Monday, April 22, 2002

Wal-Mart closing in on Kroger

Projections show sales heading for supercenters

By James McNair
The Cincinnati Enquirer

        AURORA, Ind. — Within an hour's drive of Kroger Co.'s headquarters, the implacable Borg of retailing is making its presence known.

        Like the relentless, cube-shaped entity from Star Trek, Wal-Mart is marching into an industry — and a market — that Kroger has ruled for years. Its Wal-Mart Supercenter, perched above the steady traffic on U.S. 50, represents a threat unlike any Kroger has ever faced.

        The massive store here sells the usual discount goods, but also has a large garden shop, a pharmacy, a hardware section, a vision center, a photo counter, tire and lube bays and a small McDonald's. But the part that concerns Kroger covers the southern third of the building: a supermarket.

        Multiply this site by 1,066, which is the number of Wal-Mart Supercenters nationwide. By year-end, there will be one of those for every two of Kroger's 2,418 stores.

        With about 200,000 square feet of floor space — about three times the size of an average Kroger — supercenters are making a big pitch for consumers. While other chains, notably Target Corp., are stepping up their supercenter presence, Wal-Mart commands the most attention because it is not only the world's biggest retailer, but also the world's biggest company.

        “They're in it to win,” said James Degen, a food marketing consultant in Templeton, Calif. His J.M. Degen & Co. predicts food and sundries sales by supercenters to almost double to $76 billion by 2005.

        The big question is how Kroger will fight back. So far, it has cut prices to hold onto shopppers, although that's hurt profits. It hopes long-term to fend off Wal-Mart and the other “Borg” by offering more convenient stores that are quicker to navigate because they are smaller.

        With $50 billion in sales and a No. 22 ranking in the Fortune 500, Kroger is no pushover, even at the hands of Wal-Mart. In the $481 billion-a-year supermarket business, Kroger is the Mercedes-Benz name.

        But it doesn't take the Borg's verbal calling card — “resistance is futile” — to realize that Wal-Mart has taken aim at supermarkets, primarily Kroger. In recent talks with investors, Kroger chairman and CEO Joseph Pichler described the current business environment as the “most challenging” period in his 22-year career.

        Yet Mr. Pichler shows no fear of Wal-Mart's belligerence. In the 13 Kroger markets where Wal-Mart Supercenters have attained at least the third-highest share of food sales, he said Kroger's market share has risen a combined 0.6 percent.

        In a recent interview, Mr. Pichler, 62, grinned when asked if the mention of Wal-Mart evokes strong feelings in Kroger's inner sanctum. The former University of Kansas dean is admired by investment analysts for his candor. He said he doesn't take competition lightly.

        If Wal-Mart wants to get grabby in the food retailing arena, Mr. Pichler's attitude is: Let them come.

        “What happens at the end of the day is there's room for supercenters, there's room for Kroger and maybe one or two other competitors,” he said. “There's not a whole lot of room for anybody else unless you're a specialized operator.”

        Indeed, regional chains such as Harris-Teeter and Hannaford have retreated from some markets. Albertson's, the second-biggest supermarket chain, has been selling stores, including 16 in Texas to Kroger April 11.

        Simultaneously driving the change are the movement of shoppers to non-traditional retailers and the flourishing of large, well-managed companies with strong distribution and information systems. Economies of scale allow companies to reduce prices. Grocery shoppers respond by spreading their patronage to supercenters and warehouse-style membership clubs.

        The result for players such as Kroger has been flat sales. After posting an aggregate 1.9 percent increase in sales in stores open at least a year in the first quarter of 2001, Kroger's same-store sales rose 0.8 percent in each of the next two quarters, then fell 0.3 percent in the most recent period.

        Supercenters, meanwhile, are on the march. Boston Consulting Group, a management consulting firm, says Wal-Mart's growth rate will make it the world's biggest food retailer by the end of 2005. Target is opening 18 more SuperTargets by year-end. Then there are the regional supercenters, Meijer and Bigg's.

        “Consumers do not want to spend hours of time running errands after a long day of work,” analyst George Dahlman of U.S. Bancorp Piper Jaffray in Minneapolis wrote in a massive analysis of U.S. food retailing in January. “They want to make one, possibly two stops, and then go home.”

        Customer loyalty appears to be in flux. At the Wal-Mart Supercenter here, several customers said they aren't glued to one source for groceries.

        “Every once in a while, I come out here and pick up a few groceries because of the variety, and the meat's a little cheaper,” said Tom Anderson, who drove 35 miles from Fort Thomas and spent $140. “My sister does the same thing. She lives in Erlanger.”

        Aurora retiree Virginia Knippenberg bought a dozen eggs at the Wal-Mart Supercenter for 50 cents. Still, she said she prefers to buy meats at Kroger and does most of her shopping at Aldi.

        “I don't think the Wal-Mart's as reasonable or as neat. There's birds flying in there,” she said.

        Generally, however, Wal-Mart has taken the floor out from under grocery prices. In a January survey of Dallas-area supermarkets by the stock brokerage A.G. Edwards, the tab for a 215-item purchase was 35.1 percent higher at Kroger — and 38.8 percent higher at Albertson's — than at the Wal-Mart Supercenter.

        The survey didn't take into account frequent-shopper programs at Kroger and Albertson's, but the message isn't lost on Kroger. In December, the heavily unionized company announced a plan to reduce costs by $500 million. That will give Kroger more room to cut prices. Kroger expects sales to improve 2 to 3 percent in stores open at least a year.

        That's a stretch for investors, who have been down on supermarket stocks for three years. Kroger closed Friday at $22.50, 35.5 percent lower than the March 1999 high of $34.91. Albertson's is down 46.3 percent and Safeway 28.3 percent over the same period.

        Mr. Degen, the consultant, said he thought Kroger was going to join the supercenter bandwagon in 1999 when it bought Fred Meyer, a Portland, Ore.-based chain whose stores run from 130,000 to 200,000 square feet. But Kroger has shown no inclination to expand Fred Meyer eastward.

        “If they're learning, they're learning slow and are giving up ground to Wal-Mart and Target,” Mr. Degen said.

        In Mr. Pichler's view, Kroger will be an aggregator of market share, principally at the expense of smaller, weaker players. Years from now, in a world of dominant supermarket chains, supercenters, warehouse clubs and convenience stores, Mr. Pichler likes Kroger's chances.

        “Our offering to customers is different from the supercenter's,” he said. “We offer convenient locations that are within two or three miles of your house. A supercenter costs a lot more to build and has to draw from a 15-mile ring. Our goal is to have our supermarkets spread out so that you have to drive past two or three good Kroger stores to get to a supercenter.”

        But Wal-Mart is unfolding a similar strategy with its smaller Neighborhood Markets for areas too small for its Supercenters. About 30 are open, mainly in Texas and Arkansas, with 15 to 20 due out in 2002.

        “We've seen them (Wal-Mart) lower prices anywhere from 15 to 30 percent,” said Henry Vogel, a vice president with Boston Consulting Group. “They need to be at least at a 15 percent discount to live up to consumers' impressions that they're the lowest priced.”

        Kroger boasts that its meat and produce sections and market-tailored assortment give it an edge over upstarts. More Kroger stores also feature general merchandise, natural foods, automated checkout, pharmacies, photo centers, banking and gasoline.

        Even so, Mr. Vogel said, Kroger has challenges ahead.

        “The convenience and the neighborhood part of their strategy is absolutely critical,” he said. “That means getting the right assortment and services catered to the demographics of a neighborhood. Given their location advantage, they need to make sure they're better grocers so consumers won't have to make an extra trip.”

        Then there's the issue of consumer stamina. At 200,000 square feet, supercenters are almost twice the size of a Home Depot. That leads to Mr. Pichler's assertion that his stores are easier to shop.

        “I've been in this business long enough to have seen the terrors of the Cub stores in 1980, followed by the discount drugstores, the membership warehouse stores and then it was the Internet that was going to take over the business,” Mr. Pichler said. “I've been through a lot of scourges.”

        In spite of his experience, he admits he has no idea what the store of the future will look like.

        “Ultimately, what we do is to respond to customer needs, and the day we stop doing that is the day we die,” he said. “Wherever customers take us, that's where we go.”


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