THE CANADIAN ALTERNATIVES

DAVID KOSUB

There's a saying north of the 49th parallel that if something becomes popular in California, give it five years and it will be popular here, too.

From cars and movies to hula hoops and grunge music, Canadians historically have let their cousins to the south try out new ideas before embracing those ideas themselves. Americans set the pace, most Canadians believe. Canada? Well, sometimes Canada is just a little slow on the uptake.

Sometimes, but not always. Consider the food business, or more particularly, the growing phenomenon of the alternative supermarket format. It wasn't U.S. retailers that discovered the bloom was off the rose of the conventional supermarket 20 years ago, said Perry Caicco, equity analyst, CIBC World Markets, Toronto. Europeans made the conversion from conventional to alternative formats first, quickly followed by the Canadians, and then the United States, Caicco noted.

"The U.S. assets are still very much levered to classic, traditional, conventional stores. But like everything else in the supermarket industry, you look at Europe and you say in five years it'll happen in Canada, and 10 to 15 years later it'll happen in the U.S."

Even that's not quite accurate, however. Consider the small Canadian prairie city of Saskatoon as far back as 1979. That was the year the first Real Canadian SuperStore opened its doors, a 75,000-square-foot ancestor to the mammoth supercenters that now grace most of western Canada, Ontario and the Atlantic provinces. Since then, supercenters, along with discount stores and so-called "fresh boxes," have gobbled up an increasingly larger share of the Canadian food dollar from classic, conventional supermarkets.

Caicco said 55% of Canadian supermarket assets are still comprised of the conventional supermarket format. Yet in the United States, it's even higher. The evolution from conventional format (i.e., perimeter department full of perishables and center store full of groceries, with generally high prices except on flier days) to alternative formats is accelerating in Canada. In fact, Caicco predicted that by 2010, less than 35% of Canadian grocery sales will be rolling through conventional supermarkets.

"It's a conversion process," he said. "You look at the assets that are there now [and] ask, 'How tired are these?' And you decide what other format to put into it. Sometimes it's a discount store, sometimes it's an expansion to a superstore, [and] sometimes it's an evolution to a fresh store. But it has to be one of those."

Bill Chisholm, an equity analyst with Dundee Securities, Toronto, agreed, though he's particularly fascinated by the growth of the discount format in Canada since the late 1970s. The catalyst for growth on the discount side, he said, was high operating costs, especially for labor.

"Unionized labor was very strong in the supermarket business then, and a lot of locations became uneconomic," he said. "What the supermarkets did was start to recycle some of their real estate."

Chisholm and Caicco pointed to Loblaw as the best example of real-estate recycling -- notably its conversion of older, conventional Loblaw stores to No Frills stores, a bare-bones discount operation that quickly became franchised and now runs at a much lower labor cost.

What Loblaw and others quickly realized is that battle lines were largely being drawn by consumers who indicated early on their preference for price over service, sometimes even quality.

"Some consumers are willing to trade off," said Kim McKinnon, vice president of the Canadian Council of Grocery Distributors, Montreal, Quebec. Retailers have responded, she added, by creating "a retail environment that suits the neighborhood, or what the consumer wants to buy there."

Consumers have shown a remarkable willingness to pull items from metal shelves in store environments with a warehouse ambience, stand in long lines, and pack their own items using their own recycled shopping bags.

Yet an even easier consensus in Canada is that the emergence of the supercenter coupled with the discount format (e.g., Loblaw's Real Canadian SuperStore or RCSS) has provided the single best defense against encroachment by price-focused multi-nationals like Wal-Mart Stores and Costco. These multi-nationals, Caicco reminded us, are not alternative formats, but rather alternative grocers -- companies whose core business has not been groceries, but who nonetheless "are rapidly rushing into the game" because they see an opportunity to exploit their cost base and, sometimes, their convenience base.

"Alternative grocers run their own format. What they try to do is do a better and better job on groceries inside the formats that they operate," Caicco said.

The signal that Real Canadian SuperStore may have at last come into its own in Ontario is Loblaw's decision to rebanner RCSS and remove the Loblaw and Zehrs names, allowing the company to differentiate RCSS from the conventional stores with separate ads and its own pricing structure. This was prompted in part by the impact of sales at eight new RCSS stores on Loblaw's and Zehrs' conventional stores and by a desire to cut into competitors' market share.

In Quebec, meanwhile, Loblaw found itself in trouble because of the 12 85,000-square-foot stores it purchased from Provigo that, according to Caicco, had done a poor job with food and general merchandise. Loblaw quickly ditched the general merchandise component and operated the stores as extra-large, but very inefficient, operations. The solution: Convert nine of these units into "unique Quebec superstore operations" under the Maxi & Co. banner. These are stripped-down versions of RCSS, with most categories retained, except for adult clothing, and with half the floor space devoted to low-priced general merchandise.

Convenience, size and price have given way only slightly to the fresh box as an alternative format. The formula is fairly straightforward: Cut a conventional store in half, and devote one-half to perishables so that at least 50% of sales comes from the big five: produce, deli, bakery, meat and seafood.

"You have relatively lower prices on the groceries, and you make all your difference on the perishables, and you do those better than anyone else," said Caicco. "We've seen a number of people convert a conventional format to a fresh-box format quite successfully in Canada."

Among these are Metro and IGA in Quebec, Sobeys in Ontario and in western Canada, Save-on and several independents. Further south, Caicco pointed to U.S.-based fresh boxes that are doing equally well, such as Wegmans and even Whole Foods, normally considered an organic/natural store. "They're high priced, and the organic is sort of interesting, I suppose. But what they really are is great fresh stores," Caicco explained. One theory why alternative formats have been slower to take off in the United States than in Europe or Canada is that traditional grocery stores in the United States are still controlled by consumer packaged goods companies through vendor allowances and supplier rebates. This has become a larger and larger part of the operating income of classic U.S. grocery companies, said Caicco.

"So if you make a decision to reduce the amount of space that you're giving to the people that are giving you all those rebates and to give it to other products that don't carry those rebates...you're taking a financial risk. It's a risk that Europeans took many years ago, the Canadians took many years ago, and that we're only just beginning to see take hold in the States."

How Canadian Formats Compare

Supercenters, fresh stores and discounters are fast becoming the destination of choice for many Canadian shoppers. While conventional supermarkets represent 55% of the Canadian food formats today that percentage is expected to shrink to 35% by 2010.

Parameters: Supercenter; Fresh Box; Discount; Conventional Supermarket

Size: 85K-225K; 25K-45K; 15K-40K; 25K-65K

Price Index: 85 cents; $1; 80 cents; $1

Labor %: 8.5%; 12%; 8%; 12%

EDLP Ratio: 30%-35%; 10%-15%; 90%; 5%

Avg. Order: $75; $25; $15; $30

Perishables Ratio: 35%; 50%; 40%; 25%

GM/HBC Ratio: 25%; 5%; 5%; 3%

Source: Company reports and CIBC WorldMarkets.