REINVENTING ALBERTSON'S

DAVID GHITELMAN

NEW YORK -- Trim and tanned and tie-less, Larry Johnston told the investment analysts gathered in an elegant meeting room at the Hotel Pierre here one morning last month, "Albertson's has been running on a fast track for the past 11 months."

Then, pointing to the image on the screen at the front of the room -- a time line displaying a dozen key dates since he had joined the Boise, Idaho-based retailer as chairman and chief executive officer on April 24, 2001 -- Johnston added, "In fact, when I look at this chart of what's happened over the past 11 months, I get tired."

Three hours and not a single coffee break later, his audience may have shared some of the CEO's weariness.

But they had also heard Johnston, along with select players from what he called his "unified team of energized associates," explain in often very specific detail how they had changed Albertson's from a company that sought to grow profits through relentless expansion into one that is now dedicated to growing profit by maximizing the return on existing assets.

In addition to Johnston, the marathon featured presentations by Peter Lynch, president and chief operating officer; Kevin Tripp, executive vice president, drug and general merchandise; Larry Stablein, executive vice president, merchandising and marketing; and Felicia Thornton, executive vice president and COO.

Albertson's had flown its entire executive council to the meeting, with the sole exception of John Sims, who had been named executive vice president and general counsel that morning.

Johnston outlined his management approach in these terms: "We're moving ahead using a new matrix, one that's relatively common in the financial community and progressive companies around the world.

"We're going to begin by growing through significant value creation, building new, exciting formats and business concepts. Next, we'll operate these businesses with world-class efficiency, customer service. Finally, we will constantly cleanse our portfolio, selling and exiting mature assets while simultaneously acquiring new and vibrant companies."

At the new Albertson's, the stress will be more on remodeling than opening new properties. In 2001, the company opened 80 food stores and remodeled 91. This year, it expects to open only 65 food stores but remodel as many as 182.

Johnston also laid out the reasons why the company had needed to change.

"When I joined Albertson's last April, I was pleasantly surprised by the sheer size and reputation of the company," he said, "but admittedly concerned to see that we were out of shape and lacking the energy needed to establish a strong growth momentum."

He described the new Albertson's he wants to create as "a unified team of energized associates who are obsessed with creating the world's No. 1 food-and-drug retailer in terms of market value, scale, profitability, customer service and associate satisfaction."

Many of the innovations highlighted at the session were programs the company has very publicly trumpeted in the last year, including store closings, market exits, loyalty program rollouts, online grocery expansion, new service additions and dual-branded, combo-store growth. (For more about dual-branded combos, see story on Page 26.)

Others, however, have taken place behind the scenes, largely invisible to customers -- deliberately so, Johnston and his fellow presenters noted -- but also possibly unseen by the investment communities in New York and Boston.

These changes, several of which involve the use of new-and-improved technology, include the shift from a profit-center model to a break-even model for distribution, better gathering and use of market intelligence, customer-focused store design, major reductions in administrative and management staff above the store level, and the use of management teams to drive costs out of a variety of operating areas.

Some of the ways Albertson's is looking to maximize its return-on-invest capital include:

Cleansing The Portfolio

Since Johnston's arrival, the company has conducted two purges of its store inventory. Starting last July, it has been closing 165 underperforming units. Then last month, Albertson's said it would sell or close its stores, about 95 units in all, in four major markets: Houston; Memphis, Tenn.; Nashville, Tenn.; and San Antonio.

In all of these closures and market exits, the company has looked beyond just individual store performance, Lynch explained.

"The new Albertson's real estate and capital strategy is different from the old approach," he said. "We used to look solely at individual store performance to make real estate decisions without full consideration of the long-term market needs."

Now, however, he noted, "We are looking at market share, store density, square footage, current growth potential and hundreds of other factors that make up the DNA of our business."

Breaking Down Organizational Barriers

Lynch observed that Albertson's used to operate its distribution system as a profit center, giving it an incentive to raise prices on the items it sold to the retail side of the company.

"It's easy to see how this could put our retail out of sync against competition, even in some cases cause us to lose our focus," he noted.

In contrast, he said, the company's change to break-even distribution has helped "break down barriers within our own organization to provide more transparency on customers to our retail business."

Reducing Costs

Albertson's goal is to create $500 million in annualized savings by mid-2003, Lynch said.

He explained that about $216 million of that will come from re-engineering processes to take out labor costs and make scalable improvements, $100 million from administrative and management staff reductions, and $59 million from restructuring activities.

Another $125 million will be cut, Lynch said, through having a series of management teams (each one chaired by a member of the company's executive council and named "bullet trains") attack a particular cost area, including advertising costs, energy management, employee benefits, construction and maintenance costs, distribution, accident reductions, telecommunications, and travel and living expenses.

The advertising bullet train was able to produce $40 million in savings last year, according to Lynch. This was done "by renegotiating print media contracts, consolidating pre-press processes, and bringing some functions in-house rather than using outside vendors," he said.

"Most importantly, this process will be invisible to our customers. It will not in any way affect the quality or reach of our ad program. The dollars we save, we pump back into additional advertising."

The distribution bullet train should "generate significant savings in 2002," according to Lynch.

"By fine-tuning our technology systems, we'll be able to increase our average truckload rates, which in turn will improve the stock efficiencies," he explained. "We also have many safety-awareness training programs designed to reduce turnover and the cost of workers' compensation plans."

Bringing Management Closer To Customers

Albertson's has been working to streamline its organization structure to eliminate the layers of middle management that used to come between top executives and customers, Lynch observed.

"In January 2001, in our first streamlining of operations, we eliminated our regional layer of management and downsized our division structure -- 34 divisions became 19," he said. "In the process, we changed some of the roles and responsibilities of our merchandisers and our sales and category managers. More authority, more accountability was given to our operators. They have responded by moving more quickly, and applying the specific data and information they have at their fingertips to meet the needs of our stores and, more important, the needs of our customers."

In July, when the company said it would close 165 stores, it reduced the number of divisions from 19 to 15, "further streamlining processes, eliminating redundancies, and achieving significant cost savings without negatively impacting our operating efficiencies," according to Lynch.

Now, with the four market closings announced last month, he added, the number of operating divisions will be reduced yet again, from 15 to 11.

Improving Customer Service

Lynch said the company's program to improve customer service (called "Service First, Second to None") is "not just a slogan but a primary operational focus."

At its heart, he explained, is a comprehensive audit program that measures customer satisfaction at Albertson's stores nationwide as well as at their competitors' stores.

"We benchmark against the data and use the results to focus our team on opportunity areas," Lynch said, "and we are pleased to report that our performance and service levels continue to improve and customer satisfaction levels are increasing steadily.

"Our Service First initiative began in March 2001, and our customer satisfaction levels rose from 80% in May to 85% at the end of the year."

Training, he noted, has been an important factor in bringing up service levels. "Programs we introduced include bilingual training, associate reward and recognition programs, mystery shoppers and checker bagger contests," Lynch said.

Among analysts, Albertson's got the most credit for closing stores and exiting markets. Gary Giblen, director of research and senior vice president, C L King Associates, New York, told SN, "I'm impressed. Albertson's is now proceeding to do the right thing" by exiting entire markets instead of only closing individual stores. "They've made the right choices. They're moving forward positively."

Andrew Wolf, equity analyst, BB&T Capital, Richmond, Va., said that Albertson's "getting out of those four markets is a major correction of the previous management's failed growth strategy."

He also said he endorsed the company's move to work on maximizing return-on-capital investment. "It's an appropriate change toward the Safeway playbook," he noted.

He added that the company has to "execute a catch-up" with the competition and "stabilize" its performance before it ramps up to the next level.

"The next iteration will be closer to a complete invention of the company," Wolf said. In that phase, he said he believes Albertson's "will attempt to sell things within the four walls of a supermarket that haven't been sold there before."

As for what those things could be (apparel, general merchandise, automobiles), Wolf wasn't guessing.

And Johnston and his team -- although they said much about the past, present and future of the company in what may have been the longest series of presentations about a single company ever in the supermarket industry -- were keeping that a closely guarded secret.

TWO BRANDS FOR THE PRICE OF ONE

In Albertson's efforts to maximize its return-on-investment capital, the dual-branded combo store is one of its principal and far-from-secret weapons.

According to Larry Stablein, Albertson's executive vice president, merchandising and marketing, the idea of a dual-branded combo store -- a supermarket and a drug store under a single roof -- occurred to Albertson's leadership shortly after the company acquired American Stores in 1999, a deal that put both a strong supermarket chain, Jewel, and a strong drug store franchise, under Albertson's management.

Albertson's decided to do more with this two-format expertise than simply put pharmacies in food stores or food aisles in drug stores, Stablein explained.

"Our ambition is to be the best food store and the best drug store, which is something quite different from being the best food-and-drug store," he said.

Albertson's goal, he noted, is to get pharmacy customers into a drug store under the same roof as a supermarket. Those customers spend an average of $330 annually on prescriptions, he added, and of their total drug store purchase, 29% comes from nonprescription, front-end products.

"In the mature, dual-branded combo market, [drug store customers make] 29% incremental purchases outside pharmacy; purchases are strongly weighted to food as well as the health and beauty care categories," Stablein said.

He noted that these pharmacy sales are not just cannibalizing Albertson's other drug stores. "Our customers in a mature market will shop both the dual-branded combos and the stand-alone drug stores," Stablein said.

The dual-branded option also gives Albertson's the ability to expand its drug store presence quickly in a market where it already has supermarkets. "We can convert 10 existing supermarkets to the dual-branded format for less money than the development of a single, solo drug store," he said.

While the concept is simple, the execution has not been a no-brainer, according to Stablein. "I was very involved in the Chicago market several years ago when we first brought the food and drug sides of our business together under common management and operating structure," he recalled. "When we did that, we made mistakes.

"In fact, some of the mistakes had the risk of compromising the independent brand equity of those two powerful brands. It took us years to perfect the model in that market place.

"The beautiful thing is that we're in the position to cut that learning curve as we extend [the format] to other markets."

The extension began in fourth-quarter 2001, with the introduction of the format in Reno, Nev., and Tucson, Ariz. Earlier this year, the first combo stores opened in Omaha, Neb., and more are scheduled to open soon in Phoenix.

Andrew Wolf, equity analyst, BB&T Capital, Richmond, Va., told SN "the odds are high" that one of the next places where the company is likely to roll out the format is Southern California.

"They have to defend Savon [Albertson's California drug store brand] against Walgreens, which is about to enter the Southern California market," he said. "With the dual-branded format, Albertson's can play defense and offense simultaneously."