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Pint-Sized Power

In Pittsburgh, there's a new Giant Eagle that isn't so giant. In Baltimore, they shrank a Super Fresh to one-fifth of its typical size. Out West, supermarkets are lacing up the gloves to face a new contender that's well below their weight class but just might have a power punch. And while traditional supermarket growth is stagnant, compact specialty stores like The Fresh Market and Trader Joe's are

In Pittsburgh, there's a new Giant Eagle that isn't so giant. In Baltimore, they shrank a Super Fresh to one-fifth of its typical size. Out West, supermarkets are lacing up the gloves to face a new contender that's well below their weight class — but just might have a power punch.

And while traditional supermarket growth is stagnant, compact specialty stores like The Fresh Market and Trader Joe's are aggressively pursuing new sites.

Call it a small trend, or perhaps a small consequence of a larger trend toward growth at the extremes, at the expense of a crowded middle. So while larger stores like Kroger's Marketplace and Loblaw's Real Canadian Superstore are expanding, going small is also getting big these days.

“It's the hourglass economy, where the conventional supermarkets are getting squeezed out,” David Livingston, managing partner, DJL Research, Pewaukee, Wis., told SN. “You're seeing big chains like Farmer Jack disappearing while 17,000-square-foot limited assortment stores like Aldi and 12,000-footers like Trader Joe's are growing — while at the other end of the spectrum you have your Wal-Mart Supercenters, Costcos and SuperTargets, and they're also growing fast.

“That 50,000- or 60,000-square-foot store is just getting squeezed out,” he added. “Other than companies like Publix, you don't see that much growth of that format anymore.”

To be sure, the small footprint is not replacing the traditional store, but the proliferation of the small format, observers say, indicates a retailing trend toward niche marketing, where a store can eschew a wide net for the precision of targeting a particular segment of the shopping public and speak to a customer in search of convenience. “The idea is an alternative to the once-a-week, giant load-up slog to the grocery store that you do as infrequently as possible,” said once source who asked not to be identified. A smaller box, the source added, “turns it on it its head.”

Traditional stores are also trying smaller boxes to head off competition from alternative formats, as Giant Eagle is doing with its Giant Eagle Express store, or to squeeze into dense urban markets where competitors fear to tread, as Super Fresh and Sobeys have done in recent years. Retailers who make advances in their private-label and branding programs will find they can build stores less reliant on vast selections of branded goods and associated clutter, observers added, though they caution that a smaller box is not necessarily a simpler one.

“You can get a small store wrong fairly easily,” Perry Caicco, an analyst with CIBC World Markets, Toronto, told SN. “You want to have the selection of a grocery store, the quality of a restaurant and the in-and-out convenience of a convenience store, but it's possible to get the high prices of a convenience store, the slow pace of a restaurant and the bad selection of a small grocery store.

“I'm not going to say everyone who tries to go small is going to get it wrong, but hitting that seam is a tricky thing without compromising,” he added. “There's no guarantee it will be a slam-dunk.”

Niche Players

The supermarket industry is abuzz with what to expect as British retailer Tesco begins to invade Los Angeles and other Western cities later this year with a 15,000-square-foot concept called Fresh & Easy. Perhaps nothing illustrates the trend toward smaller stores better than Tesco, which, observers note, could have chosen almost any vehicle for its arrival.

“Tesco in the U.K. has stores of 2,000 square feet and 100,000 square feet,” Mark Husson, an analyst for HSBC, said during an International Council of Shopping Centers panel discussion on supermarket real estate recently. “They're going into California with a 15,000-square-foot footprint that will look like a Walgreens with a lot of chilled food and no detergent or cigarettes.”

The Fresh & Easy concept was crafted after Tesco officials spent months studying consumer shopping habits. The store will rely heavily on private-brand prepared foods as it zeroes in on consumer desire for convenience and meal solutions. “And with clear aisles and simple store layouts, we'll be making it easy for you to find all the products you need without all the clutter you don't,” according to the Fresh & Easy website.

“They won't sell 24-packs of beer, much to the chagrin of the local student body, but they will sell dinner for tonight,” Husson added. “The lesson is that the format has to be tailored to the activity you're talking about.”

Elsewhere, privately held specialty stores like Trader Joe's and The Fresh Market are making aggressive expansions. Trader Joe's, based in Monrovia, Calif., is known for its unique grocery items and for its low prices; The Fresh Market, Greensboro, N.C., for upscale fresh goods. “For some people, the two of them is all they need,” Andrew Wolf, an analyst at BB&T Capital Markets, Richmond, Va., said.

Speaking at the ICSC panel, James Dewey, real estate manager for The Fresh Market, said his company is seeking multiple locations in the Northeast as part of a plan to grow the chain by 20% annually. He said the retailer sticks to a 20,000-square-foot box so as not to interfere with the intimacy, or the convenience, of the shopping experience there. He said its ideal shoppers conform to an upscale demographic, live nearby and shop the stores once or twice a week.

Volume-driven conventional supermarkets aimed at the mass market don't have the economic structure to go so small, countered Richard Matwes, senior real estate representative of Wakefern Food Corp., the cooperative of ShopRite operators, speaking on the same panel.

“We're often asked if we'd go the 35,000-square-foot route, and I understand [some retailers] are doing stores like that,” Matwes said. “But in order for us to get our mix in in terms of gross profits, we need to stay in the 65,000- to 70,000-square-foot limit.”

Matwes said Wakefern has had success operating smaller stores under the discount Price-Rite banner. The company has 32 PriceRite stores today but is looking at new locations, he said.

“The more that store serves a particular niche and the more homogeneous their customer base is, the smaller a store can get,” Harvey Gutman, president, Brookside Advisors, Marlboro, N.J., told SN. “The mass market stores, with a more heterogeneous customer base, still need that large store.”

New Ways to Compete

While leaving a small footprint is a strategy, it can also be a necessity. For Super Fresh and Sobeys, shrinking their stores got them into dense city locations their traditional formats couldn't reach.

Super Fresh, a division of A&P, Montvale, N.J., in January opened an 11,000-square-foot store in downtown Baltimore that officials noted made Super Fresh the only grocery store serving thousands of residents and workers in Baltimore's rebounding central business district. Sobeys, Stellarton, Nova Scotia, turned to tight urban locations in downtown Toronto when it found expansion sites in the suburbs were difficult to come by.

According to Caicco, the Sobeys Express downtown stores, based on the Tesco Express model in the United Kingdom, are “a great opportunity” to grow but probably not yet profitable as a group. The advantages include a customer base that is less price-sensitive than in the suburbs, as well as competitors who tend to be less savvy.

“In the cities, you typically have stores that are run-down and dirty, where costs are high and people snarl at you when you walk in. That's a classic urban grocery store,” Caicco said. “For somebody who can operate a good store, that's an opportunity.

“People downtown tend to be a little less price-conscious and are more interested in the idea of getting in and out fast,” he added. “If you can give them a decent meal at a decent price, they're going to love you.”

Giant Eagle this spring debuted a new store, Giant Eagle Express, in its Pittsburgh home base. The 14,000-square-foot store combines a drive-through pharmacy, a 16-pump fuel station and a menu designed to satisfy fill-in shopping trips. A Giant Eagle spokesman told SN recently that the retailer is examining other possible locations for Express stores but was not ready to announce them yet (Giant Eagle is also at work on massive Market District superstores, illustrating the dichotomy of formats).

“Giant Eagle has seen [convenience store operators] Sheetz and Wawa come in with gasoline pads of 16 to 20 pumps and stores doing $100,000 a week, and that's taking a lot of volume out of Giant Eagle,” said Burt P. Flickinger III, managing director, Strategic Resource Group, New York. “To their credit, they have done something about it.”

Small Problems

Challenges of the smaller store box range from distribution, particularly in tight urban markets, to issues like managing the selection and pricing perception, sources said. And though finding and developing small spaces tends to be less problematic than the large pads typical of a conventional grocery store, competition for those spaces is hot.

A grocery chain running stores of multiple sizes has to be aware of keeping selection consistent throughout the chain, observers said.

“If you have a 25,000-square-foot store and a 55,000-square-foot store, your shoppers expect the same selection in both stores, including what's in the weekly ad flier,” one source, who asked not to be identified, told SN. “That's a problem, because once you've gotten in all the items from the advertisement, there may not be room for anything else.”

D'Agostino's, the Larchmont, N.Y.-based chain with stores throughout Manhattan, has the problem of product selection and display licked, its chief executive officer, Nick D'Agostino III, said. Experience has taught him to orchestrate deliveries in the late morning so as not to interfere with city traffic or sleeping neighbors, and using fewer shelf facings of products helps stretch the SKU count, he said.

But competition even for the small spaces his stores tend to occupy has become a challenge many operators won't overcome, he said.

“If Chase Manhattan wants to pay $300 a square foot, I have to pay $300 a square foot or I can't have the space. That is very challenging,” D'Agostino said at the ICSC panel. “We're going to have a plague in the city. With the prices of real estate being as high as they are, supermarkets are not going to be able to be there. The ones who are left will be the ones who can do it better.”

In suburban locations, convenience stores and drug stores have also become more aggressive players for the 10,000- to 25,000-square-foot box, Flickinger said.

Private label can allow for reduced brands and, theoretically, a smaller store, but that places an emphasis on store and private-label product branding, sources added. Private brands are also important to a small store as a means of developing a positive price perception. Top-performing fresh departments — a staple of The Fresh Market, Tesco's planned Fresh & Easy banner and the shrunken versions of Super Fresh and Sobeys — are vital to their profitability.

While acknowledging the activity around the development of smaller stores, observers stopped short of declaring the phenomenon a full-blown trend yet. Some, like Flickinger, said he doubts many conventional operators would try a small concept because they rely too heavily on being showcases for their suppliers' goods and tend to change slowly.

“Supermarkets have a narcotic addiction to slotting fees and product placements,” He said. “And because they tend to have their different departments in different silos, they tend to only make minor improvements upon what they had in the past. You'll see the smaller, more nimble players make changes like this before you see the bigger companies try it.”

According to Caicco, new urban concepts like Sobeys Express need more locations and better scale still. The Fresh Market has yet to prove itself in the rough-and-tumble Northeast. Fresh & Easy will be watched closely. Imitations may indicate their success.

“If there's one conventional supermarket company that can put out a small store like Tesco it would be Safeway, since they've had some success with the lifestyle store, California is their home state and they've indicated they wouldn't be averse to trying new formats,” Caicco said. “If the Tesco thing looks like it's got legs, then Safeway could get on it quick, and you'd have a trend on your hands.”

Retailers Cite Importance of Real Estate, Site Selection

TEANECK, N.J. — While supermarkets remain respectful of the importance location plays in their success, rising rents are causing some consternation, especially in the New York Metro area.

“I have to compete directly with banks for real estate, so if Chase Manhattan wants to pay $300 a square foot [in rent], I have to pay $300 a square foot, or I can't have the space,” Nick D'Agostino III, chief executive officer of Larchmont, N.Y.-based D'Agostino Supermarkets, said in a panel discussion at an International Council of Shopping Centers Next Generation conference here last month.

The panel, made up of executives and real estate representatives of several area retailers, and Mark Husson, a New York-based financial analyst covering food retailers for HSBC Securities, painted a picture of a resilient industry that more than ever rewards niche players who target shoppers with precision, and large operators who cast a wider net but survive on scale. The Next Generation program examined how the evolution of the supermarket affected the outlook for real estate developers and brokers and landlords.

“Supermarkets are the easiest to understand, but least understood, of any retail sector,” said Harvey Gutman, president of Brookside Advisors, Marlboro, N.J., and moderator of the panel discussion. “Their demise had been predicted many times. In the 1970s, it was the warehouse stores like Aldi and Plus that were to be the demise of the industry. In the late '70s it was the club stores. In the '80s the [leveraged buyout firms] were going to ruin the industry. In the 1990s, Wal-Mart Supercenters were said to be the demise of the industry — and they still may be — as well as Internet shopping.

“Not that there hasn't been fallout,” Gutman added, “but the industry has stayed healthy and very vibrant.”

Pressures from those issues and others — such as escalating rents in New York City — have tended to make the surviving companies stronger. “With the prices of real estate being as high as they are in the city, supermarkets are just not going to be able to be there,” D'Agostino said. “The ones who are left will be the ones who do it better.”

Panelists agreed that real estate plays a role in the success of a retailer, though they said the real estate needs of each company vary.

Richard Matwes, senior real estate representative for Wakefern Food Corp., said that merely putting the ShopRite name on the former Super G and Stop & Shop stores Wakefern recently acquired from Ahold should improve those sites' performance off the bat. But, he added, the stores have strong locations to begin with.

“We have a reputation in South Jersey, and our owners will be committed to making those stores work,” Matwes said.

Wakefern, he added, tends to place its emphasis on site characteristics — particularly parking — above the shape or condition of the building. The company tries to stay in the 65,000-square-foot range, and stores must have adequate parking. “We've been in every shape of building you can imagine, but if it means getting to a location we want, we will find a way,” Matwes said. “Parking is very important to us. If you draw 35,000 to 40,000 customers a week, and most of them come Friday to Sunday, you can't survive without parking, no matter how good the site is physically. We're very selfish about it.”

As a newcomer to the Northeast, The Fresh Market cannot afford to stray from stringent location standards, said James Dewey, real estate manager for the Greensboro, N.C.-based small-format fresh food retailer. “We have a cult-like following in the Southeast, where folks know us well and will find us, so we can be a little more flexible in terms of location,” Dewey said. “But we have to place a huge premium on site characteristics in markets like this, where we will have to introduce ourselves to the shopping public.”

Dewey said The Fresh Market, which operates 70 stores in the Midwest and Southeast, is seeking sites throughout New Jersey, Long Island, N.Y., and areas north of New York City. It has no stores in the area currently. He said the new store rollout would be a “multi-year plan,” which will look at reusing well-located sites, as well as doing new builds where possible. The Fresh Market looks to use 20,000-square-foot sites that are convenient to upscale neighborhoods.

“There is not much open dirt here, which is a challenge,” he said. “The real estate we're looking for is more mature, which has left us finding second-generation buildings and redevelopments, as opposed to what we've done in the Southeast, where there are more opportunities. We have to be patient and stay true to the criteria we're looking for.”

Husson predicted that mergers between supermarket operators will continue to occur, as cost leverage becomes an increasingly important component of profitability for supermarkets. He also said he expects that price spreads between conventional and organic products will shrink as the latter become more mainstream, which is why Whole Foods is pursuing a merger with Wild Oats.

“Whole Foods may have a 35% margin, but ultimately they're going to have to learn to live with 33% or 32%. If their margin advantage can be competed away, they have to get more scale in the business to get leverage on costs,” he said.

Smaller companies, in the meantime, have to sharpen their focus on their niche and develop deeper relationships with customers, said Jim McCaffrey, president of McCaffrey's Markets, Langhorne, Pa., which operates three stores and a commissary.

“We haven't had a lot of competition from Wal-Mart in this area of the country, but to see their effect, just go look at the Plains states, where the 50,000- to 60,000-square-foot store has become obsolete as Wal-Mart surrounds them and makes them ghost towns. In order to survive in the marketplace today, you really have to niche-market: Identify who your customer is and go after them.”
— J.S.