THE NEW VALUE EQUATION

MARK HAMSTRA / Additional reporting: Christina Veiders / Elliot Zwiebach

That sound you don't hear is the silent price war that's being waged in supermarket aisles around the country.

Through a series of interviews with executives and analysts, SN has learned that low prices are becoming an increasingly important component of the value equation for the nation's supermarket operators. Some supermarket chains appear to be entering the price wars covertly, however, subordinating their low-price messages to avoid de-emphasizing their other points of differentiation.

Many of the supermarket chains that offer loyalty cards have become smarter about how they use them, offering the best price deals to their best customers and combining other incentives to use the cards, thus adding to their perceived value. In addition, supermarkets have gotten better at leveraging their private-label programs so that consumers can spend less in the stores without hurting retailers' profit margins.

Although price competition is always a feature of the industry, mainstream supermarkets are under more pressure to offer price deals than they have been in years because of the slowing economy, a lingering high rate of unemployment, and the growth of alternative formats that specialize in offering bargains on grocery staples.

According to "Trends in the United States, Consumer Attitudes & The Supermarket, 2002," a report released last month by the Food Marketing Institute, Washington, consumers are placing more emphasis on low prices, ranking the attribute as the third most important store feature when the survey was conducted earlier this year. Eighty-four percent of shoppers in the survey ranked low prices as "very important" this year, up from 77% that said so last year and 71% in 2000. A clean, neat store and high-quality fruits and vegetables ranked as the Top 2 features consumers considered important.

Closing the Price Gaps

Supermarket chains are responding to the increasing importance of low prices in a variety of ways.

Kroger, Cincinnati, in December unveiled a plan to reduce expenses by $500 million and to use some of the proceeds to become more price-competitive. The company also slated another $300 million to fund price cuts and promotional activity.

"They said they let the price gap between Wal-Mart and themselves get too wide, and that they were going to address that," said Meredith Adler, analyst, Lehman Bros., New York. "They said they were going to be selective about how they did that, and they were going to be as stealthy as possible, so it wouldn't be like putting a banner in front of their stores saying, 'Just lowered 12,000 prices.' It will be through using their loyalty card or other kinds of things."

Safeway, too, late last year said it was moving toward becoming more aggressive in its pricing by taking the efficiencies derived through reductions in shrink and centralized procurement and directing them toward becoming more competitive on price.

"They talked about kind of a combination of looking at shelf prices and making their advertised specials hotter," Adler said.

Meanwhile, Wegmans Food Markets, Rochester, N.Y., this spring switched to an everyday low-price strategy for more than 4,000 items, which many analysts saw as a move to retain market share as Wal-Mart expands in Wegmans' upstate New York territory.

At Jax Markets, Anaheim, Calif., which operates four stores in low-income, inner-city areas of Southern California, Bill MacAloney, chairman and chief executive officer, said in an interview with SN that the slumping economy has prompted the chain to become more price-focused.

"We've tried to get a little hotter on our ads to help the consumer," he said. "And we're putting more emphasis at the stores on temporary price reductions [TPRs], which has been a great help to us in maintaining our customer base. I think we've been more aggressive with TPRs as manufacturers and brokers have been coming up with better pricing structures, and we take that money and give it back to our customers."

Although Jax's customer counts are remaining steady, customers are buying less, MacAloney said, citing a 2.5% to 3% decline in sales during the past four to five months.

Many of Jax's customers are in the service industries, he explained, and the decline in travel since the terrorist attacks of Sept.11 has hit them especially hard. He said that although customers are spending less, they have not changed their buying habits.

"They're still looking for private label, generic brands and reduced costs, and the major manufacturers have recognized that and are giving us better prices," he said. "We're putting that into things we can see. We don't like to separate shoppers with programs like loyalty cards."

Jax focuses instead on retaining customers through high levels of service, he said.

At Save Mart Supermarkets, Modesto, Calif., Bob Piccinini, chairman, president and CEO, also shuns the use of loyalty cards. He said he's seen no aggressive price moves by either Safeway or Kroger yet, even though he said they "create a low-price image" through the use of their cards.

"To compete, we run a regular weekly ad with hot specials that are very price-competitive," he said. "The difference between us and them is that anyone can walk into our stores and get the benefit of advertised prices, and at this moment, we're doing extremely well."

Rich Parkinson, president and CEO, Associated Food Stores, Salt Lake City, said he hasn't seen any sharpening of prices by the national chains in his markets, but the company has taken some steps to defend itself against the spread of Wal-Mart supercenters.

Associated, a wholesaler and retailer, in the past year has increased its focus on low prices on about 500 products it calls "known value items," including soup, paper goods and some general merchandise.

"We take an ambitious stance on those prices," he said. "We're not trying to match prices with Wal-Mart, but just to create a better value image for our stores."

Mike Houser, vice chairman and chief marketing officer, Fresh Brands, Sheboygan, Wis., operator of the Piggly Wiggly and Dick's Supermarket chains, said the company uses its loyalty cards to reward its best customers not only with lower prices, but with prizes such as tickets to local sports and cultural events as well.

"It's not just a card-savings program," he said. "We actually use that data on a daily basis to make sure we're building a wall around our best customers. We are really focused in terms of keeping our best shoppers at our stores."

Penn Traffic, Syracuse, N.Y., parent of the Big Bear supermarket chain, said it also relies on its Wild Card loyalty program to help it compete on price.

"We believe our pricing strategy is the reason we can say that we will never let another supermarket get a price advantage on us," said Marc Jampole, spokesman, Penn Traffic. "We've gotten smarter at it. We certainly do a much better job now than we used to in figuring out what the customers want."

The company launched the Wild Card program two years ago at Big Bear, and it now counts 70% of its sales from Wild Card customers.

"That is another part of our pricing strategy because we funnel the best deals to our most loyal customers," said Jampole.

He also said the company has made greater use of the Internet to offer customers bargain prices, both through the use of auctions in which it buys products at a discount and by posting weekly specials online.

Some analysts and retailers questioned supermarkets' use of loyalty cards as price-promotion vehicles, however, saying that customers who don't have cards can be put off by the price breaks they're not entitled to receive. Also, customers in some markets are accumulating the loyalty cards from all the local supermarket chains, negating the advantages of offering the cards, analysts said.

"What happens is customers get three or four cards, so there's really not much of an advantage once other retailers have the programs," said Carlene Thissen, Retail Systems Consulting, Naples, Fla.

She said one way around that is for retailers to become more creative with their loyalty cards, as Winn-Dixie Stores, Jacksonville, Fla., is doing by offering sweepstakes to card users. According to Thissen's May "In-Store" newsletter, Winn-Dixie recently launched a program in which loyalty card users can enter to win a lifetime of free groceries (up to $100 per week) by using their cards. Another Winn-Dixie program offers onetime discounts of up to 20% on a shopping basket based on the level of use of the card during a certain period of time.

"In that case, you have the pricing that's on the card plus some other means of keeping the customer interested," Thissen said.

Neil Currie, analyst, UBS Warburg, New York, said he doesn't think loyalty cards are providing sales gains for many supermarket operators, since most loyalty card promotions appear to be reincarnations of the manufacturers' specials that chains have always offered.

"I haven't seen a lot of analysis that shows customers are actually better off with loyalty cards than they were getting promotions," he said.

Factoring In Private Label

Many retailers, including Hy-Vee, West Des Moines, Iowa, reject the cards because they exclude some customers. Instead, they focus their efforts on offering competitive pricing across the board and especially sharp pricing on private-label items.

"We take the position that we price private label very aggressively," said Ron Pearson, chairman and CEO, Hy-Vee.

The company has three private-label brands: the 35-year-old Hy-Vee label; a savings brand called Midwest Country Fare; and a higher-end line called Hy-Vee Grand Selection.

"We continue to expand private-label variety, because consumers are buying more private label and they continue to see it as a way to save money while still getting great quality," he said.

Analysts agreed that strengthening a private-label program is perhaps the best way to compete in today's environment.

"Private label is vitally important," said Mark Husson, analyst, Merrill Lynch, New York. "The thing about private label is that Wal-Mart can't touch you on price because there's no directly comparable product, the second thing is that private label does a good job of reducing the average consumer's shopping basket price, and the third thing is that it provides a high level of gross profit, which enables you to be cheaper on branded products where everybody can compare on price."

In addition, he pointed out, larger chains can use private label as a competitive advantage against the smaller, regional chains that can't afford to produce such product lines.

The growth of private label also could be contributing to the slow sales environment, given that some retailers are reporting flat or higher customer counts but declining average tickets, noted Adler of Lehman Bros.

"I think [trading down] is some of what we're seeing in what is clearly a sluggish top line," she said. "Clearly, if it's people switching to private label, then that's not a negative. It builds loyalty and it drives gross margins."

Going Beyond Low Prices

Analysts cautioned that supermarkets have to walk a fine line between offering low prices and promoting themselves too heavily as purveyors of low prices, however.

"If you're just promoting yourself as a place that can get good deals, then consumers look at Wal-Mart and say, 'Your deals aren't so great, and you're not offering anything else, so why shouldn't I just go to Wal-Mart?"' said Russell Jones, vice president, retail consulting in the McLean, Va., office of Cap Gemini Ernst & Young. "Consumers, at least in the U.S., believe that if they want low prices, they should go to Wal-Mart."

A Cap Gemini survey conducted late last year revealed that offering fair prices may be far more important to consumers than offering the lowest prices.

The survey, in which Cap Gemini Ernst & Young polled consumers about use of all retail channels, found that consumers ranked fair prices as the fourth most important feature when deciding where to shop.

"I think supermarkets spend way too much time worrying about price," said Jones. "Offering the lowest price is pretty far down the list of the most important things consumers look for."

He cited as an example the success of Richmond, Va.-based Ukrop's, which manages to retain significant market share and customer loyalty by focusing on service and the overall quality of the shopping experience.

"Even though they do some price advertising, clearly everything about the way they operate their stores says other things are more important than price," he said. "They have people to take your groceries to your car, people to answer questions, their stores will be cleaner than most of their competitors, and there's a nice consistency to the feel of most of the departments."

Jones said he thinks price has actually become less important to grocery shoppers because consumers are spending a smaller portion of their income on groceries than they have in the past.

"Compared to 15 to 25 years ago, price was more important because grocers consumed a lot more of your spending dollars," he said.

Pearson of Hy-Vee, which has long competed against a variety of price-oriented formats in its Midwestern markets, said he doesn't foresee any major price wars looming on the horizon.

"If you are wondering about the old-fashioned price wars on commodities, we don't see that happening," he said. "For retailers to survive and be competitive, they have to price competitively across the board."

But if giants like Kroger and Safeway do start getting more aggressive in their pricing, will other retailers start to follow suit?

"That's always the fear," said Adler of Lehman Bros. "This is an industry that has a fair amount of experience beating itself to a pulp."