TREND WATCH 2000 1996-04-29 (2)

News & Solutions Special Report

re of the supermarket industry is that it will look a lot different than the present.

That's the easy part. The real issue is how each component of change will add up to give shape to the future.

In some ways the future is becoming more and more distinct as key directions and trends surface and lend themselves to critical analysis. What are these trends

that together suggest how the industry will look at the turn of the century and beyond? To many observers, they are: consumer abilities and confidence; the change in ways consumers will source packaged goods and finished means, including by way of supercenters; economic concentration in the supermarket and other retailing industries; direct-to-consumer selling by manufacturers, and electronic selling.

Management Horizons, the consulting division of Price Waterhouse, took a close look at these trends in putting together this "Trend Watch 2000" special report. (See Page 11 for more on how this report was compiled.) At the core of all considerations about how supermarkets will fare in the future is the consumer: specifically, how consumers are positioned economically both in fact and in their own perception. After all, consumers who are well off economically -- and who also believe themselves to be well off economically -- are good customers.

But one of the great puzzles of our time is the degree to which consumers fail to recognize how lucky they are. Americans live in a time of steady economic growth with rising living standards, historically low inflation, low and declining interest rates, improved government fiscal responsibility, peace abroad and no significant foreign enemies. What could be better? Still, American consumers are persistently pessimistic, worried about their jobs, convinced their living standards are poorer than those of past generations, and concerned that their children's lives will be even worse. Why are consumers so gloomy? The issue may be relative deprivation. How can consumers not feel deprived when television shows depict middle-income families living in 4,000-square-foot houses? That makes middle-income Americans feel as if they are actually poor, which they are not. And certainly consumers are misinformed. News broadcasts and other news media create the impression of economic disaster by giving enormous currency to modest layoffs at big companies, while failing to report on the increase in employment taking place at countless small businesses. Somehow, despite four years of economic growth, many Americans still think we are in a recession and still think that inflation remains a problem. Still, consumers do have a point. Their point is that, even though the economy is growing, real wages have remained fairly stagnant. So for many workers, there has been no marked improvement in living standards for some time. And even though the economy is growing, job security has lessened due to the massive restructuring taking place in many firms and industries.

In recent years, the overall cost of compensating workers has increased while the wage level for the average worker has not, at least when adjusted for inflation. That is because compensation includes fringe benefits such as health insurance, the cost of which has risen substantially in the past decade. So although workers have actually experienced an increase in compensation in the form of greater medical care, they have not felt richer, since there has been no change in discretionary income.

And there is the issue of job security. In the past, the downside of an economic cycle entailed temporary layoffs of production workers at manufacturing enterprises. Today, we face a different situation. Even as the economy continues to grow, many manufacturing and service enterprises are undergoing substantial changes in the way they do business. This change has been brought on by an increase in foreign competition as well as a need to adapt to improvements in information technology. And the "re-engineering" revolution is in full swing. This process, or change in business processes, entails permanent layoffs of some workers. Although the number of workers affected is actually quite small, the high-profile nature of these layoffs has caused many workers to become concerned about the security of their positions. No one seems safe. How long will situations such as these last? Surely too long to make any difference in the next year or two. So even though the economy is likely to keep growing for another two years, the retailing industry will probably not experience much strength during that time. A majority of consumers will be uncertain and will either not spend much or will be very value-conscious when they do spend.

WHERE ARE WE GETTING DINNER?

No matter how useful an analysis on the economy might be, and how accurate it is in predicting future consumer behavior, one fact remains: Everyone has to eat. The question is, where will they spend their dollars to do so? Consumer spending on food reached an estimated $656 billion last year. Of this total, consumers spent 39% on food eaten away from home, up from 31% in 1980. That trend is expected to continue. Consumers' eating and shopping patterns are clearly changing and so is the meaning of home cooking. Busy consumers are looking to take the easy way out of meal preparation. Now more than ever, they are seeking options that will satisfy their immediate consumption needs. In response, a plethora of eating choices is inundating the consumer. Many players are vying for share of stomach. Supermarkets increasingly have felt the effect of the proliferation of mealtime options, especially eating and drinking places. They also are under intense competitive pressure from alternative formats that have encroached on their packaged goods business.

Don't expect supermarkets to sit still while new formats eat their lunch and more consumers eat their lunch out. Expect to see a major transformation in the supermarket industry, and expect to see it start to steamroll well before 2005.

Leading companies will focus on adding value to the food shopping experience. Supermarkets will emphasize meal solutions and de-emphasize meal ingredients. Many supermarket operators will shift space allocation away from commodity packaged-goods aisles toward a larger selection of fresh, fresh prepared, takeout and eat-in options.

Several leading-edge supermarkets are already transitioning into reinvented supermarket style. Here are some of them and what they are doing:

San Antonio-based H.E. Butt Grocery Co.'s fresh store Central Market in Austin, Texas, features two specialty food departments, Cafe on the Run and Central Market Cafe. Cafe on the Run caters to the heat-and-eat crowd by offering numerous prepared dishes. Central Market Cafe boasts five food stations featuring entrees that range from light bistro fare to beefier barbecue offerings.

Dominick's Finer Foods' Fresh Store in Chicago features freshly prepared dine-in and takeout meal solutions, including a pasta bar, wokery, specialty pizza and rotisserie chicken in its Fresh Food Court. The Northlake, Ill.-based chain's signature Chef's Collection line of upscale, individually packaged entrees and side dishes are also available.

Harris Teeter, Charlotte, N.C., emphasizes bundled meal packages through its Chef Sampler program. Consumers can select any prepared entree and three side dishes for a single price of $5.99.

Ukrop's Super Markets, Richmond, Va., is focusing on consumer solutions with its What's for Dinner Tonight program. In-store demonstrations feature meals that can be prepared in less than 15 minutes with all required ingredients assembled near the demo station -- and ready to purchase.

As leading conventional supermarket players continue to be reinvented, expect to see a reversal of the trend toward larger stores as supermarkets become more focused on high productivity categories and convenience assortments of high-turn stockkeeping units in other categories. Some SKUs, and possibly even some categories, will be eliminated. SUPERCENTERS ROLL ON

But don't expect all stores to turn out tiny. After all, the newest full-scale player to enter the battle for consumer food dollars is the supercenter, that huge combination discount store-supermarket format that is striking fear into the hearts of many conventional operators.

And for good reason. Supercenter sales are expected to more than triple in the next five years. From a base of $24.5 billion in 1995, Management Horizons projects, the industry will generate sales of nearly $91 billion at the end of the century, representing an annual growth rate of 29.9%. The latest supercenter census shows there are 607 such units in operation today, up from 473 a year ago and fewer than 200 five years ago. Store count is forecasted to grow at an annual rate of 20.5% per year, reaching 1,500 by 2000. The supercenter economic model depends heavily on attracting frequent food shoppers who cross over to shop the higher-margin general merchandise side of the store. Supercenters are definitely building a customer base. In 1990, when Management Horizons asked consumers about their shopping behavior at "hypermarkets," 5% of consumers said they shopped this format as frequently as at least three times a month, and 30% of all consumers shopped at least once a year. In 1995, 10% of all consumers were frequent supercenter shoppers, and 41% had shopped a supercenter once in the past year.

But what about the consumer behavior that underpins the economics of supercenter operations -- cross-shopping? Management Horizons' 1995 data base shows that more than half of all consumers (51%) who shopped a supercenter in the past year purchased both food and general merchandise on their last supercenter visit. Another 23% of supercenter shoppers purchased only general merchandise and nonedible grocery products and about 22% treated their last visit to the supercenter like a visit to the grocery store, buying only food and nonfood merchandise typically found in a supermarket.

FEWER, BIGGER, BETTER

Just as the move toward supercenter retailing tends to concentrate economic power into fewer hands, intra-industry concentration in traditional food, drug and mass retailing formats is concentrating the economic focus. A prediction made by Management Horizons last summer concerning concentration appears to be right on track: Merger and acquisition activity continues to heat up in the supermarket, drug store and convenience store sectors, resulting in increased economic concentration in these historically fragmented and highly regionalized channels. Here are some recent examples:

Los Angeles-based Yucaipa Cos. gobbled supermarket chains such as Ralphs Grocery Co., Food 4 Less, Dominick's Finer Foods and Smitty's Super Valu to become a major force in food retailing. With the merger of Salt Lake City-based Smith's Food & Drug Centers into its Smitty's operation earlier this year, sales of Yucaipa's supermarket holdings topped the $11.6 billion mark.

Dutch food conglomerate Ahold has developed a major supermarket presence in the United States. Now, Ahold plans to add Stop & Shop to its holdings, bringing its sales in the United States to an estimated $12.4 billion on 826 stores.

In what would be the largest drug store industry transaction to date, the merger between 2,800-unit Camp Hill, Pa.-based Rite Aid Corp. and the 2,100-unit Twinsburg, Ohio-based Revco is pending court approval. In their respective latest fiscal years, the two companies had a combined sales volume of $9 billion.

Earlier this year, Phoenix-based convenience store operator Circle K entered into a definitive merger agreement with Tosco, a petroleum refiner and marketer. The combined entity will serve about 4,000 outlets, compared with the nearly 2,500 units operated by Circle K prior to the merger.

Management Horizons anticipates that industry concentration will continue to grow dramatically during the next decade.

The industry will see these bigger, stronger players move more toward operating on a national, and for some international, scale. It also will see more centralization of operating functions.

MANUFACTURERS GO DIRECT

Apart from the continuing likelihood for supplier concentration, what else is likely to happen on the manufacturing side that will impact food retailing?

Many manufacturers are developing strategies to deal with changes that will drive them into the arms of change, such as:

Manufacturers will lose many of their retailer customers to Chapter 11 and consolidation.

Many retailers will aggressively create and promote private-label brands.

The value of being on the supermarket shelf will decline as more shoppers opt for alternative formats or alternative meal solutions and fewer of the remaining shoppers walk their carts up and down every aisle on a typical shopping trip.

Consumables retailers will limit the number of brands on their shelves to those brands that can meet specific performance goals in the retailer's category strategy.

So what's a manufacturer to do in this new paradigm? For many manufacturers, the answer will be to "go direct." And it's already happening:

Sara Lee operates stores and catalogs for its apparel and accessories brands, Hanes and Coach, but also takes its bakery and processed meat products direct to the consumer by way of its outlet stores, and kiosks in airports and on college campuses.

Pepperidge Farm and Entenmann's Bakery operate outlet stores.

Rubbermaid operates five Everything Rubbermaid stores.

Kraft and Nabisco have food-service concepts to leverage their popular brands.

Chock Full O'Nuts has re-entered the restaurant business with Quikava double drive-through coffee restaurants and Chock Full O'Nuts Cafes and kiosks.

Meanwhile, manufacturers will also perfect ways to communicate more directly and personally with the consumer.

Coca-Cola, Healthy Choice, Frito-Lay, Tampax, Campbell and Budweiser are a few of the many brand names with their own World Wide Web sites. Most such web sites don't offer products for sale, but are used to build a relationship with consumers, offering recipes, information and coupons. Other brands such as Lipton Tea and Triaminic have developed clubs as a way to communicate with heavy users of their products.

THE ELECTRONIC SUPERMARKET

When it comes to considerations about selling and communicating via web sites on the Internet, the question arises about how successful such efforts will be, whether operated by manufacturers or retailers.

As for technology, clearly advances now enable supermarket retailers to offer new services such as consumer-friendly electronic ordering and home delivery for relatively low start-up costs. The industry is responding quickly: Latest surveys suggest that more than 25% of chains offer home delivery, representing more than 40% of the population. And the numbers grow daily.

Yet, despite computer-based trials dating back to 1970, the electronic supermarket still lacks mass-market appeal and a profitable business model, even though the value of nonstore retailing is proven in other merchandise categories, where catalogs take in $70 billion annually. Price is probably the most significant barrier to widespread adoption of the electronic supermarket. Typical delivery charges run from $7 to $10 an order. The delivery fee makes only large purchases economical and Management Horizons survey research shows significant consumer resistance to any delivery charge. So today's electronic supermarkets need to make significant strides on their value proposition to the consumer before becoming a significant market force. Progress to date suggests that Management Horizons was overly optimistic when it forecast last summer that 10% of grocery sales by 2005 will be in electronic retailing. But if the delivery fee is a major obstacle, why not just bypass the store and receive, put away, break bulk, process, pick and deliver from a facility, a delivery depot, that is optimized just for those functions? Management Horizons' analysis shows there are substantial savings in operating a delivery depot compared to a supermarket. On a typical $100 order, home delivery will cost a typical supermarket operator an extra $10 to process, pick, check out and deliver from the supermarket. A delivery depot can receive and store inventory and process and deliver the same order for about $10 to $12 less in total cost than the supermarket can.

But what happens in markets already saturated with supermarket competition, that is, virtually every market in the United States? There are two likely scenarios:

An existing supermarket operator offers delivery depot service in its existing market or a wholesaler or entrepreneur starts delivery depot-based service.

In the first scenario, the supermarket-based delivery depot operator will not need to spend much in marketing dollars to attract customers, but the service will likely cannibalize significant sales from its own stores. In the second scenario, the delivery depot operator will not need to worry about cannibalizing sales, but he will have to spend significant money to build awareness and credibility and to induce consumers to switch from their existing supermarkets. The biggest challenge will likely be supermarkets' competitive response. But since different operators in different markets are going to have different economic and competitive conditions, it is likely that a delivery depot will succeed in some markets. But delivery depots clearly face significant economic challenges in establishing themselves on the new frontier of electronic retailing.

CONSUMERS RESPONDING TO THE STATEMENT, "I ENJOY GROCERY SHOPPING." [chart]

Strongly agree 14.4%

Agree 29.8%

Slightly agree 25.6%

Slightly disagree 14.9%

Disagree 9.6%

Strongly disagree 14.9%

ABOUT THIS REPORT

"Trend Watch 2000" is an edited version of a project prepared for Supermarket News by Management Horizons, a consulting division of Price Waterhouse, Columbus, Ohio. Management Horizons is a recognized authority in strategy development, market positioning, new concept development, retail merchandising and operating strategies, and retail growth and expansion strategies. It also helps companies align strategy and operations and re-engineer business processes for improved results.

For more information, contact: Management Horizons, 1177 Avenue of the Americas, New York, NY 10036; call (212) 596-8600, or fax (212) 596-8970.

Management Horizons writers contributing to this report are: Ira Kalish (consumer segment); Sandra J. Skrovan (Where are we getting dinner? and Fewer, bigger, better segments); Mary Brett Whitfield (Supercenters roll on and Manufacturers go direct segments); and Ken Hewes (Electronic supermarket segment).