Mexican Retailers Court Growing Middle Class

Mexican Retailers Court Growing Middle Class

Modern supermarket formats are making inroads with the growing middle class South of the Border “There’s still plenty of room for long-term retail sales growth, given the size of the market and Mexico’s powerful economic growth." — Carlos Hernandez, analyst, Planet Retail  

The future looks bright for supermarket operators south of the border, down Mexico way, as they shift to smaller stores in smaller markets.

Though street vendors, open-air markets and mom-and-pop stores still play a big role in the Mexican grocery business, the proliferation of Wal-Mart formats up and down the country — and the competitive response by Mexican-based companies — has strengthened the position of modern supermarkets in Mexico over the last 20 years, industry observers noted.

“People who previously shopped in the traditional sector will switch to shopping at modern formats,” Carlos Hernandez, a Madrid-based retail analyst for Planet Retail, London, told SN.

Through 2011 the aggregate market share for the top five grocery retailers in Mexico rose to 38%, compared with 26% in 2006, and the major chains believe they can potentially boost their share another 25% to 30%, he said.

SN Releases 2013 Top 25 Global Food Retailers List [4]

“There’s still plenty of room for long-term retail sales growth, given the size of the market and Mexico’s powerful economic growth,” he added. “Domestic demand is also being driven by the emergence of modern retail formats and relatively low interest rates, [though] the reach of this future growth will be closely linked to a lasting economic recovery.”

The issue of growth comes down to financial strength, Jorge J. Quiroga, director general for Todo Retail, Mexico City-based retail consultants, told SN.

“The battle among the major players is to seize as much real estate as they can,” he said. “But while Wal-Mart has a lot of cash, Soriana, Chedraui and the others have to fight the battle with more limited resources.”

The impetus for growth in Mexico is coming from two factors that favor modern supermarkets, observers told SN — a growing middle class and the fact that 60% of the country’s population is under the age of 20.

With some urban areas over-stored, the battle for share-of-wallet is shifting to smaller stores in smaller cities, they added.

Jaime Gonzalez, director of Costco Wholesale Corp.’s Mexico operations, said the middle class is continuing to grow “because more people are pursuing higher education, and there are more skilled job opportunities and increased foreign investment — factors that translate to higher disposable incomes.”

Sources said the middle class has grown from about 12% just 20 years ago to a number approaching 50%.

One industry observer said the emerging middle class in Mexico “wants to enjoy its success by buying more made-in-America goods as well as buying more international foods and eating healthier diets — and those people are willing to pay more for American goods.”

Citing an ABC News report, he said sales of made-in-America products have doubled in Mexico to $198 million over the last five years.

Family Demographics

According to Quiroga of Todo Retail, even more important than the growing middle class is “the phenomenon we are seeing of more people getting married, which means two-salary households [with more disposable incomes].”

The country’s relatively young population represents “an incentive for grocery retailers, which are generally favored by younger shoppers,” he added.

According to Matthew McClintock, a retail analyst for Barclays Capital, New York,  “The differences in small-format expansion strategies among the major retailers could ultimately create the next level of separation for market-share stories in Mexico.

“Major retailers have accelerated growth in smaller store formats that more effectively compete against informal market participants,” he pointed out.

The number of smaller-format stores among Mexico’s five largest chains exceeds 1,200, compared with about 350 in 2006, sources indicated.

The impetus for smaller formats apparently came from the success of Oxxo, a convenience-store chain with more than 11,000 locations in Mexico, they added.

“The success of Oxxo has demonstrated a demand for smaller retail formats, and those formats can be sustained simply from market-share gains without the need for further macroeconomic growth,” McClintock said.

The edge smaller-format supermarkets have over convenience stores is that they carry perishables, he added.

The ideal expansion target for smaller-format stores is cities with populations of 25,000, observers said.

According to Quiroga,  “It’s a smart move for supermarkets to locate stores in small cities because it enables them to create loyalty among their customers.”

McClintock said the decision by companies to focus expansion on smaller-format stores “is based on expectations for returns, which would indicate that smaller formats offer a compelling avenue of growth.”

However, while Mexico-based retailers like Soriana and Chedraui are targeting their smaller formats of 15,000 square feet almost exclusively in smaller cities, Wal-Mart is concentrating more on moving into urban markets with its 4,000-square-foot Bodega Express format — an approach McClintock said he believes is likely to be the more successful strategy.

 “The larger, longer-term opportunity lies with the urban locations,” he said.  “While smaller cities could represent low-hanging fruit from the potential lack of scale of competitors, the challenge is generating enough return from a smaller populace to justify the investment. 

“Soriana addresses this challenge through pricing strategies.”

Local Business

Despite the persistent growth of American companies, “the face of retail in Mexico is still more Mexican than American,” Quiroga told SN.

“The companies that have come to Mexico from the U.S. have adapted their operations to the local consumers, and the industry here reflects trends from within the country rather than American influences.

“There are new retail stores everyday, and we see new trends in Mexico all the time.”

However, there is still room for new formats in Mexico, Quiroga added — “something like Walgreens, which does not exist in Mexico.”

According to McClintock, “Mexican supermarkets are becoming more sophisticated in the way they appeal to customers, offering a more comprehensive range of services as they expand the variety of retail formats,” he noted. “But I wouldn’t say they are becoming more Americanized.”

The Mexican supermarket business was pretty much local, with each Mexican company dominating one region of the country, until Wal-Mart’s entry in 1991, Quiroga said.

“Since then, the retail sector has been following in Wal-Mart’s footsteps in many ways.”

According to estimates, Wal-Mart and Soriana are on an equal footing in the northern part of the country, with a comparable number of stores and a market share of about 25% each. However, in the northeast, Soriana is a distant second to Wal-Mart.

In central Mexico, Wal-Mart doubles Soriana’s share; and in metropolitan Mexico, Wal-Mart controls 44% of the market compared to single digits for Comercial Mexicana.

In southeast Mexico Wal-Mart controls 20% of the market, to Chedraui’s 13%; while in southwest Mexico, Wal-Mart has 38% to Chedraui’s 12%, with Soriana a close No. 3 at 10%.

According to Quiroga, Wal-Mart has imported some of its practices in Mexico to its U.S. operations. For example, when Wal-Mart saw the profit numbers for the big produce departments at its Aurrera stores in Mexico, it began integrating more produce into its U.S. floor plans, he pointed out.

“And the equivalent of Neighborhood Market stores have been here for a long time, and now Wal-Mart is opening more of those in the U.S.”

But there are significant differences among American operators in Mexico from their U.S. stores, he added. “Though Wal-Mart’s stores in Mexico look pretty much like Wal-Mart’s U.S. stores, if you walk the aisles, you will find several differences in the assortments.

“Also, several of its formats in Mexico are more profitable that its U.S. supercenters. For example, Bodega Aurrera has become a giant in Mexico.

“But Costco is exactly the same in Mexico as in the U.S.”

The Competition

Following is a closer look at the major food retailers in Mexico:

  •  Walmart de Mexico, or Walmex, with 2,360 stores and estimated sales of approximately $37.5 billion (U.S.).

 “Wal-Mart’s aggressive expansion strategy, coupled with low prices, has enabled it to make massive inroads into the Mexican market, with sales exceeding the next three local retailer combined,” Hernandez said.

After entering the market in 1991 with a single Sam’s Club through a joint venture with Cifra, one of Mexico’s major retail operators, Wal-Mart acquired the majority stake in Cifra in 1997 and in 2000 changed its name to Walmex.

The company operates a multitude of formats: 227 hypermarkets (Walmart Supercenters), which average 130,000 square feet; 142 Sam’s warehouse clubs, averaging 105,000 square feet; 671 discount stores (413 Bodega Aurrera and 258 Mi Bodega Aurrera), covering 68,000 square feet and 18,000 square feet, respectively; 90 Superama supermarkets of 30,000 square feet each; and 759 limited-assortment stores (Bodega Aurrera Express), 30,000 square feet; as well as seven Farmacia Walmart drug stores; 100 Suburbia clothing stores; and 364 restaurants (Vips, El Porton and Ragazzi).

Although Wal-Mart continues to expand all formats, most of its growth in Mexico is focused on its Express format in urban areas, with growth coming in store clusters to provide enhanced logistical capabilities, said Matthew McClintock, a retail analyst with Barclays Capital, New York.

“The Bodega Express format provides the company with a relatively unique tool to address the informal market in urban areas,” he explained.

With Soriana and Chedraui focusing on smaller cities, “this essentially concedes the urban market to Wal-Mart,” he added.

Wal-Mart’s expansion across the country has also resulted in more emphasis on private label by other chains to compete more equitably with Wal-Mart, Hernandez said.

However, unlike its U.S. stores, Wal-Mart stores in Mexico don’t necessarily have a pricing edge over competitors, Quiroga told SN. “Wal-Mart is expensive if you compare it to Soriana or Chedraui,” he said.

“It’s Wal-Mart’s Bodega Aurrera Express format, geared to low-income shoppers, that has better prices in some areas. However, in many price checks we have made, Bodega Aurrera has been the most expensive store, even with its Great Value [private-label] line.”

  • Organizacion Soriana, based in Monterrey, Mexico, which has 807 locations, with sales estimated at $10 billion.

Approximately half its volume comes from Northern Mexico, where it operates the bulk of its stores — an area plagued by security issues that threaten traffic growth, observers said.

According to McClintock, sales tend to drop off after dark because of escalating crime rates, with people opting to stay home or in other non-public areas. In response, Soriana has become more aggressive in the region with home deliveries, he said.

Soriana sought to diversify geographically following its $1.4 billion (U.S.) acquisition in late 2007 of 199 stores from Gigante, then Mexico’s fifth largest retailer, which enabled it to consolidate its position as the nation’s second largest grocery operator.

Most of Soriana’s stores are hypermarkets — operating under the Soriana Hiper banner — though it has diversified its formats in the face of Wal-Mart’s growth, adding a warehouse format, City Club, in 2002; a superstore format, Mercado Soriana, in 2003; a convenience-store format, Super City, in 2005; and a conventional supermarket, Soriana Super, in 2007.

Given its historic heritage in smaller cities, Soriana sees ongoing expansion in smaller cities as the driver of long-term growth, McClintock said.

“The Soriana Express format could serve as the flagship for future growth,” he explained. “It offers value to consumers as a convenient source of supply for many smaller communities where residents often were forced to travel to other cities to fulfill their shopping needs.

“The format is designed to serve the needs of populations smaller than 60,000 people with a medium low- to low socioeconomic level, with an average sales floor of 15,000 square feet and approximately 8,200 SKU’s across all product categories,” including clothing and other general merchandise.

The investment to open a Soriana Express is relatively low, he added, “and the company generally has pricing power in these [smaller] cities as there are few alternatives for the consumer. As such, productivity levels are much higher than other formats, margins are essentially higher, expenses are less due to lower salaries and land costs are less.

“These benefits are offset by higher transportation costs.”

  • Grupo Comercial Chedraui, based in Xalapa, which operates 198 stores, mostly in central and southern Mexico, with total sales estimated at $9.2 billion (including approximately $1 billion from sales in the U.S.).

Unlike Walmex and Soriana, Chedraui is more focused on expanding with hypermarkets (Chedraui) and large supermarkets (Super Chedraui) than smaller-format stores, Hernandez said.

The company has grown through acquisitions, buying the 29 Carrefour stores in 2005 that it was operating in a joint venture with the French retailer and adding three independent stores in Baja in 2010. It also acquired seven Gigante stores in Southern California from Soriana in 2008 (which operate as part of Los Angeles-based Bodega Latina, doing business as El Super) and 11 Fiesta Foods in Texas in 2010.

Despite operating fewer stores than either Walmex or Soriana, “Chedraui has done an impressive job competing on price against larger retailers with more scale,” McClintock said. “However, its commitment to low prices places a limit on margins, as any improvement is consistently reinvested back into prices.”

Chedraui’s growth strategy is to expand within existing cities as well as to establish its large-format stores in underserved regions with populations greater than 25,000, he added.

“Chedraui is more focused on acquisitions in the Mexican market,” McClintock said, “and is targeting smaller family chains with solid real-estate locations,” including a variety of Mexican-owned independents. Sources said it may also have its eye on the Mexico stores operated by H.E. Butt Grocery Co. and also Casa Ley, the company in which Safeway has a 49% investment.

  • Controladora Comercial Mexicana, based in Mexico City, which operates 250 stores and has a volume estimated at $4 billion this year.

The company has a format mix similar to Walmart’s, with hypermarkets (Mega), supermarkets (Comercial Mexicana), superstores (Bodega), warehouse clubs and restaurants, with most of its sales coming from the country’s central region, including Mexico City.

Comercial Mexicana continues to test new formats, Quiroga said, citing “two recent bold moves” — City Market and Fresko.

City Market is designed to pamper high-end customers, he said, with average transactions of $150. The stores offer high-end selections, plus service bars where certified chefs prepare pintxos (Spanish tapas) “that customers can enjoy with a good glass of wine,” Quiroga pointed out.

He described Fresko as “more like Whole Foods, but with better prices.”

Comercial Mexicana had been part of a 50-50 joint venture with Costco that originated in 1992 and ended last June, when Costco bought out its partner for $760.4 million. Comercial Mexicana used those funds to pay down debt, observers said.

  • Casa Ley a chain of 195 stores based in Culiacan, with locations in northern and western Mexico and estimated sales of $2.1 billion. Casa Ley is a company in which Safeway owns a 49% stake, which resulted from a joint venture instigated in 1981 by Vons Co., now a division of Safeway.

Among Casa Ley’s strengths is a high percentage of food and perishables, which makes it competitive with larger chains, along with optimal store locations and local market knowledge, observers said.

According to Hernandez, Casa Ley stores average just under 50,000 square feet, though a handful are as large as 100,000 square feet. He said the stores are also strong in non-foods such as toys and clothing.

  • Costco Wholesale Corp., Issaquah, Wash., with 32 warehouses and estimated sales of $2.8 billion in Mexico.

Jaime Gonzalez, director of Costco’s Mexico operations, said the company has done well there, with plans to ramp up expansion in new and existing markets and to launch an e-commerce site this fall.

“We are very disciplined in executing our business plan,” he added.

Merchandise and services are the same in Mexico as in the U.S., Gonzalez said. “The only exception would be the addition of domestic foods and sundries.”

At the time Costco bought out Comercial Mexicana last June, it said it had always been responsible for managing the joint venture, so the only change would involve who owned the shares.

According to Hernandez, the split from Comercial Mexicana could enable Costco to expand more rapidly in Mexico. “Being on its own means Costco is not dependent on a troubled retailer to operate in Mexico and perhaps has a better chance to resume expansion,” he pointed out.

Costco has not opened any new facilities in Mexico since opening two warehouses in 2009.

  • H-E-B, San Antonio, which operates 44 stores, mostly in Northern Mexico, from a base in Monterrey, with estimated sales of $1.4 billion (nearly 7% of the chain’s estimated total volume of $19.4 billion.)

H-E-B entered Mexico in 1997 and opened a distribution center there in 2004.

Interviewed by SN several years ago, Howard Butt III, director general of H-E-B’s Mexico division, said, “We’re betting on the country and its growth. It’s a young country, and we think it has a lot of economic potential.”

While most American food retailers doing business in Mexico entered through a joint venture, H-E-B chose to go it alone because it felt it offered a familiar brand, having operated stores along the Mexican border for more than 60 years that attracted business from Mexican residents who crossed into Texas to shop.

H-E-B sought to distinguish itself from the competition in Mexico by focusing, as it does in the U.S., on the quality and variety of its perishables departments, Butt told SN. Over the years it also broadened its selection of general merchandise to compete with Mexican hypermarkets, offering such items as refrigerators, stoves and furniture.

H-E-B stores in Mexico run between 80,000 square feet to 90,000 square feet, although some units are as small as 30,000 square feet.

While it initially opened stores close to the U.S.-Mexico border, H-E-B has moved further into the country’s interior, where its name is not as well known, over the last few years.

  • Smart & Final, Los Angeles, which operates 13 stores as part of a joint venture in Baja, Mexico — within 50 miles south of the U.S. border near San Diego —including six stores in Tijuana, three in Mexicali, two in Ensenada and two in Rosarito Beach.  

Sidebar: Bribe Allegations Hang Over Wal-Mart

Wal-Mart Stores has made a commitment to getting to the bottom of alleged bribery charges in its Mexico division that came to light a year ago.

“If any violations occurred, then appropriate actions will be taken,” S. Robson Walton Jr., chairman, told the company’s annual meeting last June. “That is my personal commitment to each of you.

“We will do the right thing the right way. You have my word on that.”

His comments followed reports accusing Wal-Mart de Mexico of being “an aggressive and creative corruptor,” based on allegations that company officials had paid millions of dollars in bribes over several years to Mexican officials to sidestep local regulations and obtain construction permits for several stores — actions that may have been known to various corporate executives.

The alleged bribes were designed to allow Wal-Mart to expand quickly in Mexico and to subvert building and safety regulations.

Walton said the company was cooperating with investigations by the Department of Justice and the Securities and Exchange Commission and was also conducting its own investigation — one initiated, before the allegations were published, by the audit committee of the company’s independent directors working with outside counsel.

Wal-Mart said it is committed to having “a strong and effective global anti-corruption program everywhere we operate and taking appropriate action for any instance of non-compliance,” adding it had made significant improvements in its compliance procedures around the world nearly two years before the allegations became public.

Wal-Mart subsequently created a new corporate position to oversee compliance with the U.S. Foreign Corrupt Practices Act, which prohibits payments of bribes by Americans to foreign officials, among other practices.

According to published reports, Eduardo Castro-Wright, who led Wal-Mart’s Mexico operations between 2002 and 2005 — and who later ran the company’s U.S. division — was the driving force behind “years of bribery.”

Castro-Wright retired in July with the title of vice chairman and CEO of global e-commerce and global sourcing.

Sidebar: Mexico at a Glance

Mexico is the second largest country in Latin America, after Brazil, with a population of about 116 million.

The rate of growth has slowed in recent years due partly to immigration to the U.S., sources said.

Total grocery spending in 2013 is estimated at $200.7 billion (U.S.), or $1,710 per capita, Carlos Hernandez, Madrid-based analyst for Planet Retail, London, said.

However, many Mexican consumers still shop at street stalls, open-air markets and traditional mom-and-pop stores. Mexico had approximately 600,000 mom-and-pop stores operating in 2011, trading from an average space of 2,300 square feet.

Mexico’s three largest population centers are Mexico City (with 20 million residents in the metropolitan area), Guadalajara and Monterrey.

The urban population is around 75% — comparable to France and higher than Italy, sources pointed out.

Consumer spending is among the highest in Latin America, totaling $829 billion (U.S.), or $7,153 per capita — though it is low when compared to other developed countries, Hernandez noted.

By 2020 Mexico is expected to by among the top 10 economies in the world — growing at a rate of about 4% annually — just behind India, China and Brazil and ahead of Russia, observers said.