SAFEWAY'S LIFESTYLE STORES

Elliot Zwiebach

PLEASANTON, Calif. -- Safeway here is putting all its eggs and everything else in the store into one basket -- its "lifestyle" store format.

The company said it expects to have 25% of its store base, or 450 stores, operating with the lifestyle format by the end of the year, compared with 142 stores, or 8%, at the end of 2004.

Safeway's goal is for 86% of its stores to operate with the new format by 2008.

All new and remodeled Safeways are intended to be lifestyle stores -- a concept that uses perishables as a point of differentiation to drive top-line sales and improve margins. The goal, industry sources told SN, is to boost sales by as much as 15% to 20% and raise gross margins by 1%.

Steve Burd, chairman, president and chief executive officer, has said previously the lifestyle format is "an opportunity to reinvent the business" by creating a quality image as well as an improved environment for produce, meat, delicatessen, bakery, prepared foods and floral departments that offers the right product selection, though not necessarily more selection.

Safeway decided to pursue the lifestyle stores strategy, Burd said, "to make this a game that is about more than price. It's about the quality of the shopping environment, it's about the service delivered by our employees and it's about the unique proprietary products that are carried only by us.

"Price is always going to be in the game, and our strategy is to be priced with the conventional guys, but with better quality products and a better shopping experience."

Remodeled stores put produce at the front and center, including expanded natural and organic selections; behind produce is a square service counter featuring prepared foods, delicatessen and baked goods, with meat and seafood on the rear wall, floral in the front left corner and pharmacy in the front on the right. The stores also include unique merchandising fixtures and a variety of island displays with specialty items.

Burd said in February stores that have been remodeled to the lifestyle format are delivering returns 23% greater than what remodeled Safeway stores with similar investments have delivered, "and most of us believe we can do better than a 23% improvement," he added.

He also said Safeway believes the format, with some adjustments, can be successful in any neighborhood, regardless of income level. "While the contents of the store really need to be adjusted to the demographics, we think everybody wants quality perishables, everybody wants a good meal experience and everybody wants a comfortable environment. So I think you accent different aspects, depending on the demographics.

"It's our current belief, based on testing across multiple income levels, that it can work in multiple markets."

Analysts and others contacted by SN had mixed opinions about the prospects for Safeway's lifestyle stores, praising the concept and execution but questioning the wisdom of proceeding with a single-format strategy.

Jonathan Ziegler, Santa Barbara, Calif.-based analyst with J.M. Dutton & Associates, El Dorado Hills, Calif., told SN the potential return on invested capital through margin pickups should make Safeway's shift to the lifestyle stores a positive move.

"This format is a powerful tool to reinforce loyalty and to attract new customers," Ziegler explained. "It improves the productivity of working capital because it shifts more sales to fresh so inventory turns faster, and it improves margins because perishables have higher margins. And if you can turn products quicker, there's less shrink so margins improve, and that should mitigate the impact of promotions and changing prices on the product mix."

The lifestyle stores also allow Safeway to differentiate itself from competitors "and to make its stores rise above price as the only vehicle for driving sales," Ziegler said.

He said the lifestyle format represents a cross fertilization between Safeway and the companies it's acquired over the last few years -- Dominick's, Randalls and Genuardi's -- "each of which was more upscale in its approach when it was independently owned," he noted.

Another factor motivating the format shift, Ziegler added, "is that Safeway sees how successful Whole Foods is, and it wants to move in that direction. It anticipates a degree of success by changing the way it merchandises, so rather than trying to beat competitors on price, it will try to beat them on merchandising.

"That plays to Safeway's strength, which is merchandising, and it knows staking its reputation on quality perishables builds more loyalty and more repeat visits."

On the other hand, although the lifestyle format is easy to manage and potentially cost-effective, "it doesn't play into the granularity of the market it's servicing," Ziegler said. "It will work in different demographics, but it might have been preferable for Safeway to retain a format like Pak 'n Save, its old warehouse format, to service different segments of the market.

"By not giving a downscale format like that a chance, Safeway has eliminated an important logistical and pricing advantage that a store like Pak 'n Save offered -- including more labor savings, more limited stockkeeping units and an everyday-low-pricing formula -- and overlooked an opportunity to approach different markets differently."

The switch to the lifestyle format requires no structural changes, Ziegler pointed out, but does involve equipment changes, with installation of more European-style cases to show off products better. "There may also be some costs involved in training store personnel to have more of a food-service orientation and to keep perishables properly rotated," he said.

Bob Gorland, vice president in the Harrisburg, Pa., office of Matthew P. Casey & Associates, Clark, N.J., said the product mix at the lifestyle stores is the key to their success. "Safeway isn't changing its pricing -- the stores may add salad bars, specialty foods and more organic and natural foods, but they will still feature sale items on endcaps -- so it's not a radical departure from what it was doing before," he told SN.

"But it's looking for more gross profit with these stores. If it had a 30% gross, it's looking to get 30.5% or 31% out of its lifestyle remodels, given the emphasis on perishables merchandising. These changes are not just for ambience but also to boost sales by taking dollars from specialty operators like Whole Foods or Trader Joe's and enhancing the mix to help profits. Safeway wants to attract additional upscale customers and improve not only the mix but also the amount of sales per transaction.

"If a store is doing $350,000 a week and Safeway spends $1 million to upgrade it to the lifestyle format, it probably wants to see a sales increase of at least 5%. If it spends $3 million to $5 million on a major remodel, including new equipment, it would probably want to see a 15% to 20% gain, and with a new store that costs $10 million, it would hope for a 50% increase."

On a category basis, Gorland said enhancements in certain fresh departments can result in margin increases of 0.5% to 1% with the same pricing and a better mix. "If grosses are running 10% in produce and they go to 10.5% or 10.8%, that gives the store a better overall gross and a better mix within the store for a better profit performance," he said.

Gorland said some of Safeway's effort to upgrade its stores "may be a defensive move against incoming competition and future sales impacts by trying to limit sales and market-share losses against competition."

Gary Giblen, senior vice president and director of research for C L King Associates, New York, echoed that opinion. "It sounds like a wonderful new idea, but it's really a retreat to a more defensive positioning," he explained. "Safeway hasn't succeeded in getting labor costs in line, so it's retreating to an upscale format to have a point of differentiation.

"But that's probably the best strategy for Safeway, since it's fighting a battle on costs in which it's inherently at a disadvantage. To be very competitive on price requires low costs, and there's no way Safeway can be a low-cost operator because of its labor contracts."

Asked if the lifestyle format will fulfill Safeway's goals for it, Giblen said, "I give the company credit for putting its finger in the dike. It had to go upscale, but that doesn't really alter the downward pressure on its business, and these lifestyle stores aren't a total solution.

"Safeway is at a disadvantage with Whole Foods because Whole Foods can afford more labor, and Whole Foods has more credibility on the fresh and natural side. But Whole Foods is less ubiquitous than price operators like Wal-Mart or Costco, and there's no way Safeway can compete with those companies on price.

"Whole Foods serves fewer areas than Safeway, so Safeway's lifestyle approach will work better where Whole Foods or similar specialty stores are less prevalent. In those cases, Safeway can seize that positioning, at least until someone else gets to a given market."

For the lifestyle stores to be deemed a success, they must earn more than the cost of capital invested, "and that won't be easy," Giblen said.

In locations where Safeway opens a lifestyle store without similar competition, it should be able to get a good return "until the competition comes in," Giblen said. "I think Wall Street would be tickled pink if it got an 11% return on capital over several years, combined with a 15% increase in sales.

"But where it opens a store more as a defensive move to prevent sales erosion, I doubt Safeway will be able to get 15% if you blend results from all stores. If two-thirds of its stores are defensive and they get a 2% sales lift and the other third gets a 20% lift, then the blended result of probably 6% would be considered good, though Wall Street will be looking for a blended sales lift of 10% to 15%.

"It's also true that Safeway is putting a lot of investment into these stores up front, with the hope that volume and margin pick up to pay off. But moving in that direction largely as a defensive strategy means sales are likely to slow even further. And if Safeway doesn't get a big lift, then it's just losing less sales with these stores."