MISSION TO MEXICO

Mark Hamstra

MONTERREY, Mexico -- For H.E. Butt Grocery Co., the leap across the Rio Grande wasn't that far geographically, but it represented a cultural change unlike any the company has encountered in 75 years of operating in Texas.

After opening its first store in Mexico in 1997, H-E-B has expanded its presence south of the border to 21 locations and last year opened a new distribution center that the company hopes will support its goal of opening three to four stores per year for the next three years.

"I'm optimistic for our opportunities," said Howard Butt III, director general of H-E-B's Mexican division, in an interview with SN. "We're betting on the country and its growth. It's a young country, and we think it has a lot of economic potential."

Butt is the nephew of Charles Butt, chairman of San Antonio-based H-E-B, which operates about 300 stores in Texas generating nearly $11 billion in annual sales. He has spearheaded the privately owned company's expansion into Mexico from the chain's regional headquarters here, importing much of the operations expertise from the parent company but adapting to the local business environment as well.

One of the biggest differences between the U.S. model of food retailing and the Mexican model is the supply chain, although Butt said the Mexican distribution system is changing to be more like that of the U.S. In Mexico, Butt explained, dry-grocery vendors typically deliver directly to the stores, rather than a central warehouse, so that individual supermarkets sometimes receive more than 100 deliveries per day from their suppliers.

"That's very complicated, and it adds a lot of cost and inefficiency," he said.

As that model begins to evolve in Mexico, H-E-B is hoping that its new 325,000-square-foot warehouse -- which Butt refers to as a "retail support center" -- will help it transition with the rest of the country into a more modern system of retail supply.

"Chains in Mexico are moving toward more of a central distribution model," Butt said. "The difference is, in the U.S., we have traditional warehousing, where we maintain large amounts of inventory in center store. In Mexico, it's moving toward more cross docking and pick-on-receipt."

H-E-B's new distribution center, located just north of Monterrey, replaced three smaller facilities that handled meat, produce and a limited portion of the dry groceries that the company purchases. The new facility, split evenly between dry goods and perishables, will have the capacity to serve up to 50 H-E-B supermarkets.

Going Solo

H-E-B began to explore the possibility of operating stores in Mexico in the early 1990s. The company had already begun selling products to Mexican chains that it produced at its manufacturing facilities in the U.S., although Butt said that operation was fairly small in scope.

"We then began to seriously consider the possibility of retailing because at the time [the North American Free Trade Agreement] was being debated in the U.S. Congress and the Mexican Congress," he said.

H-E-B worked with consulting firm McKinsey & Co., New York, to prepare a feasibility study, but the chain's efforts to expand in Mexico were delayed by events on both sides of the border. In Mexico, the peso devaluation of 1994 crippled the Mexican economy, while in Texas, Wal-Mart was making an all-out assault on H-E-B's home turf in the Rio Grande Valley.

Although Butt himself was involved in overseeing the research that the chain conducted to prepare for opening in Mexico, he said he found he still had a lot to learn once the company actually began operating there.

"We learned some things in research, but obviously when you are here on the ground, beginning a start-up operation without a partner in a new country, with new laws and so forth, it's quite an experience," he said.

One of the options that had been proposed in the McKinsey feasibility study to ease H-E-B's entry into the market was to enter the country through a joint venture, as other U.S. companies had done.

Wal-Mart Stores, Bentonville, Ark., for example, entered Mexico through a joint venture with a company called Cifra to operate Wal-Mart's Sam's Club warehouse stores in the country. Since then, Wal-Mart has acquired a controlling stake in the business and folded it under its Wal-Mart de Mexico division, but the joint venture allowed the mega-retailer to leverage Cifra's in-market knowledge and experience. At the time, French retail conglomerate Carrefour also had entered the Mexican market through a joint venture with Gigante.

"The joint venture was the typical method for companies to come into Mexico, and we considered that pretty carefully, but in the end we decided to come in on our own," Butt said.

Weighing in H-E-B's favor in its decision to enter without a partner, he said, was the fact that H-E-B had already operated for more than 60 years on the Mexican border and was a familiar retail brand to many Mexicans, especially those living in the northeastern part of the country who had traveled to Texas.

"Northern Mexican customers that came to the U.S. for New Year's, or Holy Week, or the big vacation periods were familiar with H-E-B, and there was a lot of cross-border shopping done in the Texas border towns" like Laredo, McAllen and Brownsville, where H-E-B has operated since the early 1930s.

Middle-income customers in Monterrey are frequent travelers to Texas, Butt said, which was one of the reasons H-E-B chose Gaza Garcia, an affluent city adjacent to Monterrey, to open its first store in Mexico.

Expanding Into New Areas

Recently, however, H-E-B has expanded its Mexican operations into more remote locations such as Tampico, which is about 300 miles from the border.

"In some of the newer markets that we're opening in, deeper into the country, the name is not as well-known, and that's a challenge to us," Butt said. "There's a lot of work that has to be done on selling the brand and selling the advantages of the brand and the format."

It is even more challenging to move into new markets in Mexico than it is in the U.S., he said, because the H-E-B name is so well-known in Texas that customers are already familiar with it by the time H-E-B comes to town. In Mexico, lower-income consumers in areas further removed from the border are less likely to be familiar with the H-E-B banner.

"We began opening stores in upper-income areas, and within two or three years we began opening stores in lower-income areas," he said. "It's no different from the U.S. -- there's a big difference between serving an upper-income customer and serving a lower-income customer."

The positioning of the banner remains the same, however, regardless of the income level of the customer. H-E-B seeks to distinguish itself from the competition by focusing on the quality and variety of its perishables departments. Produce is inexpensive and plentiful in Mexico, Butt said, and it "accounts for a significant part of the sales mix."

H-E-B has beefed up its produce-sourcing efforts in Mexico to supply stores on both sides of the border since opening the new warehouse.

"Mexican produce has always been an important part of our offering, but we're able to do more direct buying today based on seasonal needs," Butt said. "We've got U.S. produce moving into Mexico and Mexican produce moving into the U.S. It just depends on the availability, the cost and the season. That's more common now than when we first started."

In center store, the chain focuses on variety, a complete selection and competitive prices. The offering includes very few canned fruits and vegetables, as the customer prefers fresh product.

Store brands also are an important part of the mix. Although the company currently sources most of its store-brand product in the U.S., it also is expanding sourcing in Mexico and eventually hopes to procure 50% of its store-brand product in Mexico.

Nonfood offerings have expanded over time at the chain, as the company's main rivals in the country operate hypermarkets offering a broad selection of general merchandise, including clothing and large appliances, in addition to groceries, especially in lower-income neighborhoods.

Although H-E-B doesn't offer clothing, the company has broadened its array of offerings to include things like refrigerators, stoves and furniture, in addition to the automotive and seasonal general merchandise offerings that the chain carries in Texas. As H-E-B expands its U.S. nonfood offerings with larger stores, Butt said the company plans to offer some of the same products in Mexico.

H-E-B stores in Mexico average about 80,000 to 90,000 square feet, although the company operates some as small as 30,000 square feet and has one store that measures 109,000 square feet.

H-E-B experimented with a smaller, low-priced format called Economax in Mexico, modeled after the H-E-B Pantry stores in Texas, but the banner was not successful and the stores have been closed or converted into traditional H-E-B locations.

Merchandising Differences

Although H-E-B has been able to leverage the expertise gleaned from its U.S. operations as it has expanded in Mexico, there are some key differences in merchandising south of the border that have influenced the way H-E-B operates.

In the bakery department, for example, the company does not offer any prepackaged goods -- all breads and pastries are baked on-premise and displayed on self-service trays where consumers help themselves using tongs.

"It's quite a different look and feel in the bakeries in the two countries," Butt said.

The deli departments at H-E-B south of the border also operate on the Mexican model, in which supplier representatives actually work inside the supermarkets hawking their products and slicing meats and cheeses to order. They are paid on a commission basis.

"That's evolving toward self-service, but it's going to take awhile," Butt said.

Currently, the offering of prepackaged deli products is much more limited than the typical offerings found in U.S. supermarkets.

The pharmacy department also differs considerably in Mexico, where all medications are prepackaged and the barriers to entry are low, which has created a high level of competition.

H-E-B also employs "paqueteros" -- boys and girls age 14 to 16 who remove groceries from customers' carts and place them on the belts, then carry the groceries out to to customers' cars. They are paid only in tips.

"This is a government program that all retailers participate in," Butt said. "It's been very successful to get children into the workforce."

Although the paqueteros program is unique to H-E-B's Mexican operations,, the company has found a few opportunities for cross-border synergy in areas such as loss prevention and retail shopping-center development.

"In Mexico, small shops are leased out in the lobbies of stores," Butt said. "That's a concept that's common here. It's less common in Texas, but we're experimenting with that concept."

H-E-B Mexico Faces New Competition

MONTERREY, Mexico -- Entering Mexico not only presented H.E. Butt Grocery Co. with supply-chain and merchandising challenges, it also pitted it against some new competition.

While the San Antonio-based company is accustomed to being the market-share leader in its headquarters market and in other areas throughout southern Texas, at its headquarters market here in northeast Mexico, H-E-B faces some well-entrenched adversaries, including Organizacion Soriana, a fast-growing, family-owned chain of hypermarkets that is also based here.

"They are a very aggressive company," said Howard Butt III, director general of H-E-B Mexico, in an interview with SN. "They are growing their square footage by about 15% per year, and they have a strong price perception."

He also said Soriana has a strong loyalty-card program that it promotes aggressively, and it also promotes its store-brand products heavily. In addition to its hypermarkets, Soriana operates a smaller format called Mercada Soriana and a club banner called City Club.

"They are a very well-managed company," Butt said. "They are a big factor here in the northern market that everyone has to account for."

He said Soriana has responded to H-E-B's entry into the market by expanding its product lines to be more like H-E-B, with a greater focus on perishables and an expanded center store in a format called Soriana Plus.

Butt estimated Soriana's percentage of the market share in the northeast region to be in the mid-40s, followed by H-E-B, which he said has a share in the mid-20s. Wal-Mart de Mexico, which operates multiple concepts in Mexico, has a share in the region in the teens, he said.

With about 700 total stores, Wal-Mart is the market-share leader for all of Mexico, he said. It operates supercenters, a warehouse format called Bodega that targets the low-end market and a concept for higher-end consumers called Superama. The company also has been experimenting in the central part of the country with a smaller warehouse format called My Bodega, which measures about 25,000 square feet, according to Butt.

"Wal-Mex wants more share, and they have an aggressive new-store program that targets almost all of the country, including the northeast part of the country," Butt said.

Safeway, Pleasanton, Calif., is the only traditional U.S. supermarket operator other than H-E-B that has a significant presence in Mexico. The company has a 49% interest in Casa Ley, which operates 115 stores in western Mexico and does not compete head-to-head with H-E-B.

Other large Mexican food retailers include Grupo Gigante, which operates about 270 supermarkets in 19 Mexican states, and Controladora Comercial Mexicana, which has about 175 food stores in various formats.

Earlier this year Carrefour, the Paris-based global retailer, sold its 29 hypermarkets in Mexico to Grupo Comercial Chedraui, a Veracruz, Mexico-based hypermarket operator with 64 locations in the country.

Mexico at a Glance

Population: 106.2 million (2005 estimate)

Population Growth Rate: 1.17%

Gross Domestic Product: $1 trillion (2004 estimate)

GDP Growth Rate: 4.1%

GDP Per Capita: $9,600

Population Below Poverty Line: 40%

Unemployment Rate: 3.2% (plus underemployment estimated at 25%)

Supermarket Sales: $29 billion (2004 estimate)

Supermarket Sales Growth Rate: 9.6%

Source: CIA World Factbook and National Association of Supermarkets and Department Stores of Mexico.