Supermarket Smackdown

By Julie Rawe

Cocky. Ruthless. Vicious. Mean. Those are some of the ways Jerry Davis, CEO of Affiliated Foods Southwest, describes the supermarket juggernaut that is Wal-Mart. He could have added hyperefficient, low cost and customer focused. The megachain's rapidly expanding grocery business--which now accounts for a fifth of U.S. food sales--has left a trail of shuttered supermarkets in its wake. This year in particular, the damage is piling up. Winn-Dixie, once a Southern power, suspended its dividend indefinitely, causing its stock to drop 28% in January, and is expected to close more than a hundred stores. This comes on the heels of Fleming Cos.' liquidation last summer of what had been the second biggest grocery wholesaling business in the country. But even excluding that particular flameout, the industry has lost more than 50% of its market value in the past five years. "The people at Wal-Mart don't want some of the business," Davis seethes in Little Rock, Ark., where his wholesaling cooperative supplies 50 supermarkets and some 600 convenience stores in and around Arkansas. "They want all of it."

Blaming Wal-Mart is a common industry response, but it's also misguided. The grocers have contributed enormously to their own problems. Their inefficient supply chain, for instance, provided Wal-Mart with a golden opportunity. And their initial response to the new threat was fairly myopic. Like too many of his fellow grocers, Davis thought getting bigger himself would make things better. Before Wal-Mart, he says, "we tried to limit our distance from our warehouses to 300 miles. Now we're going 500 miles" to reach stores as far as the Gulf Coast. Kroger, Albertson's and Safeway each went on an acquisition spree a few years ago, but whatever savings that resulted from centralizing operations have been offset by the obliteration of local ties and customer service. And Albertson's isn't finished. The company (2003 sales: $35.4 billion) just bought New England's Shaw's from old England's J Sainsbury for nearly $2.5 billion. Apparently, the British have had it with the colonies' low ROI.

"There really is a crisis in the industry," says Gary Giblen, head analyst at boutique Manhattan research firm CL King & Associates. The sky started falling--along with same-store sales--in 2001, as alienated shoppers began steering their grocery carts not only toward Wal-Mart's food-laden Supercenters but also toward warehouse clubs, discount chains, drugstores, dollar stores and, on the high end, trendy salutes to organic produce. "Conventional supermarkets really have no reason to exist anymore," says Giblen. "They're basically becoming convenience stores."

The big national chains are undergoing a massive restructuring that will determine which among them survive. "We've made a few mistakes," concedes Safeway CEO Steve Burd, who was the industry darling for years until his cost-cutting skills sucked the life out of recent acquisitions, including Dominick's in Chicago and Genuardi's in Philadelphia. Revenues at the 1,800-store chain edged up 2%, to $35.6 billion last year, as the company logged $170 million in losses. With several big pension funds calling for his head, Burd embarked on a two-week road show last month to convince investors that his performance (Safeway's share price has dropped nearly 60% from 1999) is at least on par with his peers'. He also maintains that his tough stance on labor negotiations--which resulted in a strike in Southern California that cost the region's big three chains some $350 million in earnings last quarter--won enough concessions to stay competitive, even after Wal-Mart unleashes its Supercenters in the area. The next step, experts agree, is to continue narrowing the price gap with the world's largest retailer and find a way to justify the remaining premium. Here's what supermarkets need to do to avoid the ultimate checkout:

DIFFERENTIATE OR DIE

After Wal-Mart launched its Supercenter format in 1991, it took the company three years to reach $1 billion in annual U.S. grocery sales. But a mere decade later, it is topping $100 billion a year, which is almost as much as the sales of the next three biggest chains combined. "To a certain extent, Wal-Mart's strength is more of a reflection of the lack of difference among stores," says Willard Bishop, a supermarket consultant in Barrington, Ill. Conventional grocers are starting to get the message--differentiate or die--which is why some are jazzing up the old big-box routine. The northeastern Wegmans chain just opened its first store in Virginia, where it is spicing up its prepared-foods sections with daily cooking demonstrations. In Indiana, Marsh opened two stores this winter that have circular layouts. Each store has a central cafe with European-style markets on the perimeter showcasing, for example, artisanal cheeses in one room and baby food and supplies in another. And sticking with the old retail-is-detail adage, Marsh pipes mellow guitar instrumentals not only into the stores but also into the parking lots and faux-stone bathrooms.

The mood seems to work. "There's something about this place that isn't in-your-face stimulating," says Cathy Beerbower, 45, who frequents the new Marsh store in Fort Wayne, Ind. And her reason for avoiding the local Wal-Mart--"it's too chaotic"--could be the industry's salvation. Kroger is trying to emulate the swanky Whole Foods scene in a few of its 2,500 stores by adding in-store chefs, gourmet meals and upscale wines. Likewise, Safeway, which is making a huge push into quality perishables in general and prepared foods in particular, is doing so with new woodlike floors and softer lighting. "The feedback we're getting from consumers is that it's just a less stressful place to be," Burd says of the new look.

Meanwhile, Albertson's 2,300 stores hope to reel in customers with the power of other retail brands. Its new store-within-a-store concept has carved out space not only for its well-known pharmacy, Osco, but for 1,900 Toys "R" Us alcoves, 1,000 Krispy Kreme nooks, some 300 Starbucks cafes and a dozen or so Office Depot sections. "We're really just trying to maximize choice," says Bob Dunst, Albertson's chief technology officer. That impulse helps explain why his company--along with several others, including Kroger, Marsh and H-E-B--is hedging its bets via multiple store brands that cater variously to upscale, discount and ethnic shoppers. Some supermarkets have even been installing gas stations in their parking lots to bring in more traffic.

HANDLE THE UNIONS

Labor unions have represented workers at big chains like Safeway since supermarkets first appeared in the 1930s, but their inability to crack Wal-Mart leaves the chains' employers at a wage disadvantage they can't abide. Something has got to give, so Burd's most formidable target is labor, which accounts for 68% of Safeway's budget. According to consulting firm Retail Forward, Wal-Mart's labor costs are 25% to 30% less than the big unionized chains', which contributes to prices that are 15% lower.

Knowing that Wal-Mart plans to open 40 Supercenters in California in the next five years, Burd, who took the helm at Safeway in 1993 and has been lauded for trimming bloated costs, played hardball during regional negotiations with the United Food and Commercial Workers (UFCW) union last fall. After its workers went on strike on Oct. 11, Albertson's and Kroger subsidiary Ralphs locked out their UFCW employees. Five grueling months later, the UFCW agreed to a two-tier plan that pays new hires less and requires them to contribute more for health care. "It still leaves [existing employees] with the highest wages, the highest health-care plan and the highest pension benefits in all of retail," says Burd. The tactic may have helped the company reach a settlement recently, without a strike, in and around the Washington-Baltimore area, another UFCW stronghold. Since a hostile work force won't help bring in new customers, Safeway wisely created a multimillion-dollar hardship fund to provide financial grants to employees who fell behind on their house, car or other payments during the strike.

Albertson's, which is giving its employees $10 million in strike-ratification bonuses, is taking other preventive measures by outsourcing some of its customer service to a new call center in Utah and reducing the overall need for checkers, hostile or otherwise. The company has installed 1,800 self-checkout aisles and plans to reach a total of 5,000 by fall. It is also using the Dallas--Fort Worth market to test a shop-and-scan technology, similar to Speedpass, that obviates the need even to go through a checkout aisle.

At Meijer, the Michigan retailer that invented the supercenter way back in 1962, the top brass would no doubt argue against such a strategy. Sales plummeted at the company when Wal-Mart started moving into its strongholds a few years ago. "They sold everything we sold and ran promotions that we could not match," says Jim Jensen, 46, who was managing a 209,000-sq.-ft. Meijer in Howell, Mich., when a Wal-Mart moved in across the street in 2000. Jensen responded with six-hour price specials, supersales and coupons galore, and when those initiatives failed to pull the store out of its death spiral, he got employees to start offering product demonstrations in every department, including fashion shows. It took a full 12 months for sales to climb back to pre-Wal-Mart levels, and, says Jensen, the most successful measure that year was also the simplest: "Talking to people, making them feel at home."

STREAMLINE OPERATIONS

For years the supermarket industry viewed its 1% net profit margin as a badge of its efficiency. In reality, the opposite was true: the grocers earned so little because they weren't that good at managing the supply chain. Wal-Mart exploited that weakness with devastating effect on the grocers, and it has forced food suppliers to become more efficient too. For starters, the leviathan has changed the way grocery stores deal with their vendors, as everyone seeks to copy its Retail Link system, which provides real-time sales data to manufacturers. Wal-Mart also helped persuade the pack to subscribe to UCCnet's data-synchronization service, which, by cutting back on invoice errors, should save companies $1 million for every $1 billion in sales, according to a study by A.T. Kearney.

But perhaps Wal-Mart's greatest industry legacy will be helping supermarkets wean themselves from a slew of so-called vendor allowances, which suppliers pay to cover everything from how an item is promoted to how much shelf space it gets to how much of it is sold. These allowances have little to do with consumers and add complexity to operations. Yet the industry has relied on them for profits--instead of, say, finding and selling the stuff that shoppers really want. Grocery manufacturers, who have leaned on the allowance system to help launch new products and unload unpopular ones, were forced to shift gears because Wal-Mart forgoes all allowances and simply negotiates--famously and ferociously--for a lower total price, or dead net cost.

Since then, Albertson's and other big chains have publicly vowed to follow suit. Safeway, for instance, has gone dead net with a few vendors but admits that the evolution is slow because it takes so long to sift through years' worth of byzantine allowances in order to compute--and compare--dead net. "It's a little bit like translating some ancient scrolls that you might find in the Dead Sea that are in a language that you don't know," Burd told analysts. It's an honest--and stunning--admission that Safeway doesn't know what its true costs are.

But even with the advent of dead net cost, supermarkets will never be able to go head to head with Wal-Mart on the price of every item. "That way lies madness," as one Wall Street analyst put it. The only viable alternative is to narrow the perceived price gap by bringing down the cost of a select group of products that customers are prone to use when comparing prices. "The art is knowing which items," says Bishop, who for a fee lets clients in on the secret.

KEEP CUSTOMERS LOYAL

The new variable in this food war is that customer loyalty is either dead or very much divided. Last year Stephen Hoch, a professor at the University of Pennsylvania's Wharton School, published a two-year study of Chicago-area shoppers that showed 73% of consumers regularly bought grocery items at two or more stores. And cherry picking isn't just a metropolitan phenomenon. In Racine, Wis., for example, special-education teacher Stacey Goetz, 26, routinely treks to Sam's Club for meat, Aldi for dairy products and a health-food store for oat flour and sugar-free waffles. In between these trips, she scours supermarket flyers for good deals.

Despite this trend, the industry is still banking on the notion of good old-fashioned customer inertia. "For consumers that are not pure price or niche driven, location is the No. 1 reason for choosing one retailer over another," says Burd. "We have hundreds of locations that retailers would refer to as Main and Main."

It's no surprise, then, that Wal-Mart isn't content to stick with giant stores on the outskirts of town. For the past five years, it has been tinkering with a smaller Neighborhood Market that is designed to penetrate urban centers and, says Burt Flickinger III, managing director of New York City's Strategic Resources Group, "occupy the empty stores of bankrupt supermarkets."

This means that even as the big chains are scrambling to compete, they all know that Wal-Mart is just getting started. "We could be so much better than we are," Wal-Mart CEO Lee Scott told TIME. "We are not as good in food as we need to be yet, so there's a lot of upside." He rattles off expansion plans for the company's Supercenters, Sam's Clubs and Neighborhood Markets and notes that even in the Wal-Marts that aren't adding perishable sections, the plan is to sell more food. In other words, the grocery wars are just beginning. "You will see it on all fronts," Scott says, "in all the things we do, food will be a key part of it." --With reporting by Steve Barnes/Little Rock, Elizabeth Coady/Fort Wayne and Stefanie Friedhoff/Howell

With reporting by Steve Barnes/Little Rock, Elizabeth Coady/Fort Wayne and Stefanie Friedhoff/Howell