Food remains Wal-Mart's fuel

by Josh Sosland
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As its sales and profit growth have slowed, Wal-Mart Stores, Inc. certainly has not stood still. In the midst of a three-year strategic restructuring, the company earlier in the summer announced plans to significantly rethink its longstanding single-minded focus on directing its capital toward opening as many stores as possible as quickly as possible.

Even as management makes significant breaks from the past in its strategic approach, it is apparent grocery products continue to have a bright future at the Bentonville, Ark.-based company. The outperformance of groceries versus other Wal-Mart categories has been a steady theme over an extended period of time. In the most recent sales update, for the five weeks ended July 6, Wal-Mart Stores comparable store sales were up 1.6% from the same period a year earlier.

Commenting July 12 on the results, Carol Schumacher, vice-president of investor relations, acknowledged continued softness in the stores’ apparel and home sales and said grocery sales continued to be stronger than general merchandise.

"Perishables led the way with solid comparable store sales in dairy, bread and deli," she said. "Food items generally used for entertaining did well, driven by dry grocery and snacks."

Grocery sales have been a bright spot in an otherwise lackluster comparable sales growth picture for the world’s largest retailer. Still, grocery sales are not believed to have reached their potential at Wal-Mart.

The depth of the challenges facing Wal-Mart was laid out in a recent webinar hosted by Information Resources, Inc. (I.R.I.).

Citing company data, I.R.I. noted growth rates of the Wal-Mart Stores Division (U.S.) have declined in each of the last four years, from 12.9% in fiscal 2003 to 7.8% in fiscal 2007. In the first quarter of the current fiscal year, the growth rate was only 5.6%.

The results were achieved against a backdrop of steady to accelerating store openings, so same-store comparisons paint an even darker picture. From 3.9% same-store sales expansion in 2004, growth fell to 1.9% in 2007 and was -0.1% in the first quarter of fiscal 2008.

Sheila McCusker, editor of I.R.I. Times & Trends, noted that after decades of increasing its household penetration, Wal-Mart in 2004 began to see losses in the percentage of new shoppers who come to the chain. She said the retailer’s business in the past also had been bolstered by an increasing frequency with which shoppers visited Wal-Mart, an acceleration that diminished in recent years and turned negative in the first quarter, in part because of rising gas prices.

"Eighty per cent of U.S. households shop at Wal-Mart, but that number has been declining," she said (the company puts the figure at 84%). "Wal-Mart is no longer bringing in new customers. So for the foreseeable future, growth will come from existing consumers."

More recently, business has been helped by increases in the average dollars per trip being spent at Wal-Mart.

Still, results have met neither investor nor the company’s expectations. Over the past five years, Wal-Mart shares have been basically flat, rising less than 10% cumulatively. Over the same time span, the S.&P.500 has climbed more than 80%.

In the first quarter ended April 30, Wal-Mart income from continuing operations rose 6% from the same period in 2006 while sales rose 8%.

"While these are record sales and earnings, we feel there was an opportunity to have done better," said Lee Scott, president and chief executive officer. "Delivering on our mission — saving people money so they can live better — is more important than ever around the world. The worldwide organization is focused on improving sales and returns."

Commenting on the quarterly results, Mr. Scott said Wal-Mart "experienced tremendous change" over the past year.

"We’re in the second year of an ambitious three-year strategic plan that Eduardo Castro-Wright, president and chief executive officer of our Wal-Mart Stores Division, is leading to improve our business," he said. "While some points in the plan have not delivered the results yet that we would like to see, the core of that plan, improving our customer service and improving returns, is critical to the continued success of our company.

"Our core grocery business continues to do very well. Food and consumables are leading the way for our Wal-Mart supercenters."

Expanding on the strategic initiative, Mr. Castro-Wright noted major changes within senior management as a key step and cited a number of steps to increase labor productivity, including a well-publicized move to optimize scheduling of Wal-Mart employees.

"We were very disappointed with our soft performance in the quarter with comps that were about flat," he said. "Comps continue to be pressured by softer traffic. Having said that, there are some positives. Of our six business categories, half performed at or above plan in the first quarter."

Mr. Castro-Wright’s list of strong performers began with "groceries driven by food."

Breaking down results by product segment, Ms. McCusker said the company’s strategy appeared to be to build market share in promising categories, and food/beverage ranks atop this list. Among the 10 categories in which Wal-Mart’s dollar share has declined the most sharply over the past year or so, frozen poultry, with a 3.7-point decline, was the only food product. Other top decliners included baby accessories, down 4.8 points; facial cosmetics, down 3.4; tights/socks, down 2.9; and pet supplies, down 2.8.

By contrast, Wal-Mart is gaining share in a diverse collection of food and beverage categories, beginning with ready-to-drink tea/coffee, up 3 points; Mexican sauce, up 2.7; shelf stable dinners, up 2.3; and frankfurters, up 2.

Perhaps the most compelling case for continued potential growth for Wal-Mart in food and beverage is the large number of categories in which the chain has an under-developed presence among the middle- and upper-income shoppers who regularly shop at Wal-Mart.

Figured as Wal-Mart’s share of category spending within an income segment divided by Wal-Mart’s total consumer packaged goods spending within the income segment, the chain posted mediocre scores among middle-income shoppers in many categories, including refrigerated salad/coleslaw (76), ice cream/sherbet (68), sports drinks (82), snack/granola bars (84), chocolate candy (85) and salad dressing (92).

Ms. McCusker said among upper-income shoppers, the performance figures are even worse, including refrigerated salad/coleslaw (50), ice cream/sherbet (54), sports drinks (61), snack/granola bars (62), chocolate candy (67) and salad dressing (69).

Finding ways to sell more to these customers in these categories is no small task. In a presentation earlier this year, Allan S. Noddle, a retired supermarket executive, noted Wal-Mart will be remodeling 1,800 stores before the end of 2008. He also discussed a different approach to retailing being tested in a Plano, Texas, model store. He described the markedly improved selection and appearance of each of a variety of departments — produce, wine, refrigerated, shoes and housewares.

Reaching middle- and upper-income customers will require wooing them from rival Target Corp. and other higher end competitors, Mr. Noddle said.

To John E. Fleming, executive vice-president and chief merchandising officer, progress toward attracting these customers will be dependent on fundamentally changing the Wal-Mart brand.

"The brand has always stood for low prices, broad assortment and trust," Mr. Fleming said in a recent interview with The McKinsey Quarterly. "We need to evolve it to being a broader value proposition."

Dubbing the principal group of coveted customers "selective shoppers," who come into Wal-Mart frequently but shop in a narrower range of categories than core customers, Mr. Fleming described this group as "time starved."

"They want solutions, not just items," he said in the McKinsey interview. "For example, something like 85% of selective shoppers don’t even know what they’re having for dinner an hour before they have dinner. And you know what? We have a lot of people in our stores at that time, so we need to be able to present meal solutions. That’ s a big change for us because we’ve built our business selling items.

"It’s about convenience. It’s about solutions. It’s about value more than just price."

Mr. Fleming said the Plano store experience demonstrated that a supercenter could be presented in a manner that appeals to customers with significantly higher income than the core Wal-Mart customer.

"That doesn’t seem to be a barrier," he said.

This great potential and the fact grocery stands out as one of the fastest growing areas of Wal-Mart’s business does not exempt the company from skepticism about how well it will execute these changes, said Charles Holley, executive vice-president.

"I’ve had a lot of questions from analysts over the last few months about our grocery business and how well it’s really doing with some cynicism," Mr. Holley said at a Lehman Brother Retail Seminar in May. "We haven’t done a good job of getting that across that this is a very strong part of our business, grocery, continues to be. I believe our comps in dry grocery ‘out comp’ the industry.

"I think the real focus this year though is going to be the fresh area. You’re going to see things, obviously with organics, you’ll see a lot more specialized product innovation like with the artisan breads that we’re rolling out. They’ve proved very successful. You’ll see more kinds of breads in that line. Our take-and-bake has gone into pizzas, chicken pot pies and lasagnas. Those have proven very, very good. You will see more of that product innovation throughout the year in this fresh area."

Mr. Holley insisted the strength in the new food product areas does not excuse Wal-Mart from its role as a low price leader, noting price rollbacks have been instrumental in drawing customers back to the stores in recent months.

"We will continue to be the price leader," he said. "It’s really our entry into the game. Our customers depend on us to be the everyday low price in the food area."

Grocery has not been the only area of growth in the store, but Ms. McCusker of I.R.I. suggested food and beverage may benefit from success Wal-Mart is achieving outside the grocery aisles — in pharmacy.

In September 2006, the company announced a program to make nearly 300 generic drugs available for only $4 per prescription. Announcing first-quarter results, Mr. Scott said the program, which has attracted considerable public attention, "performed better than we had expected."

Ms. McCusker said food companies should be aware the program is "a great traffic driver as well as pharmacy driver."

"If you have food and beverage products with disease management qualities, I think there is great opportunity," she said. She noted the focus on health will be bolstered further by the introduction of 400 health clinics into stores over the next two years, a move that will offer shoppers a value-added convenience and will have the potential to increase how much consumers spend with each store visit.

Still another indication "business as usual" is not ruling the day was indicated in a shift announced recently by Wal-Mart management regarding expansion plans.

For some time, Wall Street analysts have suggested Wal-Mart would add value by slowing down the rate at which it adds new stores. For instance, Michael Exstein, an analyst with Credit Suisse, New York, was critical earlier this year of management’s apparent unwillingness to change its approach.

"We believe a move toward better capital allocation (slower expansion, cap-ex reduction, return cash to shareholders) will help reinvigorate the stock and the organization," Mr. Exstein said in May.

Accordingly, Mr. Exstein was congratulatory a few weeks later when management addressed the issue at its annual meeting.

In particular, he noted a management decision to "slow down its new store expansion from 265-270 new supercenters to 190-200 in 2007 and then down to 170 in 2008-2010."

"Today’s announcement reflects a significant change in capital allocation strategy and should allow management to better focus on improving the performance of its existing store base," Mr. Exstein said on June 1. "The real message is that balance is finally becoming evident in many of the company’s actions. Gone is the notion that the company could overcome any challenge with seemingly unlimited human and economic capital at its disposal.

"Longer term, we believe Wal-Mart’s customer segmentation and ‘store of the community’ initiatives will be a major driver of sales as the company attempts to better tailor its merchandise on a market-by-market and even store-by-store basis. With better store standards, remodeling of key departments and better tailoring of merchandise, Wal-Mart should be repositioned to drive higher same-store sales growth."

Customizing stores on a local basis is not the same thing as individualized merchandising, a problem that had developed but is being rectified, Mr. Fleming said in the McKinsey Quarterly interview.

"Because buyers had the ability to get any kind of packaging they wanted with any kind of signage from suppliers, our stores looked like a city with no zoning," he said. "Furthermore, the signs in the stores were different from the circulars, which didn’t necessarily look like the television advertising."

He said the company has moved toward "a more centralized function," establishing "processes to ensure consistency."

International success may translate in the U.S.

Will Wal-Mart Stores, Inc. succeed in broadening the appeal of its grocery section among middle and higher income customers?

The experience the world’s largest retailer has had at a pilot store in Plano, Texas, gives the company confidence the Wal-Mart name is flexible enough to encompass more than "low prices, broad assortment and trust," as one executive described the brand.

Still, beyond the company pilot store, additional evidence of its higher end capacities may be seen in the results of its international division, said Sheila McCusker, editor of Information Resources, Inc.’s Times & Trends.

Ms. McCusker spoke specifically of Wal-Mart’s ASDA division in the United Kingdom, the nation’s second largest retailer.

Citing the introduction of organic and fresh products at ASDA, premium private label and niche lines, including products targeting children, Ms. McCusker said Wal-Mart’s achievements in the U.K. have not been driven exclusively by low price leadership.

"ASDA initiatives that were very successful in Europe could spread to the United States," she said.

Wal-Mart’s International business is important both because of its scale and because of its torrid growth. In a recent I.R.I. Webinar, Ms. McCusker noted International accounts for 22% of Wal-Mart’s annual sales and is by far the fastest growing segment at the company. In fiscal 2007, International sales grew by 30% versus 12% for the company overall and 8% for Wal-Mart Stores (U.S.).

"In other words, less than one quarter of the company’s business is accounting for 50% of its growth," she said.

In a June 19 presentation at the William Blair & Co. annual growth stock conference, a review of International performance was offered by John Menzer, vice-chairman and chief administrative officer.

His description of ASDA’s performance in certain respects mirrors what the company hopes to achieve in the United States.

"Our ASDA operations in the U.K. had a very strong year in 2006," Mr. Menzer said. "The U.K. economy picked up and our earnings picked up, and we’re gaining market share significantly right now in the U.K. We added 1 million customers in the last year. In their strong comeback we showed positive like-for-like sales this past year. Our market share continues to increase. Our customer perception of value for what our price spread is to our closest competitor is at the widest gap it’s been over two years. So we really got our price investment in place.

"We made significant investments in our value proposition, including investment in price. We developed organic foods; convenient fresh fruit assortments are in the stores. We’re also investing heavily in customer service and so making these products accessible in a very convenient shopping experience for our U.K. customers."

Also offering promise internationally is Canada, said Mike Duke, vice-chairman with responsibility for International. Mr. Duke said Wal-Mart knew as it entered the marketplace competition would be formidable.

"We had a great deal of respect for the food industry in Canada," Mr. Duke said. "So, the team took it very seriously. And I think you’ve seen, and I think your reports indicate from the fresh areas, the produce area was expanded from a traditional supercenter. The meat department and the bakeries were fantastic.

"It’s a combination of learning from the United States but also learning from ASDA in the United Kingdom and Mexico. There are great food operations around the world, and the Canada team took good ideas from all around Wal-Mart but also from our competitors."

Mr. Duke said additional supercenters will be rolled out in Canada with "plans moving full speed ahead there."

This article can also be found in the digital edition of Food Business News, July 24, 2007, starting on Page 1. Click here to search that archive.

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