REFINING THE NEIGHBORHOOD

DAVID GHITELMAN / Additional reporting: BILL BOWDEN

BENTONVILLE, Ark. -- A year after opening its first four Neighborhood Markets, all relatively near the company's northwest Arkansas headquarters, Wal-Mart Stores here said it has developed an updated template for the concept.

The new prototype is embodied in the design of Wal-Mart's fifth Neighborhood Market, which opened last month in nearby Fayetteville.

It will be repeated when the company takes the concept to an urban area and away from Arkansas with the two Neighborhood Markets scheduled to open in January in Oklahoma City as well as the two scheduled to open sometime next year in the Dallas-Fort Worth region.

"We think we have the format close to what we want," a company spokesman told SN. "This store is a blueprint to build other stores."

Precisely as Wal-Mart intended, the store looks a lot more like a supermarket. The power tools are gone. The floors are basic stained concrete, rather than tiled as in the first four stores.

"We are trying to create the atmosphere of a fairly traditional food-and-drug-type store," the spokesman said.

The Neighborhood Market concept is simple: 40,000-square-foot stores featuring supermarket fare (the 20,000 to 25,000 best-selling items from the chain's superstores, which stock roughly 100,000 items) at discount center prices.

The Oklahoma and Texas stores slated for next year are the only ones announced so far out of five to 10 planned Neighborhood Markets. The spokesman said the company expects to open an additional 15 to 20 stores in 2001.

He explained the company can put up these units a lot faster than a discount center or superstore. The zoning process is simpler, and the smaller building goes up faster. "We could imaginably start one in August and finish it by the end of the year," he said.

Meanwhile, the company has been trying to downplay expectations. David Glass, Wal-Mart's chief executive officer, told the company's last shareholder meeting the format is just an "experiment" that has already garnered too much media attention.

However, industry observers told SN the potential for the experiment is huge. Ken Teague, retail consultant at Reach Marketing, Westport, Conn., said he believes Wal-Mart intends to have 350 Neighborhood Market stores generating $4 billion in annual sales by 2005.

Still, the company insists it is not yet ready for a national rollout.

"I would not characterize this as a rollout," said the spokesman. "It's still a test concept. We are constantly refining and fine-tuning the concept."

The Fayetteville store differs from the original Neighborhood Markets in several small but significant ways.

The logo has been changed.

Last year, it featured Wal-Mart in small letters, Neighborhood Market in big letters. This year it's the reverse.

"The emphasis is now on Wal-Mart," the spokesman said. "That's the name folks associate with everyday low prices on brands names."

Store layout has been changed.

The pharmacy section of the Fayetteville unit is smaller than at the older stores. This is not because the new store is selling fewer items, the spokesman explained, but because, in standard supermarket-style, "general merchandise [such as laundry detergent and paper towels] has been dispersed throughout the store."

The arrangement of several other departments has also been altered. "Greeting cards have been moved from the main aisle," the spokesman said. "Nutritional products are closer to the rear of the store. We've given cosmetics a higher profile."

Decorative elements have also been altered.

"There are skylights in the new store," the spokesman said. "And there's a different floor. In Fayetteville, there's a stained concrete floor. The other stores have a tile floor." In other words, it looks more like the supermarkets most shoppers are used to.

Power tools are out.

At the debut of the first round of Neighborhood Markets, Wal-Market executives proudly said the stores would stock everything from diapers to power drills. At Fayetteville, the spokesman said, the focus is on stocking the type of items people expect to find at a supermarket.

Entertainment ("e-tail-tainment" in Wal-Martese) features have been reduced.

The first Neighborhood Markets featured television monitors throughout the stores broadcasting Wal-Mart commercials, product information and reports of missing children. Fayetteville, instead, offers an in-house radio station alternating piped-in music with commercials.

"In Fayetteville, we're trying to focus on things that are more relevant, more useful," the spokesman explained.

According to at least one industry observer, even the original four stores have proved very relevant and useful. Consultant Teague said the company had initially expected a typical Neighborhood Market to generate yearly sales of $12 million to $15 million. Wal-Mart now sees each store producing between $20 million and $25 million annually.

"There were some things that surprised them," said Teague. "The drive-through pharmacy, for example, was much more successful than anticipated. I've heard no negatives from customers."

Not that the shoppers lacked suggestions when Wal-Mart questioned them in focus groups. "They said give me wider aisles, bigger shopping baskets, more produce," according to Teague.

He doubts, however, that Wal-Mart will tinker much with the size of the stores. "David Glass hammered home he wanted to keep those stores no larger than 40,000 square feet," said Teague.

"It gives them flexibility," he added, flexibility, if and when the rollout arrives, to expand by acquisition. So far, all existing and announced stores have been new construction.

"All they would have to do is find a retailer out there with boxes of that size," he said.

That is, if the rollout happens at all.

"A lot of it depends on what they decide to do with their Market Express format," Teague said.

Market Express, which essentially involves simply adding more supermarket items to existing Wal-Mart discount stores, could be a tempting alternative to rolling out a whole new line of stores, he noted.

"What Kmart found, when it added its Pantry format to its Big Kmart stores, was that not only did sales of food items increase by 20%, but sales of other items increased by more than 20%," he said.

He added Market Express "is a sure-fire winner" in some towns, particularly isolated locations in the rural South where Wal-Mart will face few low-price competitors.

And, of course, Teague added, Wal-Mart could go with a strategy of introducing Neighborhood Markets in some locations and Market Express departments at others.

Either way, small supermarket companies are likely to find themselves struggling. "It's going to become significantly more difficult for regional and independent chains to survive using a traditional approach to marketing," Teague said. "The ones that will survive will be those that come up with a competitive and unique formula, like Ukrop's. They have such a good loyalty program it would be extremely hard to dislodge them."

Some observers agreed that a rollout of Neighborhood Markets would threaten the already perilous state of many regional and independent companies.

"It's certainly going to hurt the smaller players more," said Gary Giblen, New York-based managing director of Bank of America Securities, San Francisco. "It's in the forefront of every CEO's mind. If you were thinking about retiring, you're going to retire sooner."

But others said the effects of a rollout are harder to predict and depend on where the company decides to build the stores.

"I don't think it's an immediate threat," said Ed Comeau, equity analyst at Donaldson Lufkin & Jenrette, New York. "It's mostly going to become a threat when Wal-Mart starts to build these things in metro markets."

No one, at least no one outside Wal-Mart, knows when, where and if there will even be a rollout.

On the matter of when, Comeau said, "If you look at anything Wal-Mart has done, the new rollouts have come a year or two later than people expected."

On the matter of where, Giblen said, "Oklahoma City is not a weak market. It's a place where there's good competition. Perhaps Wal-Mart wants to test its mettle against some of the better independents, like Homeland."

As for if, Giblen said he thinks the company is really still testing not just the format but the format's effect on its other stores. "They have to decide whether a small-scale format works for them or whether it just cannibalizes the superstores," he said.

Still, he did not downplay the potential importance of the experiment. He said, "When Wal-Mart sneezes, the entire retail-food industry goes into conniptions."