THE NEW ERA

A new generation of supermarket has arrived, bringing with it fine-tuned nonfood offerings.Somewhere between the traditional grocery stores and the gargantuan supercenters are these large-scale, locally tailored supermarket/general merchandise hybrids, which include pharmacy and health and beauty care.Although a supermarket with expanded GM isn't an original concept, some retailers are etching out

A new generation of supermarket has arrived, bringing with it fine-tuned nonfood offerings.

Somewhere between the traditional grocery stores and the gargantuan supercenters are these large-scale, locally tailored supermarket/general merchandise hybrids, which include pharmacy and health and beauty care.

Although a supermarket with expanded GM isn't an original concept, some retailers are etching out a customized and original approach to nonfood. In recent years, two chains have garnered the most attention: Kroger, Cincinnati, with its Marketplace format and H.E. Butt Grocery Co., San Antonio, with its H-E-B Plus stores.

Meanwhile, industry observers will be watching Supervalu, Edina, Minn., to see what it does with its large-scale bigg's format in the Cincinnati market once it absorbs its Albertsons acquisition.

This strategy is the newest and most aggressive tactic supermarket retailers are using to gain or maintain market share as they confront discount supercenters from Wal-Mart Stores and Target, and other new combatants in the food market.

"The Marketplace stores are just one of a number of different formats that Kroger uses to try to serve a wide range of customer interests," said Lynne Marmer, group vice president of corporate affairs, Kroger. "This format offers a full grocery selection along with general merchandise in targeted categories, based on customer interest."

While Kroger Marketplace and H-E-B Plus have taken a similar overall approach, Kroger's stores are smaller and concentrate mainly on home products, leaving out categories such as apparel and extensive entertainment software offerings. H-E-B's stores, on the other hand, feature an extensive selection of CDs

and DVDs and, in general, present a wider variety of nonfood products.

Kroger's Marketplace stores, most of which are around 100,000 square feet, concentrate on strategic nonfood offerings.

"It varies by location, but we generally focus on housewares, cookware, office, furniture and expanded seasonal items and general merchandise," Marmer said. Kroger opened its first stores of this format under the Fry's Marketplace banner in the Phoenix area six years ago and now operates 17 such stores in that market. Then in 2004, it remodeled five former Fred Meyer Stores in Utah to the Smith's Marketplace banner and opened the first Kroger Marketplace store in Columbus, Ohio. One more has opened in the Columbus area this year, and another is under construction. Two are planned for Cincinnati this year, according to transcripts from investor conferences.

Ranging in size from 109,000 to nearly 200,000 square feet, the H-E-B Plus format comes a little closer to the supercenter concept with expanded entertainment, furniture, Bed & Bath, Cook & Grill, Card & Party, baby and dollar sections. However, H-E-B Plus also offers special items for local tastes, the company said in a statement.

H-E-B Plus stores can be found in the Texas cities of Corpus Christi, San Juan, Waco, Round Rock and San Antonio. In media reports, H-E-B would not reveal its plans for more Plus stores, and declined to speak with SN about the format.

"The new generation of big stores are an effort to create and innovate, and are more highly differentiated than the usual large-store format," said Bill Bishop, president of the Willard Bishop consultancy in Barrington, Ill. "They are much more than a supercenter."

IT'S ALL ABOUT 'SOUL'

"Most supermarket chains have been thinking one color, one layout, one tile and one sign - stay consistent," said Kevin Kelley, principal and co-founder of the design firm Shook-Kelley, Los Angeles.

"New large-format supermarkets bring back a soulful approach. Supermarkets become fun, instead of looking like they are pushing stuff on you."

These stores are trying to become more relevant in some nonfood categories than Wal-Mart, Target or other supercenters, said Neil Stern, senior partner, McMillan-Doolittle, Chicago.

In its March fourth quarter investor remarks, Kroger tracked its competition against supercenters. The company reported that it competes against a total of 1,129 supercenters - 875 operated by Wal-Mart.

However, its market share gains in the 28 markets where it competes against supercenters rose nearly 40 points on a volume-weighted basis during 2005, only 4 points less than its overall share.

"A popular theme among some investors and the media these days is that traditional supermarket operators like Kroger are being squeezed out by price-focused discounters at one end and high-end specialty retailers at the other," said Dave Dillon, Kroger's chief executive officer, in the same investor remarks. "To the contrary, the market statistics that I just shared with you show that Kroger continues to grow in this highly competitive industry environment.

Privately held H-E-B competes with Wal-Mart on its home turf in Texas, as well.

SUPERMARKET CREDIBILITY

The difference between new big-store formats and supercenters, some industry experts said, is in credibility, which can be gained chiefly through presentation.

"Imagine a large rectangular box where you are exhausted with a sea of product with no differentiation. It becomes a visual overload with no pattern recognition and assaulting images - this is what you want to get away from," said Kelley, who designed the initial 112,000-square-foot Fry's Marketplace store for Kroger in Phoenix.

There is an emotional strategy developed for that store, he said, describing a series of merchandising "realms" or "neighborhoods," each inspiring a significant change of consumer mind-set.

"If you don't present appliances in a certain way, for instance, you don't have any credibility and authority to convince consumers that they should buy them from you," he said. "They might think, 'Well, why not go to a place that really sells blenders.'"

The idea is to present products with the comfort, familiarity and, above all, the authority of a specialty shop, like Bed Bath & Beyond or William Sonoma, but to keep the prices reasonable and the shopping convenient.

"You have to give consumers perceived value," Kelley said. "You don't have to sell at rock bottom. They just don't wan to be gouged."

Part of the authority for supermarket retailers lies in convenience. "I don't think the pure convenience of the supermarket will disappear," said Chuck Cerankosky, food retailing analyst, McDonald Investments, Cleveland.

"[In Texas,] consumers do not want to get stuck at a Wal-Mart supercenter with staff getting cut and part-timers not knowing where product is, or shelves not being fully stocked," said Burt P. Flickinger III, managing director, Strategic Resource Group, New York. He added that H-E-B Plus stores fill an unmet need in the state.

"In many of H-E-B's markets, all three generations of a family shop together after church on Sunday. With managers running the store during these peak periods, it is a much more pleasant experience than that of a more sterile supercenter."

For Kroger Marketplace, its expertise was gained with the acquisition of Portland, Ore.'s Fred Meyer in 1999.

"The continued rollout of our Marketplace strategy would not be possible without the general merchandise expertise of the great team at Fred Meyer that knows which categories and products to sell, and how to sell those products," said Dillon, during the third-quarter 2004 investor conference call.

"It is a lot easier to get into completely new categories when you have the buyers and a supply chain already in place," said Andrew Wolf, analyst, BB&T Capital markets, Richmond, Va.

Far And Wide, And Local

Kroger Marketplace and H-E-B Plus also have the advantage of carrying a lot of items that might not be found in other retailers, Flickinger said. "Bigger supercenters buy nationally where Kroger and H-E-B import from Europe and Asia and often carry a range of specialty local items."

Unique items help to get customers both in the door and knee-deep in nonfood.

"H-E-B tends to get close to 50% of its customers crossing over into key nonfood categories," Flickinger said, calling the Plus stores' traffic flow a "natural continuum to the nonfood departments."

However, its tough to pin down a merchandising strategy for H-E-B Plus because "they go through a constant evolution based on what sells," said Tim Morrison, retail supermarket principal, Little Diversified Architectural Consulting, Charlotte, N.C.

Evolution is unavoidable for Kroger Marketplace, as well. The format goes through shifts as new stores are rolled out, an industry observer with first-hand knowledge of the store told SN.

But overall, the observer said, "the nonfood and food sections are thoughtfully intertwined. There are common-sense adjacencies like baby and toys, reading and Starbucks, and creative touches like reading glasses in the reading area."

"It is fascinating to watch a consumer shop a thoughtfully presented zone," Kelley said. "Their body actually slows down. They are imagining. They are contemplating how they'd like to live and how this product might help them do that. And if you get consumers back in a state of imagination, you've done a tremendous feat."

Entertaining an Opportunity

At H-E-B Plus stores, one of the most significant nonfood categories is entertainment.

The large stores operated by H.E. Butt Grocery Co., San Antonio, have extensive entertainment sections, which include 15,000 CDs and 10,000 DVDs, complete with listening stations, according to the company's website. This is a "remarkable opportunity for H-E-B," said Burt P. Flickinger III, managing director, Strategic Resource Group, New York.

"Reason being, Best Buy started in the North-Central United States and reached the Southwest later in its retail lifecycle. So, H-E-B Plus came up just before Best Buy did. This was happening as Circuit City struggled and Kmart almost completely exited H-E-B's core markets."

So, H-E-B Plus filled an entertainment void for Texans, he said.

Part of the reason H-E-B Plus was able to capitalize on one-of-a-kind opportunities, analysts told SN, is because it is not public. "H-E-B is a privately held company, so they will not have irate public shareholders on the phone," said Andrew Wolf, analyst, BB&T Capital Markets, Richmond Va.

"Whatever H-E-B is doing, they take the torpedo approach," said Kevin Kelley, principal and co-founder of the design firm Shook-Kelley, Los Angeles. "Torpedo is a riskier approach, cutting edge, and it works."

H-E-B's Cultural Fare

Multicultural marketing is a necessity and an advantage for H.E. Butt Grocery Co., San Antonio.

For H-E-B's large-format Plus stores in Texas, "Hispanic marketing is giving them an advantage with the Latino customer constituency, the fastest-growing consumer base in North America," said Burt P. Flickinger III, managing director, Strategic Resource Group, New York.

Competitor Wal-Mart Stores' most loyal customer constituency is Caucasian Americans, he said.

Fresh-baked pan dulce and bolillos - traditional Mexican bakery items - and an expansive Carniceria, a Mexican-style delicatessen, can be found in the grocery section of the H-E-B Plus in San Antonio, the company said.

"This gives H-E-B Plus better brand loyalty with their main customer," Flickinger said.

"Locally and nationally, H-E-B has become a master at building buzz," said Kevin Kelley, principal and co-founder, Shook-Kelley, Los Angeles. "As a company, they have created the authority that says they are serious about their customer and that has an indirect effect on every area of their stores."