WELCOME TO THE NEIGHBORHOOD

Elliot Zwiebach

WEST BRIDGEWATER, Mass. -- Shaw's Supermarkets here is betting the store that differentiation will be its key to success against traditional competitors and Wal-Mart Supercenters.

In the past three months Shaw's has opened several stores with distinctive formats: an urban store with a strong perishables offering in downtown Boston; a neighborhood store with a Hispanic flavor in Providence, R.I.; and three fresh stores with expanded nonfood departments in Vermont and Massachusetts. Still to come are a rural-store concept and two or three other formats that Paul T. Gannon, president and chief executive officer, declined to pinpoint during an interview with SN.

"Every company is looking to differentiate itself -- to find points of difference beyond price," Gannon told SN. "Customers are attracted to variety and they like to have an exciting shopping experience, so the more you can do to introduce different elements in your stores, the better off you will be in the long term."

The standard grocery store carries an assortment of 20,000 to 30,000 items, Gannon pointed out, "but there are up to 90,000 items available in the marketplace, and it's those secondary or tertiary items that make the difference and that we want to make available to customers to try to generate and build traffic."

Operating throughout New England, differentiation is a key at the local level, Gannon said. "The differences are not so much state by state -- it's more a matter of market by market, town by town," he explained. "Certain markets are tougher than others in terms of the competitive environment, particularly those in urban settings. But given our size, we don't have to look at groups of stores. Instead, we can treat each store individually."

Shaw's began the process four years ago of finding ways to tailor stores to individual locations in terms of buying, marketing, merchandising, and information and supply-chain systems, Gannon said. "It wasn't simply a matter of putting new store decor in place but of fundamentally tailoring variety, logistics, services and promotions to individual store locations," he explained.

"Over the four years we took a modular approach to store formats. We looked at a lot of market research, demographic data and shopping patterns and used that information to develop product varieties. It's only been in the last six months that we've moved to a higher level by trying to tie those elements together, and we're only just beginning to scratch the surface."

Neighborhood Stores

The first full flowering of its efforts was reflected in the flagship store Shaw's opened in downtown Boston in late April. Called MarketFresh in the City, it's a 40,000-square-foot store that caters to a mix of office workers, tourists and everyday shoppers, and features an extensive offering of fresh and prepared foods, plus expanded space for basic categories like frozen foods, dairy, beverages, cereals and snacks. (See "Store of a Different Shape," Page 13.)

A few weeks later Shaw's opened the first of what it calls its neighborhood stores -- a 65,000-square-foot unit in Providence, R.I., that caters to a Hispanic and Italian clientele, featuring ethnic products from family-owned businesses in the area with large local followings, including Guatemalan and Italian bakeries and a tortilleria. "It has a completely different feel from the [Boston] store, with bulk bins for produce, handwritten price signs and a variety unique to that store," Gannon said.

In late May Shaw's opened the largest store in the chain -- a 73,000-square-foot neighborhood store in South Burlington, Vt., with an extensive perishables offering, an expanded kosher section and a section dedicated to gluten-free foods. The store also features products from local Vermont vendors, including pasta, hot dogs, deli meats and cheese.

"The Burlington store is what we refer to as a core-plus store," Gannon said -- "a fresh store with a larger perishables focus, a power grocery aisle and an expanded assortment of nonfoods, particularly health and beauty care, including a more updated look for the nonfoods sections."

Two more fresh stores opened earlier this month -- a 58,000-square-foot store in Harwich, Mass., and a 68,000-square-foot unit in Marshfield, Mass., both replacement stores.

Over the next two years Shaw's plans to launch three to five new formats, Gannon said, including a rural store format of 50,000 to 60,000 square feet and others that he declined to enumerate.

The initial impetus for Shaw's efforts to tailor its stores to meet the needs of different communities was the tough competitive landscape in New England, Gannon told SN. "We began that effort to strengthen our position against traditional operators like Hannaford, Stop & Shop, Demoulas, Roche Bros., Victory and Big Y."

A year or so into the project, the prospect of Wal-Mart Supercenters entering New England arose, "and we felt if we could differentiate ourselves against the traditional competitors, we'd be in a better position to compete with Wal-Mart," he explained.

Gannon said he believes Shaw's is well positioned against Wal-Mart. "We will tailor our pricing, promotions, service and overall store operations to Wal-Mart, just as we would against any new competitor," he said.

According to Andrew Fowler, securities analyst with the London office of Merrill Lynch, Shaw's neighborhood market approach should work well against Wal-Mart. "Shaw's has already gone down the branding route, with a strong price component, which is OK when you're playing against Stop & Shop but not when you start trading against Wal-Mart," he said. "So Shaw's philosophy now is, since no one can beat Wal-Mart on price, it's going to try to differentiate itself on quality and choice."

Besides tackling Wal-Mart's New England expansion, Shaw's focus going forward will include:

Continuing an aggressive capital spending program as it shifts its attention from remodels to accelerating its new store program.

Seeking acquisitions in geographies adjacent to New England, including a possible move into New York.

Integrating the 17 Ames Department Stores it acquired late last year, including determining how many to keep and how many to spin off.

Shaw's operates as a wholly owned subsidiary of J Sainsbury, London, which has owned controlling shares in the chain since 1987. It operates 190 stores, all in New England, including 88 in Massachusetts, 28 in New Hampshire, 23 in Connecticut, 20 in Maine, 17 in Vermont and 14 in Rhode Island.

Sales for the year ended March 29 rose 1.2% to $4.4 billion -- accounting for about 17% of Sainsbury's sales -- and comparable store sales for the year climbed 0.9%.

Shaw's has a solid No. 2 market share in New England -- approximately 22%, compared with nearly 27% for Ahold's Stop & Shop -- "and that puts Shaw's in a good position now that Stop & Shop is living with a distressed parent," analyst Fowler pointed out. "And it's also in a good position for Shaw's to be in with regard to Wal-Mart because its core store base is in the Boston area, and that will be a difficult area for Wal-Mart Supercenters to penetrate because the cost of real estate is so expensive."

Shaw's repositioned itself between 1996 and 2001 from an everyday-low-price operator to a promotions-oriented high-low company, Gannon said, "by offering promotions that were strong enough that we were able to enjoy good success in making the transition." During that time the company had compounded sales growth of 10% and profit growth of 26%, "so whatever bumps we hit, the impact was small," he explained.

Gannon, 50, has been part of the Shaw's management team since 1990, working successively in the areas of information technology, financing and marketing. He was named president and chief operating officer in April 2002 and added the title of CEO last fall when Ross McLaren retired.

According to Fowler, the relationship between Shaw's and its parent company is probably stronger today than it's been at any time in the past 10 years.

"Historically, Shaw's had been just a little test bed for Sainsbury's investment ambitions in North America," he explained. But issues in the U.K. kept Sainsbury from expanding through further acquisition in the U.S., he added, "and once Sainsbury decided to raise $1 billion by selling Home Base [in the U.K.] rather than Shaw's, it's developed a much closer relationship with Shaw's instead of treating it like a distant cousin."

Cap-Ex Growth

One result has been an influx of capital, Fowler pointed out. "After several years in which Shaw's had to live off a cap-ex budget of $150 million a year, Sainsbury has expressed its greater confidence in Shaw's by putting a lump sum of money behind the business," Fowler said.

Shaw's capital budget, comprised of money from Sainsbury and its own funds, will total $254 million this year, on top of $218 million last year -- the most aggressive investment in Shaw's store network in the company's history.

This year's funds are earmarked for 24 new stores, including 11 replacements, compared with just two new units a year ago; and 16 remodelings or expansions, compared with 32 remodelings in 2002.

According to Gannon, Shaw's is in the second year of a three- to four-year program that will see it remodel, expand or replace 90% of its store network. The program was originally designed as a three-year effort but may take slightly longer following the acquisition in November of the 17 Ames Department Store units, he pointed out.

Six of the Ames stores are in Massachusetts, three each are in Vermont, New Hampshire and Maine, and one each is in Connecticut and Rhode Island.

Gannon said Shaw's does not intend to operate all 17 locations. "Some may be sold for real-estate opportunities," he explained. "We're in the process of negotiating with the landlords to determine which locations might be better suited to drug stores, office supply stores or other retail formats so we can sell some of the leases to those operators."

The Ames units run 50,000 to 75,000 square feet -- larger than the chain's average of 35,000 square feet, Gannon noted, but certainly within the range of stores Shaw's is opening. "The Ames stores are larger than the existing Shaw's stores in the shopping centers in which we both operate, and we will use most of them as replacement units for our stores in those centers," he explained.

Four of this year's replacement stores will be Ames conversions in Dedham, Beverly and Waltham, Mass., and Springfield, Vt.

According to Gannon, most of Shaw's planned growth will be in its existing New England operating area, though the company might be willing to expand into New York, he told SN. "There's not a cliff between New England and New York," he explained, "and the idea of going into New York is something we've considered seriously in the past. So while we see plenty of growth opportunities in New England, we also see some potential in New York as well."

Shaw's is looking for additional acquisitions beyond Ames, Gannon said, though he was reluctant to comment on industry speculation concerning the company's potential interest in Pathmark Stores, Carteret, N.J., as an acquisition target.

Fowler told SN he doubts Sainsbury would be interested in acquiring a company the size of Pathmark. "Shareholders at Sainsbury might be interested in growing Shaw's through the acquisition of some little distressed add-on chain," he said, "but I'd be surprised if Sainsbury felt strong enough from a financial or management standpoint to seek to double Shaw's size by buying Pathmark."

Gannon acknowledged that it would be easier for Shaw's to acquire and integrate companies on the East Coast, "though if an acquisition has the potential to add shareholder value, we would look at anything, anywhere, regardless of geography," he said. "But it's certainly easier to get synergies and better value from a company that's closer to our existing operations, and it makes communication a lot easier."

Shaw's has been actively pursuing growth through acquisition for the last few years, acquiring the 53-store Star Markets chain in 1999 and 19 Grand Union stores in Connecticut and Vermont in 2000 before buying the Ames stores late last year.

Shaw's has a good record on integrating acquisitions successfully, Gannon noted, "because we set our targets pretty high in terms of the acquisitions we go after, and we do a pretty good job assessing the true synergies. We spend a huge amount of time doing that, and we approached Star and Grand Union with a huge amount of up-front planning.

"We also attribute part of our success integrating those stores to the fact that both the Star and Grand Union acquisitions were in Shaw's existing market area. That gave us an advantage over other companies that have conducted acquisitions outside their operating territory."

With Wal-Mart already operating 18 supercenters in New England and with more to come, Shaw's anticipates that some competitors' stores may become available as acquisition candidates in the next few years. "If you look at the last five years, whether it was the influx of supercenters or the economy or the number of strong competitors, a number of acquisition opportunities have presented themselves. This year has been no different, and we expect to see more opportunities in the future, and if they are attractive possibilities, we're always interested," Gannon said.

Competitive Response

Any new square footage in the market -- whether it comes from supercenters, Costco or limited assortment formats operated by Save-A-Lot and Aldi -- presents new challenges, Gannon said. "It forces you to seek ways to build your business and to go after growth in new ways, which is why we've been expanding prepared foods, natural and organic foods, perishables and pharmacies."

Much of Shaw's impetus for acquiring cross-state rival Star five years ago was to gain its expertise in prepared foods from its La Carte sections and its expertise in natural and organic foods from its freestanding Wild Harvest stores, Gannon acknowledged. Besides expanding those sections within its stores, Shaw's has also begun installing pharmacies, he added.

Shaw's operates pharmacies at 60 locations -- only about a third of its store base -- "but that compares with no pharmacies six years ago, so we're proud of having 60," Gannon noted. Pharmacies are now being included in every new store and every remodel or expansion where there's space and no lease restrictions, he said.

Asked how much autonomy Shaw's has, Gannon said, "Sainsbury looks at our long-term return-on-capital and profitability. We set targets for sales and operating profit, and we're expected to meet those goals, and as long as we do, we have a fair degree of autonomy."

Fowler said he believes Shaw's has less autonomy than it did 10 years ago when Sainsbury was less committed to its U.S. operation. "More recently Sainsbury has gripped Shaw's from a management point-of-view, and as a result most of Shaw's programs are in line with Sainsbury's in terms of strong supply chains and systems bases."

Fowler also said he sees few synergies between the two companies. "There are certainly no buying synergies, though each probably learns a little from the other about how to display fresh foods," Fowler said.

Asked about synergies, Gannon told SN, "The biggest synergies have come from strategizing because Sainsbury is in a marketplace in the United Kingdom with large, well-capitalized competitors, just as we are. So they operate at a high level, and we've been able to benefit from their thinking and strategizing to our advantage."