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Small Format Stores And The
Ever-Changing Retail Environment

We have spent loads of electrons writing extensively about Tesco’s Fresh & Easy. We have profiled Safeway’s small format store here and here, and we reflected on Wal-Mart’s Marketside concept in many places, including here and here… all this analysis has left open one question: Do American consumers want to shop in small format stores?

We know that specialized small format stores can succeed. Aldi, with its economy-focus, attracts shoppers and so does Trader Joe’s, with its foodie riff. It is quite an unproven concept whether consumers who today are shopping at Safeway, Kroger or Supervalu banners, or regional powerhouses, such as Publix and HEB, want to switch to much smaller stores.

Of course, it is always possible that supermarkets will simply deliver consumers into the hands of these waiting rivals.

The basic argument against small stores is that they are inherently not convenient. They may seem convenient in that consumers can shop them quickly but their limited assortments leave consumers wanting products available at the supermarket. This transforms a visit to the limited-assortment stores into an extra trip and makes it inconvenient. It is too easy for consumers to decide to skip the small format store and just go to the supermarket where the consumers can get all the products they want to buy.

Now we have argued that Fresh & Easy needlessly compounded this problem by devoting its precious shelf space to private label items, and so we thought Wal-Mart did a better job with its Marketside concept by focusing on well known brands. Still, a smaller format almost inevitably means fewer items, fewer brands, fewer sizes and, in general, fewer choices. As a result, although we can see these “general interest” small format stores succeeding in urban areas where the competition doesn’t have 60,000 square feet and people don’t drive, we have trouble seeing Americans abandoning their large stores in suburbia to shop in these venues.

Unless, of course, the supermarkets voluntarily give up their assortment advantage — and we are starting to get a sense that this is precisely what is happening in this economic climate.

Ahold has been going down this road for some time, calling the strategy its Value Improvement Program — and it has been quite successful:

The most significant area of focus for our value repositioning strategy is in the Stop & Shop and Giant-Landover banners. Previously announced as the Value Improvement Program (VIP), this program has the most impact on the company’s overall financial results in the near-term.

VIP contains all the elements of repositioning, as Ahold’s needed to improve identical sales growth at both Stop & Shop and Giant-Landover. These elements are being applied to both businesses in the following manner:

Improving product and service offering: We are enhancing our offering across all categories. In terms of product improvement, we have already simplified our produce offering. This has allowed us to enhance freshness by reducing transit and warehousing time in our supply chain. We will continue to make similar improvements on a category-by-category basis during the coming months. In terms of service improvement, we are also working on modifications to our store layout and check-out areas to simplify the customer shopping experience and place a greater emphasis on convenience.

Improving price positioning: We are rolling out a program to lower prices across a wide range of items. Promotional activity will continue, but will focus on a more targeted group of products. Prices are already being lowered as part of a major repositioning of our produce prices that began in September, and further price reductions will continue throughout 2007. In addition, we are simplifying our pricing architecture to manage this element more effectively.

Reducing costs: We are implementing a comprehensive program to reduce costs across Stop & Shop and Giant-Landover over the next 24 months.

You can read about Ahold’s growth strategy here. There are many elements to this strategy but two of the key elements are these:

Providing the best choice. Ahold operating companies plan to excel in fresh foods by improving quality, selection and presentation. They are significantly increasing their selection of innovative private label products at a variety of price and quality levels. We will also improve and expand the existing general merchandise assortment.

Making shopping easy. Each operating company is simplifying their overall assortment with the goal of making shopping easier. They are also providing more convenience-focused products and services and enhancing the overall customer experience to make shopping more convenient. Format development is an important tool in achieving this. The operating companies are improving existing store formats and developing new format concepts using different layouts, assortments, sizes and service models.

Put another way, the plan involves first “rationalizing” SKUs by reducing assortment; in produce this has been carried out and is explained this way:

“In terms of product improvement, we have already simplified our produce offering. This has allowed us to enhance freshness by reducing transit and warehousing time in our supply chain.”

In other words, carry fewer produce items, focus marketing and merchandising capacity on the remainders and increase velocity of sales… which establishes a virtuous circle in which faster sales result in fresher product, which leads to more sales, ad infinitum.

The other half of the plan is to expand its private label offering:

“Throughout the store, you’ll see that the presence of private label has grown,” says Michael Sherman, senior director of sourcing for Ahold USA. “That’s a big part of our strategy — to make our private label presence shine even greater than it already does.”

Though this doesn’t seem to have had much implication in produce, it certainly affects the overall assortment of the store.

Now it is very hard to argue with success. When last month Ahold announced its 3rd quarter earnings, there was notable improvement in same-store sales for Giant-Landover, Giant-Carlisle and Stop & Shop. In fact, it was Ahold’s American results that excited the market, as results in Europe for Albert Heijn and the Central Europe stores were growing weaker while US results were growing stronger.

The Citi Investment Research Retail Food Retail Team, working out of London, put its assessment this way:

Retail margin of 4.7% better than our 4.3% forecast, tipping point reached — Clean retail EBIT of €276m was above consensus, driven by a very robust performance from both the US divisions. This is the first time in a very long time in which the Stop & Shop / Giant-Landover margins have improved year-on-year, which suggests that the Value Improvement Program has now reached an inflexion point from both a sales and margin perspective.

FY08 retail margin guidance unchanged at 4.8 — 5.3% — We had thought Ahold might narrow the range of its guidance, and possibly lower the bottom end. A reiteration is extremely encouraging, especially considering that the company could legitimately have lowered guidance on the back of currency and that consensus before today was for 4.7%, i.e., for Ahold to miss.

Implications for 4Q08 — Achieving the top end of guidance looks implausible, but to hit the bottom end of the range, Ahold will have to deliver a flat margin year-on-year in 4Q. This is slightly more stretching than it sounds given Ahold is unlikely to repeat the blowout Dutch margin from 4Q07. This strongly suggests that Ahold is confident on its US margin development in 4Q08.

Injection of confidence, shares should react very positively — Today’s numbers suggest the US business has reached a crucial turning point in margins as well as sales. We would expect earnings upgrades — amplified by the stronger US$ — given that consensus was below guidance before today. As food inflation declines in 2009 we expect Ahold to be one of the better placed companies in the sector, given that it is now taking market share in the US.

With an assessment like that — “now reached an inflexion point from both a sales and margin perspective” — Ahold has obviously achieved a lot.

To some extent it got a bit lucky — luck is perhaps the most useful business tool out there — in that it had decided to focus on value and then the country fell into a recession.

And, indeed, with its northeast strength, which means it is a region with relatively few Walmart supercenters, Ahold may have hit upon a winning formula if it can provide better value than competitors in its region.

Still this leaves two related questions for Ahold:

Is this positioning something that will hurt Ahold when the recession starts to end? For the sake of short term prosperity, is Ahold putting itself in a long term strategic box?

Wal-Mart is sure to build more Supercenters in Ahold country, and one doubts that the Value Improvement Program will position Ahold to really compete on price.

The reduction in assortment and increased emphasis on private label reduces costs and boosts margins today. The value proposition also appeals to today’s consumer, but isn’t that broader assortment precisely what is necessary to differentiate from Wal-Mart and, of course, compete effectively against limited assortment small format stores?

Is Ahold setting itself up for a pincer movement where Wal-Mart rolls out both Supercenters and Marketside stores and Ahold finds itself without the value proposition to beat the supercenter and without the variety to defeat Marketside?

At least Ahold operates in many real-estate-restrained markets, where expansion by competitors is quite difficult. These concerns apply nationally, except even more so.

A reputation for bounty and variety may not be the winning card in a year when the focus may be on value. But reputations are easier to lose than to win back, and retailers who decide to reposition themselves as value-based retailers may find that positioning turns on them quickly as new competitors enter the market or the economy starts to turn.

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