Food retail in flux: From deflationary blues to the e-commerce challenge

Prolonged deflation 'can create a world of hurt in an environment where retailers are measured on their same store sales growth' says Jim Hertel at Willard Bishop

What keeps US food & beverage retailers awake at night? Amazon? Deflation? Competition from new channels? The prospect of a border adjustment tax? We quizzed retail experts to get their take on the biggest challenges facing grocers today.

Some things – such as health care benefit costs, staffing, regulations, credit card fees and the economy – are regular fixtures in the Food Marketing Institute’s (FMI’s) annual ‘worry index’ (based on a poll of retailers and wholesalers) but other things are steadily moving up the priority list, say analysts.

One of the biggest strategic challenges facing bricks & mortar food retailers right now, is how to navigate the e-commerce channel, which is growing fast, and getting a huge amount of attention, but still accounts for a very small percentage of overall sales, says Jim Hertel, managing partner at consultancy Willard Bishop.

When it comes to business models, some retailers are picking from dedicated fulfillment centers/warehouses, and others from stores, while some are offering home delivery and others are focusing on curbside pickup, he says.

For retailers that don't want to tackle the last mile directly, meanwhile, 'on-demand' players such as InstaCart and Google Express can deploy an army of personal shoppers to pick and deliver orders from retail partners in their own vehicles.

InstaCart: Pros and cons

While partnering with the likes of InstaCart is probably the simplest way to offer online shopping, especially for smaller retailers, it’s not without risk for larger brands, however, says Hertel.

Aside from the fact that retailers are losing access to valuable customer data and outsourcing the critical last mile of the process (getting product to the customer’s door), they are also relinquishing control of the user experience, which could over time diminish the importance of their brands in consumers’ minds, he contends.

Put another way, if InstaCart is the brand consumers see when they place and receive their orders, the retail brands it partners with could ultimately become less important over time, he predicts.

Voice ordering could further desensitize consumers to brands

Moreover, the rise of voice ordering platforms being developed by Amazon (eg. via Alexa) and Google (via Google Home - in partnership with Google Express) will likely further “desensitize” consumers to brands (whether they are retail brands such as Whole Foods Market or CPG brands such as Pampers), predicts IHL Group analyst Jerry Sheldon.

Alexa... I'm out of diapers...

After all, he points out, if you’re not in the store experiencing the sounds, tastes and smells of Whole Foods or Andronico's, but sitting in your living room talking to your Amazon Echo device, you’re more likely to be making decisions based on product and price.

And in this environment, the platform operator (eg. Amazon) is in a good position to promote its own private label offerings, he adds.

In general, predicts Hertel, bricks & mortar retailers that take a strategic - as opposed to a tactical - approach to ecommerce, are the most likely to succeed in the long-term, even if it's hard to make the numbers add up in the short term.

“I think the mental attitude you’ve got to take, is if our shoppers want to buy product online we want to satisfy our shoppers’ needs, rather than just saying is this accretive to the P&L and gosh we can’t make any money out of this right now.”

"We're building our digital experiences today so that customers can engage and shop for anything, anytime, anywhere with us in the future...

[But] there are a lot of companies out there right now investing in digital and e-commerce in opportunistic ways that will likely never create value for their shareholders.”

Rodney McMullen, CEO, Kroger, Q4 2016 earnings call 

GET FRESH: WHAT’S FOR DINNER TONIGHT? 

Perhaps the other major strategic challenge many food retailers are pondering right now is how to improve their fresh prepared food offer, and more broadly, how to re-organize stores more intuitively so that they cater to consumers looking for meal solutions, says IHL’s Sheldon, who notes that many younger shoppers are “thinking two or three meals ahead, at most.”

Indeed, says Adam Zbar, CEO of meal kit delivery firm Sun Basket, the rise of meal kits – the components of which are readily available in most grocery stores – in part reflects grocery retailers’ failure to adapt to this changing consumer.

Do retailers need to rethink store layouts?

Today, he says, grocery stores are competing with bars, restaurants (and restaurant delivery apps), meal kits and meal delivery services, but they are still laid out as if shoppers are primarily focused on restocking their pantries instead of making it super-easy for them to work out what to have for dinner.

Indeed, for consumers that lack time, energy, imagination or cooking skills, the experience of shopping at grocery stores is stuck in the last century, he contends. "The experience is poor as it is organized by category - meat, produce, and so on, rather than by consumer need: ‘I want to cook easy meals or Paleo meals or gluten-free meals.’"

STORE FORMATS: WHAT’S THE WINNING FORMULA?

As retailers have wrestled with this conundrum, there has been plenty of experimentation with new, smaller, store formats in recent years, from Kroger’s Main & Vine and Ahold’s bFresh stores to Walmart’s Express format, Whole Foods’ 365 stores, to Amazon’s groundbreaking ‘Go’ store, plus continued growth from limited assortment players such as ALDI and Trader Joe’s.

But what the failure of Walmart’s Express stores highlights is that there’s no winning formula, he says. In other words, not every retailer can win with smaller stores, in part for structural reasons (eg. Trader Joe’s success is in part due to heavy reliance on private label, a limited assortment and a loyal customer base) and in part because a big box brand like Walmart doesn’t suddenly become associated with freshness and convenience just because it tries operating from a smaller footprint.

Whole Foods, by contrast, may simply confuse consumers with its new, more budget-conscious 365 format, he observes. “It’s a tough one. To me, it’s a bit like Tiffany’s having an outlet store.”

Publix: Excellent customer service from top to bottom?

Despite the current interest in small store formats, he says, the success of brands such as Publix, Wegmans and Kroger – which typically operate from fairly large stores – shows that you can still engage consumers from a bigger box, provided you have excellent customer service and loyal shoppers.

“If you’ve got problem with something you’ve bought at Publix, they’ll replace it just like that. My younger son was sick recently and they only had one of the two bottles of medicines he needed in stock, so my wife had to come back the next day for the second bottle. They gave her a $25 gift card for the inconvenience of having to come back.

“They insist on taking groceries to your car and refuse to be tipped.  It’s all these little things that collectively amount to excellent customer service from top to bottom.”

A BORDER ADJUSTMENT TAX: GOOD, BAD OR UGLY NEWS?

As for what the Trump administration means for food retail, it’s too early to say, but talk of a border adjustment tax (BAT) is raising the blood pressure of some retail executives, says FMI senior director, sustainability, tax and trade, Andrew Harig.

The tax – which was pitched by House Republicans last summer along with a cut in the top rate of corporate taxes from 35% to 20%, but has yet to be spelled out as a legislative proposal - would prevent corporations from deducting the cost of imports from their taxable income, while all income earned from exports would be exempt from the new tax.

This would mean that companies selling imported goods in the domestic market would be taxed on the full proceeds of the sale, not just on the profit earned, says Harig. Meanwhile, the tax would be zero on the sale of exports.

While a BAT might therefore seem to penalize importers, the expectation is that the dollar should appreciate relative to the currencies of America’s trading partners. In other words, longer term, so the theory goes, a stronger dollar would make imports cheaper, offsetting the increase in taxes paid.

The problem is, he says, that no one knows when – or indeed if - this will actually happen, or how the WTO or US trading partners will react, and in the meantime, food companies importing goods could suffer.

“It looks elegant on paper,” says Harig, “but in the near term, it means consumers will pay more for [imported goods such as] coffee, seafood and bananas, and while we want to see tax reform, it’s just too risky. We also don’t want to start a trade war.”

FOOD DEFLATION: IS THERE AN END IN SIGHT?

As for deflation, which has dogged the sector for the past year and prompted a sprint to the bottom on price for many retailers, there is some light at the end of the tunnel, says Harig, with food-at-home inflation flat (as opposed to declining) for the first time in more than a year in January, and some commentators now predicting that prices will rebound in the coming months, although they are likely to remain depressed for some time.

While on the face of it, prolonged food deflation might not seem like much of a big deal – in that you pay less for goods, and then charge correspondingly less for them – it has sparked a pretty brutal price war among some players in the trade, which has dented margins, as fixed costs elsewhere in the business remain the same, observes Hertel at Willard Bishop.

“It can create a world of hurt in an environment where retailers are measured on their same store sales growth. Kroger is one of the best managed traditional supermarket operators, but it’s incredibly hard to keep increasing same store sales in this environment [Kroger last week posted its first negative set of comps after 52 straight quarters of same store sales growth].”

RETAILER TO WATCH: ALDI

Right now, says Jim Hertel at consultancy Willar Bishop, two brands worth watching are German discounters Lidl (which opens its first stores on the east coast this summer), and ALDI – which has just unveiled a $1.6bn plan to remodel and expand 1,300 US stores by 2020.

I’d say for the past five years ALDI has been the strongest food retailer domestically. We estimate that they are growing same store sales in the 7-8-9% range, and no one else is doing that. They are also remodeling stores and aggressively expanding [By the end of 2018, ALDI - which currently operates nearly 1,600 stores in 35 states - expects to operate nearly 2,000 stores].

Willard Bishop co-founder Bill Bishop, who now runs consultancy Brick Meets Click, meanwhile, also singles out ALDI as the brand to beat in US food retailing today, recently estimating that top line sales will increase from $14.6bn in 2016 to $24.9bn by the end of 2021.

Remodeled ALDI stores (the Dundee Road store in Palatine, IL, is a good example) offer a more modern and convenient shopping experience with 1500-1700 items, wider aisles, a stronger produce, dairy and bakery offer, glass doors, super-sized food graphics on the walls, chalkboard signs, and a more “bright and contemporary” look, he says.

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