Refrigerated & Frozen Foods Retailer

When Kroger comes up in conversation these days, talk is likely to focus on the chain’s aggressive private label program, its ongoing SKU rationalization, its push for consumer insights, and its battle with Walmart for market share.

 

This story will focus on each of these points, and in that order. Although we have friends we know and love at Kroger, the company as a rule declines requests for interviews with the trade press. Since our requests went unanswered, what you’ll read here is based on remarks made by Kroger executives on conference calls with securities analysts, and on our interviews with consultants, Kroger competitors, brokers and vendors.

 

Because of ongoing business relationships and other sensitivities, those interviewed require anonymity. So far, we can’t think of another way to do this, but if you have any ideas that don’t involve breaking the laws of physics or whatever (ahem!), let us know.

When Kroger was our Retailer of the Year in June of 2006, private label made up 24% of dollar sales and 32% of units. Those figures rose to 27% of dollars and 35% of units by the end of last year.

 

David Dillon, Kroger’s chairman and CEO, told security analysts during a March 10 conference call that the company’s $12.5 billion private label program now has more than 14,400 SKUs, and that its upscale Private Selections brand — the fastest-growing in the private label portfolio — exceeded $1 billion in sales in 2008.

 

“We leverage our manufacturing and procurement capabilities to innovate and introduce new items that add value for our customers,” he said. (Kroger manufactures upwards of 40% of its private label products in 41 plants.) Dillon added that both premium and value brands are enjoying strong growth. 
 

He noted that the company has focused more attention the past few years on its private label from the quality, marketing and packaging standpoints. Kroger has broadened its selection and introduced a value brand, with excellent results, he said.

 

The slow economy has made customers a little more willing to try the private label products, especially when they view them as providing better value, according to Dillon. With the economy expected to remain difficult for the rest of the year, he said, the trial rate of Kroger brands should continue to increase. 
 

Dillon stated he had seen “lots of commodity cost declines, where there has not been a respective cost decline of the base product by the national brands. And if that continues very long, the price differential between our Kroger brand products and the national brands will continue even higher.”

“Our growth in tonnage in the (fourth) quarter in grocery in particular was all driven by Kroger brands,” he continued. “The national brands were basically flat or slightly down in tonnage, and there may have been a few brands that were up, but on the whole, it is a Kroger brand story, and that is going to continue as long as that kind of price differential exists, and as long as we keep handling our brand, with the professional way that we have learned how to do.”

 

One security analyst asked Dillon what Kroger might do if the price gap between private label and national brands grew much further. Would the company continue to lower its shelf price on private label in lock-step with commodity price decreases, or would it take some extra margin?

 

Dillon’s response: “I think it will be item by item. We will not make a blanket statement that every cost improvement in product costs of Kroger brands will be reinvested to lower prices, but generally speaking that will be our intention. If we see some products that actually don’t improve in sales by lowering the price, then we would argue ourselves that we ought to keep that margin, and instead invest that margin in something else that does matter to the customer.”

 

Rodney McMullen, Kroger vice chairman, added here that “Our divisions and merchants actually will look at that analysis on an item-by-item basis, and make that call.”

 

As you might imagine, the private label gains do not bring joy to branded manufacturers. While vendors we interviewed were quick to preface their remarks with praise for the Kroger buying and merchandising team — “Great people, really professional and honest” was a typical remark — they are really unhappy about losing facings to private label.

One branded vendor pretty well summed up the feelings of his counterparts with the following comments: “If your product isn’t unique or they think there is any risk it will hurt PL (private label), they won’t stock it. They think PL is why they are doing well.

 

“My contention is that recent success is due to better pricing and nicer stores and they would do even better if they weren’t so focused on cutting national/regional brands to benefit private label. Walmart recognizes that consumers don’t come to stores looking for PL — they look for brands and aspire to purchase brands as much as they can. Where Walmart and some regional chains are smarter is that they stock more brands, but often price private label at retails that encourage cash-strapped consumers to trade down without forcing PL on them or providing limited options.

 

“The lack of variety and forcing of PL on the consumer will hurt them and other retailers (as it did A&P and Winn-Dixie in the past) as they compete with Walmart and try to build customer loyalty. It is rare that a consumer says ‘I’m going to Kroger because I only want to buy their PL items and if they do it is because they are so cheap' — typically not because that PL item is something they ‘have to have’ and can get exclusively at Kroger. They can pick up a cheaper PL item at any store and Kroger does better on PL than other retailers because they are so aggressive on PL pricing, not because they have gotten rid of brands.”

 

“I believe the better way is for retailers to provide aggressive PL pricing, but not at the expense of limiting branded variety. Luckily for them (Kroger), other big retailers like Safeway are copying this model and not providing the consumer a solid value proposition (still very high priced) so Kroger customers have little incentive to leave Kroger unless they have Walmart or a regional chain option (i.e., H-E-B) that is providing a good value proposition and branded choices.

 

“Kroger also misses the fact that regional or second brands can sometimes provide better margins than national brands/category leaders, so by stocking a regional brand and maintaining a gap versus their PL (to ensure PL isn’t hurt by second brand presence), they can maximize margins and consumer satisfaction while ensuring customers aren’t picking up some of their branded needs/wants at competitors,” the branded vendor concluded.

 

It should come as no surprise that private label vendors are pleased with Kroger’s program. As one private label vendor of frozen foods put it, “It’s a pretty good program. Kind of auto-pilot for us in many ways. I wish they’d promote their own brands stronger, like Safeway.”

 

And while Kroger’s private label program has been getting lots of publicity lately — generally tied to consumer newspaper stories about the economy — it’s only fair to note that its aggressive corporate brand program was around well before the economy began heading south.

Observers say Kroger is in the middle of an aggressive SKU rationalization program, significantly reducing the number of offerings store-wide (including frozen and dairy). Vendors say the company is putting more focus on minimum packout requirements, with an eye to driving efficiency at the shelf.

 

“We heard they just did the breakfast category, and some companies got hugely whacked,” says one vendor. He said he’d heard the SKU rationalization effort has been driven in part by research by London-based dunnhumby showing that consumers prefer shopping at Walmart more than at Kroger. Reportedly, if fewer SKUs are producing customer satisfaction and also improved sales and profits at Walmart, then that’s where Kroger wants to go. More facings for fewer items also give you the obvious benefits of lower labor costs and fewer out of stocks.

 

We have no idea how true the story about dunnhumby is, and will be happy to print a Kroger denial if they contact us. Since starting its relationship with dunnhumby about six years ago, Kroger has kept details about it close to the vest.

 

Suffice it to say that dunnhumby — a specialist in data management, customer analysis and insight-led planning — is held in high regard within the U.S. supermarket industry. It mines data from Kroger’s loyalty cards (40% of all U.S. households held a Kroger shopping card in 2006) and works with Kroger to unlock customer insights that provide guidance for product selection, merchandising and promotion. In this context, it could certainly be expected to offer detailed advice on SKU rationalization.

 

At a conference with analysts last October, Don Becker, exec vp and head of merchandising at Kroger, said “We’re not looking at it (SKU rationalization) from, ‘how much can we eliminate?’ But we look at it from our own data on what is the customer buying or not buying?”

He noted that in the breakfast cereal category (which was mentioned by our frozen food vendor friend), Kroger eliminated nearly 30% of all the SKUs. “Again, we did it with our data,” Becker said. “The customers were telling us with their wallets what they were buying. And so we eliminated some sizes. We eliminated some different SKUs and even some variety — keeping in mind localization, what was really important to that store or to that area.

 

“And we stayed in stock better and our customers only asked us to put one item back in because they were really concerned,” he continued. “They only missed one item enough that we needed to put it back in. So, SKU rationalization, we know we’re heavy, we know it’s a real opportunity and we also know that we can’t do it just looking for a certain percentage that we need to take out of every category.”

 

Becker noted at the time that as studies on the first ten categories were completed in test markets, and Kroger was able to determine “the sweet spot” (presumably an ideal SKU count or assortment), widespread rollouts began. He added that the SKU rationalizations would vary by market, taking into account local needs. Kroger has long said that its schematics are store-specific.

 

Kroger’s efforts to manage the shelf more efficiently have been paying off. In that same October conference, Don McGeorge, Kroger’s president and COO, noted that the company has cut its out of stocks by 38% since 2005.

One refrigerated food vendor told us that Kroger is “a bear for consumer insights,” and we’d have to agree. Let’s go back to McGeorge’s conference comments, for a good example of this. He said Kroger’s ability to tailor its product offering to meet the customer needs of each trading area is a unique competitive advantage.

 

“It is the combination of our extensive loyalty card data plus the analysis capability that we have through our partnership with dunnhumby,” he noted. “This combination gives us the ability to understand our customers better than any other US grocery retailer.”

 

McGeorge explained that sophisticated customer segmentation lets Kroger communicate with its best customers four times a year via its “loyal customer mailings,” or LCMs. “We think these mailings are kind of like to talking to your spouse or your significant other,” he continued. “Even though you love them, they kind of need to know once in a while and they need to hear from you. And we kind of think about our LCMs, these mailings to our best customers as a reflection of two things. One, that we understand their product needs and that we appreciate their business.

“What’s truly amazing is how unique these offers are,” McGeorge said. In a recent mailing to 9.4 million households, fully 95% of customers received a combination of offers that was unique to their household, he stated. McGeorge added that when he became a grandfather recently, the system recognized his change in purchasing behavior and began sending his household offers for diapers.

 

None of this came as a surprise to any of the vendors we interviewed. Several admitted to some anxiety on the night before a sales presentation to Kroger as a result. Here’s what one vendor told us by e-mail, and it gave us chills at the thought of calling on the company:

 

“They want knowledge of category and consumer trends, and recommendations derived from analytics of their customer loyalty data base… They excel in the area of mining consumer loyalty data through their partnership with dunnhumby. Not only does it allow for very targeted direct mail programs, but provides them with detailed information about household penetration, loyalty, consumer purchase behavioral changes that they can address through focused, pin-point marketing and promotions. This data is also being used to make assortment decisions and will soon be employed to improve promotional efficiencies.”

We don’t want to get in the middle of a battle over this, but there are definitely two camps on whether or not Kroger is losing share to Walmart in key markets. The clear majority of vendors we interviewed said they believe Walmart is winning nearly all of the head-to-head battles. Not by big margins, but slowly and steadily. Figures we’ve seen, purportedly from a major syndicated data provider, show Kroger share down slightly in most of its major markets last year, with Walmart up.

 

Kroger has a different view. Dillon, in the March 10 conference call, said that “In the major markets we serve, Kroger gained 61 basis points of additional market share according to the internal methodology we use to estimate market share. This is the fourth consecutive year Kroger has achieved significant market share gain. Over the past four years combined, Kroger’s share in our major markets has increased roughly 225 basis points.”

 

One hundred basis points make up one percent. (Yes, we had to look it up.) We happen to love both Kroger and Walmart. And we believe different methods and standards are being used to calculate the share numbers, and that nobody is trying to be dishonest. But our gut tells us that Walmart probably has the edge right now.