

Remaining privately held, with no intentions of going public or selling the company.

Continuing to invest in upgrading existing stores while expanding its base slowly and deliberately.

Seeking gradual expansion in several Midwest markets, with a long-term eye on Minneapolis and Chicago.

Private ownership has been an important element in Hy-Vee's success, Pearson said, giving it the freedom to do what it wants at the pace it wants to do it. "Never in our history did we say we had to get something done in a specific quarter to accommodate Wall Street. Instead, we look at our goals in five-year increments," he said.

"We prefer to limit the number of new stores we open each year so we can reinvest in existing stores," Jurgens said. "If we were a public company and announced to analysts we would be investing only a certain percentage of capital in new stores, we would be met with mixed reviews, but as a private company we don't have to worry about that. We just need to decide we want a strong market position for as long as we want to be in a given market, and that's enough.

"We focus on sales -- weekly, quarterly and annually -- and the market share takes care of itself, especially if we keep growing the business -- though with so much competition from alternative formats, it's harder to measure."

According to data from Metro Market Studies, Tucson, Ariz., Hy-Vee has the No. 1 market share in two of its major operating areas: here in Des Moines, where its share is 35.7%, compared with 20.7% for locally based Dahl's Foods; and in the Quad Cities area (Rock Island and Moline, Ill., and Davenport and Bettendorf, Iowa), with a share of 37.7%, compared with Wal-Mart Stores' 17.2%. It's No. 2 in Omaha, Neb., with a share of 17.8%, behind Kroger-owned Bakers' 28.1%; and tied for third in Kansas City, Kan., with Wal-Mart (supercenters and Neighborhood Markets) at 13%, running behind Ball's Food Stores, with 17.8%, and a group of independents owned by Associated Wholesale Grocers, with 15.6%.

Staunchly Independent

Given Hy-Vee's history of success, Pearson told SN it's unlikely the company will ever consider giving up the autonomy its management and employees enjoy by selling the chain. In fact, prospective buyers have stopped asking, he noted.

"We haven't had any buyout offers for years," he said. "We got a few when a lot of mergers were going on in the late 1990s, but anyone who has had the ability in size to buy us has already made a pass at us, and the answer was always, 'Absolutely not."'

"Everyone in the industry knows Ron," Jurgens added, "and they know our pre-disposition to remain private."

"From a financial standpoint, Ric and I could make a lot of money if we sold," Pearson said, "but it would be like turning on all our people. We have a unique system of sharing ownership and store autonomy that would all be lost if the company were sold, and we're not interested in doing that.

"Besides, we don't have to sell because we're more successful than anyone who could buy us."

Hy-Vee is 100% employee-owned by officers, staff members and store directors, along with approximately 22,000 employees (47% of the chain's total), who collectively own a 15% stake in the company's profit-sharing plan.

That's been the essence of the Hy-Vee culture since the beginning, Pearson pointed out. "As long as an employee is active with Hy-Vee, he has an opportunity to share in the profits of the company. But it's not an employee stock ownership plan. In an ESOP, the value of the company is appraised each year by an outside expert, whereas we structure our employee ownership through a trust, which is held at book value at the end of each year, and that's the value of the stock.

"The book value has gone up every year for 75 years. In 2004 the stock was valued at $565 million, with $1.4 billion worth of assets."

Pearson said he believes Hy-Vee is the most autonomous company operating in the United States. "Making decisions at levels closest to the customer is not only a privilege but also a responsibility, and we think the system has attracted special employees who have perpetuated the system," he said.

Personal service in the stores has enabled Hy-Vee to operate some of the biggest volume stores in the U.S., he added, "because we've set out to establish experts in each department -- individuals who become the consumers' personal experts and who are dedicated to building a relationship with each customer, even though we have thousands of customers. Our people will do anything for the customer, which is the difference between us and some competitors.

"That's where employee ownership comes into play. When you own part of the business, your future depends on satisfying every customer who walks in," Pearson said.

Steady Growth

Hy-Vee is in no hurry to grow its store base.

Expansion will come gradually, Pearson said -- at a rate of about five to 10 stores a year, including new and remodeled or relocated units, at an annual investment rate of 3% to 4% of sales, "which is higher than the industry average," he pointed out.

In the fiscal year that just ended, the company spent $220 million to open four new stores and remodel or relocate eight others -- the same number of new and upgraded stores as in 2004. Pearson said capital plans for next year encompass five new stores and nine upgrades at a cost of $280 million.

"We could open more new stores a year than we do," Jurgens said, "but we're investing some of that capital for other uses -- for gas stations, expanded wine and spirit sections, upgrading front-end systems and upgrading our offerings in produce, frozen and dairy."

Asked whether Hy-Vee is considering a move into any new geographies, Jurgens said, "There's still room to expand within our current operating areas and to finger out from there a bit."

Pearson said "fingering out" could ultimately move Hy-Vee into Minneapolis or Chicago. "We're not looking at any sites in either city right now, though we have stores within 20 miles of the suburbs of each of those cities," he said. "But there's still a lot of territory in the Midwest where we'd like to operate more stores, including Omaha and Lincoln, Neb.; Kansas City, Mo.; and the Quad Cities on the southeast edge of Iowa and the northwest edge of Illinois."

Store growth is unlikely to come through acquisitions, the executives said. Although Hy-Vee has made small acquisitions over the years, it prefers to build its own stores, Jurgens said. "It's easier to do it our way. But if we do buy a store or a chain, it's usually because we want a site, not a group of stores."

"Moving slowly has worked very well for us," Pearson added. "When we entered Kansas City in 1985, for example, we bought two buildings -- a market owned by an independent and a site on which he had started to build -- and grew from there. Building our own stores gives us the kind of store we want."

The kind of store Hy-Vee wants runs to about 78,000 square feet. "We've been opening what we call our '21st century lifestyle stores' since the early 1990s," Pearson said, "with larger perishables departments; on-site nutritionists and pharmacy consultants; a drop-off laundry service; postal services; banking; expanded video; restaurants; cooking demonstrations; expanded florals; plus a more visually impactful exterior."

The stores have also been adding HealthMarkets -- sections featuring an assortment of natural and organic products, specialty foods and neutraceuticals -- that have grown from between 1,200 and 1,500 square feet to about 2,000 square feet, "which we are continuing to expand each year," Jurgens said.

The HealthMarkets occupy space near the front of the store or, in some cases, in their own alcove. "Rather than integrating them into the gondola aisles, we wanted to keep those items separate so customers could find them easily and so they can be located near the pharmacies," Pearson said.

"As we've expanded those sections, we've slowed down the item growth somewhat because so many natural products have developed a broader reach and are becoming more mainstream," Jurgens added.

Hy-Vee is also enthusiastic about the expansion of its wine and spirits offerings -- to approximately 3,000 stockkeeping units per store, and growing. The sections are located at 53 stores, usually set off to one side with a separate entrance as well as access from inside the store, Pearson said. The company also has 15 freestanding wine shops.

One area Hy-Vee hopes to improve is its online service offerings. "With the staff nutritionists and the growing concern with personal health, we've challenged ourselves to improve our online services to customers," Pearson explained.

Hy-Vee has incorporated Starbucks into 15 stores. "Starbucks was an instant success for us," Pearson said.

Competing With Supercenters

Hy-Vee competes with approximately 95 Wal-Mart Supercenters and 15 SuperTargets, as well as price-impact operators like Aldi and Save-A-Lot, in virtually all markets. In-store pricing is a modified high-low approach, with some elements of everyday-low-pricing, "because of all the supercenters that have opened around us in the last six years," Jurgens said -- "though we still run specials and promotions."

The chain is unlikely to get involved with loyalty cards. "We tested them at 30 stores in the mid-1990s and found they did not offer any growth opportunities," Pearson said. Hy-Vee completed the conversion of its 26 drug stores from the Drug Town banner to the Hy-Vee Drugstore banner in late September. "Drug Town was a division we started in 1969, when we didn't have pharmacies in our food stores, so we created the name to give those stores a separate identity," Jurgens said. "Customers were not always aware of the connection, although the drug stores carry Hy-Vee private-label items.

"But now, with pharmacies at virtually all stores, it's important that customers understand we have their information and the same products available at both formats so they can go to the drug store pharmacies or the pharmacies in the Hy-Vee stores for the same immediate recognition."

In contrast to its tenet about not acquiring supermarkets, Hy-Vee is interested in buying drug stores "to get the prescription files," Jurgens said.

Hy-Vee operates a full-service distribution center of 1.5 million square feet in Chariton, Iowa; a 500,000-square-foot facility in Cherokee, Iowa, that carries all categories except produce; a 375,000-square-foot perishables facility in Des Moines; and a 150,000-square-foot specialty foods facility in West Des Moines. The company also operates five small floral warehouses in Des Moines; Omaha, Neb.; Kansas City, Mo.; Columbus, Mo.; and Davenport, Iowa.

Pearson, 64, joined Hy-Vee in 1960, while he was still in college, and has been president since 1983; he added the titles of chairman and CEO in 1989 when Dwight Vredenburg, the son of the one of the chain's co-founders, retired. Jurgens, 56, joined the company in 1969; Pearson turned over the titles of president and CEO to him in 2003.

"In fact, since the company was incorporated in 1938, we've had only three CEOs -- Dwight Vredenburg, myself and Ric," Pearson noted, "which is a testament to continuity at Hy-Vee."

Hy-Vee's Philosophy

WEST DES MOINES, Iowa -- Hy-Vee Food Stores here was built on a set of cultural values developed nearly 75 years ago that continue to set the tone for the way the company conducts itself today.

Ron Pearson, chairman, spelled out those values in a booklet he wrote five years ago, based in the principles of Dwight Vredenburg, the son of one of the chain's two founders and the guiding force at Hy-Vee for 51 years. "As Dwight was getting older, I wanted to capture his great philosophy, most of which was not written down," Pearson told SN.

Ric Jurgens, president and chief executive officer, said, "The book is based on notes Ron took over the years listening to numerous speeches Dwight gave, and it's a continuum of 75 years of preaching the same message."

According to the book, Hy-Vee fundamentals include the following:

A commitment to friendliness and "a helpful smile in every aisle."

Hiring people who really care about customers and who find ways to make their trip more pleasurable, fun and exciting.

Sincerity, "[so] our customers know what we say is what we do."

Respect for the differences and for the wants and desires of all customers.

A morality that calls for employees to "do what is right at every turn [and to] never uphold less than the finest caliber language, behavior or standards."

A dedication to providing the best customer service.

A sense of fairness so that every decision is based on what is most fair to all involved.

Politeness and good manners at all times.

The utmost dignity in treating customers and employees.

Employee ownership so "all Hy-Vee growth accrues to the employee/owners. That's why we work hard to help the company improve and grow."

"All our people believe in our culture, and they protect it by teaching it to new employees to make sure it survives," Jurgens said.

"Everyone buys into the philosophy of caring for customers and treating them with courtesy -- that's universal at all stores. Employees really want to take care of customers, and they share an attitude of friendliness and dedication -- they think alike.

"And there's a strong sense of independence within a strong corporate culture at Hy-Vee. That doesn't mean employees are a loose bunch of mavericks doing what they want. What they are is a dedicated group of people bound by a culture and by a central source of financing and supply that is critical to enabling autonomy at store level."

ELLIOT ZWIEBACH