Sunday, December 05, 1999
New stuff at Kroger
With Fred Meyer merger, merchandise and strategy are shifting
BY LISA BIANK FASIG
The Cincinnati Enquirer
Joe Pichler, Kroger CEO and chairman.
(Michael E. Keating,
Randy Mazzola photoillustration)
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Shopping trips to Kroger have changed since old Fred from the West came into the Cincinnati grocery giant's life. Television sets sit just 20 paces from the bananas. Computer equipment complements the growing organic foods section. And boudoir lamps are taking shelf space along with private labels that compete with Ben & Jerry's.
But save room in your shopping cart, shareholders — Kroger is pledging that its earnings will rise, too.
“They've got Canon scanners and printers. They've got Toshiba DVDs,” said Marvin Schram, a Kroger shopper and shareholder for 24 years. “I was wondering why it was there, but I forgot all about the relationship with Fred Meyer.”
As the 6-month-old merger of Cincinnati-based Kroger Co. with Fred Meyer Inc. of Portland, Ore., plays out, fruits of the marriage are rolling onto Kroger's shelves.
Nonfood items, added private labels and specialty foods are emerging as the local supermarket chain takes advantage of Fred Meyer's supplier relations and manufacturing systems. Kroger also opened a Fred Meyer Jewelers in Eastgate Mall in November.
But a larger part of the story is playing behind the scenes, in cost reductions designed to benefit Kroger shareholders. These savings range from reduced prices on pharmacy vials to consolidating manufacturing and management information systems.
“There's a big range of things,” said Joe Pichler, chief executive and chairman of Kroger. “It's like the iceberg. It's what's under the water that's bigger than what you see.”
Analysts of Kroger think the unseen might be even bigger than Kroger is predicting. Some observers forecast that Kroger's long-term cost savings of $225 million may be conservative.
Industry authorities are saying that Kroger's merger with Fred Meyer is a necessity to compete against the rising nationals — Wal-Mart and its mixed-merchandised brethren, such as Meijer and the Costco wholesale buying club. To succeed, a supermarket chain must compete on product and price.
But competing on price costs money. In an industry where margins are as thin as an apple skin — one or two pennies on the dollar — the most effective way to save money is through expansion.
“Kroger's learned from Costco and Wal-Mart that consumers want primarily price, with some assortment and variety,” said Burt Flickinger III, managing director with the retail consulting firm Reach Marketing.
“Pichler's always said, "We'll fight to survive and be successful and thrive.' But it's a competitive threat that you can't take your eye off of for even a day.”
Peas and printers
For Kroger, balancing consumer demands against Wall Street's expectations means carefully testing new products while expanding lines that have been successful. Fred Meyer's buying relationships capabilities allow Kroger to try some products that were too expensive for Kroger to buy and sell on its own.
“We've got a lot in the pipeline coming,” said Mr. Pichler.
“Fred Meyer is a direct buyer. They've been in this business for a long time; they know a lot about it. We can offer customers better quality, better variety and better pricing as a result of the Fred Meyer merger, and that will start showing up next year.”
There are two main areas where Kroger will expand its product mix under Fred Meyer: more private-label lines and an influx of nonfood goods that Fred Meyer already distributes at its own stores in the West.
A closer look at each product category plan:
• Private label: Retailers like private labels because they contribute more to the bottom line by eliminating the middleman. Kroger's primary private label, generating 25 percent of grocery dollar sales, competes against brand leaders such as Jif peanut butter and Breyers ice cream. Now, two other levels are being added.
Private Selection, a high-quality line, will compete in categories such as ice cream and cookies. Kroger plans to add 350 Private Selection products. One hundred items are expected to be introduced by year's end.
The second category, called For Maximum Value, includes products that are safe but fall below national brand standards. A good example is broken cashews. Kroger plans to introduce 80 items before next year.
• General merchandise: Fred Meyer operates a chain of multidepartment stores that mix food and nonfood items — apples and undershirts, T-bones and TVs. It also operates a chain of jewelry stores, one of which opened in Eastgate Mall last month. Two more are planned for Tri-County and Middletown in spring.
Fred Meyer has established relationships with its suppliers, and as a result of the merger extends that relationship to Kroger.
“They direct-import this product (from overseas) at a far lower cost than we can buy it,” Mr. Pichler said. “They have buyers who specialize in general-merchandise lines — patio furniture for example. We'll have better quality, better variety and more competitive prices of those items as a result.”
The result translates to miniature television sets, VCRs, printers and even pies. Fred Meyer also specializes in some food categories, such nutritional supplements.
Kroger is not alone in its diversification efforts. Carole Throssell, spokeswoman for the Food Marketing Institute, said 34.5 percent of supermarkets operated nonfood categories five years ago. These days, the share is 56.4 percent.
While some retail followers say Kroger is smart to diversify its selection a la Wal-Mart and Meijer, analyst George Thompson thinks mass merchandising is a minor feature of the Kroger-Fred Meyer merger.
“Historically, people haven't shopped in grocery stores to buy that kind of thing,” said Mr. Thompson, with Prudential Securities in New York. “It's not a significant sales boost.”
True, while shopper Marvin Schram indulged himself with a scanner and printer at Kroger, it's not likely everyone will follow his example.
“For something like that, I guess I'd go to a store that deals with that more,” said Ruth Ann Anson, 70, a shopper from Mount Lookout. “I just shop for what's on my list.”
But, she said, she does try new food items at Kroger.
Cost savings
When talking about Kroger's merger with Fred Meyer, Mr. Pichler emphasizes that the most significant benefits of the deal won't be visible to the average shopper. These changes involve cost savings that will make Kroger leaner and a more efficient profit generator on Wall Street.
Kroger expects to realize $40 million in savings this fiscal year, ending Jan. 29, as a result of the merger. It anticipates saving $225 million by its third year after the Fred Meyer deal.
Some analysts call that a modest figure.
“We think actually there are opportunities for more than that in coming years,” said Tony Howard, an analyst covering Kroger for J.J.B. Hilliard, W.L. Lyons, a Louisville-based brokerage firm. “In hindsight, this merger makes more strategic sense.”
Half of the cost savings will come from purchasing power — a $43 billion company can make larger orders at better prices than a $28 billion company.
This goes beyond ordering up extra truckloads of Tide detergent at a lower price. Kroger buys tens of thousands of little vials for its pharmacies — it expects to save $500,000. Through centralized purchasing of perishables, it saves $750,000 on a 30 million-pound order of mini peeled carrots.
“The interesting thing is when you're a company of Kroger's size and see the sudden increase, all of a sudden a 10 percent savings on things like tires or pill vials becomes a lot more significant,” said Charles Cerankosky, an analyst who covers Kroger for McDonald & Co. Securities in Cleveland.
“(Plus) you have the more diligent attention of your suppliers. Everyone who was supplying Kroger now has a bigger customer base.”
The remaining 50 percent of Kroger's cost savings is coming from consolidated administration, distribution and manufacturing operations on both sides.
To wit: Kroger folded together operations in Arizona, and Mr. Pichler said Kroger will likely phase out one of its four management information systems (MIS) in the second or third year of the merger.
The latter move could strike home, since Kroger's MIS platforms operate in Cincinnati, Denver, California and Portland.
“We're studying how to do it, which ones to do it and so forth,” Mr. Pichler said. It's not clear how many, if any, jobs would be affected; many MIS workers are on contract.
The savings Kroger is expecting will be passed on to shoppers and shareholders. The chain anticipates its earnings per share will increase 16 percent to 18 percent beginning fiscal 2000 — Jan. 30. Pre-merger, Kroger expected an increase of 15 percent to 17 percent.
That doesn't mean much now, when Kroger's stock is down more than 25 percent this year. Mr. Pichler said Kroger's bruised stock is a victim of several factors.
Significantly, several major players in the industry have made acquisitions in 1999, and the benefits are taking longer to realize than investors expected. All major players in the grocery industry are down — Kroger happens to be outperforming its peer group.
Consider: Last week, competitor Albertson's Inc. said its profits fell in the third quarter because of higher-than-expected consolidation expenses. Kroger's stock took a hit as a result. Albertson's is down more than 45 percent for the year.
“My belief is what's going to happen is the industry is going to stay ... under pressure here until there's some consistency of performance in earnings after the mergers,” Mr. Pichler said. “People get nervous, they see risk, of course. But also, I'd point out risk means opportunity.”
Kroger's future
Investors see a future at Kroger that includes higher earnings, but the supermarket chain must constantly “fight to survive,” as industry specialist Burt Flickinger put it.
Kroger may dominate in the supermarket business, but a bigger threat may loom in mixed-merchandise chains such as Wal-Mart, which Mr. Flickinger calls “the greatest retailer the world has ever known.”
“It's going to be the greatest challenge to Kroger since those days when there were no antitrust laws to protect (founder) Barney Kroger,” he said.
Mr. Pichler said Kroger is talking about expanding the Fred Meyer store format, which is similar to that of Wal-Mart. And it is cautiously experimenting with online product delivery in a way that won't cost Kroger its shirt if the efforts go bust.
But Barney Kroger's company didn't make it to the supermarket summit by taking side trips to unexplored territories. Kroger for now will focus on the pressing matters — saving money and looking into ways Fred Meyer can make it a better company.
“The first job of the merger is to get the $225 million synergies that we have on our plate,” Mr. Pichler said. “To get past Y2K, which is coming up on us, and so forth.”
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