SHAKE-UP IN CALIFORNIA

Elliot Zwiebach

Wal-Mart Stores has only one supercenter in the state of California, but it's already shaking up conventional operators there.

Even before that first supercenter opened, the Bentonville, Ark., behemoth was causing seismic shifts in Southern California. The pressures of its expansion into Northern California in October may cause new fissures there resulting in an earthshaking upheaval in grocery retailing in the Golden State over the next few years.

Or maybe not.

Opinion seems to be divided on how much impact Wal-Mart supercenters will have on supermarket operations in the state.

Considering California's size and its diversity of marketplaces, some questioned the impact Wal-Mart will have statewide, particularly in the short term, when its stores will be spread over a very large geography. Others suggested that Wal-Mart's expansion, however slow, will ultimately undermine the status quo.

Further, a number of supermarket operators thinks knowing their customers better than Wal-Mart ever can will ensure their survival, observers noted. In addition, quite a few believe the points-of-differentiation they create today will serve them well as supercenters multiply.

"Wal-Mart is a threat. Even one Wal-Mart supercenter is a threat," one in-state observer told SN.

Wal-Mart has already had a major impact in Southern California. The 141-day strike-lockout that ended in early March was prompted by the threat posed to the conventional chains' cost structures by Wal-Mart's lower wage and benefit rates.

While the issue was ultimately settled there with the creation of a lower-paid second tier for new hires and a rollback in some health care benefits in the third year of the new agreement, it is still not clear how it will be resolved in Northern California, where the chains are negotiating with two groups of union locals.

Although the economic issues they face may be similar, Southern and Northern California are two separate and distinct marketing regions.

In the South, it's a three-ring market with Ralphs, a division of Kroger; Albertsons; and Vons, a division of Safeway, bunched at the top, with Stater Bros. Markets playing an increasingly stronger role.

In the San Francisco Bay Area in Northern California, Safeway's home base, Safeway is the dominant factor, with Albertsons a weak second. In the Sacramento marketplace east of the Bay Area, hometown-based Raley's vies with Safeway for market supremacy.

Regardless of the market dynamics, Wal-Mart is the primary threat to the status quo, said industry sources.

Wal-Mart announced two years ago that it planned to open 40 supercenters in California by 2008. It opened the first in La Quinta, a desert community 20 miles east of Palm Springs in Southern California, in March, with a second location scheduled to open this fall in Hemet, about 40 miles northwest of Palm Springs. Wal-Mart is also scheduled to open its first Northern California supercenter at about the same time in Stockton.

"It's taking Wal-Mart a long time to get started in California," one state-based observer told SN, "and it's going to take them a long time and a lot of stores to have a significant impact in any given area of California."

Despite its slow start, however, Wal-Mart is likely to achieve its 40-store goal over the next four years, Gary Giblen, senior vice president and director of research for C L King Associates, New York, said. "It usually hits its targets," he pointed out, "and it can always catch up if it's running behind."

Posing a potential challenge to the pace of Wal-Mart's expansion plans are the legal challenges it continues to face from several communities, now that Inglewood and Los Angeles have pointed the way.

Voters in Inglewood rejected Wal-Mart's attempts to bypass municipal approval to open a supercenter there in April, and the L.A. City Council voted 13-1 earlier this month to enact a law requiring big-box store operators like Wal-Mart to present the city with their own economic impact studies indicating how a store opening would affect existing businesses.

In its response to the Los Angeles action, Wal-Mart applauded that the city did not place an outright ban on supercenters, as was proposed in an earlier version of the ordinance. Yet the lack of an outright ban in Los Angeles doesn't mean Wal-Mart won't continue to face stiff resistance going forward, industry sources said.

"Wal-Mart is going to face tremendous challenges from a number of communities," one told SN. "It promotes itself as a good corporate citizen, but there are a lot of stories about what it costs taxpayers to have a Wal-Mart in their community because of its low pay scales and the burden that puts on local health care facilities. That's going to unravel some of the positive things they say about themselves."

Some feel the L.A. law will be a model other cities might follow.

"The 13-1 vote reflects the mood of politicians as they look at Wal-Mart," Jack Brown, chairman, president and chief executive officer of Stater Bros., said. "Since L.A. often leads the legislative chariot, this is a pretty stunning deal. I'm not saying Wal-Mart has hit an iceberg, and obviously the law won't prompt it to walk away from California, but it will make for a tougher row to hoe," Brown stated during a conference call with industry analysts.

Brown is among the first retailers to go toe-to-toe with Wal-Mart in California, with two Stater stores competing with the La Quinta supercenter. "Wal-Mart said La Quinta was its best supercenter opening in the company's history, but volume at our stores never dropped, even during their grand opening," Brown declared.

Pete Kanelos, Wal-Mart's California spokesman, told SN the La Quinta supercenter is doing "phenomenal business -- better than our expectations. We've had a tremendous amount of positive response from the community."

With only one supercenter open and two more due this year, industry sources said Wal-Mart's ability to have a major impact statewide may be years off. "It's going to be tough for them to find locations for supercenters and to find trained people to work the stores. I don't see them having much impact till they have at least 100 stores in California," one observer said.

Jonathan Ziegler, principal in PUPS Investment Management, Santa Barbara, Calif., said he believes it will take years -- and more than 40 supercenters -- before Wal-Mart will have a significant impact statewide.

"If food sales in California represent 10% to 12% of the U.S. total of $600 billion, that's about $70 billion worth of food that's sold in the state," Ziegler explained. "And if 40 supercenters do $15 million to $30 million a year in food, that's about $1 billion. If Wal-Mart is doing $1 billion out of $70 billion, everyone could handle that, and it's not going to have much impact."

Ziegler said he expects most of Wal-Mart's long-term supercenter expansion to focus on the San Joaquin Valley, where a lot of land is available. "That would mean chain operations in San Francisco and Los Angeles would not be impacted because those markets would be protected from a strong Wal-Mart entry," he said.

"As a result, most of Wal-Mart's $1 billion volume would be done in the agricultural region along the Interstate 99 corridor, which would affect companies like Albertsons, Safeway and Save Mart."

Albertsons and Safeway have experience competing with supercenters in other parts of the country, "but Save Mart might be more vulnerable," Ziegler opined.

Bob Piccinini, Save Mart's chairman and CEO, addressed that perception when he told SN he's more concerned with doing what his company does best. "Through the years, successful companies have been those who work hard, take advantage of opportunities, reinvest, and take care of their employees and customers. If we do all those things, then bring 'em on," he said.

"We know that Wal-Mart's forte is cheap, and we understand that we can't be cheaper, or even as cheap, as they are on the food side," Piccinini added. "Wal-Mart uses food as a football, and we won't try to compete with that. But we can do a lot of little things better in terms of product categories and services, and we're striving to strengthen our programs in those areas."

For Giblen, there is no magic number of supercenters Wal-Mart needs to open in California to have an impact, "because its power grows exponentially with each supercenter it opens.

"Three Wal-Mart supercenters in an area will do nine times the business of one, not three times more than one supercenter, because the more stores it has, the more credible it gets," Giblen explained. "Supercenters have been around since 1991, but it wasn't until around 2001 that the industry really felt their impact. Why? Because more and more were being built, gradually and steadily, and then all of a sudden consumers realized Wal-Mart was a reasonable place to buy food.

"Some supermarkets still tend to underestimate Wal-Mart's food operations, but the cumulative effect of more locations is very powerful.

"Wal-Mart isn't going to get four or five supercenters into an urban area of California, but it can go into more sparsely populated areas and have a significant impact. Its improved perishables execution has good drawing power.

"A supermarket retailer might say one supercenter will affect one-and-a-half stores. But four supercenters might not simply impact four times one-and-a-half stores, but as many as 16 stores because all of a sudden, people are aware of Wal-Mart as a food alternative and that's where they go."