A Matter of Cents

CHRISTINA VEIDERS

As long as the nation's economy stays in dire straits, savings on fuel and food will remain a critical rallying point for supermarket chains in 2009.

Despite an 11-cent jump in the second week of January of the national average retail price to $1.78 a gallon for regular gasoline, food retailers can expect relatively low gas prices this year compared to last year's price escalation to over $4 a gallon.

The Energy Information Administration's short-term energy outlook as of Jan. 13, 2009, predicted regular gasoline in 2009 to stabilized at an average annual price of $1.87 per gallon given a fragile economy and lower projected crude oil prices.

The retail price of gasoline is about the only indicator that has risen recently.

“Whether it's retail sales, manufacturing — all of the indicators show that we are in the worst recession since the Great Depression,” said President-elect Barack Obama in a recent interview with ABC News, and he acknowledged it will take time to fix.

Most troubling was the loss of 524,000 jobs in December, bringing unemployment to 7.2%, the highest rate since 1993, according to the Bureau of Labor Statistics.

These continued economic pressures are putting a clamp on consumer spending and adding extra pressure on retail fuel prices and retailers' investment in fuel promotions.

When consumers faced record-high retail gas prices last year, supermarkets were quick to revive their fuel promotion programs as a defense to Wal-Mart's Operation Main Street initiative, designed to help consumers save on necessities, and to the lure of other alternative formats' low gas prices. But now that retail fuel prices have dropped by 56% from last July's high of $4.11 per gallon, the question remains whether supermarkets will pull back on fuel rewards or scale them down in an effort to recoup lost margin.

There was some indication that retailers were attempting to adjust their fuel rewards earlier this month when Ukrop's Super Markets, Richmond, Va., cut back its fuel incentive from 10 cents for every $50 spent in the store to 5 cents. Bigg's, an 11-store hypermarket division of Supervalu, Eden Prairie, Minn., launched a fuel incentive in Cincinnati offering 1 cent off per gallon for every $10 spent in the store or 5 cents with $50 spent. For many retailers, the standard offer has been 10 cents off with a $50 purchase.

Spartan Stores, Grand Rapids, Mich., which has been offering a 10 cents with $50 purchase reward, ran a temporary gas reward offering fuel for 99 cents a gallon with a $100 grocery store purchase at D&W and Family Fare stores, Jan. 4-6.

The economics of fuel retailing could be playing into these adjustments as retailers evaluate their margins, which ironically are lower when gas retails are high. This is often because of consumer price resistance and intense retail competition at the pump that makes it difficult for retailers to adjust prices upward with the rise in the wholesale price. Conversely, when the wholesale price falls, there is often a lag before retail prices come down, as retailers try to recoup margins by slowly lowering their prices.

In the current economic environment, the normal rule does not apply, though, said Gary Giblen, executive vice president, Goldsmith & Harris, New York. “The consumer is desperate and strapped. Gas retailers realize the consumer mindset and are just passing the lower fuel costs on immediately,” he said. However, this strategy hurts the overall business, which needs profits to meet fixed costs, which do not fluctuate.

If the lower wholesale cost is being passed on cent for cent, it may impact retailers' fuel promotional offers, Giblen said. With gasoline margins being at the low end of 7 cents to 9 cents a gallon, Giblen said, retailers may have a hard time sustaining fuel incentives, and they could reduce the benefit, just as airlines increased mileage reward levels for frequent fliers.

He added that generally, the goal for supermarkets is not to use gasoline as a loss leader, but to make some profit, even though it's small.

“Fuel perks are still a good idea,” Giblen said, “because gasoline is such a highly visible price product for the consumer. However, retailers might have to adjust the magnitude of their discounts.”

More guidance of the margin squeeze comes from California, where Ed Weller, managing director at ThinkEquity Partners, San Francisco, in a report said that “lower gas prices will reduce Costco's U.S. comps by more than 4% [for the month of December] without the benefit of improved gas profitability, it seems.” While gas prices fell nationally from Dec. 15-22, California prices rose 7 cents due to increased refinery costs, even though crude prices were down.

According to Weller, “California's unbranded retailers' margins went more negative … and were probably poor for Costco, too.” He pointed out that for the first four week's of Costco's current quarter, ending in mid-February, the average price per gallon was about 45% lower than last year, resulting in 9 cents per gallon profit, compared with 18 cents in the prior year.

Costco and Wal-Mart don't offer fuel promotions. Instead, they offer several cents off a gallon through the use of their store-branded credit and debit cards.

Industry consultants don't see supermarkets scaling back their fuel rewards in a recession.

“When we didn't have incentives, one never thought about the connection between gasoline as a consumable and other food in the mix. Now we are getting promotions from the pump to the store and the store to the pump. We crossed a line where gas is now regarded as a consumable product, so in that sense it is important and now part of the set,” said Bill Bishop, chairman, Willard Bishop, Barrington, Ill.

Kelly Hlavinka, a partner with Cincinnati-based Colloquy, which covers the loyalty marketing industry, said she believes that over the short term not much will change as far as supermarkets' fuel rewards go. “Consumers are incredibly worried about what the future holds, and their ability to stretch the dollar as far as they used to. It's hard to argue the effectiveness of these programs given the economic times we are in,” she said.

While marketers are enjoying the sales benefits from the first wave of fuel rewards, smart marketers should start preparing for the second phase, when the economy starts to improve, Hlavinka said. “Is a couple of cents off per gallon going to remain compelling over the long term, especially when fuel promotions are so easily copied?” she asked.

Supermarkets should be better prepared to compete against Wal-Mart with a message that is not just about price, she added. “Differentiate from that message, with one that sets me apart and engages customers' minds beyond just dollars off with something more aspirational,” Hlavinka said.

Bishop said the economy has led Wal-Mart to broaden its message from one of price difference per item to how much the consumer can save over the course of a year. “People are looking at different ways of communicating price. I think more emphasis is on the impact of income vs. impact of price.” Relating this idea to fuel, Bishop said that when the price of gas is under $2 a gallon, it doesn't have as much impact. But the annualized savings from a fuel rewards programs could be more impressive to the consumer.

“There is a huge focus today on communicating price and value. Every source of leverage has to be thought out more carefully and aggressively,” he said.