THE PACE SETTERS 2002

Five food-distribution companies have forever changed the map of food retailing. What distinguishes these companies from each other is the innovative and sometimes risky strategies they are pursuing to accomplish their market gains, often at the expense of conventional food retailers.

at has changed the retail food industry forever.

Ahold USA, whose aggressive move into food service could provide significant synergies in its retail-food operations.

Fleming, which is broadening its customer base to encompass a wider variety of formats. Costco Wholesale Corp., which constantly experiments with a variety of products to keep the excitement level high in its warehouses.

7-Eleven, which is seeking to upgrade its image with consumers by adding more fresh products at the same time it's lowering its pricing levels.

Wal-Mart's Power Through Efficiency

Wal-Mart Stores' supercenters, Bentonville, Ark., has been changing food retailing for years, "but that impact has been cumulative, and it's now exploding because of the sheer number of supercenters," Gary Giblen, senior vice president and director of research for C L King Associates, New York, told SN.

"Wal-Mart transformed the industry by shifting the whole matter of procurement from regional to national deals, and that caused the chains to consolidate to achieve quasi-national scale or, in the case of Ahold or Delhaize, international scale, so they could all become more cost-efficient.

"Supercenters were always a powerful format, but for years Wal-Mart lacked food execution. It didn't have enough of a base and most consumers didn't put that much store in supercenters, which were attractive primarily to a blue-collar, cost-conscious clientele.

"But now that Wal-Mart supercenters have proliferated to more than 1,000 units, and now that their food execution has improved, more customers from all demographic groups are finding the stores attractive. When there were only a few, supermarkets could use zone-pricing against them, but now that they're everyplace, supermarkets have had to lower their cost structures or die.

"And getting into self-distribution made Wal-Mart even more cost-competitive."

Looking ahead, Giblen said Wal-Mart supercenters are likely to cause further industry consolidation "and further untimely demises, with astonishing rapidity, as we've seen when the bottom fell out of Winn-Dixie and when Kroger lowered gross expectations recently."

He said most short-term consolidation is likely to involve regional players. "At some point, companies like Publix or Wegmans will begin to be proactive in seeking merger partners, or else they could end up like Furr's, which had a high market share but perished in the face of Wal-Mart's expansion in the Southwest."

Ahold's Food-Service Diversification

Ahold USA Foodservice, Chantilly, Va., has welded together the second-, third- and fourth-largest food-service players in the United States into a powerful operation that has the potential to expand rapidly in the decade ahead, analysts said.

Juergen Elfers, an analyst with Commerzbank AG, Frankfurt, Germany, said food service represents the strongest growth segment in the U.S. food industry, "with growth being mainly volume-driven rather than price-driven."

Ahold is well-positioned to benefit from that growth, he noted, "as the boundaries between grocery retailing and food service become increasingly blurred, reaching a point at which distinguishing between the two will appear meaningless."

Elfers said food service accounts for about 52% of "share of stomach" in the United States, with expectations that figure will rise to 58% by the end of the decade. In fact, while industry growth has declined in the wake of Sept. 11, Ahold's U.S. Foodservice operation grew organically by 4%, Elfers pointed out.

Deborah Weinswig, an analyst with Bear Stearns, New York, said the acquisition of Alliant late last year gave Ahold food-service distribution across 95% of the United States.

"U.S. Foodservice principally operates in the Southeast and Northeast, while Alliant's geographic presence expands the company's penetration to the Midwest and Western U.S., allowing Ahold to have nationwide food-service distribution and realize significant synergies due to its increased scale -- $70 million this year and $120 million within two years," Weinswig said.

"The addition of Alliant will also allow Ahold to gain significant purchasing efficiencies, which should drive margin improvements," she added.

However, Ahold has yet to realize many synergies between its food-service and retail operations, Giblen pointed out. "Ahold got into food service as a different way to expand in the U.S. because of limits by the Federal Trade Commission on retail acquisitions -- and because it was already involved in food service in Europe," he said.

"As it gets more into seeking out synergies between its two U.S. businesses, it will do better in its in-store delicatessens, with better knowledge of handling and a better quality of items," Giblen said. "And for its upscale stores in particular, having restaurant-quality food service might be a good sales booster."

Fleming Expands to Nontraditional Segments

Fleming, Dallas, is evolving into a new type of food distributor that seeks to supply all outlets that sell food, not just conventional supermarket operators.

That approach was made quite clear a year and a half ago when it opted to take on all of Kmart's supercenter business and a portion of Target's supercenter volume as well -- at about the same time it began selling off its conventional corporate stores to concentrate on price-impact warehouse models.

According to Weinswig, Fleming is an industry leader "in its ability to service nontraditional segments -- including supercenters, convenience stores, discount stores and drug retailers -- which boast double-digit sales growth. And by increasing distribution to Kmart and Target, Fleming has reduced traditional supermarkets as a percentage of distribution revenues from 73% in 1998 to an estimated run-rate of 42% in 2001.

"The divestiture of all traditional retail stores and the move to the price-impact format has been successful in boosting comparable-store sales growth [upward], compared with a negative a year earlier -- levels that are impressive considering the relatively small proportion of sales from pharmacy and gasoline, which typically inflate growth numbers."

"Longer term, the move to serve Kmart will prove a positive one as it provides the scale necessary to generate significant buying power through vendor partners and source general merchandise for Fleming," Weinswig said.

Jonathan Ziegler, San Francisco-based managing director of Deutsche Banc Alex. Brown, New York, pointed out the risks Fleming is taking with its approach. "It's always a risk when a supplier gets so involved with a single customer," he noted.

"And it is also a risk to its relationship with smaller retailers, though Fleming says it has educated those retailers that bringing in Kmart's business will enable Fleming to buy better and give better pricing to all its customers."

Selling off its conventional stores to focus on growth concepts like warehouse stores and limited-assortment stores was also a risk, Ziegler said. "But it did a good job selling the conventional stores, and it's moving ahead gradually on rolling out Yes! Less! [limited-assortment] stores to reduce the risk.

"But if it didn't do anything, there wouldn't be any risk."

Costco's Wow Appeal

Costco, Issaquah, Wash., is "a very adventuresome company," Ziegler told SN.

"It's always bringing in new merchandise and taking a variety of well-educated risks to get customers excited," he said, including seeking out more expensive real estate that has the potential to produce higher volume.

"That led Costco to open seven or eight clubs three years ago in Atlanta, which was a market that had previously been left exclusively to Sam's Clubs, and that move went so well for Costco that it has subsequently challenged Sam's in other new markets, including Detroit, Chicago, Philadelphia and Texas."

Other risks Costco has taken over the years include adding in-store pharmacies, fuel centers and an executive membership program for professional members that requires higher fees but offers greater services, Ziegler said. In addition, the company has tested a "food factory" at a Seattle store where members can watch products being prepared for sale, including seeing water and orange juice being bottled, coffee roasted and tacos being made, he said.

Costco has also experimented at smaller locations with business-only warehouses that offer large packages for resale only, Ziegler pointed out.

Giblen said Costco "has set the gold standard for club execution of perishables, and it's raised the bar for supermarkets to do a better job than Costco is doing. Because if customers can save money and get good fresh foods at Costco, it's a strong combination."

According to Weinswig, "Costco is always trying to have a unique offering in its stores. The 'food factory' is one example that was designed as a way to make the shopping experience more fun, and I think the company plans to expand pieces of that concept. And there's a store in Seattle that's tested a doughnut factory, which may be too capital-intensive to expand but it shows the company is willing to try different things regardless of the investment."

In perishables, there's always a risk of over-ordering, Weinswig pointed out, which makes Costco's twice-a-year fresh seafood fair a risky undertaking.

"Costco is extraordinarily innovative -- and seeking to create a treasure hunt atmosphere when the majority of your sales are in consumables is pretty impressive," said Weinswig.

7-Eleven's Dashboard Features

7-Eleven, Dallas, is changing food retailing by attempting to make the convenience store a more formidable competitor to other food formats.

One of 7-Eleven's strategies has been creating "dashboard dining" items -- edible products designed to fit into a car's cup holder -- Ziegler said. "7-Eleven is constantly working with vendors to design products specifically for customers -- products that you can eat with one hand while you drive with the other," he explained. "Then they cull out what doesn't work and keep the items that do work."

The company's successes have included Slurpees, cafe coolers -- "a reasonable alternative to Starbuck's," Ziegler said -- and a variety of heat-and-eat items like frozen burritos.

In addition, 7-Eleven is trying to improve its merchandise mix to get customers back into its stores more frequently, Ziegler said.

The product risks 7-Eleven takes is part of its basic strategy, Weinswig said. "That's how it differentiates itself," she explained. "It presents new product ideas to a manufacturer and has them develop it, then it has exclusive rights to that product for six months or so."

According to Giblen, 7-Eleven continues to be an innovator in fresh foods. "It's trying to create a convenience store that's more than just a convenience store -- more than just a pit stop," he explained. "It's really trying to provide fresh food in a nice ambience -- to become a neighborhood center to augment of what a c-store is."

SN's Special Report on Top 75:

Wal-Mart lengthens its lead with Sam's ClubPage 18

Top 75 chart and rankings include Club stores and 7-ElevenPage 20

Top 20 market leaders in U.S. food salesPage 28