Food focus orients toward price-impact format - Power Retailer - Kroger Co.'s plans for Fred Meyer division

DSN Retailing Today, April 22, 2002 by Mike Duff

The Kroger Company, in its recent actions and statements, continues to leave clues to the ongoing mystery of what it will do with its Fred Meyer division.

The company has yet to expand the supercenter business beyond its traditional bastion in the Pacific Northwest. In fact, Kroger recently withdrew the banner from its one market outside the Northwest.

That's not to say the 1999 Fred Meyer acquisition wasn't important to Kroger. In 1998, the last year in which the companies operated separately, Fred Meyer posted sales of $14.88 billion, according to Kroger's filings with the Securities and Exchange Commission; for the same period, Kroger's sales were $28.20 billion. Kroger's net earnings for the year were $411 million, while Fred Meyer lost $164 million, including a $39 million extraordinary loss. For the period of 1999 prior to the acquisition, Kroger's sales were $8.79 billion and net earnings were $176 million, while Fred Meyer's sales were $4.70 billion and net earnings were $35 million.

By the end of fiscal 2000, the last full year the company reported, Kroger operated a total of 2,354 stores. For that year, Kroger posted sales of $49 billion, up from $45.35 billion in fiscal '99, with earnings reaching $877 million, up from $613 million in the year-earlier period.

Flying in the face of expectations, Food4Less, another format Kroger acquired in the Fred Meyer purchase, has turned into the current nontraditional growth vehicle for Kroger. The result isn't altogether unlikely. The Fred Meyer format, which combines a mid-tier retail operation with an upscale supermarket, has never really taken off outside its core market.

On the other hand, food retailers have been high on the price-impact store format, and Food4Less is among the best known examples of its kind.

Price-impact stores are attractive to supermarket operators because they are considered effective in markets where Wal-Mart supercenters are changing pricing dynamics. To compete effectively in such markets, supermarket operators, such as Kroger, are emphasizing value-added products, variety and services. The theory is that middle-class and affluent shoppers will prefer the range of choice in fresh, upscale and prepared food that the supermarkets provide to the less expansive, but also less expensive, assortment at Wal-Mart.

However, the strategy forged for standard supermarkets essentially concedes to Wal-Mart's more price-conscious lower middle-class and working-class consumers. Food4Less provides a vehicle to reach out to those consumers who are attracted not only to supercenters but also warehouse clubs. Warehouse dubs are especially enticing to lower-income consumers who have large families and who have traditionally spent a lot of money in supermarkets.

By emphasizing packaged food, warehouse-style fixtures and on-the-pallet stocking, the price-impact format builds the value it provides customers on low-cost store operations and other economies of scale.

In a conference call in December, Joe Pichler, Kroger's chairman and ceo, announced the company would roll out Food4Less in Chicago, with three to five Food4Less units set to open this year. "We're excited about it," said Pichler.

Originally designed to appeal to Southwestern Hispanic shoppers, future Food4Less growth will lean toward markets further afield where Latinos have a strong presence, said cfo Michael Schlotman at a Merrill Lynch investors conference earlier this month. Although Food4Less can draw from multiple ethnic groups, Kroger had the original intent in mind as it identified Chicago as a likely market for the format.

"One of the reasons we're excited about that asset is for the expanding Hispanic population of the United States," Schlotman said. "We chose Chicago because we felt that segment of the population was an underserved part of the community, with obviously a very strong population base."

Food4Less provides a complementary operation that the company can pair with its standard supermarkets to build share in markets where it faces competitive and/or real estate challenges with its established supermarket and food and drug store formats.

Chicago will be a critical test for Food4Less, and Kroger has earmarked $100 million this year for the initial introduction to the market. With a single-market exception, all Food4Less stores are located in the Southwest. Success in a faraway market and an intensely competitive market, such as Chicago, will confirm the value of Food4Less as a growth vehicle.

Still, Michelle Barishaw, an analyst with Fitch, IBCA Duff & Phelps, said Food4Less might have received more attention because of the slow economy. She asserted that Kroger, since the acquisition of Fred Meyer, has identified the multidepartment formats as a focal point of development. "I don't think Food4Less is their only prospect," she said.

Indeed, Kroger hasn't given up on more expansive formats, leveraging the nonfood expertise it has developed since acquiring Fred Meyer. Kroger has pumped what it has learned into a new format, the initial manifestation of which is Fry's Marketplace.