MEGAFOODS CHANGES TEXAS STRATEGY

ELLIOT ZWIEBACH

SAN ANTONIO -- In acknowledgment that its low-price operation could not jump the competitive wall put up by H-E-B Grocery Co., Megafoods Stores has decided to abandon its price-impact format here.

In a major shift in strategy -- a strategy that was scant weeks old -- Megafoods will convert its 15 Texans' Foods price-driven stores in the area to a conventional high-low operation offering double coupons. Moreover, Megafoods will rebanner the stores as Handy Andy, a name it uses on 21 other stores, giving it a consolidated operation of 36 stores under the same banner.

"H-E-B would not concede the title of lowest-priced operator in the marketplace, and you can't run a warehouse market without everyday low prices," Jack J. Walker, chief financial officer of Megafoods, told SN.

"As a result, nine weeks after we opened in San Antonio, we've thrown in the towel."

Asked why the company had opted to cut its losses so quickly, Walker replied, "If you're lying in the road and badly hurt, there's no point in getting run over again and again and hemorrhaging."

Megafoods, based in Mesa, Ariz., operates 70 stores, including 34 price-impact stores in Arizona, Nevada and southern California, and the 36 units here in Texas.

For the year ended Jan. 1, the company posted a loss of $19.5 million, of which $16.5 million was lost during the fourth quarter.

The company attributed the loss totally to the preopening

expenses and post-opening margin impact in Texas, compounded by "the very heavy cost associated with establishing the company's new stores in San Antonio," Walker said.

Of the 36 Texas stores, Megafoods acquired 15 from Kroger Co., Cincinnati, last fall but did not reopen them until January because of rain-related delays. When the stores did open, it was with a slightly modified pricing policy from the chain's warehouse stores in other areas because the stores here were 10,000 square feet smaller and carried less variety, Walker said.

Megafoods' problems started with the new name it chose for the former Kroger stores -- Texans' Warehouse Foods. When it became clear that consumers here were not comfortable shopping a warehouse store, the name was changed to Texans' Foods.

But the name was among the least of its problems.

H-E-B, which is based here and has dominated this market for years, met Texans' price-for-price, and so generally did Albertson's, based in Boise, Idaho. "We didn't think H-E-B would see it as crucial to take business from us because it is already so well established," Walker said.

"It wasn't as if there was a completely new entry in the market because Kroger had been here before and we simply took over from an established player. But we underestimated what H-E-B wanted in terms of market domination."

Once Megafoods realized it was losing "a lot of money -- more than we'd anticipated -- it became clear that H-E-B was not going to allow itself to be beaten on delivering the lowest prices to consumers," Walker said.

"At that point, we had to rethink our strategy," Walker said.

The company agreed to acquire 21 Handy Andy supermarkets in February after it became clear the warehouse approach was not working.

At the time of the Handy Andy acquisition, local sources estimated that H-E-B controlled just under 50% of the market, compared with 17% for Albertson's, 9.5% for Handy Andy and 6% for Megafoods' operation.

"We decided to acquire Handy Andy in order to get more market size and protection and then convert to a different format from EDLP," Walker said.

The new format is conventional, with high-low pricing and double coupons. Handy Andy traditionally used a high-low formula, but no one in the market offered double coupons since Kroger left, he said.

By mid-May, Walker said, he expects all 15 Texans' units will be operating under the Handy Andy banner. Walker said he believes the conventional format will pay off for Megafoods in a relatively short time. "There's more gross margin available to a conventional store, and our research shows we can make money as a conventional operator instead of trying to battle H-E-B with EDLP."

The Texas division of Megafoods is already breaking even since the Handy Andy acquisition, "and that's two months before double coupons," Walker said. "Those crazy specials were losing everyone a lot of money."

Even if H-E-B opts to match Handy Andy's weekly specials, he noted, the high-low pricing formula will give Megafoods' Texas operation enough room to make money. "Now there's room in the market for both of us."

Asked why Megafoods has been successful with price-impact stores elsewhere but not here, Walker replied, "We've never had a competitor of the size, dominance or financially deep pockets as H-E-B. And they don't have to worry about shareholders."