TRAFFIC COURTING

MARK TOSH

TROY, Mich. -- Attention supermarket operators: Kmart is getting more aggressive in the grocery aisle.

As part of a wide-ranging redesign of its traditional discount units, Kmart Corp. has added 1,500 grocery stockkeeping units in a new department called "The Pantry," and plans to promote the area with hot prices on a select few items each week as a means of driving customer traffic through the rest of the store. The total grocery SKUs in the stores now are between 5,000 and 5,500.

The strategy isn't new at Kmart -- having been first tested and refined at a handful of stores in Fort Wayne, Ind., beginning about 18 months ago -- but the chain expects to accelerate the conversion of traditional discount stores to the new format beginning this year.

The hope is that the new design can increase sales per square foot to industry standards for a company that has faced major financial problems in the last few years.

To date, about 186 stores have been converted to the format, which Kmart calls its "high-frequency strategy," and an additional 450 units are expected to get a makeover using the new design by the end of the current fiscal year. The first batch of 1997 conversions should be completed by April.

The primary markets for this year's remodeling efforts are Los Angeles, Chicago and Detroit, but select stores in other markets, notably parts of New Jersey, Pennsylvania and other Northeastern states, are slated to be overhauled, too. Last year, Kmart remodeled 100-plus stores in markets such as the Baltimore-Washington corridor; Miami; Tampa-St. Petersburg, Fla.; the Carolinas; and northern New Jersey.

Each store conversion costs about $600,000, according to Shawn Kahle, Kmart's vice president of corporate affairs. In addition to a new layout, the new Kmart format focuses on three distinct merchandise areas: home fashions; Kids' World -- which includes children's apparel and toys -- and The Pantry.

Indeed, Kmart officials stress that the high-frequency format is broader than just a new low-margin grocery department, and should not be viewed as a supermarket competitor. Rather, it's a new version of the traditional discount store with selected groceries added as a "convenience" for time-pressed shoppers.

"The notion we like to communicate in terms of the high-frequency stores is that it's not just consumables," Kahle said, noting that home fashion and apparel assortments have been upgraded as well. "It's a whole new store format. You have to look at it as a complete picture."

So far, the remodeled Kmart stores are meeting or exceeding expectations, with same-store sales rising in the double-digit range and profit margins up, but to a lesser degree. "We've been very pleased with both their sales and profitability performance," Kahle said. "We're seeing gains in overall performance in categories -- not just in The Pantry -- of upwards of 15%, and in some instances much more than that. Those kinds of sales increases, obviously, are helping the stores achieve improvements in profitability, especially in some of the categories that are key to the conversion, such as home fashions."

In the The Pantry, the grocery and consumables area, Kahle said the remodeled stores are showing "very nice and very significant improvements," but she declined to specify the gains.

The new, 7,000-square-foot pantry area covers about six aisles near the front center of the store, or about 6% to 8% of the selling area, and is adjacent to the in-store pharmacy and health-and-beauty area. It stocks some standard fare, like snacks and soft drinks, as well as new grocery-type SKUs, like dry and canned goods, bread and a limited-assortment dairy.

The new program is being supplied by a combination of local and regional wholesalers, including both Minneapolis-based Supervalu and Oklahoma City-based Fleming Cos.

G. William Gryson, vice president of special projects at Kmart, told reporters he believes the remodeled stores set Kmart above the typical Wal-Mart discount store.

'We're much wider open to the customer and our pantry operation is entirely different than anything Wal-Mart has done and Target, also," he told reporters during a store tour in Gaithersburg, Md., last year. "The layout, with the adjacencies of commodities next to home fashions, is unique to the discount industry."

Each grocery aisle is capped with a hot-price special, such as Campbell's tomato soup at three cans for $1 or Instant Quaker Oatmeal at two boxes for $5. Soft drinks and snacks also are often heavily promoted. In areas where Kmart operates high-frequency stores, the pantry specials are advertised on a special half-page "wrap" around its weekly sales flyer.

Gryson said the goal is to price competitively with supermarkets, but "not start a price war. That's not Kmart's strategy. But the customers will get a good price for the product."

Given this type of promotional stance, supermarket operators, who often are located in the same strip shopping center as the remodeled Kmarts, have had to pay close attention to the new pantry departments. Some report a slight negative impact on their own sales.

"I don't know whether they're having success or not, but the format seems to be carefully planned and developed, and reasonably well executed," one executive at a small chain in the upper Midwest said. He said it's clear Kmart has "made something of a commitment to it" and is likely achieving, at a minimum, the expected results.

"It's obviously a price-image, traffic-builder kind of thing," he added. "They're not doing this to create a cash cow. The disconcerting thing, of course, is that it would force us to rethink some of our strategies if they begin to have a major impact."

Eventually, Kmart expects to roll out the new format to its entire chain of 2,035 discount stores as part of a plan to improve profitability and become more competitive with Wal-Mart Stores, Bentonville, Ark., the nation's largest retailer and chief Kmart competitor. Kmart has been losing sales and market share to both Wal-Mart and Target, the third-largest discount chain, for the past few years and desperately needs to make its store base more productive than the current sales level of about $200 per square foot.

Unlike Wal-Mart, which is investing heavily in the supercenter format, with plans to roll out 100-plus a year, Kmart has cut back capital spending recently to focus on improving its existing operations. The discounter also completed a $3.7 billion refinancing effort early last year, easing some of the concerns about the chain's financial stability.

The high-frequency strategy will not affect Kmart's supercenter operations. The chain currently operates about 100 supercenters, which are known as Super Kmart Centers, and four new supercenters are planned for this year.

"We're going to make every effort that we can to further enhance the sales and profitability of those supercenters we have in operation currently," Kahle said. "We are going to use our capital in a more conservative way in 1997, but would expect that in 1998 we would be making greater investments in Super K because we do identify Super K still as a very important growth vehicle for us."

An executive at a wholesaler in the Midwest said he believes the new high-frequency format gives Kmart "a twist to its operation that's not too complex in terms of implementing" and that the strategy bears watching. Kmart will likely continue to refine it so that "two years from now it probably won't be what it is today," he added.

One shortcoming, however, is that as it now stands, The Pantry doesn't have a large enough assortment to be a one-stop shopping trip for groceries, the executive said. Customers are usually reluctant, especially in times of economic prosperity, to split their shopping trips between stores.

"This is always an evolving industry and I think that's true more so today than ever before," the Midwest executive said. "There's a blurring of the lines in terms of where customers think they have to buy things. That's one thing you have to bear in mind. Customers are not locked in with a traditional type of thinking like they used to be."

Another executive at a chain in the Northeast said he doesn't believe Kmart has faced some of the typical challenges associated with operating a supermarket, like keeping in stock and handling all the new-item introductions from major manufacturers.

"Kmart is still in the honeymoon phase," the executive said. "New sizes, shapes and flavors are coming out all the time. When they start seeing those challenges, they may have a different view."

On Wall Street, some securities analysts noted that Kmart has chosen initially to convert stores that either don't compete against top Wal-Mart or Target units, are underperforming the company average or are most in need of renovation, which almost guarantees a short-term sales boost and a quick return on investment.

However, at the store tour last year, Gryson said the remodeled stores' performance has exceeded the improvements that typically accompany a remodeling project. '

'Obviously, the fact that we've have added the pantry and the commodities is driving traffic in the store and giving us a lift in the other departments," he said at the time.

Analysts also wonder whether Kmart isn't being "cherry-picked" for its heavily promoted items without getting the benefit of "brush-off business" in the other, higher-margin areas of the store, which is key to the success and profitability of the strategy.

But Kmart officials say the crossover shopping strategy works.

"We're seeing a crossover so once the high-frequency format is put in, those other frequently shopped departments like children's and home fashions are showing gains upwards of 15% on average," Kahle said.

She also noted that there is a shopper -- the young woman with a family -- that every retailer wants to attract. Kmart's goal is to encourage that shopper to make more frequent visits to its stores by, in part, offering strong assortments in home fashions and women's and children's apparel in combination with low prices on selected grocery items.

Rick Church, a securities analyst at Smith Barney, New York, said he believes it's "still a bit too early to call" whether the format will be successful.

"I think that in some instances they've been able to show some improvement," he explained. "But it's difficult to really discern whether it's because of the format per se, or whether just by spending more capital dollars and renovating the store Kmart has stimulated more sales."

Still, Church said he believes Kmart is deriving some benefit from the capital dollars invested in the new format.

"By the same token, the other unknown now is what will happen when they start competing more directly over time with supercenters," he added. "What's going to happen to this high-frequency format? That's the unknown."

"I hear it's doing well," said David Poneman, a securities analyst at Sanford Bernstein, New York. "I think it's hard to argue with the numbers. If they're getting increases in traffic, it sounds like the format is constructive."

Told that Kmart was downplaying the significance of the new pantry area in its discount stores, the Northeast chain executive scoffed at the notion.

"Do people think of Kmart as a supermarket?," he asked. " No, people still think of Kmart as a discount department store. But by adding various grocery categories that they didn't have before and consolidating it in one place, they give a much stronger supermarket look to their discount department store. That's a fact."