Kroger keeps pace with change

by Josh Sosland
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In a retailing world featuring the likes of Whole Foods, Target, Costco and Wal-Mart, Cincinnati-based Kroger may not be the sexiest name. But in what has unquestionably been a decade of challenge and great change in the retail segment, it is the 133-year-old Kroger that accomplished something its high-flying competitors have not — 10 years of uninterrupted same-store sales growth, every single quarter.

The company describes same-store sales (it excludes fuel sales from this calculation) as “a key performance target for our long-term growth strategy” and is projecting 2.5% to 3.5% growth in fiscal year 2014 (year ends Feb. 1, 2015).

The importance of the metric has not been discounted by the investment community. During this 10-year period, Kroger shares, adjusted for dividends, have tripled in value in trading on the New York Stock Exchange. The 196% share price gain easily beat the S.&P. 500 index over this period (up 106%) and outpaced Wal-Mart and Target as well, lagging only Costco among retail leaders.

The same-store growth also outpaced Kroger’s top-line and bottom-line growth over the past decade. Net income of $1,531 million in fiscal 2013 was not dramatically higher than an earlier high water mark of $1,203 million in fiscal 2002. Net sales in fiscal 2013 of $98 billion were about double the $52 billion of sales in fiscal 2002.

Still, Karen Short, a securities analyst for Deutsche Bank, is optimistic Kroger is poised for further gains ahead. In a recent research report, Ms. Short said Kroger shares are substantially undervalued considering its metrics targeting same-store growth of 3% and earnings-per-share growth of around 10%.

“Kroger stands apart from other conventional grocers given its much greater scale, stronger local market positions, broad private brand portfolio and very consistent history of positive non-fuel I.D.’s (identical stores),” Ms. Short said.

A customer first approach

Exactly how Kroger has performed so well for so long was the subject of a discussion in March between J. Michael Schlotman, the company’s senior vice-president and chief financial officer, and Robby Ohmes, an analyst with Bank of America Merrill Lynch. The two spoke at the latter company’s Consumer & Retail Conference. Mr. Schlotman summarized Kroger’s approach as a “customer-first strategy” and went on to explain exactly what that means and how it sets Kroger apart in the retail space.

“If you look around our competitors, there’s really nobody that’s trying to do all four things simultaneously that we are in the customer-first strategy, between people, product, shopping experience and price,” Mr. Schlotman said. “And price gets the most play because it’s the most obvious when people look at our gross margin over time, although our operating margin, which is what we focus on, has started to grow nicely. You can live as a retailer for a very long time on any one of those four elements. At some point each of those elements runs out of a little bit of steam and it’s hard to recreate yourself if it’s a single element you’re trying to recreate.”

At Kroger, management is constantly looking to balance the allocation of resources — time, energy and money — against the four elements in a rigorous, consumer research driven process.

“So it’s not so much person X in the company wants to do this,” he said. “It’s person X ran a team of people who did consumer research, and the consumer tells us in this arena here’s what they’d like to see more of or less of. Everything is steeped in the background of what our customers tell us and our competitors’ customers tell us about what they’d like to see more or less of. So, every one of those initiatives in the customer-first strategy is predicated on that.”

Insights and innovation

The result of the process was likened by Mr. Schlotman to the customer experience at a Courtyard by Marriott hotel.

“When you go into a Courtyard you know what to expect, right?” he said. “You can walk in almost every room, you know where everything is. When you walk into a Kroger, the customer now knows what to expect. They know to expect better prices. They know to expect shorter lines. They know to expect a good product offering, and they know to expect people who are increasingly more friendly and more helpful inside the stores.”

Elaborating further on the research underpinning the company’s approach, Mr. Schlotman credited a 12-year partnership the company has had with dunnhumby USA, the U.S. branch of a United Kingdom-based research company that helps retailers and consumer products companies analyze data to enhance customer experiences and build loyalty.

“dunnhumby is in the background helping us understand to what depth and breadth we need to make price investments based on other price investments we’ve made, whether it’s the same initiative somewhere else or promotional pricing,” Mr. Schlotman said. “At what price points does it drive the most optimal customer penetration in that category? Because you can go too low on some categories, and you wind up investing in price that really doesn’t drive incremental operating profit dollars.”

The creation in late 2012 of Simple Truth, a Kroger store brand focused on organic and natural products, was done with help from dunnhumby and outside agencies, Mr. Schlotman said.

“We treated it as the launch of a brand,” he said. “How would a C.P.G. company, if they had Simple Truth and they were going to launch all the products in that line, how would they go to market with launching a brand? So we had radio, TV support. We had billboard support. We had print support. We never really had done that before. And here in a short period of time it’s going to wind up being a $1 billion dollar brand.”

A key to the success of Simple Truth has been orienting the brand toward meeting the needs of a “core Kroger customer” rather than trying to use the brand to lure away devoted customers of specialty retailers like Whole Foods. He described the latter store as having a “totally different feel” than a Kroger even while there is considerable product overlap.

“I think we will be fighting a very big uphill battle, if somebody who wakes up in the morning and wants to go to Whole Foods, if we think we’re going to get them to wake up in the morning and want to come to Kroger just because we have the product.”

Still, there was considerable opportunity for improving the presentation of organic and natural products within traditional supermarkets, Mr. Schlotman said.

“Natural foods for a very long time was a sub department of grocery,” he said. “It wasn’t a department onto its own. It didn’t have its own merchandisers and people out there finding new products, merchandising it, how to sell it in the store, how to price it in the stores.

“It was a subset of a much bigger category. It was almost an orphan inside of a very big category. As soon as we broke it out, put a leadership team in place of it and gave them some direction of what we were hoping to see, the products really started turning around.”

The same-store sales growth has allowed Kroger to gain market share steadily over the past decade and has helped create a positive environment between Kroger and its suppliers, even as overall supermarket industry sales have been flat to lower, Mr. Schlotman said.

“By and large, many of them (food companies) continue to see good growth with us, which is good because our overall tonnage is up,” he said. “Our corporate brand tonnage is up and our national brand tonnage is up, both of those in the grocery category. So we’re a little bit of an outlier relative to the overall industry.”

New leadership looks ahead

While Kroger’s relationship with dunnhumby remains intact as the company enters 2014, another important element that has been in place over the course of its 10-year streak is changing — senior leadership.

David B. Dillon retired at the end of 2013 as chief executive officer of Kroger, a position he had held since June 2003. The 63-year-old executive will remain chairman of the board until the end of 2014. Before he became c.e.o., Mr. Dillon had served as president and chief operating officer, beginning in January 2000. His successor as c.e.o. is W. Rodney McMullen, 53, who first joined the company in 1978 on a part-time basis working on a stock crew. Mr. McMullen has been president and chief operating officer since 2009 and previously held a range of senior management positions, including executive vice-president of strategy, planning and finance.

When the succession plan was announced in September 2013, Mr. Dillon credited Mr. McMullen for his contribution toward the changes implemented by Kroger over the past generation.

“Rodney has played a leadership role in every major decision Kroger has made of the past 25 years, including the development and implementation of Kroger’s Customer 1st approach as well as our current growth strategy,” he said. “He is ready to be c.e.o.”

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