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Growth Engine

Safeway believes its corporate strategy combining a series of initiatives to create a national brand, regardless of banner will ensure its long-term success. With the strategy we have in place, I think Safeway has become a perpetual-growth machine, Steve Burd, chairman, president and chief executive officer, told SN. That strategy resulted from lessons learned in the early 1990s, when Burd took over

Safeway believes its corporate strategy — combining a series of initiatives to create a national brand, regardless of banner — will ensure its long-term success.

“With the strategy we have in place, I think Safeway has become a perpetual-growth machine,” Steve Burd, chairman, president and chief executive officer, told SN.

That strategy resulted from lessons learned in the early 1990s, when Burd took over an operation with declining sales and margins and increasing costs — what he called a speed bump.

“What we learned from that speed bump was to think even longer-term than we were and to develop growth engines to help us get over future speed bumps,” he said.

Since a course correction in 2003, the Pleasanton, Calif.-based chain's financial performance and marketing clout have resulted in steady growth and prosperity through a combination of efforts — converting its store base to a “lifestyle” format; designing the Ingredients for Life campaign; developing proprietary lines of natural and organic products to enhance Center Store sales and a premium line of signature perishables; creating Blackhawk Network, a third-party gift card business; deciding to get into the restaurant business; committing itself to the environment; and adopting a market-based approach to health care.

Those combined efforts have earned Safeway SN's Retail Excellence Award for 2007.

Burd didn't hesitate when asked what he believes makes Safeway an excellent retailer. “Our track record speaks for itself,” he said.

“Regardless of the nature of the competitive threat, we've adapted and made changes, and as a result we've had more success the last few years than anyone in the S&P 500, even though most of those companies operate in growth sectors.

“Certainly, other companies have done as well as us, but not in a mature sector like ours, where most of our competition is non-union, with lower cost structures. But we've rejuvenated ourselves and created a value proposition that has enabled us to grow our business, with the real prospect of continuing that growth.”

Burd doesn't see acquisitions as a part of the chain's growth plans, at least not for a few more years.

“We're focused on executing the strategies we have in place now, which are generating a lot of shareholder value, with earnings up 22% last year and expectations of increases of 13% to 16% this year.”

According to analysts' consensus estimates, Safeway is likely to increase earnings 15.5% this year to $2.01 per share, up from $1.74, and to boost sales 4.4% to $42 billion, up from last year's $40.2 billion — a result of the ongoing success of the lifestyle stores and the accompanying shift to higher-quality perishables.

“Perhaps when the lifestyle remodels are nearly behind us, and if the right opportunity comes up, we could find ourselves doing an acquisition,” Burd told SN. “But we don't feel compelled to do acquisitions now, and we believe we can be a perpetual-growth company without making any acquisitions, due to our ability to grow organically.”

Industry analysts contacted by SN were upbeat about the job Safeway is doing.

“The development of lifestyle stores was an excellent avenue for the company to use to reinvent itself,” Gary Giblen, executive vice president of Goldsmith & Harris, New York, said. “It's hard for a company to change its stripes, but Safeway did it with those stores.

“And probably more than any other chain, Safeway recognized that successful supermarkets require consumer marketing to create a brand identity beyond a price-and-item approach, and it brought in marketing people to help create that brand. And the development of Blackhawk was an example of innovative, outside-the-envelope thinking.”

Mark Husson, New York-based managing director and global head of consumer research for HSBC Securities, London, said Safeway has become “very good at keeping in touch with what consumers today want and then selling it to them. The chain realized several years ago the mass market of consumers was changing and that it had fallen behind the curve, and it was able to redesign its stores and retool the quality of its perishables offering and communicate that to customers. And it was the only retailer to see the value in the third-party gift card business.”

Hitting the Sweet Spot

According to Perry Caicco, an analyst with CIBC World Markets, Toronto, “Safeway has achieved the great distinction of being able to pay for price investments from the profits made by selling more perishables and more private label. In the grocery industry, this is the sweet spot, and Safeway has earned it.”

Safeway's efforts to achieve that sweet spot were preceded by seven years of escalating returns, followed by five difficult years when the industry as a whole was being squeezed by the rise of price players and niche operators while Safeway at the same time was trying to centralize its marketing, merchandising and procurement, and struggling to digest acquisitions in Chicago and Texas.

The chain's current growth curve started with the decision in 2003 to remodel its entire store base over the ensuing six years to reflect contemporary lifestyles, with an emphasis on top-quality perishables, a line of proprietary items that would make Safeway a destination store and a stimulating ambience that would prompt shoppers to tarry a bit longer in the supermarket.

Those efforts were strengthened by other initiatives “to help consumers connect the dots,” Burd said, including the development in 2005 of a marketing theme, “Ingredients for Life” — “a long-range campaign that says we're not just providing shoppers with ingredients for meals, but a much broader offering of ingredients consumers need to make their lives better,” he explained.

One way Safeway is trying to make consumers' lives better is by adding products that offer opportunities for better health and wellness, signified by the introduction of the O Organics and Eating Right lines. It's also developed various premium brands in the perishables segment, including Rancher's Reserve beef, Signature soups and sandwiches and Primo Taglio deli meats and cheeses.

“As we looked at the industry in 2003, we saw competitors coming at us from all different directions,” Burd said, “and while our sales levels were in the middle of the conventional operators, we realized all supermarkets basically looked alike, and to win in the pressure-cooker environment we were in, we needed to create a strong difference between us and the other conventionals that would be meaningful to consumers.

“Everyone carries Oreos and Kraft Macaroni & Cheese, but we thought we could make a distinctive difference in the quality of the product offering.

“Simultaneous with the decision to change the look and feel of the stores, we began introducing proprietary products in the center of the store, which we felt would give us the ability to transform Safeway from a collection of banners to a real brand. And if we could pull that off, we knew we would have the opportunity to become a cult.”

Safeway never thought of its makeover as a short-term effort, “because consumers change, and we have to be willing to change as well, so by definition our effort has to be a continuum,” Burd explained.

Lifestyle Makeovers

The primary vehicle for the makeover was the lifestyle store. “That's the merchandising vehicle for all the great products we planned to offer,” Burd said.

The chain's store base encompasses approximately 1,750 stores, including Safeway-banner stores in Northern California, the Pacific Northwest and the Washington-Baltimore area; Vons in Southern California; Dominick's in Chicago; Genuardi's in Philadelphia; and Randalls and Tom Thumb in Texas.

“We knew that if we tried to build a chain with a common look from scratch, the most we could build was 80 stores a year, which meant it would have taken us more than 20 years to replace all of our stores,” Burd noted. “But by opting to remodel, we felt we could transform the company within six years.”

The conversion process is moving along right on schedule, with nearly 1,000 stores already “lifestyled,” 300 more scheduled for next year and another 300 or so scheduled for 2009, “at which point we will be the first conventional supermarket chain ever with a common look and feel across the entire store base,” Burd pointed out.

The format has been successful for Safeway regardless of the banner, he added. “The level of sales increases is not identical — it's more a function of the asset base itself. But we're getting great returns in all markets, and they are reasonably similar, with sales increases coming from existing primary shoppers spending more and from our ability to convert secondary shoppers into primary shoppers. And the number of consumers who shop with us exclusively has jumped dramatically, which tells us lifestyle stores increase customer loyalty.”

While some industry analysts have expressed skepticism that Safeway will be able to maintain its momentum once the remodeling program is completed, Burd said, “There will always be skeptics. But anyone who follows and understands the Safeway story should not be concerned about 2009 and beyond” for three reasons: the continued sales growth of lifestyle stores in the years after the remodelings are completed; the adaptations Safeway is constantly making; and its ability to develop other growth engines.

“First, the stores in their second and third year after conversions have continued to show stronger results — with sales in the first year exceeding what occurs at more traditional remodels; getting a lift of 46% of the first year's increase in the second year; and climbing 36% over the first year's increase in the third year — and that escalation has continued now that some locations are four years past the remodeling,” he said.

“There was an ad I used to see when I was a kid that said, ‘Diamonds are the gift that keeps on giving,’ and our lifestyle stores are like that — they're stores that keep on giving — so no investor should worry about what will happen in 2009 or 2010.

“Second, we're very adaptive — some might say innovative — and we make constant changes to meet the changing needs of consumers. Population grows at about 1.2% a year, yet we've been growing faster than that during my 15 years here — at the same time, Costco has doubled its size; Wal-Mart has increased from 30 supercenters to 2,300; Whole Foods has built its entire business from whole cloth; and Webvan was supposed to destroy our business, which never happened. So we're a resilient company that's been able to take sales from others and grow at an extraordinary rate.

“Third, we've developed a knack for creating growth engines related to our business. Blackhawk is an extraordinary growth company, and our restaurant, Citrine Bistro, is a culinary center that allows us to test entree selections for our stores.”

New Brands

Another way Safeway is growing is by developing new corporate brands across multiple categories, including O Organics in 2006 and Eating Right this year, “and from now through 2009, you will see stronger doses of health-and-wellness items,” Burd told SN.

O Organics is designed for the consumer who prefers organic products, Burd said. “A lot of people assume there are health benefits in organics, but we don't say that — we just offer it as an organic line of products.”

The line's success has been extraordinary, he indicated. “Within the first 12 months after its introduction, O Organics ranked as the fifth-highest-selling organic brand nationally, and considering the line is sold only in Safeway stores, sales per store have exceeded every other organic brand,” Burd pointed out.

Eating Right is designed to pick up on the trend that consumers want to eat healthier, he added. “If you look at a box of cereal, it tells you the required daily allowances for the vitamins and minerals it contains, but unless you're a nutritionist, you don't know how to work with that.”

Each Eating Right label contains one of 13 color-coded icons indicating the dietary benefits of that product — whether it is low in fat, low in sodium, low in cholesterol, heart-healthy or other similar designations — “to make it easy for people to utilize the information,” Burd pointed out.

Less than a year after its introduction, and with fewer stockkeeping units, Eating Right is outselling O Organics at the same point in its history, he noted.

“And if you think about the names of those two lines, the beauty of it is they describe the virtues of each product, so the names are expandable across all categories. If you try to think of any national brands whose name describes the product attributes, you can't. So we think O Organics and Eating Right have a lot of upside.”

Among other proprietary brands developed in the last few years are the Primo Taglio line of delicatessen meats and cheeses; Signature soups and sandwiches; and Rancher's Reserve beef — “all of which have become destination brands for us, as we intended them to be,” Burd said, “with customers making the choice of where to shop based on the availability of those items.”

Asked whether Safeway would ever consider making any of its proprietary labels available to other retailers, Burd replied, “What we always do with our asset base is try to optimize its value. That can mean keeping something proprietary or sharing it with others, and that depends on the brand, the time and the place.

“So we're not ruling anything out. These brands were designed to be proprietary, but we're flexible.”

Blackhawk Takes Flight

In a giant leap of out-of-the-box thinking, Safeway launched Blackhawk Network as its first major growth engine, courtesy of Don Kingsborough, an entrepreneur it hired in 2001 to come up with original ideas.

“With 28 million customers a week coming into our stores, we knew we had hidden assets that we weren't using, so we brought in someone and suggested he think of ways we could sell all those people something else,” Burd said.

“He put on his thinking cap and thought about products or services we could deploy to leverage those assets, and he came up with the idea of selling other companies' gift cards in our stores and creating a distribution network across the country.”

Blackhawk created a new supermarket category, Burd indicated — prepaid gift cards for hundreds of different stores, sports companies and entertainment venues that Safeway is distributing to its own and competing supermarkets all over the U.S. and the United Kingdom, with anticipated moves to France, Germany and Australia, he said.

Burd said Blackhawk will contribute $100 million in corporate pretax earnings this year, and while he declined to pinpoint sales levels, he said sales will continue to grow at an 80% compound rate for the next five years. “At that level of growth, supermarket growth could be anemic — around 5%, though we don't expect that — and we'd still hit a 12% growth rate,” Burd said late last year.

He said the idea of hiring an entrepreneur stemmed from his first job, at Southern Pacific — “ a company rich in assets that was not deploying those assets well.”

“The company had developed an internal phone system so it could communicate with different spots along the railroad lines, but it wasn't until an entrepreneur pointed out the potential to use that system to create a business to compete with AT&T that Southern Pacific developed what eventually became Sprint.

“Creating growth engines is like investing venture capital. You have an idea and you try it, and you may hit a single, or maybe a triple, or even a home run. Blackhawk was a home run.”

Safeway is working on other growth engines, he noted, “though it's our practice not to discuss them until we're farther down the path to where we've built a market position and can protect it.”

As to when the next growth engine might become visible, Burd replied, “It's imminent,” though he declined to be more specific.

Another outside-the-box undertaking for Safeway was the opening of Citrine New World Bistro in Redwood City, near San Francisco, earlier this year — a freestanding fast-casual restaurant where customers place their orders at a counter and then seat themselves, with orders then delivered to their tables.

Safeway said it is using the restaurant to test potential entrees for its in-store food-service operation. The restaurant, which is open for lunch and dinner, utilizes ingredients sold at Safeway stores, with menu items ranging from $6.99 to $13.99.

Safeway has operated the 125-seat facility with little fanfare. The only deliberate attempt to connect the restaurant with the chain is the statement on the menu that the dishes are prepared with “only premium ingredients, including O Organics chicken, produce and seasonings; Rancher's Reserve tender beef; and Primo Taglio meats and cheeses” — though it's left up to diners to connect those names with Safeway product lines.

Although Safeway's website at the time Citrine opened in early June said the chain was seeking staff and management to serve “a growing number of locations throughout the San Francisco Bay Area,” Burd told SN Safeway has no plans to open additional restaurants.

Health Care Reform

Safeway's initiatives also involve environmental efforts and a major push for health care reform.

Its commitment to preserving the environment includes implementation of renewable wind power to save energy at nearly 300 fuel stations around the U.S. and the opening last month of the first of 23 solar-powered stores in California.

“It all comes down to what consumers are looking for,” Burd explained. “Consumers today are concerned with the environment, so if we can make business decisions that are good for the environment and visible to consumers, there's a small reward that comes our way.”

The solar equipment will produce approximately 7,500 megawatt-hours of electricity per year — enough to provide 20% of a store's average power usage and up to 48% of its power usage during peak hours, the company said.

Burd said he believes consumers, especially those in California, are generally aware that Safeway is an environmentally friendly operator. “And we're also well known for the work we do in health care and medical research, and that connects us to consumers as well.”

Burd said he began thinking about Safeway's commitment to health care about three or four years ago, “because it was a very large cost for us that was escalating at double-digit rates for our non-union employees.

“We take great pride in being able to look at things and find better ways to do them, and what we discovered early on was that 70% of all health care costs are driven by behavior and 74% are confined to four chronic conditions — cardiovascular disease, diabetes, cancer and obesity-related illnesses.

“So why not redesign our health care plan and put back incentives to change behaviors? By doing that, we were able to lower our employee costs by 30% and the employees were able to get better benefits at a 30% lower cost.

“We've held those costs flat in 2007, and they may go down in 2008.

“So we felt we had discovered something important, and if it could work for non-union employees, why not for everyone in the nation?”

The approach Safeway is pursuing uses market-based solutions, Burd said. “In essence, we want people to have the information they need about health care the way they have it on the costs and quality of other products they buy so they can make informed decisions.

“With sufficient information, there's greater transparency on costs to help solve the crisis of coverage in the U.S.”

Burd formed a coalition of other executives from the industry and from drug companies to lobby officials at the state and federal levels, and he's optimistic there will be major health care reforms in California “that could be a template for the rest of the country.

“It's harder to get something passed at the federal level, especially during a presidential election cycle. But I'm sure the problem will get resolved within the next five years,” he told SN.

Labor Accord

PLEASANTON, Calif. — Health care reform is an issue that has brought Safeway and the United Food and Commercial Workers Union closer together.

Safeway and the union “have developed a good relationship as we discuss the concerns we have in common on health care,” according to Steve Burd, chairman, president and chief executive officer of the retail chain. “While wage increases will always be a touchy subject, Joe Hansen [president of the UFCW International] and I are in constant communication on the issue of health care and how we can advance the cause.”

Hansen offered similar comments. “We both share a passion for comprehensive health care reform, and we talk regularly about that issue,” he told SN.

“We both agree that achieving that reform will require an investment of time by as many industry partners as possible building bridges and working together.”

Relations between Safeway and the UFCW have not always been as smooth, especially during late 2003 and early 2004, when Safeway was the union's target during a 141-day strike-lockout in Southern California.

That contentiousness appears to be gone. “There's been a sea change and a more collaborative spirit in our relationship with the union,” Burd told SN.

“There's still dynamic tension in negotiations, but there's more of a feeling that we're partners and that neither side can overreach because we've got to come to an accommodation.

“At the local bargaining level, a lot of the discussions are about controlling health care costs, and there's a lot of creativity going on among many locals on how to do that,” he said.

“In the Southern California agreement we signed earlier this year, there was a lot of input on prevention and wellness, which, from my viewpoint, is a more creative, constructive approach than in the last round of talks [in 2003 and 2004], and it puts us on the same side of these issues as people, more so than adversaries, and these are building blocks for other things we care about together.”

Outlining his thoughts on health care in a speech earlier this year, Burd said he got energized about finding market-based solutions to health care because of concerns the federal government might nationalize health care policies.

“When the market is allowed to work, what you get is cost reduction and quality improvements,” he said. “This is a solvable problem.”

The keys to a successful health care program include changing employee behavior, encouraging wellness initiatives and making costs more transparent, Burd said in his speech.

At Safeway, employees fill out a health-risk questionnaire that provides a baseline of their medical conditions, he explained, and their subsequent coverage “allows them to do the things behaviorally that would cause them to get out of that risk category. And if they change their behavior, they get further reductions in their health care plan.”

Safeway also focuses on wellness programs that encourage people to engage in healthy physical activity, he said. “Employees will be healthier, life expectancy will be improved and tens of thousands of people will avoid catastrophic illness without increasing any of the costs to the employee.”

Without transparency in the cost and quality of medical care, “consumers can't make good decisions,” Burd said. “When consumers are responsible, they demand. And with the Internet you can make that cost and quality transparency available to virtually everybody.”
— E.Z.