WAL-MART

Meet Your New Neighborhood Grocer

Wal-Mart has muscled its way into the food business. Now competitors are scrambling to keep up. Brian O'Keefe Mon May 13, 2002 Fortune Magazine

To say that Kimberly Rutkowski is an organized grocery shopper is to seriously understate the case. Rutkowski and her husband, Sean, live  with their daughter, Ashley, 5, and son, Tyler, 2, in a modest,  two-story pink brick house in the fast-growing Dallas suburb of  Rockwall. Every Sunday morning the 32-year-old working mother goes  through the paper, clips coupons for products she likes, and then  transfers them to a gray plastic box labeled kimberly's coupons. When  she's through, she begins planning her family's dinner menu for the  coming week--cheesy chicken casserole on Monday perhaps, pancakes  every Thursday--and makes a list of what she'll need. She then  crosschecks that with a list of about 100 of her family's staples,  sorted by category, which she has organized into an Excel spreadsheet. By early afternoon she is ready to climb into her Dodge Caravan minivan and hit the aisles.

She doesn't have to go far. Area developers have made sure the folks who inhabit the rapidly expanding suburban Dallas enclaves will not  want for retail options, especially when it comes to groceries.  Dallas, in fact, is probably the most cutthroat, overstored market in  the country. At a single intersection half a mile from Rutkowski's  house, Super 1 Foods and Albertson's grocery stores face off against a brand-new Tom Thumb. But virtually every time this expert shopper heads out, she drives by all three, continuing the extra two miles to  buy the bulk of her groceries at the new Wal-Mart supercenter in  Rowlett. Rutkowski, who spends $150 to $200 each weekend on groceries, figures that she saves about $50 this way. That has made her a loyal Wal-Mart shopper--despite some bad experiences with less-than-fresh  dairy products and pushy customers. "The kind of crowd that Wal-Mart  brings in can be a little scary, but I guess I'm one of them," says  Rutkowski with a laugh. "If I had a choice, I'd go somewhere else."  But for the price-conscious, there really is nowhere else to go: The  discounter saves food shoppers like Rutkowski an eye-popping 30%, on  average, on their weekly grocery bills.

That kind of pocketbook appeal is helping Wal-Mart, the world's largest retailer, take on a new title: your neighborhood grocer. The  chain that Sam Walton built by stacking up discount clothes and  fishing gear rang up $56 billion in grocery sales last year, making it the nation's No. 1 food retailer. While Wal-Mart had less than 6% of the grocery market in 1995, Bear Stearns estimates it now commands an  impressive 10.3% share--a figure that could rise to 15% as early as 2004. And that doesn't even count the food sold at its network of  Sam's Club wholesale stores. Wal-Mart's resounding success selling  groceries is sending shock waves through a staid industry, forcing out smaller players and driving stronger ones to bulk up or face the same fate. And it won't get any easier for the competition. Says UBS  Warburg grocery analyst Neil Currie: "The whole value-for-money  equation is forever shifting toward Wal-Mart."

To think that, less than a decade ago, Wal-Mart had barely gotten its start in the food business. Sam Walton's discount chain tinkered with  the idea of groceries for years, first borrowing the concept of the  supercenter--180,000-square-foot units that incorporate a full-sized  grocery store inside a regular discount store--from the European  "hypermarket" in the late 1980s. But it wasn't until the mid-1990s,  after Walton's death, that then-CEO David Glass decided to stake the  company's growth on its ability to sell meat and potatoes in an  expanding network of supercenters. The rationale was simple--traffic.  Whereas the average shopper might come to Wal-Mart only once or twice  a month, people buy groceries, on average, more than twice a week.  Glass also looked at the grocery business and saw an industry three  times as big as discount retail, but highly splintered and lacking a  heavyweight that could match the Arkansas company's famed logistics  and distribution capabilities. In short, Wal-Mart's management looked  at the food business and didn't see a Wal-Mart.

It hasn't looked back. Since 1996 the number of supercenters has jumped from 260 to 1,060, and the company will probably double that in the next four years. Grocery sales at Wal-Mart's supercenters are growing twice as fast as its overall business. Not only that, but the  company is ramping up its food distribution network. UBS Warburg's  Currie predicts that the company could support as many as 4,000  supercenters across the country by 2006. Wal-Mart, for its part, won't project the growth of its grocery business beyond this year. "We just don't talk much about our food business publicly," says spokesman Jay  Allen. (The company declined to make a member of management available  for this story.) The enormous supercenters remain the cornerstone of  its strategy, but Wal-Mart is also tinkering with smaller-sized  supercenters and even cozier grocery-only Neighborhood Market stores.  These are designed for metro areas, where supermarkets typically  dominate. CFO Tom Schoewe told shareholders at last year's annual  meeting that the company is still refining the strategy. "Then you'll  see our foot pushed on the accelerator," he boasted.

Wal-Mart investors didn't always find groceries so appealing. The combination of entrenched competition and low margins seemed like a  profit-killer. In truth, grocery store margins drifted upward during  the past decade, as retailers jacked up prices faster than their costs increased. That rise gave Wal-Mart a perfect way to crack the business. If supermarkets make a penny of profit for every dollar of  grocery sales (the common statistic cited by the industry), Wal-Mart  was willing to make do with far less. Supermarkets work with gross  margins of around 24%, whereas Wal-Mart will reportedly go as low as  16%. It's all part of a bigger strategy. Wal-Mart knows that moms who  come in to buy, say, eggs and Lean Cuisine often wander over to buy  higher-margin stuff on impulse, like lamps or, in the case of KimberlyRutkowski, plastic organizers. The more regular shoppers the company cultivates, the easier it is to drop prices even further. That's why  on a recent afternoon Rutkowski could buy Jif peanut butter, Kellogg's corn flakes, Ragu spaghetti sauce, and a gallon of milk for just $8.61 at Wal-Mart--stuff that would have cost her $11.66 at Safeway-owned Tom Thumb.

Such a yawning price gap is leaving Wal-Mart's major competitors with two choices: get big or get gone. The need to scale up has led to the emergence of a few national players--the Big Three of Kroger, Albertson's, and  Safeway--that are aggressively snapping up smaller players to keep pace with Wal-Mart. For the little guys, being bought is often the best they can hope for. Indeed, Kroger CEO Joseph Pichler says that 1,800 grocery stores or pharmacies have been either shuttered or acquired in the past 22 months alone, at least partly because of the supercenter effect. In addition to Wal-Mart, other discounters like Target are getting into the grocery game and vying for their share. Walgreen has even started adding fresh produce in many of its drugstores.

Not surprisingly, traditional grocers are studying Wal-Mart more closely than ever. In December, Kroger, the biggest of the Big Three,  with $50 billion in sales in its 2,400 stores last year, announced a  sweeping plan to streamline management, centralize its buying  procedures, and plow profits back into prices--in short, to be more  like Wal-Mart. That's harder than it sounds. Pichler says the company  has only recently developed the kind of technology necessary to stock  and manage its stores nationally, rather than regionally. "We've  learned some things from Wal-Mart, no doubt about it," he says.

Mainly what they've learned is that to survive they must compete on price, says Henry Vogel, a pricing expert at Boston Consulting Group.  In the past few years the grocery chains have developed shopping cards for regular customers. They allow the companies to track individual buying habits, giving shoppers special discounts in return. In the  past six months each of the Big Three has announced that it will be  reducing the disparity between its own prices and Wal-Mart's. That's  easier said than done--the gap averages as much as 30% before  discounts and coupons. To do so, Kroger announced in December that  it's chopping $500 million from its operating costs. Albertson's has  the same goal. It's a major effort--and it still may leave them at a  competitive disadvantage. "I think some of them have their heads in  the sand about the impact of Wal-Mart in the future," says UBS  Warburg's Currie. "I just worry that it's a little too late, and not  enough."

That's not to say that price is the only way to counter Wal-Mart. Possibly the most distinctive store in Dallas is the new Central  Market, a gourmet superstore recently opened by the San Antonio-based H.E. Butt Grocery Co., whose H-E-B chain is the second-largest private supermarket business in the country, after Michigan-based Meijer. On a recent Tuesday afternoon, the aisles were packed with customers--and high-end products. The choices can be overwhelming. Some 30 types of  apples. Twenty kinds of homemade sausage. In the beverage section are  2,300 labels of wine and 400 types of beer (plenty of Pilsner Urquell, from the Czech Republic, but not a Bud in sight). The store hires special food experts called Foodies to give cooking demonstrations and dispense recipes. Customers leave with an average bill about twice as big as at the company's H-E-B stores. "Head-on with Wal-Mart is a  difficult game to win," says Scott McClelland, H.E. Butt's head of  marketing. "But we can do things the big guys can't or won't do. They  can't beat our price on items they don't have."

The Central Market example is not lost on the big guys fighting to survive in a Wal-Mart world. The supermarkets figure that if they can  put their stores closer to shoppers and beat Wal-Mart on variety and  quality, they can give the discounter its share and still prosper.  "There's no doubt in our minds that Wal-Mart's going to continue to  grow, but not everyone wants to shop there," says Albertson's CEO  Larry Johnston. Right now, Albertson's is the No. 1 grocer in the  Dallas market. But to stay on top, it's adding six new stores there  this year--for a total of 100--and pouring in more than $125 million  in capital investment over the next two years. Kroger, meanwhile, has  begun to specialize in Signature stores, where the shelf selection is  heavily determined by surveys mailed out to the surrounding  neighborhoods before the opening. The new store on Parker Road in  Dallas opened in early April with 860 varieties of produce--including  bitter melon, Chinese long beans, and flowering chives that the nearby Asian-American population requested. Such attention to detail makes Merrill Lynch analyst Mark Husson, who's bullish on the grocers, say  that Wal-Mart will never lure away more than the fixed number of  shoppers who always shop for price. "It's like saying everyone who  shops at Gucci ought to shop at Old Navy."

Maybe. But consider Ann Harrell. Harrell, a Dallas homemaker and the wife of a dentist, is exactly the kind of customer that the grocery  chains are relying on. She buys fresh ground coffee and recycled paper products at Tom Thumb, and likes the fresh seafood and helpful employees at her local Albertson's. She's never shopped for groceries  at a Wal-Mart supercenter because she's unwilling to make the  20-minute drive to get there. But if it opened one closer? "Oh, sure,  I'd give 'em a go. I like to get my dollar's worth."