SOUTH OF THE BORDER

R. MICHELLE BREYER

MONTERREY, Mexico -- In the shadow of the Chipinque Mountain, two hours south of the U.S. border, H.E. Butt Grocery Co. has embarked on one of its most ambitious ventures ever.

On Feb. 19, the San Antonio-based chain opened a 74,000-square-foot store in an upscale suburban area of Monterrey -- the first of what could be many Mexican stores for the company. An 80,000-square-foot store is scheduled to open nearby early next year, and officials are hunting for a third site in Monterrey, a city of more than 3 million people about 130 miles southwest of McAllen, Texas. H-E-B plans to open two stores a year in Mexico over the next few years.

Success in Texas doesn't guarantee success in Mexico, and Charles Butt, H-E-B's chairman and chief executive officer, knows it.

"We're rolling the dice," Butt said. "It hasn't been proven we'll be successful. It's a competitive market, getting more competitive."

H-E-B must adapt to different laws, take on new competitors, cultivate new suppliers and win over customers who have never heard the initials H-E-B.

The company has never shied away from new ideas, like installing gas pumps at its stores, and opening Central Market, which doesn't sell such staples as Coca-Cola and Kellogg's Corn Flakes.

Although H-E-B is one of the few U.S. grocery chains to go south of the border, it joins a growing roster of retailers, including Wal-Mart, Sears Roebuck & Co. and JCPenney.

"I really admire H-E-B's willingness to do well-thought-out experiments," said Howard Solganik, president of Solganik & Associates, a retail food-service consulting company in Dayton, Ohio. "So many other chains either do the same thing over and over, or follow somebody else's lead. They don't do original thinking like H-E-B has done."

The brightly colored store, named H-E-B Chipinque, is located in a new strip shopping center on busy Gomez Morin Manuel Avenue in San Pedro Garza Garcia.

"They have bagels. They have seafood. They have real bread," said Annette Lupo, an American working for a U.S. long-distance company in Monterrey. "They have every kind of hot pepper you've ever seen. This place will be an absolute hit."

Lupo recalled a recent visit to the store when it was impossible to move in the aisles because they were so crowded with shopping carts.

H-E-B Chipinque stocks 150 varieties of fresh bread, 140 types of cheese and 1,800 kinds of wine, beer and liquor. The cheese case at a nearby competitor had a limited selection, which included Kraft Singles.

The store stocks about 18,000 to 20,000 stockkeeping units, compared with the 30,000-plus SKUs stocked by H-E-B stores in Texas.

The store features one-hour photo processing, a Bancomer bank office, a pharmacy and a flower shop.

One corner of the store is dominated by a three-story, Discovery-Zone-style playscape. For 10 pesos -- less than $2 -- children are entertained while their parents shop. This feature is a first for H-E-B.

Several customers relaxed in chairs in the gourmet coffee bar, which had the feel of a Starbucks.

H-E-B borrowed many of the ideas for H-E-B Chipinque from its Texas stores. Its heavy emphasis on perishables originated at H-E-B's Central Market in Austin. The store sells 375 to 400 types of produce. Central Market's bakery manager, Edouard Damez, has spent the past few months in Monterrey teaching the bakers how to make European breads.

One popular U.S. supermarket trend is noticeably absent from the new store -- prepared foods. Other than pizzas and rotisserie chicken, few prepared food items can be found in the aisles of H-E-B Chipinque. In Mexico, it is customary to prepare food at home, Butt said.

"We don't want to go down there with a heavy Texas hand and say that's how we want to do things," Butt said. "We need to do a lot of listening to the management, partners and customers in Mexico about their expectations and ideas."

H-E-B Chipinque is the realization of a longtime dream for Butt, who began thinking about Mexican opportunities while finishing college at the University of Pennsylvania's Wharton School. He did his thesis on U.S. supermarkets in Mexico and spent the summer before graduation touring the country.

After college, Butt's time was monopolized by the company's explosive growth in Texas. The company has grown to 240 stores with revenues of more than $5 billion. It has left few areas of south, central and east Texas untouched and has ventured across the state line to Louisiana.

As the company expanded, Butt closely monitored business activity in Mexico, waiting for the right time. In the early 1990s, with Texas operations thriving, the company was in a good position to make the move.

Monterrey seemed an ideal location because it is relatively close to the Texas border and many of the customers at its stores in the Rio Grande Valley traveled from the city in northern Mexico to shop.

But it took five years to make the new store a reality. Butt enlisted the help of a consulting firm to study the market. Several formats were considered, ranging from the company's smaller Pantry stores to an upscale, full-service supermarket.

Although the company originally considered opening a smaller store in a less affluent neighborhood more representative of the demographics of Mexico -- only 20% of the country's residents earn more than $600 a month -- Butt eventually opted for the upscale concept in San Pedro Garza Garcia.

"We thought that was probably the safest initial effort," Butt said. "Eventually, we're anxious to serve the entire market there."

Despite years of preparation and study, nothing readied Butt and his company for the enormity of the undertaking. The administrative costs of starting up a new division in a new country have been high.

Several hundred H-E-B employees were sent to Mexico to train the staff, and the 370 employees at the Monterrey store also traveled to Texas for training.

"Because of the proximity of Texas to Mexico and our large Spanish-speaking population here, it's deceptive to think it's not a big leap to go across the border," Butt said. "But they have different ways of doing everything. You have to be prepared to start from scratch."

The Mexican market today is much different than it was when Butt, 58, was in college. Several good Mexican and international supermarket retailers entered the market during the 1970s, 1980s and 1990s, and more are on their way.

Soriana is a 92-year-old chain of grocery and discount department stores based in Monterrey with 58 stores in northern and central Mexico. The company has about 50% of the market in northern Mexico, a position H-E-B is used to holding in Texas.

Wal-Mart and Cifra have been involved in a joint venture since 1991, and the companies operate almost 20 Wal-Mart, Sam's Club and Aurrera stores in 12 cities, including Acapulco, Chihuahua, Ciudad Juarez, Mexico City and Monterrey. Cifra, Mexico's largest grocery retailer, also operates Cifra stores.

Grupo Gigante is one of Mexico's leading nationwide retailers, with 23 stores in Monterrey and several hundred across the country. Carrefour, the French supermarket firm with sales of $24.5 billion and 252 locations, will be coming to San Pedro Garza Garcia within a year in a joint venture with Grupo Gigante. Despite increased competition, Butt still believes Mexico is an underserved market with room for H-E-B.

Competition from other supermarket chains has been only one of the challenges faced by H-E-B. Two of the biggest hurdles have been finding land and working with new suppliers.

Butt said Mexicans consider land a valuable asset that is held for generations. For this reason, land costs two to three times what it would in Texas. Lack of available land has hindered the company's efforts to find satisfactory locations for new stores.

The company must adapt to a new distribution system that is dramatically different from the efficient, centralized U.S. system, which allows it to deliver groceries to its stores seven days a week, 24 hours a day.

In Mexico, the suppliers all deliver the merchandise directly to the stores. Getting 50,000 items into the store each day can be difficult, Butt said. About 85% of those products are purchased in Mexico and 15% are trucked in from the United States. H-E-B officials hope to increase the volume of U.S. products to 20%.

Difficulties in getting supplies resulted in shortages during the first weeks of operation, and some shelves were empty.

There are added costs of doing business in Mexico. Although the North American Free Trade Agreement has loosened restrictions on Mexican imports, 10% to 15% of the cost of bringing in products from Texas is the result of border and import fees, Butt said. H-E-B also must contend with a Mexican economy that has been anything but stable.

H-E-B Chipinque still is a work in progress, Butt said. The company will continue to tinker with its pricing and product mix and will work to develop relationships with new suppliers.

Based on early estimates -- not counting initial startup costs -- the store should be profitable within the first year, said Howard Butt, Charles Butt's nephew and the general manager of H-E-B's Mexican division. But it will take hard work, flexibility and patience.