Analysts Ponder: Is Kroger All It Can Be?

NEW YORK — Kroger Co. is likely to continue seeking to build volume at a slow and steady pace, while Safeway is counting on Just For U to give it a sustainable boost, according to participants in SN’s 17th annual Analysts Roundtable here.

“Kroger believes winning the war of attrition takes time,” John Heinbockel, managing director at Guggenheim Securities here, said. “The end game is that, at some point, you are left with Wal-Mart and Kroger and little else, [at which point] Kroger can more easily differentiate itself and then margins drift up.”

However, with so many different banners, it’s hard for Kroger to create a national identity, Andrew Wolf, managing director at BB&T Capital Markets, Richmond, Va., noted. “But it can let the shopping experience speak for itself because when you go in that store, it is winning on all the going-to-market attributes that a supermarket should win,” he said.

Heinbockel expression similar comments about Kroger. “It’s not the best in price, but it is good enough. It’s not the best in perishables, but it is good enough. It’s not the best in service, but it is good enough. If you are not extreme, it makes it that much harder to brand yourself.”

Despite its operating success, Kroger continues to breed negative expectations on Wall Street, Meredith Adler, managing director for Barclay Capital here, said. “Although it beat expectations and didn’t miss once throughout 2011, many people believe it is due for a miss simply because it hasn’t missed in so long.”

Gary Giblen, an independent analyst, said he had a similar opinion. “It’s on an execution tightrope to balance good revenues without much margin sacrifice, and while, to its credit, Kroger usually [balances itself], worries about the next quarters haven’t allowed its stock to perform well.”

What could change the chain’s momentum would be a shift toward more store growth, Scott Mushkin, managing director at Jefferies & Co. here, noted. “It seems [Kroger’s] appetite for store growth has increased a little,” he said. “For the first time in years it seems like this company actually wants to change the growth algorithm, so I think it could begin growing by about 2% a year.”

Turning to Pleasanton, Calif.-based Safeway, the analysts said the chain’s expansion in the early 1990s — when it acquired Vons in Southern California; Dominick’s in Chicago; Genuardi’s in Philadelphia; and Randalls and Tom Thumb in Texas — has left it with challenges it is only just beginning to resolve.

“If that money [used for acquisitions] had been invested in building share, Safeway could have become the Publix of the West Coast by now,” Mushkin said, “and it would have a very different margin situation — if it had used that money to invest in its core markets and build up market share as Publix did.”

But with completion of the national rollout of Just For U, “sales at Safeway are picking up pretty briskly, and it is definitely making progress,” he added.

Adler said she believes Just For U has the potential to deliver better value to existing Safeway customers and draw in new ones. “Just For U is a way of delivering value in the context of who Safeway already is, and it enables the company to stand out in people’s mind by reminding them there is value there,” she explained.

Deborah Weinswig, an analyst with Citigroup here, said she is enthusiastic about the prospects for Just For U. “It includes 30 million unique offers based on purchasing history, and every customer gets his own offers. The more you shop, the better the offers are. The customer feels she gets great prices and great service, so I think Safeway will exceed its original targets.”

In other comments during the roundtable discussion:

• On top management changes at Safeway: “After a period of watching executives come and go, it looks like the management team has settled down to a group [Steve] Burd [chairman and CEO] feels exceedingly comfortable with,” Giblen said.

• On Whole Foods Market: “It’s best growth may actually be ahead of it,” Mushkin said. “There are so many people under 25 who really like natural and organic — almost double the general population — and those trends are shockingly strong.”

• On Fresh & Easy Neighborhood Market: “I think Fresh & Easy will pack it in and leave the market,” Wolf said. “When you have low-volume stores with low prices, you can’t make money — the math doesn’t work. So if Tesco sticks to the deadlines it set, it is probably going to pull the plug.”

• On conventional-format stores: “There are still so many conventional chains around that validate the concept,” Wolf said. “If you run a good store, people will still shop there.”

But Mushkin said Millennials tend not to like supermarkets. “The Millennials almost mistrust traditional retailers, and they are actually starting to trust mass merchants more. For [that] generation, the traditional format doesn’t look great.”

• On industry innovations: Weinswig said she is excited about the new queuing program at Kroger that eliminates waiting in checkout lines, and she said she is also encouraged by workforce management technology, “[which] will really allow retailers to compete better and more effectively with the discounters and the clubs, even in an environment where the grocers are operating with more expensive and less flexible labor.”

The full text of the second half of the roundtable discussion follows:

KROGER

SN: What are your thoughts on Kroger?

Gary Giblen: Kroger gets a lot of love, but it’s on an execution tightrope to balance good revenues without much margin sacrifice — and if there’s a stiff gale, even the best tightrope walker can fall off. Ironically, right after the love-fest at last year’s Supermarket News roundtable, Kroger reported mixed results and the stock plummeted. It seems Wall Street is now awakening to the idea that Kroger has to walk the execution tightrope every quarter, and while, to its credit, Kroger usually does, worries about the next quarters haven’t allowed its stock to perform well.

Andrew Wolf: I think Kroger’s is the only stock among the big public companies that is undervalued, unless you think the industry headwinds are so strong that you should just stay out of those stocks altogether, which is the consensus view on the buy side, and it’s a very legitimate view. But its EBITDA is going up, and its returns are going up, and it has resolved the issues at Ralphs, which was its only problem division.

Meredith Adler: The market has no confidence in Kroger. Although it beat expectations and didn’t miss once throughout 2011, many people I speak to believe it is due for a miss simply because it hasn’t missed in so long.

Giblen: Everyone has thought Kroger operates in this permanent nirvana between healthy profits and sales, which is very difficult to do when the headwinds are getting stronger. And although it has done a magnificent job, every quarter is ultimately just a balancing act, and sometimes it is not going to work — for example, if it has to invest a lot in price or if it doesn’t get the targeted sales response because some programs misfired tactically.

John Heinbockel: I think its performance is pure in the sense that, if you are running a business in a dynamic environment, you are going to miss one or two out of four quarters and you are going to beat one or two out of four quarters. You can’t beat by a penny each quarter. My philosophy has always been that, after the company has had a big beat, it is due for a disappointment as it gives some of the beat back; and after a miss, it’s a good time to buy the stock because the likelihood of the next quarter being a solid one, as adjustments are made, is pretty high. But these are short-term tactical issues.

Wolf: I think a lot of people on the buy side are just waiting for Kroger’s gross margins to stabilize before they put their foot in the water — though predicting when that will happen has been nearly impossible.

Scott Mushkin: If you look at the long-term trends, you could have gone to sleep for five years and Kroger’s stock price is exactly the same because its EBITDA remains fairly flat. As one portfolio manager said, some days I wake up and see Kroger at $22 and I celebrate, and other days I wake up and see Kroger at $22 and I want to jump out the window.

Wolf: While the stocks of everyone else in the industry have gone down, Kroger’s stock has greatly outperformed Safeway and Supervalu. But it’s a zero-beta stock, which doesn’t really help performance. One thing that could help the stock is if Europe blows up and we hit a recession while Kroger invests in keeping its market share growing. But in a steady-state market like we have now, the company is talking about allowing operating margin to go up, and that normally improves return-on-investment, which should be enough to get the stock up.

Mushkin: What makes this discussion interesting is if Kroger is in the process of changing its growth algorithm. It seems its appetite for store growth has increased a little. If negative-1% square-footage drag becomes a plus-2%, that is potentially an important development, especially if margins are finally stabilizing. We seemed to be in this same place two years ago when the company was feeling good about margins, though nothing ever really materialized.

So when I look at Kroger, I see that it’s doing well, nearly doubling sales, but EBITDA hasn’t moved in years; and if you look at square footage growth, it’s been shrinking. But for the first time in years it seems like this company actually wants to change the growth algorithm, so I don’t think it is going to shrink any more. The company said square footage is going to be up this year for the first time in years, and I think it could begin growing by about 2% a year.

Heinbockel: But you would think that, on a comp of 3% to 5%, the company ought to be able to leverage expenses a bit better and drive more EBIT margin expansion. I sometimes jokingly accuse Kroger of chasing windmills — that there is always some new competitive threat lurking just around the corner that prevents EBIT margin from expanding. But the reality is that the company is addressing the 2 billion square feet of competitive capacity I referenced earlier [see Part 1 of the Roundtable] and doing so better than most. So it will focus on maximizing comps and market share, and EBIT margin will fall out as a result. Will that fundamentally change? I don’t think so. It’s in Kroger’s corporate DNA, for the last 10 years, to maximize market share, and I don’t think this is a bad approach. It means EBIT growth is more likely to be 3% to 4% than 5% to 7%, but it should be a sustainable 3% to 4%.

Mushkin: Do you think Kroger does a good job building its brand? CPG companies keep saying that, when you turn on the TV during the holidays, all you see is ad after ad saying, “Always Low Prices. Always” from Wal-Mart. But if you add in the coupons from Dunnhumby and the discount on gas, Kroger is going to be cheaper than Wal-Mart. Does the average consumer realize that? I think the answer is no, and that’s a fatal mistake the company is making.

Adler: But isn’t it hampered by the fact it can’t do national advertising? Would Kroger change the King Soopers banner to Kroger, for instance? And even if it did, look at what happened when Albertsons changed Lucky to Albertsons, in part because it wanted to be able to run national ads — it was an utter disaster.

Heinbockel: Kroger is really a jack-of-all-trades, which is a good thing. It’s not the best in price, but it is good enough. It’s not the best in perishables, but it is good enough. It’s not the best in service, but it is good enough. If you are not extreme — where you are the best in a category, like a Whole Foods or a Wal-Mart — it makes it that much harder to brand yourself because you are somewhat more defined by who you are competing with.

Adler: But what do you think about when you think of Kroger, compared to the others?

Wolf: I think of it as being among the best conventional supermarkets out there — in Richmond, anyway, where it’s Kroger against Food Lion and Martin’s. I totally get what you are saying — that it’s hard for Kroger to create a national identity. But it can let the stores speak for themselves — it can let the shopping experience speak for itself, because when you go in that store, it is winning on all the going-to-market attributes that a supermarket should win on, so I think Kroger is in really good shape.

But if you look at its margin structure, it is costing Kroger a lot of money. For its best customers, it doesn’t have to be priced below Wal-Mart or at Wal-Mart. Publix prices at 22% over Wal-Mart, so why is Kroger not getting any credit for what it’s doing?

Heinbockel: Are you talking about credit from the customer or credit from investors?

Mushkin: Both.

Wolf: Well, Kroger already gets it from the customer.

Adler: Peter Lynch [former chairman of Winn-Dixie] once said he thought everybody followed Kroger down, but Kroger really wasn’t differentiating itself and it didn’t need to cut prices as much as it did.

Mushkin: I agree that Kroger is not doing as much to differentiate what it is doing as it should.

Heinbockel: I think Kroger believes that winning the war of attrition takes a long time. You generally never want to see a competitor file for Chapter 11 and thereby potentially address its problems. You would rather consistently bleed them for share for 20 years. The end game is that, at some point, you are left with Wal-Mart and Kroger and little else. Kroger can more easily differentiate itself, and then margins drift up. The problem is that, once you get to the end game, does it have to fight Amazon or some other business model?

Wolf: What’s interesting is that, in essence, Kroger is running a private company strategy as a public company, and it’s doing better than everybody else — and that’s probably why it is not getting the stock bid up.

Heinbockel: In terms of store operations, most of my complaints about Kroger are more nitpicks. For example, Kroger did not want Ralphs to get in the way of Food 4 Less too much. But it never tried to widen the price gap with Vons in Southern California as it did with competitors everywhere else. I think that’s because Ralphs ran Southern California holistically and it had Food 4 Less to go after the price customer, and it didn’t want Ralphs to get into Food 4 Less’ shorts too much, so it chose not to cut prices at Ralphs. Kroger runs the two brands separately, and it wasn’t till recently that Kroger finally got around to addressing pricing at Ralphs — and even today, despite some improvements, a lot of work remains to be done.

Adler: Is it because the customer base Ralphs thought it was going after has shrunk as the middle has been eaten away and what was left was too small for Ralphs to get a decent return?

Mushkin: I think the real estate in Southern California is too expensive, and labor there is more expensive as well. But with Ralphs and Vons pretty much on top of each other in every price survey, you have to wonder if the problem is structural.

Heinbockel: I think Kroger has stopped looking at traditional supermarkets as a measuring stick and looks instead at Wal-Mart.

Adler: Kroger has said it spends no time looking at what Safeway and Supervalu are doing, or even at Wal-Mart. Instead, it puts all its energy into looking at WinCo — which is a formidable competitor in the West — and at other well-run private companies.

One of the things Kroger told me last year, which I found shocking, is that it had been allocating cap-ex dollars to each division and letting each one allocate spending to the highest-return projects, which meant that a project in one division that was better than a project in another division might not get funded. Until recently Kroger basically never looked at its capital budget across divisions, and I wonder how it could have waited so long to decide it should be efficient about trying to get the highest returns.

Wolf: That’s been the operating culture at Kroger, and it takes years to change.

Heinbockel: It also took Kroger awhile to acknowledge that its stores weren’t always starting off as well as they used to or as they had been budgeted, largely because of the macro environment, and when you reduced the budgeted sales level, some projects naturally fell out of the mix and weren’t pursued.

SAFEWAY

SN: Let’s talk about Safeway. What opportunities or challenges is Safeway dealing with?

Adler: I went back and looked at Safeway’s operating income since 2001, and I was able to identify individual events that put pressure on the company’s operating margin. Centralizing procurement was a big disaster. The 143-day strike in Southern California was a huge disaster. What I haven’t been able to figure out, though, is why didn’t Safeway ever recover? Centralizing procurement was a problem for a long time, but Safeway resolved that, and it resolved the strike problems, but the margin didn’t go up. And just for the record, its operating margin dollars, according to my numbers, went from $2.5 billion in 2001 to $1.1 billion at the end of 2011, while revenues were up.

Wolf: A lot of it was due to the acquisitions that failed. It wrote off Dominick’s for a while, Genuardi’s lost money and Texas is way down. In fact, Vons is the only acquisition that really worked, along with the smaller deal for Carrs in Alaska.

Mushkin: I think Andy is really onto something here. Safeway’s pricing on the West Coast actually isn’t bad — it’s in line with Kroger, and there’s not much supercenter activity there, though Target is a factor to a degree. But I think it was a strategic mistake for Safeway to branch out and make acquisitions all over the country.

Adler: It was only a strategic mistake because it destroyed those businesses.

Mushkin: But if that money had been invested in building share, Safeway could have become the Publix of the West Coast by now, and it would have a very different margin situation. If it had used that money to invest in its core markets and build up market share as Publix did, we might be dealing with a completely different story.

Wolf: Or if it had done what Whole Foods did when it makes acquisitions: Learn from them and bring those learnings back and incorporate them into the rest of the company. That’s what Whole Foods did with Bread & Circus in Boston, and it transformed the company and made it a great perishables merchandiser.

Adler: I’ll tell you a story I heard from someone at Dominick’s that illustrates the problems Safeway has had with its acquisitions. Dominick’s used the word “pop” in a print ad because people in Chicago refer to soda as pop. The ad had to be approved by Safeway in Pleasanton, and the corporate people there crossed out “pop” and wrote in “soda.” So the Chicago people said, “Here in Chicago it’s pop.” I was told the people in Chicago had to spend an hour and a half arguing with Pleasanton that the ad should say “pop.” To me, that’s the perfect explanation for why most of Safeway’s acquisitions haven’t worked.

Mushkin: That’s the strategic nature of the organization — it’s cost-focused, with a command-and-control type of structure.

Deborah Weinswig: Why do you think Safeway decided to buy back all those shares?

Mushkin: It obviously thought it was going to have a great year. It went back, bought all that stock, levered up and changed its pay structures to include EPS — and though EPS will be good this year, Safeway is going to have a hard time making its targets.

Adler: What bothers me is that Safeway’s stock really got hurt when Supervalu announced weak first-quarter earnings, at the same time it eliminated the dividend and suspended guidance. Don’t you think Safeway could have anticipated that before buying back so much stock?

Mushkin: The economy grew 4.1% in the fourth quarter, and I believe Safeway really thought things were going to get fundamentally better. That’s the only reasonable assumption.

Adler: Safeway is stuck in this mindset that it’s an investment-grade company, and the debt markets understand that because it didn’t lose its commercial paper availability. But I think it really got blindsided, or it simply deluded itself, because I don’t believe any company thinking rationally would have ended up with as little liquidity as Safeway has.

Mushkin: In terms of financial performance, I’m not giving Safeway a pass, but I think it clearly thought the economic environment would be different, where things were going to get better. So selling Safeway to a private equity company sounds right, though maybe now is not the right time. But whenever I talk to private equity, they say, “Not Kroger, too big, and Supervalu has too many problems, but if there’s one that would go, it would be Safeway.”

Adler: It doesn’t have the best balance sheet at the moment.

Mushkin: Right now, we’re seeing the secular decline of an industry — there’s nothing cyclical, nothing demographic in it. But if you don’t believe the decline is all secular, then all of a sudden you start to look at Safeway in a different light — OK, what if household formation picks up in California? What if it can get some of those Albertsons assets? Safeway has the Canadian operations — is there any way it can unlock that value, although that would be hard because of taxes? It has 40 manufacturing plants, it has Blackhawk, and there’s some value there. Safeway has a lot of assets.

SN: Is Just For U having an impact driving sales and profits at Safeway?

Adler: I am a fan of the Just For U program. If you start with the premise that Safeway is a high-low, super-promotional operator, then this is a way of taking the customers it already has and delivering better value to them, so it’s a good first step. Just For U is a way of delivering value in the context of who Safeway already is, and it enables the company to stand out in people’s minds by reminding them there is value there. Besides, it’s got all this data — it might as well use it.

Weinswig: Just For U includes 30 million unique offers based on purchasing history, and every customer gets his own offers. The more you shop, the better the offers are, so different people get different prices. Safeway has been incredibly smart about this idea of pre-shopping, and I believe it is the way of the future — getting your discounts for being loyal before you shop, not after. The goal is to work with the vendors to fund the program. So consumers will log on before they shop and get a great offer for Folger’s coffee, for example, which means she won’t just put “coffee” on her shopping list. It is brilliant!

Adler: What Safeway is saying to its better customers is, because you have moved into our top tier, you are getting these better deals.

Mushkin: We shop at Dominick’s every few weeks as part of our price-checking program, and we’ve been very happy with Just For U — our incremental savings have grown as the system learns who we are and how to discount us.

If you look at traffic data from the Internet, sales at Safeway are picking up pretty briskly, and it is definitely making progress, though that progress is very slow, and it’s costing the company a fortune to make a 1% volume gain.

Adler: The spending is just to roll out the Just For U program.

Weinswig: It’s to educate. Safeway said there has been heavy investment in a lot of education for certain customers.

Adler: Safeway has also been investing in markdowns, which are going to be supported by vendors. Now that Just For U has been rolled out everywhere in the country, the company is getting more vendor support. Steve Burd [chairman and chief executive officer] said Safeway used to feel it had to spend markdown money out of its own pocket, but now it’s getting so much traction that it’s going to be able to stop doing that. But you have to wonder how much investment in markdowns it was making.

Weinswig: Just For U was born in Silicon Valley for a very young, tech-savvy crowd. I think it’s great for the 35- to 54-year-olds and for the Millennials, but once you get over 54, that’s where it is getting a slower uptake, so Safeway is continuing to invest. It has been incredibly smart in terms of investing in the store-level personnel around the technology, and the customer feels she gets great prices and great service, so I think Safeway will exceed its original targets.

Mushkin: In theory it should be good, but it’s just painfully slow. Going from negative-2% volumes to negative-1%, I don’t know if it is time to throw a party.

Adler: To be fair, Safeway has headwinds that are affecting the entire industry.

Mushkin: Yes, and our data seems to show that it is actually outperforming many of its competitors.

Wolf: How is Safeway getting there? It seems to be through gross margin investment over time, whether it’s a new gas program that’s helping it out or Just For U.

Adler: But if you take out gross margin from fuel, there isn’t a trend in Safeway’s gross margin.

SN: What do you think about Steve Burd’s decision to step down as president and give up day-to-day responsibilities for operations?

Heinbockel: At the end of the day, I don’t think it’s a big change. Robert Edwards knows how Steve thinks, and I think he’ll run the business the same way. I think it’s a transition that allows Steve to maintain control over the business without having to be in every single meeting so he can focus on the things that really excite him.

Adler: That’s what Steve said. But keep in mind that Robert is not a merchant — he’s not even from a retail background. So adding creative new thoughts about retailing probably doesn’t come naturally to Edwards.

Giblen: What you are saying is that it will be business as usual.

Heinbockel: I think Robert will view things, at least in part, through the prism of “what would Steve do?” which is fine because that is how the business has been run for two decades now.

Giblen: After a period of watching executives come and go at Safeway, it looks like the management team has settled down to a group Burd feels exceedingly comfortable with.

Adler: But there’s no comparison between Robert Edwards and Rick Dreiling [Safeway’s onetime executive vice president of marketing, manufacturing and distribution, who now runs Dollar General]. Rick could have come in and actually made changes. But I agree that little is going to change with Robert Edwards as president.

Mushkin: Robert has a good reputation internally as being a much better listener than Steve. But you do have to wonder if Steve is really giving up control. My guess is there may be a couple of people there who might have a chance to get the creative juices to flow more, though that’s kind of a long shot.

Wolf: My question is, did Safeway’s board have any say in this management transition? I think there’s a case to be made that that’s why Steve isn’t president any more. It’s a signal to Wall Street and to Steve that the board isn’t going to simply rubber-stamp whatever he proposes.

Adler: Steve was never more sincere than when he said, “I got tired — I wanted to go do the things I think are fun,” or words to that effect.

Weinswig: At Safeway’s analysts’ day last fall, he seemed the most excited when he was talking about growth businesses like PDC [Property Development Corp., a real-estate company] and Blackhawk. I think he should focus on the new businesses and be there to guide Robert on the supermarket business. I think that is a win-win for shareholders.

WHOLE FOODS, FRESH & EASY

SN: Can Whole Foods continue its strong financial performance?

Adler: I think Whole Foods has been investing in gross margin, and I think it is going to keep investing. And I think the comps are going to hold up fine.

Wolf: I agree that Whole Foods’ traffic should stay strong. There’s no reason — except for social unrest due to a big financial contagion effect from Europe or unemployment rates above 10% — that traffic would go down. So Whole Foods’ shopper traffic should stay healthy, though maybe the comps would slip a bit if there were a little less inflation for a period of time. But it is positioned amazingly well when re-inflation comes because it has real pricing power, given its affluent customer base — and customers are starting to trust Whole Foods on price a lot more.

Mushkin: If you look at the data on Whole Foods, its best growth may actually be ahead of it. There are so many people under 25 who really like natural and organic — in fact, the amount of interest is almost double the general population — and those trends are shockingly strong.

SN: What do you see happening at Fresh & Easy?

Wolf: I think Fresh & Easy will pack it in and leave the market. Tesco said it is going to make a decision by early next year, and when you have low-volume stores with low prices, you can’t make money — the math doesn’t work.

Adler: And the parent company in the U.K. is not the machine that it was, so it has to be more disciplined about spending.

Mushkin: It can’t afford to lose the money any more.

Wolf: Well, it could, but Tesco put itself on record saying it is going to make a decision, and it’s hard to imagine how a low-price, low-volume store turns around in a year. The only way to do that is if you raise prices or you get the volume up. The same-store sales had a little recovery period, and then they slowed down. So if Tesco sticks to the deadlines it set, it is probably going to pull the plug.

Giblen: It has already cut back on new-store development, which I think gives it a lease-on-life for yet another year, but after that, Tesco will just have to make up its mind.

Adler: But at this point it’s not so much about the economics as it is about what shareholders are saying and how upset they are.

Wolf: I think you’re right. The way Tesco’s overall business is going, with profits down in its home market, the shareholders’ patience is probably much thinner for this kind of venture, especially as it’s still not working.

SHOPPING OPTIONS

SN: With more shopping options available to consumers, how should we think about the future of the conventional supermarket?

Adler: In the end it’s about pleasing your customers — giving them what they want, looking at what attributes customers want at a particular location, and remaining very flexible. And if you actually look at the data, conventional grocers are still dominating the industry — not anyone in particular, but in the aggregate they have a very big share, though not as big as it used to be.

SN: But that share is shrinking.

Adler: Yes, it is shrinking. But I have clients who say the conventional concept is just going to go away, and I don’t agree. It has about a 65% or 70% market share, and it’s really not likely to evaporate.

Wolf: It’s still growing in nominal terms, but it’s shrinking steadily in real and relative terms. Its real growth is down 1% a year, and that’s probably how much it will continue to shrink annually. But there are still so many conventional chains around, like Publix, H-E-B and Kroger, that validate the concept. If you run a good store, people will still shop there. It just so happens that clubs and supercenters came around and they are an incredibly good value, along with operators like Whole Foods and Trader Joe’s and all the other specialty players. There’s simply more choice, and why shouldn’t there be?

Heinbockel: If you have 65% of the market, you have nowhere to go but down.

Mushkin: One of the things that disturbs us a little bit about the traditional format as we look at Millennials is the YEMMies — the young educated Millennial mothers — who don’t seem to like the supermarket. That is a fundamental problem.

Weinswig: I think the problem is the amount of time it takes to get around the store, so now Wal-Mart has a fantastic mobile app that makes it much easier and much quicker to shop. In terms of dollar stores, they are becoming more appealing as they add more fresh food for the quick fill-in trips. The average ring is approximately $10, and they have increased the number of national brands they carry and also improved the private-label offering.

Wolf: Even the drug stores took a lot of share in food in the last year, and they’re not price competitive — they’re just convenient.

Mushkin: A lot of the interest for mass merchants among the YEMMies is the low price. That customer is upwardly mobile, but she’s not wealthy. So she’s going to go to a Target and buy her Cheerios and her Bounty and her Tide at a low price, and then she’s going to take the money she saved and go into Whole Foods because she wants natural and organic foods.

Weinswig: What percentage of the population does this customer represent, because it seems like some of these retailers might spend too much time focusing on a small percentage of the population and miss out on sales?

Mushkin: Not that much, but it’s growing, and they are the trendsetters. It’s almost like there’s a mistrust there — the Millennials almost mistrust traditional retailers, and they are actually starting to trust mass merchants more. The Boomers still love the conventional supermarket format, but for the next generation of shoppers, the traditional format doesn’t look great.

Weinswig: I worry about the fact that none of these guys is doing much online.

Mushkin: Safeway is doing it, with great home delivery, which is another thing people want.

Weinswig: I’m also talking about shipping to the home.

Heinbockel: Yes, but Safeway can’t get a return on it.

Adler: Amazon doesn’t get a return either.

Heinbockel: Amazon doesn’t care if it gets a return.

Weinswig: If you add up all the multiples of all the publicly traded supermarkets, it still doesn’t equal Amazon’s multiple.

Adler: Unfortunately supermarkets can’t get away with investing capital and getting no return, whereas Amazon can, which makes it a very tough competitor.

INDUSTRY INNOVATIONS

SN: What are some of the initiatives supermarkets are testing?

Weinswig: One of the projects Kroger is talking about is a new queuing initiative that’s designed to eliminate waiting in checkout lines. When you go in the store, it almost feels like there’s a problem because you don’t see many customers at the front end, but the idea is to speed up the checkout process by reallocating labor throughout the store to the front.

Wolf: That new front-end initiative is very exciting — after price, the thing people complain about most is waiting in line. And Kroger said it didn’t have to reallocate labor — that it was all a technology investment.

Adler: Kroger is taking people from the back of the store and moving them to the checkouts more than reallocating labor.

Weinswig: Kroger also has reduced shrink by putting extra security cameras in place, and there are still things it could do with mobile and e-commerce.

Adler: Kroger is very creative, and it uses technology in a very sophisticated manner.

Weinswig: In terms of Kroger’s e-commerce strategy, it is doing home delivery on a very limited basis and not yet shipping non-perishables to the home. That surprises me because people are buying more consumables online, and that’s something Kroger might want to consider in terms of competition. Kroger has always been very forward-thinking, so I am sure it will figure something out.

Adler: I was at a Hannaford a month or so ago, and the way they check you out is unbelievable. They have one line, and when it is really, really busy, they will assign somebody with a handheld checkout device, and though there is still only one packer per lane, they can scan orders really quickly at a single register, then place the bags on a carousel that moves around as they get filled, making it easy for the customer to take the full ones as they leave the store. How come everybody hasn’t done this? It seems like a no-brainer.

Mushkin: Hannaford’s stores are a little smaller, they are EDLP, they focus on perishables, they are non-union. And the company has built a great brand over the years because it has done all these things well. It’s an innovative, good company, with great perishables.

Weinswig: At one time supermarkets were doing so many things right, like offering dry cleaning and vision services. However, the grocery experience has changed significantly, along with the EBIT margins, so it feels like there’s no longer that element of “what else can we do for you, and how can we serve you?”

In terms of technology, we could have all gone to sleep for five years, and the industry would be in exactly the same place. There have been very few investments in technology, although that seems to be changing as retailers are waking up. I think that, with the tech titans — Apple, Amazon, eBay, Google, Facebook — presenting more of a threat to all retailers, we will see the grocers getting more tech-savvy and more aggressive.

For example, I think we’re going to see a major investment in workforce management within the grocery industry, and I think that will be a real game-changer. Investing in workforce management frees up dollars to invest in price, and lower prices help drive traffic and ticket — and while I’m not going to say this is going to save the entire industry, I think it will really allow retailers to compete better and more effectively with the discounters and the clubs, even in an environment where the grocers are operating with more expensive and less flexible labor.

Read more: Bleak Expectations: Part 1 of the Analysts Roundtable

Adler: What kind of workforce management is being done now?

Weinswig: Kroger is rolling out a program from Empower that helps it move from tasking to selling — a massive game-changer. In other words, it can continue to increase its focus on customer service as opposed to just getting the job done. The program frees up time that someone usually spends on scheduling in favor of more customer-facing hours. Using Empower, an employee who is sick or has a doctor’s appointment can enter that information into the system, and the system will then send a text out to all the people who work at that store but are not working that day, and the first one who responds will get the extra shift, instead of having the assistant manager or store manager spend hours calling around looking for a replacement. It is not only more efficient in terms of matching schedules, but at the end of the day it is also going to significantly improve the satisfaction of the workforce and the customers. We have seen it work at Home Depot and Dollar General, and Kroger is just starting to roll it out.

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