NORTHWEST PASSAGE 2006

ELLIOT ZWIEBACH

The times may be catching up with the Seattle market.

While other regions of the U.S. have already accommodated an influx of price-driven and specialty alternatives to conventional operators, the phenomenon is a relatively new one in Seattle ¡- a development that local observers believe could ultimately force some players to reassess their go-to-market strategies as they are pressed more and more from both ends of the pricing spectrum.

"It's not business as usual in Seattle anymore," Ron Brake, chairman of Associated Grocers, Seattle, told SN.

Business as usual here meant not having to confront much change in a market that's been protected from price competition by the powerful presence of Safeway, "which locked up this market for decades and has been able to price at any level it wanted," said Bert Hambleton, principal at Hambleton Resources, Issaquah, Wash. "And because no one was able to challenge that approach, pricing has never been a big issue here."

"Seattle is a market that has never had a price war, nor has it ever had to offer double coupons, either," said one retail executive,

It's a market where Safeway, Kroger-owned QFC and Albertsons account for a combined share of nearly 55% and independents account for another 9%, according to figures supplied by Metro Market Studies, Tucson, Ariz.

But change is coming.

With Safeway moving in a more upscale direction with its lifestyle format, Whole Foods Market beginning to make a mark there and upscale independents going strong, Seattle is likely to retain its image as one of the strongest upscale markets in the nation, at least for the short term.

However, as more price-driven operators proliferate on the city's fringes - including Costco, Wal-Mart Supercenters, Winco Foods, Trader Joe's, Smart & Final and Grocery Outlet - pricing pressures could alter the historic direction of the market.

In addition, with the late arrival to the market of so many alternative formats, there could be a real splintering of the volume currently controlled by conventional operators that could add further pressures.

Finally, the pending sale of Albertsons to Supervalu could also change the status quo, depending on how price-aggressive Supervalu opts to be.

Brake said he believes local competitors are up for the challenge. "Being a retailer today means changing every day," he said, "and that means learning to adapt.

"As Winco and Wal-Mart come into the market at a faster pace, it will force a lot of retailers to make decisions about what niche they want to serve based on what the new competition is doing, and that represents a new way of thinking for Seattle."

Art Turock, principal at Art Turock & Associates, Kirkland, Wash., said he anticipates growth at both ends of the spectrum. "Over the next few years, Seattle will probably become a lot more like other parts of the U.S., where a declining middle class pushes retailers to either upscale or price-impact strategies," he said. "That will force operators to try to differentiate themselves by deciding which end they want to serve - a move that will probably result in a roughly equal distribution of upscale and economy operations."

Hambleton also said he believes the pace of change in the market will put pressure on some retailers to decide who they are or who they want to be. "Do they want to stick to what they've always done and ignore promotional pricing in a market that has never had double couponing, or do they decide they have to change to meet the growing attraction by consumers to alternative formats that rely on low prices?"

Greg Saars, owner of Saars Marketplace Foods, Oak Harbor, Wash., a price-driven operation with eight of 11 stores in the Seattle market, told SN he expects more retailers to settle into specific niches.

"This market used to be more value-driven by middle-of-the-road supermarkets, but it's becoming more niche-oriented and will continue moving in that direction as the number of value-added stores, value-driven limited-assortment stores, value-driven canned-food warehouse stores and big-box stores grows," he said. "That's giving consumers a lot more options, and for conventional supermarkets, it means having to change to stay current by becoming more niche-oriented."

Most of the newer formats, particularly the big boxes, are limited in where they can expand, Saars said, "because real estate in the city's core is expensive. But they're coming in on the fringes in a big way."

Turock said limited sites in the city's core could prompt Wal-Mart to opt for Neighborhood Markets in this region.

But even that option could be blocked by the cost of land, other observers noted. "Local real estate is a hot commodity right now," one said, "and values have probably doubled over the last few years both in the city as well as on the outskirts."

Upscale Tradition

Whatever changes might be in store for this market will have to filter their way down through years of customer habit.

"Customers here have always been very selective in choosing stores with personality over price," one local competitor told SN.

"A lot of local companies have done a great job over the years educating consumers about value and quality rather than price," another retailer said. "It started with independents like Larry's Markets, which promoted the upscale format with unique offerings, followed by the original QFC, which created a high level of expectations for customers and prompted the whole market to move in that direction.

"As a result, customers here expect a lot more than price."

"I've never seen any big price activities here," another observer said. "Everyone has traditionally been more interested in competing on service and specialty departments and making money than in seeing who can offer the lowest prices."

With Puget Sound on its western edge and the Cascade Mountains on the east, the Greater Seattle marketplace boasts a large high-income demographic, spurred by the presence of a lot of locally based high-end companies, including Costco, Nordstrom, Microsoft and Starbucks, plus Weyerheuser, Amazon.com and Washington Mutual, among others.

The core marketplace is a 20-mile area "that's like an island, largely surrounded by water," one observer noted, with Puget Sound on the west and Lake Washington and Lake Union forming the city's eastern edge.

It's a highly dense area - very much like San Francisco, local observers noted - with lots of small neighborhoods catering to different population groups.

No. 1 in the market is Safeway, with 89 stores in the three-county Seattle marketplace and a share of 24.5%, according to Metro Market Studies.

Safeway has built its local reputation on "good customer service at reasonable prices," one retail competitor acknowledged.

With lifestyle remodels already done at about half its local store base, "Safeway has become even more effective in attracting a portion of the customer base looking for quality," another competitor said.

However, one of Safeway's upscale competitors told SN he isn't impressed with the long-term potential of the lifestyle stores. "When Safeway began opening them, I thought they would be very tough to compete with because the merchandise, and the decor looked great. But eight or 10 months later, they look like regular Safeways again because the culture hasn't changed and Safeway's people just don't know how to run that kind of format."

One observer said he believes Safeway should have re-branded the lifestyle stores "to do something more unconventional, as Delhaize did when it reintroduced the Kash n' Karry chain under the Sweetbay banner. Instead, Safeway has simply reinvented itself, and consumers may see those stores as a dressed-up Safeway that's still a conventional operation rather than something less traditional, in the style of a Whole Foods."

Another competitor said he believes Safeway has lost some of its local merchandising flair since it moved procurement for the stores here to its base in Pleasanton, Calif. "It's lost a lot of its local flavor," he said, "and because local vendors are very limited in the amount of communication they can have with the buyers in California, Safeway is probably missing a huge number of opportunities here."

QFC Holds No. 2 Spot

The market's No. 2 chain is Kroger-owned QFC - Quality Food Centers - with 69 stores and a market share of 18.2%.

QFC was once an industry phenomenon - a privately held chain that attracted national attention in the 1980s and early 1990s because of its powerful perishables presentation, quality offerings and unique differentiation. However, since its purchase by Fred Meyer in the mid-1990s and subsequently by Kroger Co. a few years later, most locals agree QFC has lost much of its distinctive luster.

"It's not the chain it used to be since Kroger got its hands on it," one retailer said. "When it was privately held, QFC was an honest-to-God great grocery chain, but today it's not. What used to be a unique approach in the perimeter departments, for example, has turned to a plain vanilla type of chain merchandising."

According to another observer, "QFC used to be an awesome independent operator, but it's been hurt as it's become more and more 'Krogerized.' While it's natural for a company to make changes when it acquires another operator, that usually means giving up some of the old culture and sacrificing some of the points of differentiation, and that's certainly been the case at QFC."

One local said the QFC management team "knows what QFC was, and the inability to get back to that position undoubtedly frustrates them. But they're only given so much rope in a chain operation."

Another observer, while critical, said he sees some positive signs of change at QFC. "When Kroger took over, it began striving to operate with more efficiencies and to get pricing levels down, and it brought in more Kroger private label and offered more national deals, which meant it removed some of the specialty products from the shelves that had made QFC distinctive.

"But in the last three years, Kroger has begun using loyalty card data to customize the offerings a bit more through targeted mailings, and an ongoing effort to remodel and invest in the store base has also been a positive move. In addition, the stores have expanded deli offerings, upgraded the wine departments and added Starbucks with seating areas, so there have definitely been some positive changes."

Albertsons Slips

Albertsons - No. 3 in the market here, with 46 stores and a market share of 11.8% - has seen its fortunes slip badly in the last few years, observers told SN.

"Albertsons was a wonderful chain that simply lost its way," one retailer said. "Its prices right now are high - higher than Safeway's - and every time it's built a new store in the last few years, that store is different from the previous one, so it's lost its identity."

"The merchandising at Albertsons' stores is unremarkable," another retailer said, "and in a market full of stores that cater to the particular needs of various consumer segments, there's nothing special or distinctive about its stores."

In fourth place here is Fred Meyer, the Portland, Ore.-based division of Kroger, whose 32 stores account for a market share of 9.3%.

In contrast to the significant changes Kroger made at QFC, it has pretty much left Fred Meyer alone, some locals told SN. "Fred Meyer is probably the best-run chain in the Pacific Northwest," according to one. "It was offering one-stop food and general merchandise shopping before Wal-Mart, and its prices are lower than Safeway's or Albertsons'."

Fred Meyer has been trying to stake out a claim as the area's low-price leader, local observers said. "Pricing is one area where Fred Meyer is very smart," one said. "It chooses key items at low prices to set a strong customer image. But with Wal-Mart and Winco operating on the fringes of the market, it's going to be tough for anyone to make much of a price impact."

Costco, which is based 15 miles east of the downtown area in Issaquah, Wash., operates 10 warehouses in the three-county Seattle region, with a market share of 8.6%; sales per unit average $150 million, of which about 60% comes from supermarket items, sources said.

"Costco's biggest plus is that it offers quality products at the best price, though not necessarily at the lowest price, and people trust it to procure the best merchandise," one observer said.

According to another, Costco's willingness to draw shoppers by stocking more groceries "has turned it into a more acceptable place to shop for food over the past 10 years. In fact, a growing number of consumers - as high as 10% in some surveys - name Costco as their primary grocery store."

"One of Costco's greatest strengths is that it learns from its mistakes," another retailer noted. "As a result, it just keeps getting better at delivering what consumers are looking for."

An intangible that helps boost Costco's local image, one observer noted, is the involvement of its executives in local charities, "which keeps the Costco name before the public."

Local Independents

Haggen, a 32-store operator based north of Seattle in Bellingham, Wash., operates 16 Haggen or TOP Food & Drug outlets in the Greater Seattle area, with a market share of 6.2%. According to one competitor, Haggen stores are noted for cleanliness, variety and consistency of execution, "and they have a very strong name in this area. For a small chain, they do the best job of getting the ball in the hoop."

Associated Grocers here licenses two banner groups - the upscale Thriftway chain and the more conventional, smaller Red Apple stores - while supplying most of the area's independents. Collectively, 42 area independents supplied by AG account for a market share of 7.6%, while 10 stores supplied by Supervalu (including five IGA units) control a market share of approximately 1.4%.

Asked why so many independents have been able to thrive here, one operator said it's because of a desire on the part of local consumers to seek out the best. Given the relative lack of traffic in the area, he added, "people are willing and able to drive longer distances to shop at a store they love rather than the one closest to them."

The arrival of Whole Foods is shaking up the upscale side of the market, observers told SN.

With two stores open and two more under construction, "Whole Foods has come in with a brand new concept this market hasn't seen, and it's definitely having an impact and taking share from other stores," one affected competitor said. "However, as their success grows, I believe other operators will start copying what they do and be able to catch up a bit."

As an upscale operator himself, the retailer said his reaction to Whole Foods has been "to reinforce what we do best in terms of selection and product quality, and to provide more information about the products we sell, their health benefits and how to use them, plus trying to introduce new items all the time."

Wal-Mart Supercenters are just beginning to make an appearance here, with only two locations, one north and one south of the city, and Winco Foods, based in Boise, Idaho, has a growing presence on the outskirts of the city with three stores.

Albertsons Acquisition Might Bring Changes

Supervalu has the opportunity to shake up the core Seattle market as it proceeds with its acquisition of Albertsons, particularly if it decides to pursue a price-driven approach, local sources told SN.

However, they said the direction it will take may not be apparent for some time.

"Supervalu will certainly be looking at re-merchandising the Albertsons stores, but it will probably keep the Albertsons name on them for as long as possible because I doubt re-branding those stores is at the top of its list," one observer told SN. "But given the poor reputation the Albertsons name has locally, a re-branding effort at some point could help - though Supervalu has got to be careful and do it right the first time."

Albertsons is No. 3 in the market, with 46 stores and a market share of 11.8%, according to Metro Market Studies, Tucson, Ariz.

Another source said he doubts Supervalu will make any significant changes at the stores for at least 18 months after the merger is completed "because it has bigger fish to fry at Jewel in Chicago and Shaw's in New England."

According to one local retailer, "Supervalu may decide to convert some locations to other formats they feel will do better here, while some locations will probably do well under the conventional Albertsons banner, though Supervalu will certainly refine the market strategy under that well-known name. And they are likely to convert others, depending on the locations, to price-driven formats or more upscale formats.

"But I believe they will take some time to analyze the stores first and make their decisions about what will be the best way to capitalize on what they've got."

Another retailer said he believes Supervalu could have problems in the Seattle market "because it will be taking over a group of stores that all look different, with a group of employees whose morale is way down, and no real history of running a large chain."

Even if Supervalu opts to close some of the Albertsons locations in the market, there would probably be enough interest among various independents to keep the number of stores operating in the area at about the same levels, he said. "And with growing companies like Whole Foods, Haggen, Winco and Wal-Mart seeking additional locations here, the area is likely to remain over-stored indefinitely."