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Pundit’s Mailbag — Produce Pricing Strategies… Does Stater Bros. Do It Better Than Safeway?

Jim Prevor’s Perishable Pundit, November 9, 2009

Our piece, Safeway and Stater Bros. Approach Recession Differently, brought a number of thoughtful letters including this one:

You provide an interesting analysis in comparing the business models of two retail chains, but I think you are missing the point in drawing the conclusion that branding and image placement determine long term success and that Safeway has the best strategy.

A Gucci bag can be purchased at Neiman Marcus, but not J.C. Penney, whereas the same head of lettuce can be had at either Safeway or Stater Bros. If Stater Bros. sells it — and thousands of other products — for less than Safeway, then I, as a rational shopper, will go where I get a better overall value. I’ll still go to Neiman to buy the Gucci handbag as that’s all about image.

Stater Bros. has always positioned itself in the “value” category even though many of their stores rival Vons (Safeway in southern California) in ambiance, image, and product offerings. Dominick’s was a very successful “value” chain before Safeway bought it and if it is now returning to its roots, so much the better.

The Stater Bros. strategy hasn’t changed for years, whereas Safeway and Kroger responded to the perceived Wal-Mart threat by expanding externally through acquisition instead of internally by pricing to generate traffic and volume. The economies of scale were to generate cost savings via increased purchasing power and reduced overhead. It didn’t work. They compete with the “value” chains with their loyalty card programs and occasional specials that do not substitute for regular pricing that reflects the true cost of the product plus an appropriate retail markup. Chains like Stater Bros. have been successful during both the boom times and the current recession by consistency in pricing and bringing value to their customers.

The produce industry, consumers, and stockholders would be better served if the Safeways and Krogers of the world would execute pricing strategies to move volume instead of to maximize unit margin. Nothing irks me more than looking at vine ripe tomatoes in a Vons store priced at $2.99 per pound when the f.o.b. price to the grower located a few miles away is $7.00 per box. Long term viability and success of any company is based on the correct strategy, properly executed.

Value pricing is a proven strategy in both good times and bad. Image and brand placement don’t go to the bottom line or generate customer loyalty in the retail grocery business. Good value does.

— Dave Westendorf
Sales
Bay Area Produce, Inc.
San Clemente, California

We appreciate Dave’s analysis because it gives us an opportunity to think about the nature of fresh produce and the strategies likely to drive success both for individual companies and the broader industry.

One clarification: We didn’t say that Safeway had the “best strategy.” What we said was that, in this matter, Steve Burd, Safeway’s CEO, had a better “argument” than Jack Brown, CEO for Stater Bros.

This is a significant difference. The best strategy for a company is typically determined by that organization’s strengths and weaknesses. If we used Dave’s example of a Gucci bag, but went back to Gucci itself, if a recession causes a severe drop in sales of Gucci products — so much so that the company is hemorrhaging money and heading for bankruptcy — then whether long term the Gucci brand would be enhanced and Gucci’s profit maximized by continuing to sell only upscale products is irrelevant. If Wal-Mart is willing to write a big check that will save the company but the price is selling a brand “Gucci for Wal-Mart,” the best strategy is to stay in business, live to fight another day and deal with long term issues of brand equity from a state of solvency.

We actually wrote about this issue in a piece titled, Wal-Mart Needs To Take Lessons From Tiffany and HEB. A big part of that piece dealt with an internal battle among executives at Tiffany & Co. — for years Tiffany had been goosing its earnings by selling inexpensive silver jewelry. The theory that justified the effort was that young girls would get accustomed to buying Tiffany products and would, in a sense, grow up with Tiffany jewelry starting out with a $100 charm bracelet and moving on to very expensive engagement rings and adult jewelry. There was another possibility, though, and an article in The Wall Street Journal detailed the point:

People inside the company debated the problem for months. “Some people would look at it one way and say, ‘If every 16-year-old gets her silver jewelry from Tiffany, they’ll eventually want their engagement ring from Tiffany 10 or 20 years later’,” says Mark Aaron, Tiffany’s vice president of investor relations. But “what if some of those teenagers fill up their jewelry boxes with Tiffany silver, and as they get older, they perceive Tiffany as where they got their teenage jewelry?”

The same piece pointed to the financial dilemma:

Everyone knew how beneficial lower-end silver was to Tiffany’s bottom line. Any effort to curb it could dramatically slow sales and affect profitability — and likely upset shareholders.

Ultimately, the company says it relied on focus groups to make the decision. Complaints about crowding were beginning to appear in internal consumer research. The research also flagged concerns that Tiffany’s brand was becoming too closely associated with inexpensive silver jewelry. “We didn’t want the brand to be defined by any single product,” says Mr. Kowalski.

In 2002, Tiffany began aggressively raising prices on the pieces most popular with teenage girls, particularly the Return to Tiffany charm necklace and bracelet.

Tiffany & Co. was a strong enough business to accept a great deal of short-term pain — loss of a very large and profitable cheap silver business — to sustain and enhance brand equity in the hope of maximizing future profits.

Of course, Dave is talking about produce, not jewelry, and supermarkets, not jewelry stores, and that, of course, makes a difference — the question is what difference it makes?

Now Dave, points to one big difference — product stratification. Upscale producers won‘t sell items such as Gucci purses to discount stores. Although retailers such as Costco have been known to acquire some of these items through third parties, it is difficult for them to sustain availability.

In contrast, produce is mostly available to all comers. Although it should be mentioned that this isn’t necessarily the only way it could be.

When Wal-Mart rolled out its supercenters, it tried to buy Boar’s Head product and Boar’s Head, which we recently wrote about here, here and here, simply refused to sell Wal-Mart. One can argue whether this was the best decision for Boar’s Head, but it is not obvious that a fresh-cut brand, for example, couldn’t have gained market share with such a “No Wal-Mart” pledge. Many supermarkets would have been interested in carrying a brand that would never be at a discounter such as Wal-Mart or Aldi, so they would never worry about being caught in an unfavorable price comparison on the same brand.

Still, with the current situation of pretty much universal product availability to all retailers, Dave focuses on a “rational consumer” and makes this case:

“A Gucci bag can be purchased at Neiman Marcus, but not J.C. Penney, whereas the same head of lettuce can be had at either Safeway or Stater Bros. If Stater Bros. sells it — and thousands of other products — for less than Safeway, then I as a rational shopper will go where I get a better overall value.”

Fair enough but it still raises this question: How does a consumer interpret “better overall value.” We have lots of evidence that it is not simply price. Location is a key matter. So in Los Angeles, for example, Kroger invests a lot of money getting great locations, in many cases, having to pay for parking structures, etc. These investments may prevent Kroger from being the cheapest in town, but The Kroger co. obviously thinks that many consumers will value propinquity more than low price.

Lots of surveys indicate consumer interest in cleanliness, assortment and other attributes as being very high up there, along with price, in consumer concerns.

Price is quite important but the consumer is buying a range of services and experiences that go along with the product. Sometimes a high price can be a key element of attraction for a product. Whole Foods has struggled with how to present itself during this recession for good reason. Sales suffered as consumers became more focused on price. Yet the core Whole Foods customer believes he is getting a superior product, not necessarily in the physical product but in values that go around it: That Whole Foods makes sure workers are paid fairly, that the environment is considered in its purchases, are intrinsic parts of its appeal. If Whole Foods were cheaper than Wal-Mart, it would lose credibility with its core customer who believes that Wal-Mart is too cheap to take care of all the things this customer values.

Selecting a retailer, more than an individual product, is choosing an experience. There are lots of people who choose one store over another because they are uncomfortable mingling with the clientele. So offering great bargains, although it may attract some customers, may also dissuade other customers who find those seeking all these bargains less pleasant.

The point is that part of the “overall value” delivered by a store is much more than the price of a product. If a Safeway store has wooden floors and nice lighting and if it’s a bit pricey and that keeps parking convenient and creates an opportunity to run into a shopper’s friends on the charity circuit, who is to say that isn’t a value to that consumer?

We’ve known Roger Schroeder a long time and he has done a terrific job at Stater Bros. If we were giving an award for most improved produce operation in southern California over the last decade, we would give it to Roger and to Stater Bros., yet we would be hesitant to say that their stores are equal to the best. Some are, particularly the 38 stores they acquired during the Lucky/Albertsons buyout. Many of the stores in the inland empire are old and small, and the big opportunity for the chain is really to spend the money to expand those stores to equal their best stores. In fact where they have done this, business has boomed. Showing, once again, that price is just one attribute of retail success.

Yet we agree with Dave that Stater Bros. has emphasized value and that its consistency in doing this has brought the chain great success. Where we may differ is in a willingness to extrapolate from this success a “general principle” that applies to all consumers all the time. We are more inclined to say that Stater Bros. is an excellent example of one way in which consumers can be served. There are others.

Dave makes clear that he recognizes some purchases are about image — the Gucci purse again — but, by implication, he is saying that produce doesn’t fall into this category. We are not so certain. If one is hosting a dinner party, a brunch or even a cook-out, and the guests ask, “Where did you get so much wonderful food?” — we think there are many places in America in which an answer, “Oh, I went to Wal-Mart” will create a different perception than if the answer is, “I went to Whole Foods.”

That many of the retail acquisitions Dave mentions did not work well is undeniable. A chain like Dominick’s is a pale shadow of its former self. But we would attribute the problems that Safeway, for example, had with chains such as Genuardi’s not so much to their retail pricing as to the desire of Safeway executives to maximize manufacturing and procurement efficiencies, especially on private label items, even at the cost of selling products and brands not familiar or acceptable to the shopper base.

Now Dave will win nods across the production end of the industry when he makes this call:

The produce industry, consumers, and stockholders would be better served if the Safeways and Krogers of the world would execute pricing strategies to move volume instead of to maximize unit margin. Nothing irks me more than looking at vine ripe tomatoes in a Vons store priced at $2.99 per pound when the f.o.b. price to the grower located a few miles away is $7.00 per box.

We also get irked at these kinds of disparities but we also think that this is an area where the production sector has the responsibility to do a lot more research.

After all, supermarkets all have different merchandising and marketing strategies. If one chooses to make margins in fresh produce and discount beef heavily, that may not win that chain many friends in the produce industry, but it is not unethical behavior. Presumably another chain will see the elevated prices and identify an opportunity to discount produce.

The degree to which lower prices increases volume varies by item and, on a surprisingly large number of items, consumer demand seems to function off a set-point price. As long as the item is under X price, it sells, and making it X minus 10% doesn’t have a large impact on volume.

We can shift volume from week to week with sales and specials, we can move volume from item to item with space allocations, sales and specials, but, especially considering the labor that additional sales involve, it is not easy to increase the profitability in dollars of a retail produce department by cutting prices.

The math is pretty foreboding. If we accepted that on a hypothetical high margin item that a retailer is making 75% on an item (buying it for a cost, delivered at store level, for a quarter and selling it for a dollar), and the retailer cuts the price by 50% (so now buys it for a quarter, sells it for 50 cents), one has cut the gross profit by 2/3rds (from 75 cents to 25 cents), so sales have to triple for the gross profit dollars to remain the same.

But it is more complicated than that. If sales of Dave’s vine ripe tomatoes triple but the business comes at the expense of gassed green tomatoes, grape tomatoes or lettuce, the total department profit is likely to drop. If the great bargain makes a consumer not buy a high-margin tomato and mozzarella salad in the deli, store profits are almost certain to go down. Plus the store level labor allocated to the item will increase substantially if sales triple. So even a tripling of sales will not produce the same gross profit dollars for the retailer.

Optimal pricing is important and it would well behoove production agriculture to fund some studies here so they can speak to retailers with authority.

We suspect that as frustrating as high retail prices may be for growers, it is actually an advantage to have one’s customers make a good profit on one’s product because that gives the retailer good incentive to give large displays and to promote the item.

We do fault retailers for doing things for the wrong reasons. One friend at a big retailer showed us some statistics that a private label initiative was costing the store money on certain produce items and that consumer satisfaction numbers had dropped on certain produce lines that had been transitioned to private label. The produce executive was opposed to the whole initiative but said his hands were tied because high-ups were demanding the initiative — though these executives were ignorant about produce and expecting large margin gains as they realized in other categories. This is a loss for consumers, retailers and vendors alike.

Although we agree with Dave that “Value pricing is a proven strategy in both good times and bad,” we will have to agree to disagree on his assertion that “Image and brand placement don’t go to the bottom line or generate customer loyalty in the retail grocery business.”

Safeway just spent $8 billion renovating its stores; it clearly thought that, for its customers, such an expenditure could indeed build customer loyalty and, ultimately, earn a return on investment. Besides, what is the real option? Can unionized supermarket chains operating out of high-priced real estate possibly beat Wal-Mart, Aldi, the warehouse clubs and the independents we highlighted in the October issue of Perishable Pundit sister publication PRODUCE BUSINESS on price?

If not, then wouldn’t a focus by Safeway on low price just guarantee its position as an also-ran?

This seems to us the crux of the matter. We doubt anyone at Safeway would deny Dave’s point that “good value” will go to the bottom line and generate customer loyalty. They would just say that having attractive stores and offering convenient and delicious prepared foods and stocking high end wines are part of the value Safeway delivers.

In the end,the question really is this: Has the recession created some permanent shift in psychology so that Safeway’s strategy of high service, lots of organics, beautiful shopping environment, etc., is now permanently less appealing to large numbers of people. Or, are memories short and if the economy comes back, consumer demand for the finer things in life will come roaring back as well?

Steve Burd… and the shareholders of Safeway… have much riding on this question. Many thanks to Dave Westendorf for helping us wrestle with this important matter.

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