Who knew?

Safeway, with a 7% share of the country’s retail food market, owns better than half of all supermarket refrigerated soup sales. It’s also got the largest made-to-order sandwich business of any food retailer in the United States.   These little factoids, spilled by Chairman/President/CEO Steve Burd during a securities analysts’ conference call back in March, took us aback. But perhaps they shouldn’t have. They’re just further proof that the Pleasanton, Calif.-based chain is firing on all cylinders — innovating, leveraging meal opportunities and driving profitable sales.

Here’s More Proof

Of course there are other, larger indicators of how Safeway is differentiating itself. Here are just a few:

• After Safeway converts stores to its Lifestyle format, the remodeled units have been turning in double-digit sales gains, and healthy increases in the years after.
• Safeway’s O Organic corporate brand — one of the fastest-selling organic food brands in America — is being marketed to retailers in the U.S. and overseas, along with Safeway’s other stellar health and wellness brand, Eating Right.
• Safeway is successfully executing store-specific planograms tailored to the local demographic.
• Over a 15-year period ending last Dec. 10, Safeway outperformed 97% of the S&P 500 stocks. (Burd says that one took even him aback.)

Yes, Safeway is really kicking butt. What’s behind all this is not Lifestyle stores, O Organics, planograms or refrigerated soup. It’s big-picture focus on the consumer, pure and simple. Safeway is methodically building relationships with its shoppers via sophisticated analytical tools and well-oiled store-level execution.

None of what’s been mentioned here so far would have worked — or even happened — without consumer focus. Every retailer has talked about focusing on consumers since the late Efficient Consumer Response was a pup, about 20 years ago. But Safeway is one of the first to actually do something about it.

Don’t take our word for this, though.  Just Google “Why advocacy matters to grocers.” That will take you to a white paper published last September by IBM Global Business Services. While Safeway is not the star of this nifty and useful piece of research, the chain is mentioned in glowing terms for “taking steps in the right direction in becoming customer-focused.” We yanked out the part about Safeway, and you’ll find it here as a sidebar under the headline “Becoming More Consumer Focused.”

Maureen Stancik Boyce, PhD, Distribution Sector Team Leader for the IBM Institute for Business Value, told us Safeway has done a terrific job of understanding who its core customers are at any given store, and providing product assortments and merchandising approaches that are tailored to their needs. This could mean emphasis — or lack of it— on dairy items with probiotics in specific stores, or on the correct Hispanic items to stock for a pocket of Dominicans (rather than Mexicans) in certain neighborhoods.

Boyce adds that Safeway doesn’t just keep its consumer insights locked up in a drawer somewhere. She notes that consumer data finds its way into every silo and functional area of the company, where people trained in data analysis make use of it.

But there’s much more to the story. Don’t this little prelude stop you from reading the entire IBM paper, which is likely to give you good ideas on improving your own operations.

And IBM isn’t alone in recognizing Safeway. Check out the most recent Power Ranking Survey (2007) by Cannondale Associates, Wilton, Conn. Each year, Cannondale asks more than 350 manufacturer and retailer participants to rate their trading partners on everything from “clearest company strategy” to “most innovative consumer marketing/merchandising.” No, Safeway doesn’t win “best of the best” honors, but in nearly every category, its score has risen dramatically from 2006: “Clearest company strategy,” up 7.5 points; “Best job of branding stores,” up 4.3 points; “Best retailers with which to do business,” up 4.5 points; “Best category management/buying teams, up 5.0 points; “Most innovative consumer marketing/merchandising,” up 6.9 points; “Best practice category management,” up 7.2.

Vendors Offer Praise

You get the idea. What’s even more impressive is that Safeway’s 2006 scores improved significantly over the prior year also. The most recent report has Safeway’s trading partners singing the chain’s praises:

• “When you meet with Safeway today, it is a very different organization. They are very focused on the strategies of understanding their consumer and appealing to these consumers at the local level with different Lifestyle type stores.”
• “We find it easier to talk to retailers who can specifically make requests of what they need and can talk on a strategic level. Safeway has demonstrated their ability to do this and we’re engaged in a number of projects with them that improve our mutual businesses.”
• “Safeway continues to push out with their Lifestyle segmentation and their new Optura analytical package which is helping to better understand their most important customers.”

We ran these quotes by a group of frozen and dairy food manufacturers, and found near universal agreement that they were on target. Our group added that Safeway is very different from what it was only a few years ago, and is among the most receptive of any retailer in terms of trying new products and exploring new ideas for partnerships.

One broker notes that Safeway is more willing than most to work with smaller vendors, giving them the time to present their case for why their products might be a good fit for the chain’s shoppers. Buyers also work with vendors to get products only in appropriate stores rather than forcing chain-wide distribution, the broker adds, noting that the company is fair about introductory fees in such circumstances.

While vendors interviewed agree that Safeway is never the low-price leader, they note that the chain is focused on providing a superior shopping experience via more in-store labor and better décor — especially in the Lifestyle stores. Obviously, this costs money.

“They’re kind of a hybrid on pricing,” says one frozen food vendor. “They do a mix of EDLP and hi-lo, with a nice shelf tag flagging the price reduction. They do quite a few multiples, but not many BOGOs anymore. All in all, it works very well for them.”

Frozen Food Month

Safeway is a strong supporter of Frozen Food Month and Dairy Month promotions, and is a consistent winner of Golden Penguin awards in contests run by the National Frozen & Refrigerated Foods Association. It is known for executing well against any big event it puts on its promotional calendar.

Says another vendor, “Even though Safeway is high in shelf pricing, they look at driver categories like dinners, entrees, and breakfasts where the consumer is shopping price as well as brand. Then they’ll zero in on the number-one brand and be a little more competitive with that, in a modified EDLP program.”

There is consensus that Safeway is using technology both to understand its shoppers and to build relationships with them. Its loyalty card program is being used to good advantage in customizing local stores for shoppers in the immediate area. What’s more, the card data is tied to a sophisticated category management program called Optura.

This program, launched last summer, is designed to produce closer collaboration with Safeway vendors via the sharing of shopper information. The end result will reportedly be improved assortment, pricing and promotion.

There’s plenty to talk about here. Let’s hit the two areas that have been getting the most industry buzz: Safeway’s Lifestyle stores and its innovative private label program.

LIFESTYLE: A FORMIDABLE FORMAT

Finding itself caught in the middle between low-end and high-end supermarkets and without much differentiation, the company began converting all of its stores into what it calls the Lifestyle format in 2003.

The stores, tied into Safeway’s “Ingredients for Life” campaign, embody the company’s efforts to differentiate itself with high-quality perishables. They feature earth-toned décor, subdued lighting, custom flooring and other special features designed to impart a “warm ambience” that “significantly enhances the shopping experience.”

Karen Short, senior vp and equity research analyst in the New York office of Arlington, Va.-based Friedman, Billings, Ramsey & Co. Inc., notes that there are four types of Lifestyle formats: Light, Core, Plus and Elite.

Elite features the widest array of products and stations, such as a hot food bar, elaborate sushi bar, gelato station and expansive bakery. The more than 700 Core locations have fewer bells and whistles but maintain a strong emphasis on prepared foods, Short notes.

She says that many of the Lifestyle remodels are intended to help the outlets better compete with Austin, Texas-based Whole Foods Market Inc. and other chains that offer high-quality prepared foods.

Converted Lifestyle stores typically achieve double-digit sales gains in the first year, then continue to deliver at levels above where they were before their remodels, according to Burd. The Lifestyle stores are evolving continually, and have reportedly proven effective against all forms of competition, including price formats.

The frozen food department, observers say, has seen the least amount of change, although its mix now includes a greater variety of “healthy” SKUs and more private label. The department’s size, they say, has remained unchanged, although cases and signage have been updated and improved. Significantly more change has come to the perimeter departments, with extra space going to, for example, dairy (lots more cheese, including upscale varieties) and deli (meals galore).

Lifestyle stores are split on how they merchandise “organic and natural” foods, vendors say, with some stores having these items in a special section, and other stores mainstreaming them. Observers say change in how “healthy” foods are merchandised may come soon, as Safeway recently announced to the trade that it is splitting its DSD business in the segment between Evanston, Ill.-based Distribution Plus, Inc. (DPI) and Tree of Life, St. Augustine, Fla. (Tree of Life gets back segments it had previously.)

Fighting Whole Foods

Another vendor says the Lifestyle stores do a good job against incursions by competitors such as Whole Foods. “I can only speak for frozen,” he says, “but the Lifestyle stores are putting much more focus on natural and organic not only with the addition of new items but with more signage to identify what it is and where to find it. They’re doing this with both branded and private label. If you don’t have the key brands in natural and organic, you aren’t a player in the category, and Safeway understands that.”

Safeway had converted 59% of its stores by the end of last year, and — with about 300 conversions done each year — expects to have all 1,740 of its stores in the Lifestyle format by the end of 2009. This year, Safeway expects to spend $1.70 to $1.75 billion in capital expenditures, open up to 25 new Lifestyle stores and complete as many as 255 Lifestyle remodels. Burd, who says each conversion is comparable to opening a brand new store, calls the Lifestyle stores a foundation for attracting and keeping customers. In today’s highly competitive marketplace, he sees them as both a strong defense and a strong offense.

Safeway will have more earnings and cash flow after the Lifestyle remodels are completed. No doubt, the cash will go not just dividends and stock buybacks, but for investment in margin, capital expenditures and market share defense. Indeed, Burd says free cash flow is projected to be in the range of $1.2 to $1.4 billion in 2010.

In the meantime, with remodels proving so successful, Safeway is focusing its efforts more tightly than ever. In the words of one frozen food vendor, “They aren’t obsessed with being number-one in every market. They want to produce a better shopping environment, and better service, and are taking the risks and making the investment.

“Face it — most grocery stores don’t provide pleasant experiences. If Safeway can continue to cut its costs and stay profitable and complete this program, then maybe they can attack the price line harder. For now, it looks like they’re doing things right.”

BREAKING THE MOLD ON PRIVATE LABEL

Safeway is breaking the mold on what we all thought we knew about private label. It’s selling its hottest brands to other retailers in the U.S. and abroad. It’s marketing its packaged private label products to foodservice. And it’s testing its new private label products in its own free-standing restaurant.

This has happened quickly. Only a few years ago, Safeway’s private label program was a shambles, with 70 individual brands and no clear direction. This was understandable, given the company’s acquisition spree between 1997 and 2001, wherein it acquired Vons (California), Dominick’s (Chicago), Carr-Gottstein (Alaska) Randall’s (Texas) and Genuardi’s (Pennsylvania).  To restore order, Safeway hired James White, a consumer packaged goods veteran (Nestle Purina and Procter & Gamble) as its senior vp of consumer brands late 2005. White wasted little time in whittling down that long list of brands, and updating the packaging for about 3,000 SKUs.

Today, Safeway has 10 “power brands” under four umbrellas:

• Wellness: O Organics, Eating Right
• Core: Safeway, Basic Red
• Expertise: Lucerne, Primo Taglio and Priority Total Pet Care
• Aspirational: Safeway Select, Rancher’s Reserve, and Signature

About 22% of Safeway’s corporate brand products (measured in dollars) are made at the 32 manufacturing plants it owns — 20 in the U.S. and 12 in Canada. Observers say that O Organics and Eating Right may get most of the attention lately, but Select has distinguished itself as well. This is especially true in frozens, they say, where Select has not just knockoffs but unique items in meals and appetizers, for example.

Safeway positions its brands strategically next to national brands on the shelf, inviting comparison. While the company has long made corporate brand products both for itself and for other retailers, it took a bold step this spring when it announced it would start selling two of its red hot “wellness” brands — O Organics and Eating Right — to other retailers. The O Organics line — extended late last year with O Organics for Baby! And O Organics for Toddler! — is an incredible success story. As one observer wryly put it, “The letter O seems to work very well as a marketing letter. Look how well it’s worked for Oprah.”

$300 Million-Plus

O Organics delivered $164 million in sales when it was launched in 2005, and blew past $300 million last year, on 329 SKUs. If you adjust for the fact that Safeway has a 7% U.S. market share, it would be the number-one organic brand in the country.

Observers agree that Safeway has done the right thing by integrating O Organics into mainstream shelf sets in its stores rather than putting them in a separate area for “healthy” foods. They say this exposes more shoppers to the products, and — because the line is priced very competitively — shoppers don’t experience sticker shock at the shelf. (One of the biggest arguments against integrating organic products with mainstream items is that shoppers will be able to make an easy price comparison, and steer away from the more expensive organic product.)

Eating Right

Eating Right, introduced in the second quarter of 2007, is on track to equal the performance of O Organics. With both brands sold outside of Safeway, Burd thinks the two brands combined could one day produce sales of $3 billion to $5 billion annually.

We’ll soon have an inkling of whether he’s right. In late April, Safeway announced the formation of the Better Living Brands Alliance, which will market O Organics and Eating Right across all retail channels in the U.S. The Alliance includes manufacturing, marketing and distribution companies as brand licensees. Co-pack and distribution partners have also been signed. The Alliance will receive additional support from Los Angeles-based EMAK Worldwide Inc. for consumer communications and Crossmark Inc., Plano, Tex., for communications to retailers.

Lucerne Foods Inc., a Safeway subsidiary which markets to external customers, manages the licensing of O Organics and Eating Right and is participating as a member of the Better Living Brands Alliance.

There’s already distribution overseas. Late last year, Safeway inked a deal with Carrefour to sell O Organics in the French-based retailer’s stores in Asia and South America. O Organics can also be found at D&S (under the store banner Lider) in Chile. More recently, it began selling O Organics beverages in high schools and office cafeterias in Northern California, via the Fremont, Calif., distribution center of Sysco Food Services.

This foodservice effort began with about 25 SKUs, and is likely to expand in both SKU count and venues. Reportedly, hospitals and restaurants could be next. Observers agree that a retailer selling a packaged private label product (instead of a commodity item) into the foodservice channel is a first, and may give Safeway a serious advantage as the organic market grows in foodservice.

But Safeway isn’t done breaking the mold yet. Last year, it opened Citrine New World Bistro, a 5,000 square-foot, 125-seat restaurant serving up “healthy” foods in Redwood City, Calif. Yes, it’s testing out its private labels there, too — from O Organics to Primo Taglio to Rancher’s Reserve. And it’s recruited experienced restaurateurs for its team. Direct foodservice experience will no doubt be an asset to its product developers.

Asked about Citrine in a conference call with securities analysts, Burd said “If you get a chance to come out and eat at Citrine, it is worth doing because you will find some extraordinary products, many of which we think we can carry in our own deli foodservice operation over time. The challenge is to figure out how to take that quality and provide a quality alternative like that inside the store. It is a culinary lab. It is not really a restaurant chain in the making.”

What do people in the industry make of all this? Vendors and competitors wouldn’t talk for the record, but most are withholding judgment until they see what happens over the next year. While Safeway is clearly in uncharted territory, the buzz about its efforts is generally positive.

‘Best Brands in 20 Years’

“O Organics and Eating Right are two of the best brands launched in North America in the past 20 years,” offers Tom Stephens, founder of Brand Strategy Consultants, North York, Ontario. Stephens should know of what he speaks — for seven years he was exec vp of President’s Choice International, a division of Loblaw Brands Limited, where he was responsible for the development of the President’s Choice program in the United States and Bermuda. He introduced President’s Choice in 16 retail chains with over 2,000 stores in 36 states.

Over the years, however, as chains consolidated and “exclusivity” of the President’s Choice label in any given market became problematic, Loblaw’s reportedly pulled its support from the program and it faded away. Stephens thinks some of the same problems could befall Safeway’s plan to market O Organics and Eating Right to other retailers.

“It’s certainly going to be a challenge,” he says. “Is it going to be sold only to non-competing retailers? Safeway’s already in many markets now. And if a retailer tries Safeway’s program and sees the potential there, they may just drop it and start their own program.”

Stephens adds that if Safeway supports O Organics and Eating Right like a branded manufacturer would, it may find long-term success. “Retailers won’t support a brand they don’t own unless they get money to do so,” he notes. “If Safeway wants to really grow this, they’ll have to get behind it and help their retailer customers promote it. This may turn out to be just a nice short-term success for Safeway. But, you never know… ”

sidebar: 'BECOMING MORE CUSTOMER FOCUSED'*

Here’s what an IBM report had to say about why Safeway is succeeding.

“Safeway is taking steps in the right direction in becoming customer-focused, and is realizing success. Since the company’s difficult 2002-2003 timeframe, Safeway has been working diligently to improve its operations, differentiating its offering from other conventional supermarkets by conducting extensive consumer research to determine what consumers are looking for when they choose a grocery store. Safeway integrates the findings into the operations of its business, from managing product assortment at the store level, to adding new convenience and wellness offerings, even to remodeling stores to make them easier to shop. Since beginning these efforts, Safeway has realized ten quarters of consecutive same-store sales growth and a significant increase in loyal customers.

“Safeway knows the key to success is really understanding customers and acting on that knowledge. For example, Safeway conducts customer panels on food preferences and adjusts produce assortments according to customers’ preferred sweetness of grapes or crispness of apples. Safeway works with growers and farmers to make sure they achieve the right specifications, or finds new ones who can meet the specs. The company doubled efforts to protect the cold chain, and added proper labels and online tools to inform customers of the vitamin and mineral content of foods they are consuming (as part of its Food Flex program).

“Additionally, the company is undergoing an aggressive remodel, creating Lifestyle stores that provide an improved shopping environment for customers. Finally, to help ensure customer insights are an integral and ongoing part of business operations, Safeway is transitioning from managing categories to managing customers, creating a new role, “customer managers,” that communicates regularly with key customers and shares the information companywide. Results speak for themselves; integrating customer focus throughout the organization is positioning Safeway as the grocer of choice in the eyes of many customers.”

  —*From “Why advocacy matters to grocers,” a study by IBM’s Institute for Business Value, September 2007, by Melody Badgett, Senior Managing Consultant with IBM Global Business Services; Maureen Stancik Boyce, PhD, Distribution Sector Team Leader for the IBM Institute for Business Value; and Herb Kleinberger, retired IBM Global Business Services Partner and the Global Retail Strategy Leader.

sidebar: SAFEWAY: BY THE NUMBERS

2007 Sales: Sales up by 5.2% to $42.3 billion, mainly due to continuing success of Lifestyle stores, execution of marketing strategy, increased fuel sales and higher Canadian dollar exchange rate. U.S. sales were $36,271.4 billion; Canadian sales were $6,014.6 billion.

2007 Net Income: $888.4 million, basically flat with prior year.

Store Count: 1,740 in the Western, Southwestern, Rocky Mountain, Midwestern and Mid-Atlantic regions of the United States and in Western Canada, as of March 22, 2008. In 2007, Safeway opened 20 stores (7 were replacements), closed 38 and did 268 remodels (all but 15 were Lifestyle remodels.)

Store Size: Chain average is 46,000 square feet; Lifestyle formats are typically 55,000 square feet. Safeway owns about 41% of its stores and leases the rest.

2007 Comparable Store Increases: 4.4% for the year.

2007 Identical Store Increases: 4.1% (or 3.4% without fuel.)

Distribution Centers: Safeway has 17 regional DCs (13 in the U.S., 4 in Canada) that serve its 12 retail operating areas.

Perceived Quality Improvement in Past Year by Primary Lifestyle Shoppers: Seafood, 53%; prepared foods, 61%; meat, 63%; deli, 70%.

Vendor Allowances: According to its annual report, Safeway received $2.5 billion in vendor allowances in 2007. Promo allowances made up about 75% of this, with slotting typically less than 5% and the rest attributable to contract allowances, where a vendor pays Safeway to keep product on the shelf for a minimum period of time or when volume thresholds are achieved.

Noteworthy: Safeway has a 49% interest in Casa Ley, S.A. de C.V., which at year-end 2007 operated 137 food and general merchandise stores in Western Mexico. Blackhawk, a Safeway subsidiary that markets gift cards, has produced strong results for Safeway with only minor investment.

sidebar: SAFEWAY DOES ITS PART

Safeway donated more than $172 million to charities last year, focusing its spending on hunger relief, cancer research and awareness, education, people with disabilities and disaster assistance. It also purchased 87 million kilowatt hours of renewable energy, recycled about 500,000 tons of materials for reuse and converted virtually its entire U.S. company-owned truck fleet to run on cleaner-burning biodiesel fuel. On Earth Day this year, state and local officials joined Safeway representatives on a tour of the rooftop solar panel installation at a store in Placerville, Calif. It is one of 23 stores in the state that is targeted for renewable solar energy. The entire 23-store solar program will remove 12.6 million pounds of carbon dioxide from the air, the equivalent of taking 1,045 cars off the road annually, according to Safeway.