Now that most supermarkets are learning to co-exist with supercenters, Wal-Mart Stores may create a new round of competitive challenges as it contemplates opening more medium-sized stores and developing a smaller urban model.
After months of industry speculation, Wal-Mart formally disclosed plans two weeks ago to begin opening medium-sized units of 30,000 to 60,000 square feet — with close to 40 units scheduled to open during 2011 — and to begin testing a smaller store of under 30,000 square feet as well.
“Since traditional supermarkets generally have more expensive cost structures, less flexible unionized labor and preexisting margin pressures, it would be difficult for them to compete on price with these new Wal-Mart stores,” Neil Currie, executive director of UBS, New York, told SN.
Mark Wiltamuth, executive director of Morgan Stanley, New York, said he believes Safeway and Supervalu would have the most exposure to Wal-Mart's new-store strategy.
Leon Nicholas, director of retail insights for Kantar Retail, Cambridge, Mass., suggested supermarkets begin planning now to get a jump on Wal-Mart.
“If I were a supermarket operator with plans to open ‘X’ number of stores in the next few years, I might reconsider and open X-plus before competition for real estate sites becomes too intense,” Nicholas said.
“So if I'm Kroger, I might look for more Marketplace locations, and if I'm Giant Eagle, I might look for more Express locations — formats that provide good returns and better sales per square foot.”
However, observers differed on how quickly the new formats are likely to grow.
Even if Wal-Mart moves forward with an expansion of Neighborhood Market “full force,” Jim Hertel, managing partner at Willard Bishop, Barrington, Ill., told SN, “it will have to find and identify real estate and go through extensive permit processes, so it could be as long as 18 months before it could even start to open stores, which means it could be three to five years before those new-format stores become a real retail threat.”
Nicholas also said it could be 2014 or 2015 before the number of medium- and small-sized Wal-Marts pose a major threat to traditional supermarket operators.
Wiltamuth said he believes the real threat may come a lot sooner. “While only 30 to 40 of these [medium and small-sized] stores will hit the market in 2011, the real estate pipeline is ramping, and [it's possible] the new Neighborhood Market pipeline could be in the 350 range in 2012.”
Currie said he believes Wal-Mart wants to grow its store base as quickly as possible, “but investors don't want it to spend a lot of capital, so I would not expect any degree of massive openings until it's proven the new formats work and ensured the returns are there.”
Once it does decide to move forward, however, the rollout could be rapid, Currie added. “While it may take some time for Wal-Mart to feel it has refined these [new] formats to a point where it is ready for a full-scale rollout, there is potential for it to open more than 400 of these smaller-format stores per year.
“While this level of store openings would be challenging, it would be manageable, given that smaller-format retailers such as Walgreens and Family Dollar have opened more than 500 stores per year at their peak.”
For Daniel Binder, an analyst with Jefferies & Co., New York, Wal-Mart has already proven the viability of the medium-sized format, pointing out that Neighborhood Market's return-on-investment is approaching that of a supercenter, “and EBITDA margins are apparently at least as good as the best EBITDA margins in the grocery industry — in the 5% to 6% range.
“Although that level of profitability would likely be dilutive to Wal-Mart earnings, the investment in Neighborhood Market stores has come down considerably over five years, and the company is now investing 78% of what it used to, allowing the company to achieve an ROI near supercenter levels,” Binder explained.
“So on a near-term basis, Neighborhood Market is primed for a rollout.”
Speaking at the Wal-Mart investor conference two weeks ago, Bill Simon, president and chief executive officer of Walmart U.S., said, “There are hundreds and hundreds if not thousands of opportunities in the U.S. for small formats. Some would be in fill-in markets we have already developed, but many, many, many of them exist in urban markets and small towns where we have no market share.”
Although Simon said the medium-sized stores will be similar to Wal-Mart's Neighborhood Market, he did not disclose what store banner it will use, though some observers are referring to the format as “Neighborhood Market” in their assessments.
According to one school of thought, if Wal-Mart opts to invest most of its capital the next few years in international acquisitions, then any large-scale rollout of new formats in the U.S. would be relatively slow — a scenario that would give supermarket operators a chance to chart their course more deliberately.
“These medium- and small-sized stores may not grow at the rate Wal-Mart grew supercenters, when it was opening close to 200 a year,” Nicholas told SN.
As Wiltamuth and Currie suggested, the rollout could exceed that number.
Hertel of Willard Bishop, however, said it might be too soon to predict any widespread Neighborhood Market rollout from Wal-Mart, given past history.
“I'm a bit skeptical about plans to expand Neighborhood Market because we've heard that promise from Wal-Mart in the past, yet very little has come of it. So I'm taking this discussion with a grain of salt.”
Art Turock, principal with Art Turock & Associates, Kirkland, Wash., was also skeptical. “Wal-Mart talked four years ago about growing Neighborhood Market and nothing happened — and it's opened small stores like Marketside in Phoenix that it doesn't plan to continue.
“I was very aware of the threat supercenters posed when the company first started opening them, but I do not have the same fear, worry or anxiety about Wal-Mart doing something small.
“It certainly has done well with supercenters, which is a more efficient format, but the company's track record indicates it doesn't do that well with smaller stores.”
Turock said he sees the combination of Save-A-Lot and Rite Aid in the Southeast as a more convenient, more viable approach to small formats.
Wal-Mart told the investor conference earlier this month the medium-sized stores would be similar to its 42,000-square-foot Neighborhood Market format. Though the development of Neighborhood Market has been slow, particularly by Wal-Mart standards — with only 181 locations opened since 1998 — the company said changes to the format have made it more viable as a growth vehicle.
During his presentation at the conference, Simon said the Neighborhood Market format has become a more attractive expansion vehicle over the last couple of years due to several “significant changes.”
“One of the first things we realized was that the prescription business at the stores' pharmacies was driving a disproportionate share of sales vs. the pharmacies in the supercenters,” Simon explained, “so as the share of that business and the profits improved, so did the top and bottom lines.
“We also changed our merchandising approach. For many years we were sending the same items in the same quantities to Neighborhood Markets as to supercenters, but we changed that in the last couple of years [by catering more to specific neighborhood needs].
“In addition, we began operating that format differently. Three years ago we had one market manager typically overseeing eight supercenters and two Neighborhood Markets, which meant most gave their attention to the eight, not the two. Once we made some structural changes to align the leadership in the stores and in the markets to focus on operational improvements, business improved — and our produce business also improved as we added more efficiencies,” Simon said.
According to Hertel, if the changes Wal-Mart has made to Neighborhood Market make it a more viable format, then it could be a very powerful competitive vehicle, especially in some urban food deserts.
“Right now ShopRite's PriceRite and Giant Eagle's Valu King represent the next generation of killer formats because they are priced very aggressively, albeit with some third-tier brands, and they seem to do a good job meeting the needs of local communities, particularly ethnic neighborhoods.
“That's the standard Neighborhood Market will have to meet, though I'm still skeptical about Wal-Mart's follow-through on its promise.”
Wal-Mart officials did not give out many specific details about the smaller-format stores during the investor conference. “Most markets around the globe have been successful with smaller stores, so we have a ton of institutional knowledge in our company, and we will continue to learn from our global counterparts,” Simon said.
Binder said stores under 30,000 square feet are “prevalent and successful” throughout Wal-Mart's international markets, “and the development of a prototype at Walmart U.S. will be drawing off that experience.
“The company plans to take this format into high-density urban regions where real estate availability and cost are key issues, and also out to rural markets where populations do not justify a larger format.
“This is not necessarily a dollar-store format, and given the small number of stores that will be introduced initially — and without further insight into how these stores will be merchandised — it's far too early to call them a competitive threat [to dollar stores],” Binder said.
Nicholas said he expects Wal-Mart's smaller units to be “similar to a food-and-drug store but with a site-to-store application.
“It will look like a Neighborhood Market, with a pharmacy, a limited assortment of HBC and over-the-counter drugs and a limited assortment of food and non-edibles, but it will also have the capability of serving as a pickup point for items ordered from Walmart.com.”
This approach would be particularly desirable in an urban market, Nicholas pointed out, where people tend not to be home during the day and would not want something delivered to their apartments. “But with Wal-Mart's highly efficient distribution, it could deliver products to these small stores where customers could pick them up.
“Currently, Wal-Mart is having merchandise in some cities delivered to FedEx locations that serve as instant distribution points, which has enabled Wal-Mart to expand its footprint with zero capital investment. These small urban stores would allow Wal-Mart to do what it does best, which is to distribute goods.
“It's an approach other companies could try, but they lack the scale of Wal-Mart to make it practical,” Nicholas said.
Currie suggested Wal-Mart could make an acquisition to hasten expansion of its smaller format, noting that Rite Aid, Camp Hill, Pa., would be an attractive target, “since Rite Aid's stores fit Wal-Mart's real estate needs, with numerous units over 20,000 square feet in urban areas to which Wal-Mart could bring its own processes and efficiencies, with clear potential for improvement.”
Most of Rite Aid's stores are located on the East and West coasts, with many in such urban areas as New York, Boston, Washington, D.C., and Los Angeles, where Wal-Mart does not have a major presence.
Given that Rite Aid's East Coast stores are smaller — averaging 11,000 square feet compared with a 20,000-square-foot average on the West Coast — and given that the Western stores are “better equipped to serve as a combination pharmacy/food retailer,” Currie noted, Wal-Mart could pursue an acquisition of just one segment of Rite Aid's operation.
