SOUP TO NUTS

LUCIA MOSES

For Nice N Easy Grocery Shoppes in upstate New York, life has been anything but.

Pressured by competition for gas and cigarettes, the 83-store convenience chain has looked for ways to squeeze more profit out of other products it sells. In the Center Store, that meant identifying and tossing items like tinned meats, canned soup and cake mixes that didn't matter to the typical customer who's craving staples and snacks.

"We just believe we've got to be much more in touch with the customer out there," said Fran Duskiewicz, senior executive vice president of the retailer.

Now, when Nice N Easy opens new stores, it carries half as many grocery stockkeeping units as older stores do, in the same 12 feet of shelf space. It stocks only fast-turning items like cereal, coffee and paper towels, all in the most popular sizes.

Nice N Easy is unusual for a convenience store in that it depends little on cigarettes and gas revenue. But the assortment exercise it's undergoing is typical of the industry today. Squeezed by spikes in gas prices, declining cigarette use, growth of value retailing and an increase in channels selling gas and convenience items, c-stores are re-evaluating how they can best serve customers' demand for convenience while competing on price. As part of this re-evaluation, some operators are narrowing their price gaps with supermarkets.

Consider:

Because of gas competition, the percentage of people making a weekly trip to a c-store declined in 2005 vs. 2004. More than one-fourth (26%) of shoppers bought gas at alternate formats in 2005, up from 8% in 2000, according to Retail Forward.

Other, nonfood retailers from Staples to Sears are adding convenience foods. Home Depot is

opening four c-stores in the Nashville area, and the company said it could open as many as 300 in the next five years. At the same time, c-stores' higher-income shoppers are migrating to club stores, according to ACNielsen.

High gas prices have left customers with less pocket change to spend in the store. In-store purchases per customer declined 3.3% in 2004, according to a survey by the National Association of Convenience Stores. Meanwhile, the industry's motor fuel margins declined from 8.8% in 2003 to 7.2% in 2004 - their lowest level since 1984, according to NACS.

"Because of the channel-blurring that's happening with supermarkets sticking gas stations in their parking lot and Home Depots sticking convenience items in their stores, the premium for convenience is kind of disappearing," said Tim Cote, vice president of marketing for Plaid Pantry, a 103-store chain in Beaverton, Ore. "The customer won't let us charge a premium to grocery or the drug channel any longer."

Some of their problems are of their own making. C-stores, with their dependence on cigarettes, greasy hot dogs and snack cakes, are out of step in this day of health and wellness and have a poor image with female consumers, who as a result are the dominant shopper in every channel but convenience.

"They're at a real turning point," said Todd Hale, senior vice president of consumer and shopper insights at ACNielsen. "They've got to make themselves into something new, different and improved. Gas has to be a less important driver for them."

Pumping up the fresh and prepared foods is the most visible trend in the channel today. The urban 7-Eleven stores in New York City's Manhattan are doing 20% to 30% of their sales in fresh foods, former chief executive Jim Keyes said recently. In the Chicago area, White Hen Pantry touts its artisan breads and custom-made sandwiches.

To make room for larger hot food operations, retailers are taking a cold look at their Center Store assortments. That has meant, variously, increasing SKUs in some categories and slashing them in others, paring some categories down to a store brand and a national brand, and exiting others altogether.

"I think convenience stores are increasingly looking at not having any wasted space," said Jeff Lenard, communications director for NACS.

The results of this process vary, depending on the retailer's objectives. Some retailers have focused on ready-to-eat items, leading them to replace pints and gallons of ice cream with impulse, high-margin and immediate-consumption items, said David Bishop, director of the Willard Bishop consulting firm. "Today, the largest package size you'll see is not pints but a larger variety of novelties on a stick," he said.

Nice N Easy, on the other hand, expanded its freezer space to accommodate more home-meal replacements with the fill-in grocery shopper in mind. A point of pride in the new stores is a gondola-length, open-top freezer that Duskiewicz said has "every frozen item you can think of in there."

Plaid Pantry has rationalized all its Center Store categories. Despite their vast difference in box size, the chain views Wal-Mart Stores as its competition, aware that the retail giant sets the pricing standard for all others to follow, including drug store chain Walgreens, whose stores are closer in size and role to Plaid Pantry. Plaid Pantry has thus adopted the stance that if it can't offer shoppers competitive prices on core SKUs, it will scale the category down to nearly nothing.

"If I'm too far from Wal-Mart's price, they're going to know I'm gouging them," Cote said.

As a result, Cote has walked away from health and beauty care products and dinner items like ketchup and canned green beans. It's hard to get manufacturer support for those items when sales volume is so slow, and the chain's customers, predominantly a morning and afternoon crowd, don't want them anyway.

Instead, Plaid Pantry has upped its focus on key categories like beer, breakfast cereal, soda and smokes.

By negotiating directly with the manufacturers, Plaid Pantry gets good deals on cereal, which it merchandises prominently with off-shelf displays. Cote gets prices at or below grocery stores' prices by accepting a 10% to 15% margin rather than the usual c-store margin of 30% to 40%. Another category he found he could match supermarket prices in was wine, so he expanded his assortment from five to 130 SKUs.

"If you'll make an honest commitment to being competitive with the grocery or mass channel, these guys will help you," he said of manufacturers. "If you can move cases, they've got the money for you."

Plaid Pantry makes up for lower margins in grocery by getting more customers through the doors. Cote believes the strategy is working, citing a more than 6% growth in inside store sales in 2005.

The use of price optimization software by leading retailers like 7-Eleven, Sheetz and BP is further evidence of the channel's growing acceptance that it must get more competitive on price. But while c-stores lag other channels in technology adoption, the concept of price optimization isn't new to them, Bishop said.

"Probably the first place where optimization started was the gas pump," he said. "Convenience stores sell gas, so they have some inherent capabilities built into the system."

At the same time that they're seeking to get leaner on price, c-stores are trying to make themselves destinations by emphasizing new and proprietary products, often in the highly profitable beverage category.

Plaid Pantry knew it could never compete with supermarkets' prices for multipacks of soda, so it focuses on variety in single-serve, where a customer can choose from among 220 to 250 selections. In beer, the retailer has tailored its assortments to suit neighborhood tastes, resulting in 62 different sets for its 103 stores.

At 7-Eleven, the biggest c-store chain, stores have launched proprietary wine, bottled water and sports drinks while encouraging manufacturers to test new products in its stores.

"We're just trying to focus on new items, and items that are successful, give them more visibility," said Tariq Khan, who owns five 7-Elevens and is national chairman for the National Coalition of the Association of 7-Eleven Franchisees. "If I'm selling Red Bull in my store, I don't want to give them just two facings. I give them the whole shelf."

Differentiation may take other forms in the future, if convenience stores accelerate efforts to appeal to varied customer groups through more upscale formats, urban locations and private-label programs.

Yet even though some c-stores are exiting various Center Store categories, they could emerge as tougher competitors for convenience and fill-in trips, especially as they push further into prepared foods and electronics accessories, Bishop said.

Meanwhile, more sophisticated pricing could prevent supermarkets from picking up sales that c-stores previously would have lost because their prices were too high, he said.

Willard Bishop predicted c-stores' share of grocery and consumables sales would increase to 16.3% in 2013 from 16% last year as the channel plays an increasingly complementary role to large stores and focuses on in-store sales opportunities, including food service, to make up for the decline in fuel margins.

"Their business model is very much in a state of flux," firm President Bill Bishop said.

With barely more than around 3,000 SKUs on average, c-stores, if anything, are motivated by the knowledge that they have little margin for error. As Duskiewicz is well aware, Nice N Easy can't carry the variety in its 3,200-square-foot stores that supermarkets can. "They have a lot more leeway to make a mistake," he said. That's a luxury he and others don't enjoy.

Revenue Sources

Cigarettes remain a big revenue source, but it's food and drink that make the real profits for c-stores.

Category: % of total 2004 sales*; gross margin %, 2004

Cigarettes: 37.7; 18.0

Beer**: 9.6; 19.7

Packaged Beverages: 10.1; 35.0

Candy: 2.7; 43.7

Snacks: 4.5; 33.3

All other merchandise: 19.9; 31.7

* In-store sales for 462-store sample

** Includes stores that don't sell beer

Source: 2005 NACS State of the Industry Survey Data