APPROACHING A MILESTONE

MARK HAMSTRA

LITTLE ROCK, Ark. -- Affiliated Foods Southwest, the wholesaling cooperative based here, has beefed up its buying power with the addition of dozens of former customers of Fleming Cos.

The new membership has AFS on track to crest the $1 billion sales threshold in the current fiscal year, and the additional buying power promises to give the co-op more clout in its battle against supermarket slayer Wal-Mart Stores, whose Bentonville, Ark., headquarters is just a three hours' drive from here.

As Fleming, the Dallas-based wholesaler that liquidated its supermarket distribution operations through bankruptcy during the last few months, sent its former independent customers scattering to seek supply arrangements from other wholesalers, companies like Supervalu, Minneapolis, and C&S Wholesale Grocers, Brattleboro, Vt., were seen as some of the biggest winners. Yet throughout the country, hundreds of independent supermarket operators signed up with mid-tier wholesalers like AFS.

The new members give AFS additional buying power, which augments the various strategies it already uses to sharpen prices and drive incremental sales as it competes against Wal-Mart and other national players.

AFS operates 52 stores, mostly under the Harvest Foods banner, but also under the Piggly Wiggly, SaveMart, Budget Saver, Save-U-Mor and Thriftway names, and it distributes to some 300 member independents in a seven-state area. Since Fleming's woes began earlier this year, AFS added 70 new members operating about 100 stores, the company said. Most of its new members are one- and two-store independents, with the largest operating 10 stores.

Distribution sales during the past few months are tracking up about 41% over last year, the company said. Sales have grown from $8 million per week to more than $11 million.

"This is exceptional growth in a very short period of time," said Jerry W. Davis, chairman, president and chief executive officer, AFS.

SN recently met with top executives from AFS at the company's headquarters and distribution center here, and visited several stores.

To accommodate the new business, AFS has brought on additional warehouse personnel and has plans to expand the 560,000-square-foot distribution center here with more perishables capacity. It also has added 10 tractors to its delivery fleet of 70 tractors and 150 trailers, Davis said.

Although the additional business caused a few disruptions at first, AFS quickly returned to its traditional fulfillment rate of 97%, according to John Mills, executive vice president of finance and distribution.

A History Together

AFS has been growing for four decades in Wal-Mart's backyard, and the two companies' roots are entangled. Back when Wal-Mart first started opening its low-priced stores in the early 1960s, the co-op built some of the giant-to-be's first locations and leased them back to the company.

"We're kind of the reason they're still around today," joked Davis. "We built their No. 3 and No. 5 stores."

Sam Walton, the founder of Wal-Mart, even attended some of AFS' meetings in the early days of his company, said Davis, a 36-year veteran of AFS.

Like a baby alligator that once made a cute pet but has since outgrown its welcome, Wal-Mart has become a neighborhood menace for AFS, however. In the last few years, the discounter has seen fit to open several supercenters in close proximity to AFS' company- and member-owned stores.

"Like they do to everyone else, they hurt our business," Davis said. As an example, he said sales at one of the company's stores fell by 40% when a Wal-Mart supercenter opened nearby last year. "We built it back up to 20%, and we are still trying to recover." He also verified what Wal-Mart recently told analysts in its annual growth-forecast meeting at its headquarters: The giant discount-chain operator is building supercenters closer together than it did previously, raising the possibility that competitors' stores might recover from a supercenter's impact only to be impacted again.

"We've seen for the first time Wal-Mart taking sales away from themselves," said Davis. "They're doing a lot of that now. In Arkansas, whenever they open, they are hurting themselves."

Wal-Mart operates about 50 supercenters in its home state and a handful of Neighborhood Markets, although only one of the smaller, traditional-sized food-and-drug combo outlets affects AFS' business, Davis said.

He pointed out that Wal-Mart supercenter openings don't have quite the same impact that they did when they first started building supercenters, perhaps because a lot of the weaker players have already been weeded out.

"They don't really devastate a grocery store like they used to," he said. "They've been around so long, and they already sell a lot of this product anyway."

Still, he attributed part of the slowdown in AFS' sales in fiscal 2002 to the impact of Wal-Mart. About four or five stores located near new Wal-Mart supercenters saw their sales decline by 40% to 50%. AFS also closed one store, which contributed another $7 million to $8 million to the sales decline. The weak economy also played a part in the sales slow-down, he said.

Net sales for fiscal 2002 were $554 million, down about $22 million from the preceding year, according to the company's annual report. Net income was $928,519, down from $1.34 million in the preceding year. Of those net sales, some $516 million were from food distribution. The company's retail-food stores, operated through a subsidiary, Supermarket Investors, generated about $200 million in sales. Combined sales, which include all distribution, including sales to its own corporately owned stores, totaled $755.5 million.

Competitive Tactics

AFS employs a multipronged strategy to compete with its Arkansas rival, and to build sales and profitability for its members in general. The company seeks to function as a "virtual chain" in its buying and marketing functions in order to keep its retail prices down.

Based on SN's observations, Harvest Foods stores were priced competitively with both Wal-Mart and Kroger in Little Rock. Harvest actually had lower prices than either of its main rivals in the market on some items, including bread and milk.

When a Wal-Mart supercenter opens near one of its company-owned stores, AFS also gives the store a makeover and adds a pharmacy. The stores emphasize their perishables and service departments in advertising to distinguish them from Wal-Mart's offering.

"Probably the most important thing is the measures you take before Wal-Mart comes in," said Al Miller, special assistant to the president. "We think our perishables departments are important, and we advertise that we have meatcutters in the stores. But we can't beat them on price, and we know that."

The company has several strategies to create a strong price impression, however.

One such program is a pallet promotion called "Xtra Display" in which retailers can order a pallet of each of three different items per month that are drop-shipped directly to the stores. The items are displayed on the pallets, and advertised at a discount price.

Another program the company has that helps generate a strong price image in the stores is the team-bid auction. AFS conducts these events four times annually, once at each of its three food shows and again in the fall to bid on items for the fourth quarter. During the three months leading up to each auction, AFS works with vendors to secure volume deals on a range of grocery products. Typically, vendors submit about 100 items on which vendors promise their best prices of the year. AFS narrows that down to about 20 to 30 items, and then its members get together to bid on the number of cases they want to buy, driving the price down as they collectively agree to buy more cases of certain items.

"The results have been phenomenal," said Steve Wheetley, director of special projects.

After the first two auctions resulted in orders of more than 260,000 cases of product valued at more than $5 million, the company expanded the program to its current quarterly frequency.

Those special deals programs are in addition to manufacturers' specials, which AFS' members promote with shelf tags and other in-store displays bearing the "Xtra Savings" tag line.

Another relatively new means AFS uses to promote its low-price image in the market is the Advantage Ad program. This advertising program, supported by most of AFS' members, combines the resources of the retailers, the wholesaler and the vendor to create a weekly, four-page color ad insert. By aggressively recruiting its member retailers to participate in the program, AFS said it has been able to reduce the cost of printing the weekly circulars from $42.95 per thousand to $19.95 per thousand. It produces just shy of 1 million circulars per week.

"No retailers have dropped out since we started the program," said Randy Weiss, director of marketing. "We started with 125 stores, and now we're up to over 200."

AFS also has an extensive private-label offering that includes the Price Saver economy label and its flagship Surefine brand. AFS also recently began adding health and beauty care items under the Top Care banner.

"Private label continues to be an important tool when competing against Wal-Mart," said Weiss. "It gives a strong price impression without sacrificing margin."

Technology and efficiencies in the distribution system also help keep prices down, the company said. AFS distributes in a 475-mile radius, reaching into all six states that border Arkansas. To serve the most outlying areas more efficiently, the company has five depot centers, where fleets of drivers pick up products and do backhaul.

Among the newest warehouse innovations are five automatic pallet-wrapping machines that save time and labor, and also reduce damage.

One of the newer initiatives on the technology front is an intranet that allows customers to dial in and see pricing and ordering information.

"They can even see the invoice before the truck actually gets there," explained Ron Rivers, executive vice president, operations and information systems.

Now the company only has about 20% of its customers ordering electronically.

"We would like every member we have to communicate on the Internet," said Miller. "It's a productive part of the business."

Incremental Sales

AFS also has been rolling out new offerings to its stores like fuel centers, dollar sections and Hispanic departments to generate more traffic and drive incremental sales.

The first Sav-U-Mor -- the company's limited-assortment format -- with a dollar store section opened about a year ago. Since then, several members have added this feature to their stores, including one that has a 2,500-square-foot section devoted to dollar merchandise.

"Between what we cross dock and what we warehouse, we carry about 6,000 items," said Wheetley. "We can supply a whole dollar store."

The company also carries more than 500 stockkeeping units of Hispanic products, primarily catering to the Mexican-American population in the South-Central region. Several stores have added Hispanic sections.

"We think one day before long, Little Rock should be a place where we should put an all-out authentic Hispanic grocery," Davis said.

Gasoline is another incremental business that helps drive a low-price image at the stores, the company said. AFS has a subsidiary that specializes in installing fuel centers of various brands at members' stores.

"Our goal is to be the lowest price in the market on gas," said Davis. "Everyone knows we will be 2 cents less than the competition."

With Wal-Mart also rolling out fuel centers, the company knows it has to maintain that sharp price image.

"If we come out with the wrong product at the wrong price, we kill ourselves," said Miller.