KROGER IS GEARING UP TO FACE MORE SUPERCENTER COMPETITION

MARK TOSH

CINCINNATI -- Kroger Co. here expects competitive pressure from supercenters and other low-cost operators to increase this year and, according to observers, the company is gearing up for the challenge.

Most of the new supercenters opening head-to-head against Kroger stores this year are in the Mid-South region of Arkansas, Tennessee and Missouri and will be operated by Wal-Mart, a Kroger spokesman said. The company's Memphis, Tenn., division, with about 100 stores, will bear the brunt of the openings.

Additionally, Kmart, another supercenter operator, reportedly is eyeing Denver as a prospective expansion area. Kroger's King Soopers division is the clear market leader in Denver.

Although most observers believe Kroger will hold its own against the supercenters, the company is not underestimating the challenge. Indeed, in its recent first-quarter statement, Kroger said by year-end about 12% of its total sales base would be in direct competition with supercenters. The 12% represents about 100 supercenters that are expected to be competing against Kroger stores.

This compared with 4% of Kroger's sales base competing with 40 supercenters at the end of 1993. The large increase in the amount of Kroger's sales volume that is being affected by the supercenters reflects the spread of the format across the nation, observers said.

Kroger also is faced with increasing competition from Meijer Inc., a combination-store operator based in Grand Rapids, Mich. Meijer is expected to open its first eight stores in Indiana this year, where Kroger operates about 85 stores. (Meijer stores are not included in Kroger's supercenter store count.)

Wal-Mart, Bentonville, Ark., and Kmart, Troy, Mich., expect to more than double the number of supercenters in operation this year. The two retailers operated a total of about 85 supercenters at the end of 1993 and expect to add about 125 new units this year.

Wal-Mart expects to double its supercenter store count by opening between 70 and 80 units in 1994. Kmart expects to open 55 supercenters, three times the number it operated at the end of 1993.

Meijer, Wal-Mart and Kmart all operate nonunion stores, which can give them a cost-advantage over unionized retailers.

As a result of this increasing pressure from low-cost operators, Kroger is making strategic moves to improve its competitive position. The moves, according to observers, include: · Improving private-label offerings, which should keep Kroger price competitive. (In the first quarter, Kroger told securities analysts its private-label sales increased at twice the rate of overall sales, which rose 3%.)

· Adjusting in-store service levels -- with a move toward more self-service departments -- to reduce labor costs.

· Emphasizing product variety, a supercenter weakness, according to some observers.

· Talking to labor unions about the competitive advantages of nonunion competitors.

The labor issue perhaps is the most crucial for Kroger. One strategy Kroger recently employed in Indiana, where its contract was set to expire this year, was to sign a 15-month contract extension with its union that carries Kroger through the expected Meijer openings this year.

Debra Levin, a securities analyst at Morgan Stanley, New York, said Kroger's negotiating strategy in Indianapolis gives both the company and the union time to assess the impact of Meijer's openings in that market. This strategy could be used in other markets where Kroger expects nonunion competition.

"That [a competitor's nonunion status] has got to enter the discussion when Kroger is negotiating contracts," she said. "I am not saying that every single market will choose to go to this approach and just do a one-year-at-a-time contract, but this has to be a real topic of discussion with the union."

Ed Comeau, a securities analyst at Lehman Bros., New York, said Kroger and other union supermarket operators generally have higher wage and benefit costs than nonunion competition. "The union clearly has to see supercenter competition against the likes of Kroger, Safeway and everybody else that's unionized as a severe threat to the industry," he said. "I think that this puts pressure on the union to become more flexible to allow Kroger and others to compete."

Comeau said he was "amazed" that Kmart is operating six supercenters in Chicago with nonunion meatcutters and clerks.

"They even have a supercenter in Michigan and there hasn't been so much as a picket out there," he said.

Joe Amato, a high-yield analyst at Kidder Peabody & Co., New York, said as more of the large-format, high-volume stores with nonunion labor forces come on-line traditional supermarkets will have to find ways to lower their cost structure.

"The supermarkets are not going to have a choice other than to reduce their cost structure any way they can," he said. "Labor is a big part of the cost structure."

Other operational areas Kroger is adjusting to prepare for the supercenters are at store level.

Levin of Morgan Stanley said she believes Kroger is trying to cut costs by taking service out of the supermarket, which means making bakeries and delis more self-service oriented. "Kroger is not eliminating service, but it is trying to downplay service," she said. Kroger also is adjusting its promotional approach in each market. The company has found that it can improve its price image by reducing the number of stockkeeping units and promoting more.

Steve Ruggiero, a high-yield analyst at Donaldson, Lufkin & Jenrette, New York, said Kroger can take a strong stand against supercenters by emphasizing its private-label program and by offering lower overall prices. "They will lower their price points as they need to," Ruggiero said. "Lower interest expense is enabling them to do that."

Still, many observers believe Kroger will endure the increasing supercenter threat just as it has overcome previous competitive challenges.

Mark Husson, a securities analyst at J.P. Morgan, New York, said Kroger has determined that in competing with supercenters that sales lost in the first year are recovered in the second year after some of the weaker competitors are weeded out. "It really is just a one-year hit [from a supercenter]," he said.

As it develops a strategy to compete with the supercenters, Kroger also considers the other competitors in the market and their ability to withstand competitive pressure, Husson said. "It's not like there's a Kroger and a Wal-Mart standing there and they just punch each other until one falls over," he said. Kroger's thinking, he said, is that you "don't have to outrun the bear. You just have to outrun the guy you're with because the bear is going to get the other guy before he gets you."