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Grocery Retailing1 JAY COGGINS BEN SENAUER University of Minnesota INTRODUCTION The essential output of the U.S. grocery industry is services. A supermarket is in the business of selling products, but few are produced by the store itself. Rather groceries are brought into the store through a distribution system and are then sold to consumers who have ever-increasing expectations of service quality. Consumers want a wide selection, high quality, shopping convenience, and com- petitive prices. The fact that services are the product presents certain difficulties in the study of innovation in the supermarket industry. A manufacturing enterprise, for ex- ample, can usually measure its expenditures on new-product development. It can relate these expenditures to some measure of the output of new products and their profitability. In grocery stores, as in retailing generally, innovation appears to be a more elusive concept. Something as subtle as redesigning a store's checkout counters or a display case may constitute an innovation. However, the idea and the budget to carry out such changes are unlikely to be assigned to a particular unit in the corporate structure. The line between marketing and research and development blurs as different units seek to improve the consumer's experience in the store. Although the study of innovation for this industry is difficult, we shall never- theless attempt it. Even though this chapter will perhaps contain less in the way of hard data than many of the other contributions, our goal is to describe a variety iThis research was funded by the Retail Food Industry Center at the University of Minnesota. 155
56 U.S. INDUSTRYIN2000 of innovations, their sources, and their effects on industry performance. The forces driving innovation are also important, and these are also addressed. It is useful to divide the forces driving change in the supermarket industry into three categories competition, consumer preferences, and technology. The first of these, competition, comes both from within and from outside the industry. As recently as the 1960s, the supermarket industry was highly efficient by the standards of the day. In the 1970s, as prices soared and holding goods was pref- erable to holding cash, the entire distribution network accumulated large invento- ries. Although this strategy made sense while inflation was high, as inflation fell the expense of owning inventory caused a decrease in efficiency, creating in turn a decline in profitability and industry performance. Inflation itself, while an im- portant force in the history of the industry, had an indirect effect on innovation. It helped cause inventories to increase, reducing efficiency and opening the indus- try to a competitive threat from outside. During the 1980s, the growth and superior efficiency of large general retail outlets such as Wal-Mart exerted competitive pressure on supermarkets. These retailers demonstrated that U.S. supermarkets and the distribution system behind them were not so efficient after all. When these new retailers began expanding their food offerings, pressure on supermarkets grew even further. Innovation and change became necessary for survival, and the industry entered a period of up- heaval that continues to the present. The second source of innovation is the preferences of consumers, both for types of food and for certain attributes of a shopping experience. It could be said of almost any industry that consumers drive the innovation process. But seldom is this as true as in retailing, where contact with consumers is immediate and direct. Some of the consumer changes that have forced supermarkets to change and improve their service offerings will be discussed in this chapter. The third source of innovation is the technology employed in managing in- ventories, transmitting information up and down the supply chain, and recording information about consumers' store-level purchasing behavior. Development of this type of technology, mostly electronic, is almost entirely external to the indus- try. For the most part, supermarkets adopt equipment and software developed by third parties. Computer-related technologies are crucial to many of the efficiency- enhancing advances, but the innovative role of the supermarket industry is in using the technology, not in producing it. The role of technology is itself some- what ambiguous. In some cases the availability of a new technology drives inno- vation. In other cases, technology is the means by which a new innovation is implemented. Innovation can take many forms in a retail industry. Many of the most im- portant innovations are related to processes: of inventory management, informa- tion control and transmission, and in-store product flow. These and a variety of related changes are addressed by a major industry-wide initiative that began in 1993, efficient consumer response (ECR). A section of this chapter is devoted to
GROCERY RETAILING 157 ECR. Other innovations are directly related to consumer service, such as store layout and meal replacement. Included in this category is the wide variety of new products that cater to consumers' wish to purchase meal-ready foods for home consumption. The following section provides a brief historical overview of the industry and the events that led to the aggressive change currently experienced. The third section contains a brief discussion of the role of external sources of innovation. A variety of performance measures are presented in section four. The fifth sec- tion describes the basic approach of ECR and its effects, and section six addresses service-related innovations. The seventh section presents the linkages between the various innovations and changes in industry performance. MAJOR FORCES DRIVING INNOVATION For the past decade or so, the supermarket industry has been constantly rac- ing to keep up with its competitors in reducing distribution costs and improving efficiency. It was not always this way. As recently as the 1960s, the industry was regarded by many as the benchmark against which to compare the performance of distribution systems. When Toyota, the Japanese automobile company, devel- oped early versions of "lean inventory management" or "just-in-time delivery," Toyota management gave substantial credit for the innovation to the efficiency they observed in the U.S. supermarket industry at that time (Kurt Salmon Associ- ates, 1993~. Then inflation rose during the 1970s. Firms throughout the food distribution system changed their strategies dramatically. Now excess inventories could gen- erate a return by increasing in value as prices rose (Kahn and McAlister, 1997~. The age of "the deal" came into being. Product promotions became more promi- nent and had a major impact on distribution in the food industry. Manufacturers produced the same item in large production runs and then pushed large batches of product out to wholesalers on special discounted deals, causing inventory to build up in warehouses. Likewise, wholesalers would push the product out to retailers with promotional discounts. The excess inventory would then be promoted by retailers and sold to consumers by discounting the price or providing coupons. In this environment, the goal was to maximize sales volume. The former emphasis on reducing costs faded along with concern for distributional efficiency. Industry-wide returns on net worth, which have seldom been below 15 percent in the past decade, were just over 6 percent in 1972-1973, the first year for which such data are available. The economy as a whole did not perform well during this period, but the supermarket industry was particularly ripe for change. Competition as a Driving Force for Innovation Change did indeed occur. Several factors combined during the late 1980s to deliver a wake-up call to the industry. Inflation plummeted and the economy
58 U.S. INDUSTRYIN2000 entered a recession. Holding inventories, especially large inventories, became very expensive. Most important, perhaps, was a dramatic increase in competition caused by the spread of mass merchandisers such as Wal-Mart and the entrance of alternative formats such as warehouse clubs and supercenters owned by Wal- Mart and others (Kurt Salmon Associates, 1996~. Wal-Mart's initial impact was not due to its presence in the grocery market. Rather, its electronically driven distribution system and the way in which it dealt with suppliers shook other re- tailers to the core. It quickly developed sufficient market power to alter the way the product was purchased, warehoused, and distributed. Wal-Mart demonstrated to suppliers that it was not interested in promotional deals but wanted the lowest price possible on all its purchases and would deter- mine the quantities and delivery schedule. Its retail prices were based on an "everyday-low-price" (EDLP) approach. Wal-Mart became the leader in distri- butional efficiency. Inventory turnover was high and excess supply in the system was all but eliminated (Senauer and Kinsey, 1997~. Today, Wal-Mart's reduced operating costs are 17.5 percent of sales, compared with around 22 percent typi- cal for supermarkets (Blattberg, 1996~. Wal-Mart's effect grew along with its market penetration. The number of Wal-Mart stores increased from 859 in 1985 to 2314 Wal-Mart stores and 439 Sam's Clubs in 1997 (Larson, 1997~. Their success with the EDLP approach caused retailers generally, and the grocery store industry in particular, to rethink their reliance on volume purchases, volatile prices, and maximum dollar sales. It became clear that survival required reducing costs and improving efficiency of the distribution system. If this message was not clear before, it certainly became clear in the early l990s when Wal-Mart and other discount merchandisers, including Target, K- Mart, and Meijer, began developing "supercenters," which combine general-pur- pose retail with full-scale grocery stores. Supercenter sales are expected to ex- ceed $52 billion in 1998 (Food Institute Report, 1998), of which about 40 percent, or nearly $21 billion, is grocery sales. A 1996 report of the Food Institute esti- mated that the supercenter presence in groceries would increase from 2 percent of sales in 1994 to 7.4 percent in 1999 (Food Institute Report, 1996~. Another study, by the Food Marketing Institute, predicted that sales of grocery products by non- traditional food retailers will reach about $70 billion by the year 2000 (Food Marketing Institute, 1997~. This would be around 14 percent of total grocery sales. Clearly the threat to the supermarket industry posed by Wal-Mart and other discount retailers is and continues to be serious. In a recent case study, Capps (1997) examined the effect of Wal-Mart on sales at traditional grocery outlets in rural Texas. He used data from 30 stores in the David's Supermarket chain, covering the period from 1987 to 1994. Of the 30 stores, Wal-Mart competed directly (that is, had a store nearby for at least part of the study period) with 22. Linking monthly sales at each store to local demo- graphic information, sales in the previous period, the number of competing super
GROCERY RETAILING 159 markets, and the proximity of Wal-Mart, Capps found that, on average, Wal-Mart led to a reduction of 17 percent in sales. Technology as a Driving Force for Innovation In 1992, President George Bush made headlines with his reaction of surprise to the novelty of an electronic scanner at a grocery store he visited during his re- election campaign. This device, familiar to most of us, is now used in more than 97 percent of supermarkets. Supermarkets were the first retailers to use elec- tronic scanning at the point of sale (POS). In 1972, supermarkets worked with the Uniform Code Council to develop Uniform Product Codes, setting industry- wide standards for POS information (scanners). Supermarkets adopted the stan- dard early as a way to speed checkout and eliminate the need to put a price tag on every item, thus reducing labor costs. This provided some gains in efficiency for grocery stores. In addition, supermarket POS scanner data were sold to food manufacturers and market research companies (Senauer and Kinsey, 1997~. However, traditional supermarkets fell behind the leading general retailers, including Wal-Mart, in the use of POS scanner information and electronic data interchange (EDI) in supply chain management. "Quick response" is the term applied to the restructuring of inventory replenishment in general merchandising in which the logistics system is driven by POS data. Quick response was itself based on lean-inventory management or just-in-time delivery, which has been widely adopted by U.S. automobile manufacturers and other industrial compa- nies in restructuring to become more efficient. Recent attempts to catch up to retail competitors in exploiting this fundamental technology mark some of the key innovations in the supermarket industry. In the area of labor, the biggest challenge that food retailers currently face is simply finding enough workers in areas with very low unemployment levels and tight labor markets. Most supermarkets are staffed by a core of stable long-term employees and a substantial group that has a high turnover rate. Hiring new employees is, therefore, a continuous process. Most entry-level positions require few skills and do not even require a high school diploma. The industry has a high demand for part-time workers because most of its business is in concentrated periods, between 4 and 6 p.m. Monday to Thursday and between Friday after- noon and Sunday night, when half of all sales now occur. Many of the industry's jobs are not only part-time, but also low-skill and relatively low-paying positions. Thus supermarkets have an incentive to find labor-saving capital that can substitute for workers. One example is self-checkout, in which the cashier is eliminated and shoppers scan the items themselves. Self-checkout systems have been the subject of experiments for some time, but the systems are not yet ef- fective enough to be widely adopted. An obvious problem is how to prevent shoppers from cheating by not scanning all their items. Although the need for technologically sophisticated workers is not as great as in many industries, the
60 U.S. INDUSTRYIN2000 technological demand placed upon workers is growing and will probably con- tinue to do so. As the number of jobs requiring the use of electronic equipment increases along with the sophistication of the ordering and in-store management systems, the need for more skilled workers will increase. Innovation Is Consumer-Driven Innovation in the grocery industry, as in all retailing, is driven not only by competition and technology but also by consumers. The most successful retailers respond to the wants and needs of customers. An especially important customer demand is convenience in food purchasing and consumption. The trend behind much of the rising demand for convenience is the increased participation of women in the labor force. Between 1970 and 1994, women's labor force participation rate grew from 43.3 percent to 58.8 percent. For women ages 35-44, the participation rate in 1994 was 77.1 percent (U.S. Department of Commerce, 1996~. Many consumers do not have the time to prepare traditional meals and increasingly even lack knowledge of how to cook. After work, they want a meal to eat or, at most, to assemble at home, but not ingredients to cook. They also want to relax in the comfort of their own home and not spend time and money at a full-service, sit-down restaurant (Kinsey and Senauer, 1996~. Gro- cery retailers are increasingly providing meals that can be taken home and eaten, referred to as meal solutions or home meal replacement in the industry. Meal solutions are a challenge for the industry because it has more in common with food service than traditional grocery retailing. THE ROLE OF EXTERNAL SOURCES OF INNOVATION The major trade associations and several key consulting firms play an impor- tant intermediary role in facilitating innovation by food retailers. The Food Mar- keting Institute (FMI) is the single most important trade association for the indus- try. FMI holds the industry's major annual trade show in Chicago each May, as well as other conferences and workshops throughout the year. The topics of these conferences frequently relate to innovation in the industry. Recent conferences, for example, have focused on category management and home meal replacement. FMI also does a substantial amount of research for the industry. Some is done by in-house staff, but much of it is contracted out to consulting firms. The results are then reviewed, published, and distributed by FMI. FMI receives substantial fund- ing through its membership dues from grocery stores and supermarkets. Dues are in proportion to sales. They vary from as little as about $100 for a small single grocery store operation to well over $100,000 for large supermarket chains. Three of the major consulting firms used by the industry are Willard Bishop Consulting, Kurt Salmon Associates, and Arthur Andersen. Each is known for its work in particular areas. Kurt Salmon, for example, did the original ECR study.
GROCERY RETAILING 161 Willard Bishop, whose offices are located outside of Chicago, focuses on helping retailers develop loyalty or frequent shopper programs, pricing strategies, and category management programs specifically for penshables. Bishop has devel- oped computer software that can be purchased and used to implement programs in several areas. Willard (Bill) Bishop, the firm's leader, is widely respected and regarded as one of the industry's "thought leaders," a source of innovative ideas for the industry. MEASURES OF CHANGE IN INDUSTRY PERFORMANCE Consumer Food Expenditures The performance of the retail food industry is tied to consumers' spending patterns, and a crucial fact is that the share of income spent on food has long been in decline. Real median family income has generally increased since 1970, al- though during parts of this period it flattened or even fell. The share of income spent on food, on the other hand, fell from 13.9 percent in 1970 to 10.9 percent in 1996. Expenditures on food eaten at home fell even more precipitously, from 10.3 percent in 1970 to 6.8 percent in 1996. Expenditures on food eaten away from home rose slightly, from 3.7 percent in 1970 to 4.5 percent in 1996 (see Figure 1~. Although real expenditures on food eaten at home rose, the increase in industry sales did not keep pace with population and income growth. 16 14 12 10 c' 8 6 4 - _ - _ - _ I -_ _ Food away from home _ _ ~ Total food expenditures Food at home 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 FIGURE 1 Food expenditure as a percent of income (average family income). Source: "Food Consumption, Prices, and Expenditures, 1996," U.S. Department of Agriculture, Economic Research Service Bulletin Number 928, 1996.
162 U.S. INDUSTRYIN2000 Financial Measures of Productivity The financial performance of the industry, however, has been quite good, especially in recent years. Nevertheless, profit margins have always been low. This is perhaps not surprising given the highly capitalized nature of the industry and its high sales volume. Indeed, industry members and observers have often thought of the low profit margins as an indicator of the efficiency of the industry. Defined as after-tax net profit as a percent of sales, profit margins have recently hovered around 1 percent. The industry-wide figure stood at 0.50 percent in the 1972-1973 fiscal year, the earliest year for which the data are reported. The figure trended upward through the 1970s and 1980s, reaching 1.19 percent in 1985-1986. Net profitability declined in the late 1980s and early l990s and re- covered in 1993-1994. It was 1.20 percent in 1995-1996 before dropping back to 1.08 percent in 1996- 1997 (Figure 2~. Profit margins may not be the best indicator either of efficiency or of finan- cial performance, however. Investors in publicly held supermarket companies have done very well recently. Return on net worth, measured as a percent of net worth, has been strong, reaching 16.33 percent in 1996-1997 (Figure 3~. In early 1997, Supermarket News reported that its index of 48 stocks climbed 30.3 percent between 1994 and 1995 and 45.4 percent between 1995 and 1996. The index Percent of sales 0.8 0.7 1 1.3 1.2 1.1 0.9 0.6 0.5 0.4- 1 1 1 1 1 1 1 1 1 1 1 ~1 ~1 1 1 1 1 1 1 ~00 9~9\0 9~\0 90~\0~9O~ oat ~ ~ ~ 9~19~ ~ ~\9~ 6\9~ ~¢ Al / / / / / / At, ~ / \ \ \/ \ Profit margins \ l l Year FIGURE 2 Profit margins. Source: Food Marketing Institute's Annual Financial Review, various years. Compiled by Gerne and Associates.
GROCERY RETAILING Percent of net worth 22 20 18 16 14 12 10 8 6 ! 163 Return on net worth /~\ ~1 ~ By' 4 a~ 5~0 5~693~0 95~9~0 9~0 9~9~ 9~0~ 90~ 9~9~9~ 9~9O~ 9~9~ 909~99~99~99~99~99~99~99~\ Year FIGURE 3 Return on net worth as a percent of net worth. Source: Food Marketing Institute's Annual Financial Review, various years. Compiled by Gerne and Associates. outperformed both the Dow Jones Industrial Average and the S&P 500 (Food Marketing Institute, 1997~. In-Store Measures of Productivity Traditional measures of industry performance include measures such as weekly sales per square foot, weekly sales per labor hour, and sales per transac- tion. Median real weekly sales per square foot fell from $11.71 in 1960 to $6.34 in 1996 (Figure 4~. This figure is affected by many factors, including the size of stores. Median store size has long been increasing, growing from 31,000 square feet in 1987 to 38,600 in 1996. Also, aisles have grown wider and checkout areas have become larger. Both of these changes are meant to make shopping more pleasant for consumers, and both tend to reduce sales per square foot. During the past four decades, median real weekly sales per labor hour first rose, from $78.86 in 1960 to a high of $98.72 in 1980, before retreating to a new low of $74.45 in 1996 (Figure 5~. The drop in recent years is primarily due to an increase in labor-intensive supermarket services such as deli counters. Real median sales per transaction, another indicator of a supermarket's pro- ductivity, have also fallen in recent years (Figure 6~. After several decades dur
64 U.S. INDUSTRYIN2000 13 12 11 1 10 7 6 5- , 1, 1 1 1 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1g82 1984 1986 1988 1990 1992 1994 1996 Year \ \ MA Sales/square foot HI / VVV~- - FIGURE 4 Real median sales per square foot. Source: Food Marketing Institute, FMI Speaks, various issues. 105 100 95 u~ ~ 90 o 85 80 75 ,j, IN/ \ / / / / ~ I/ / V / Sales/labor hour \ 70- 1 1 1 ' 1 1 1 1 1 ' 1 ' 1 ' 1 1 1 1 1 ' 1 ' 1 1 1 1 1 ~ 1 ' 1 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year FIGURE 5 Real median sales per labor hour. Source: Food Marketing Institute, FMI Speaks, various issues.
GROCERY RETAILING Dollars 17 16 15 14 13 165 A, ~Sales/transaction - ~, 12-1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 ' 1 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year FIGURE 6 Real median sales per transaction. Source: Food Marketing Institute, FMI Speaks, various issues. ing which this measure stayed at or above $14, it fell in the l990s all the way to $12.44 in 1996. This reflects changes in consumers' shopping habits. They tend to make more shopping trips than previously and to buy less on each trip. These measures of industry performance paint a mixed picture of an industry that is facing intense competitive pressure but has provided a healthy return to its investors. How has the retail food industry managed to maintain a relatively healthy financial situation in the face of such pressure? Much of the answer has to do with its ability to adopt new and innovative ways of operating. We now turn to a description of several of the industry's central innovative strategies. PROCESS INNOVATION: ECR ECR is U.S. supermarkets' answer to their more competitive environment. The major goals are to produce and ship products in response to consumer de- mand, eliminate costs that do not add to value, reduce inventories, spoilage, and paperwork, and simplify transactions between companies. The ECR movement was launched after Wal-Mart and other discount mass merchandisers entered food retailing with supercenters. ECR is akin to "lean- inventory management" or "just-in-time delivery" in manufacturing. The pur- pose is to reduce costs by increasing the efficiency of distribution. The strategy
66 U.S. INDUSTRYIN2000 calls for grocery retailers, wholesale distributors, and manufacturer suppliers to be linked together electronically and to cooperate closely. ECR focuses on improving the efficiency of the entire system rather than just certain activities. According to the key report on ECR by Kurt Salmon Associa- tions (1993~: The ultimate goal of ECR is a responsive, consumer-driven system in which distributors and suppliers work together as business allies to maximize consumer satisfaction and minimize cost. Accurate information and high-quality products flow through a paperless system between manufacturing line and check-out counter with minimum degradation or interruption both within and between trad- ing partners. Widespread adoption of ECR could lead to a 41 percent cut in dry grocery inven- tories and a $30 billion decline in total distribution costs along with an increase in product quality and freshness, the report predicts. The vision of ECR, as shown in Figure 7, is that a timely, accurate, paperless flow of information starts at the checkout counter and facilitates a smooth, con- tinuous flow of product that matches consumer purchases. Computers and soft- ware programs allow data to be transmitted directly to distributors and/or manu- facturers in real time. This flow of information allows fast-moving items to be replenished automatically and makes it possible for manufacturers to adjust pro- duction lines in response to consumer demand. In contrast, in the past informa- tion circulated much more slowly and only in closed circles between consumers and retailers, between retailers and wholesale distributors, and between wholesal- ers and food manufacturers and other suppliers (Senauer and Kinsey, 1997~. The Development of ECR To respond to the increased competition and need to improve efficiency, industry leaders formed the ECR working group in mid-1992. ECR was devel- oped through the main trade associations to ensure that its benefits would be widely available. The working group commissioned a major study by the con Timely, accurate, paperless information flow Food Manufacturers and Suppliers FIGURE 7 The ECR system. Wholesale Retail Distri butors Stores Smooth, continual product flow matched to consumption I Consumers
GROCERY RETAILING 167 suiting firm Kurt Salmon Associates. Kurt Salmon had helped develop quick response in the general merchandise industry. Their major report, Efficient Con- sumer Response: Enhancing Consumer Value in the Grocery Industry, was pub- lished in 1993 by the major trade association, the Food Marketing Institute (Kurt Salmon Associates, 1993~. The fundamental stimulus for the ECR initiative was the intensified compe- tition from nonfood retailers, such as Wal-Mart. Moreover, it was known that Wal-Mart had plans to enter food retailing, which it has since done with its supercenters, combining discount general merchandise and food. Food retailing is a relatively low-tech, fragmented industry. The success of the ECR initiative depended on the backing and financial support of trade associations, especially FMI and the Grocery Manufacturers Association (OMAN In addition, the large manufacturers, such as Proctor and Gamble, were behind the ECR initiative and provided much of the necessary funding. Major food product manufacturers, such as Proctor and Gamble and Coca-Cola, have substantial research and devel- opment budgets, in contrast to the retailers. The manufacturers saw ECR as a way to increase their own efficiency and profitability by streamlining distribution in partnership with the retailers. In 1993, the working group was replaced by the Joint Industry Project on ECR with representatives from ten trade associations and the Uniform Code Council. More than 200 people representing over 100 companies participated. The Joint Industry Project analyzed distribution in detail to find ways to cut costs and improve efficiency. By 1995, most of the analysis was done and the task forces were disbanded. Two groups now manage the project: an executive com- mittee on ECR to set overall direction; and an ECR operating committee to carry out additional research. Actual implementation is up to individual companies and their suppliers (Kurt Salmon Associates, 1996~. Objectives and Major Components of ECR In the new system, consumers will directly elicit supply. Product is pulled through the system by consumers, rather than pushed by suppliers. Data on con- sumer purchase behavior is paramount in this system since it drives the decisions up and down the supply chain (King and Phumpiu, 1996~. ECR has several major objectives (Kurt Salmon, 1993~: · Efficient store assortment optimizes the use of space within the grocery store to reduce costs and increase profitability. · Efficient replenishment creates a smooth synchronized flow of product based on consumer purchases, using EDI linkages between trading partners. Efficient promotion directs promotional activities away from trade pro- motions that pushed product through the system and toward increasing and re- sponding to consumer demand. .
168 . U.S. INDUSTRYIN2000 · Efficient product introduction uses consumer POS information and coop- eration among trading partners to develop new products with a better chance of success and at lower cost. To achieve these objectives, ECR emphasizes several major components: Category management. Product categories are managed as strategic busi- nesses to maximize profits. . Continuous replenishment. Products are delivered based on actual con- sumer sales, reducing time in shipment and storage, using computer-assisted or- dering (CAO), directly via POS scanner data. · Electronic data interchange. Retailers and vendors (suppliers) are linked through computer-to-computer ordering, billing, and payment. . Direct store delivery. Products are delivered directly from the manufac- turer to the supermarket without the use of warehouses or intermediate distributors. To succeed, ECR requires an effective and flexible management and good use of information technology. These and other neceesary conditions of innovation adoption are discussed below. Innovation Adoption A characteristic shared by many of the most innovative food retailers that have succeessfully adapted ECR practices is strong leadership at the top level of management that clearly supports innovation. The importance of management leadership is true for the single owner-operated store or for the large supermarket chain. H. E. Butt, a regional supermarket chain, operates in south Texas, which is one of the first areas in which Wal-Mart opened supercenters and began to com- pete in the food business. H. E. Butt is considered one of the most well-managed and innovative food retailers in terms of supply chain management. Strong, ef- fective leadership is provided by Charles Butt, the grandson of the company's founder and the current chief executive. The company has been a leader in devel- oping "activity-based costing," whose aim is to attribute to each product all of the costs inventory, transportation, and the like for which it is responsible in the entire supply chain. In another example of H. E. Butt's innovative spirit, the company's major distribution warehouse for San Antonio, where summer tem- peratures can exceed 100° Fahrenheit, was air conditioned a few years ago. This made working conditions much more pleasant for the warehouse employees and substantially reduced labor turnover, raising productivity. The "activity-based" idea can take several forms. Fleming Company, a wholesaler based in Oklahoma City, Oklahoma, recently put in place an activity- based pay scheme for its drivers at three distribution centers in Texas and Tennes- see. Rather than hourly pay, the drivers receive a fixed amount per mile driven, deliveries and pickups made, and pallets moved. Fleming reports a reduction of
GROCERY RETAILING 169 40 percent in time spent at each stop by the affected drivers. Workers responded to the new pay scheme by working faster and smarter. A survey of stores served by the three centers revealed that 38 percent of respondents felt that delivery services had improved, while only 2 percent felt they had declined. Supervalu, a Minneapolis-based wholesale distributor, has been fairly ag- gressive in adopting certain components of the ECR program. In a 1997 activity- based selling pilot program in Denver, the company separated the cost of provid- ing retailer services from the cost of the products themselves. Retailers pay for each product based on the base price of the item, plus all deals and pick-up charges. Store managers quickly learned where and how they could cut costs by ordering more products in pallet quantities, reducing the frequency of deliveries, combining stops on more efficient routes, and reducing the time spent on each delivery. As a result of the pilot program, Supervalu' s Denver facility was able to reduce its total miles driven by all trucks by 338,000 per year, with no reduction in sales volume. Supervalu's category-management program is used to align product as- sortments as closely as possible with each store's consumer demand. Some manu- facturers worry that category management, by reducing the number of brands carried by a store in a given category, will harm certain brands disproportion- ately especially private-label or store brands. In Supervalu's experience, this has not been the case in most stores. Those stores whose consumers demand the more economical store brands should maintain a place for them on the shelves. Another type of innovation adoption employs information technology to implement frequent-shopper or customer-loyalty programs. Consumers are some- what fickle, changing stores regularly. Woolf (1996) found that the top 20 per- cent of a store's customers, measured by total purchases, account for as much as 64 percent of store sales. Supermarkets are increasingly working to foster loyalty among their most valuable customers. Shopping cards and other programs are designed to reward consumers for attaining various levels of total purchases. The programs rely upon POS scanner data, which are recorded at checkout time and linked to individual consumers by use of identification numbers and cards. These programs attract customers voluntarily with various promotional benefits for participation. When enrolling, the consumer provides basic house- hold demographic data. The linkage of POS scanner data to consumer purchases and demographic information opens the door to sophisticated database marketing programs, promotions, and incentives that reflect the individual customer's de- mographics and purchases. The goal is to increase sales and decrease defectors to other stores. SERVICE INNOVATIONS Supermarkets are facing competition not only from the supercenters and mass merchandisers for the price-conscious market, but also from fast food outlets and
170 U.S. INDUSTRYIN2000 other food retailers for the convenience-oriented market for food. Although gro- cery sales in real terms are not growing, the demand for food that is ready-to-eat that can be purchased and taken-out to eat at home or elsewhere is growing. The terms "home meal replacement" and "meal solutions" have been coined to reflect this demand. Supermarkets have responded to this competition by providing more ready-to-eat or easy-to-prepare foods. Convenience is about saving time. Reducing the preparation required before actually consuming a product is one form of convenience. However, there are at least two other dimensions to convenience from the food shopper's perspective. One relates to the number of tasks that can be accomplished during a single shop- ping trip or in a single store; the other relates to the ease of shopping and time required to shop. To improve their one-stop shopping appeal, supermarkets have been adding new services, such as banks, florists, video rental, and pharmacies (Kinsey and Senauer, 1996~. To make shopping easier, supermarkets are changing their interior designs or floor layouts. A model of a typical traditional grocery store layout is shown in Figure 8. Grocery products (in boxes, bottles, and cans) occupy the center of the store. The perishable products are around the perimeter. The layout is designed to produce a specific circulation pattern for customers. In a traditional store it is inconvenient to shop for just a few items or just part of the store. Dairy products, for example, are frequently in the back of the store. The customer who wants simply to purchase some milk might be induced, during his or her long walk to the dairy case, to buy additional products. The traditional layout frustrates some customers, however, who find it much easier to shop at convenience stores for | Dairy l l Meat Frozen Grocery Bakery FIGURE 8 Traditional grocery store design. Source: Kinsey and Senauer, 1966. Check Out
GROCERY RETAILING G rocery l Health & Beauty ~Flowers, Banks ~ & stem ps FIGURE 9 New grocery store design. Source: Kinsey arid Senauer, 1966. 171 Frozen Meat . f ~ Bakery Dairy ~ ~ Fresh 1 Deli J ~ Produce J Check Out Court such items. Supermarkets have discovered that their traditional layout can reduce sales compared to a more user-friendly layout. A study for the FMI classified consumer food shopping trips into three cat- egories stock-up, representing purchase of more than 60 percent of weekly gro- ceries, routine (20-60 percent); and fill-in trips (less than 20 percent) (Willard Bishop, 1991~. Stock-up shopping accounted for less than one-third of the trips. In the stores studied, only 32 percent of shoppers were on stock-up trips, whereas 41 percent were on a routine trip, and 27 percent were on a fill-in shopping trip. The number of stock-up trips continues to decline, whereas the routine and fill-in trips increase. A traditional store reflected in Figure 8 is built for stock-up shop- p~ng. Some supermarkets have responded by dramatically redesigning their stores so that the very process of shopping is altered. Figure 9 shows a typical layout for a new or remodeled store. The perishable departments, which consumers shop frequently, are all grouped to one side. A shopper on the way home from work can conveniently buy some fresh fruit, milk, and a ready-to-eat meal for dinner. Grocery products, which many shoppers buy only once or twice a month, are now in back. The deli may have been expanded into a "food court" with several meal solution stations and perhaps even a sit-down area to eat. Frozen products are close to the checkout counters so those purchases can be made last and the items gotten home without defrosting. The question of shopping convenience was tackled by Cub Foods, a chain of supermarket stores in the Midwest owned by SuperValu. The design of many of Cub's new stores is similar to the plan in Figure 9. Cub saw that consumer
72 U.S. INDUSTRYIN2000 demands were changing. The convenience factor was becoming crucial to many consumers. They wanted to be able to shop more quickly. A typical customer could take more than an hour to shop a traditional Cub store. Cub needed to find a way to build convenience into their supermarkets. An internal Cub team was in charge of the redesign project. Consultants were employed to collect and analyze consumer information. Consumer panels were used and the participants asked, if they were to build a supermarket, how would they improve it. Cub used Plan Mark, an in-house service of SuperValu, for technical store design work. The first prototype store opened in 1991 in Apple Valley, Minnesota. Most Cub stores that have been built recently incorpo- rate the new design. The new design improves financial performance, according to Cub manage- ment. There is a substantial increase in sales of perishables and usually a small decrease in grocery sales. Perishables have much larger gross margins than gro- ceries: typically 30 percent or more, versus around 20 percent.2 Perishables also have higher labor costs. Previously Cub was oriented toward the stock-up shop- per. With the new design, Cub gets more routine and fill-in shoppers. Although the average sales per customer has declined, customers shop more often and the number of customers per week has increased. Therefore, total sales have increase. On average, customers are purchasing items with a larger profit margin. Yet another innovation that can have a significant effect on sales is rearrang- ing items on store shelves or improving displays generally. In a recent study, Dreze et al. (1994) estimated that, by rearranging products both along shelves and between shelves (from a lower to a higher shelf, for example), profits could rise by up to 15 percent. Optimizing the design of displays and product placement in this way relies crucially upon the POS information gathered at the checkout counter. EFFECTS OF INNOVATIONS ON THE CHANGE IN PERFORMANCE It is not easy to draw clear and definitive connections between the various innovations we have described and the performance of the supermarket industry. A research study by The Retail Food Industry Center analyzed the adoption of ECR practices by grocery stores in Minnesota and the impact on performance (Phumpiu and King, 1997~. Data were gathered by interviewing managers at 40 stores varying in store size, location (metropolitan and out-state), and organiza- tional form (chains and independents). An ECR "readiness index" was devel- oped, which indicated the level of adoption by a store of key business practices and technologies that support ECR. Table 1 gives the indicators included in the ECR "readiness index" and the average adoption rate by stores. The index would equal 100 percent for a store that had adopted all 17 practices in Table 1 and zero 2Gross margin is the difference between the retail price and the cost of the goods sold.
GROCERY RETAILING TABLE 1 ECR Readiness Indicators 173 ECR readiness indicator Adoption rate in stores interviewed (%) Scan merchandise Scan coupons Manager has access to a personal computer EDI transmission of order EDI transmission of movement data Scanning of incoming shipments Shelf tags have movement and/or reorder information Weekly sales forecasts based on POS data POS coordinator has formal training on scan data quality Resets based on formal planograms Non-DSD resets coordinated with outside parties Non-DSD product assortment decisions coordinated with outside parties DSD reset and product assortment decisions coordinated with outside parties Manager has attended training on category management Promotion and pricing decisions are coordinated with outside parties Telxon units are used for price verification Store uses competitor price information ECR readiness score 88 33 15 98 60 40 20 65 60 20 60 60 40 43 53 80 68 53 Source: Phumpiu and King (1997). for a store that had implemented none. The index ranged between 15 percent and 100 percent for the stores interviewed. ECR adoption was closely associated with better productivity. Stores with a higher ECR "readiness index" had substantially higher sales per labor hour, sales per square foot, and annual inventory turnover, as show in Table 2. High-readi- ness stores were defined as those with an index of more than 75 percent, moderate as 75-40 percent, and low as stores that had adopted less than 40 percent of the 17 practices listed in Table 1. However, what this study could not conclude was whether ECR readiness increases productivity or whether better performance sim- ply makes it easier to adopt ECR practices. Category management, a part of ECR that seeks to reduce the number of TABLE 2 ECR Readiness and Store Productivity Measures ECR readiness Productivity measures High Moderate Low Weekly sales per labor hour $124.01 $104.61 $78.07 Weekly sales per square foot of selling area $13.65 $10.70 $6.06 Annual inventory turnover 37 26 16 Source: Phumpiu and King (1997).
74 U.S. INDUSTRYIN2000 products in a store, has been shown to improve the bottom line. Although it might seem that consumers would prefer more choice rather than less, the evi- dence shows that this may not be so. Too many choices can lead to shelf clutter, making it hard for a shopper to decide what to buy. In a study conducted in 15 Chicago stores, Stickel (1996) reports that when 25 percent of individual items were removed in one category, sales in that category rose by 2 percent compared with control stores. The annual U.S. supermarket industry data for 1995-1996 compiled by the FMI were used to suggest that ECR adoption was having a positive impact on performance (Zwiebach, 1997~. Although sales fell for the third year in a row in 1996 after adjusting for inflation, average operating income rose to 3.05 percent, compared with 2.68 percent a year earlier. The average net profit margin reached 1.2 percent, as shown in Figure 2, the highest level since FMI began tracking it in 1972, compared with 1.14 percent the previous year. However, net profits fell in the most recent year, 1996-1997, and many factors affect net profits. Companies using ECR practices had the best performance. Earnings were strongest among those using category management and EDI. According to the 1996 FMI data, 36.7 percent of companies are using EDI, 35.9 percent have implemented cat- egory management, and 13.4 percent are using continuous replenishment. FMI also found that 45.3 percent are operating frequent-shopper programs, with higher average sales and margins as a result. Average transaction size was $36 for frequent shoppers last year, compared with $22 for others. The average gross margin was 25 percent on frequent-shopper purchases, versus 23 percent for others. Only 18 percent of frequent-shopper participants defected to other stores, compared with 21 percent of regular shoppers (Zwiebach, 1997~. CONCLUSIONS The U.S. supermarket is currently undergoing significant changes in the way it operates. Competition, especially from retailers outside the supermarket indus- try, is increasing. Pressures to reduce prices likewise have hit the industry in recent years. Consumers are driving much of the change. They have become accustomed to buying high-quality products at low prices from general-purpose merchandisers. Americans devote less time to food preparation than they ever had in the past, so they demand and are willing to pay for food products that require little preparation at home. The share of food expenditures spent away from home continues to rise, squeezing the supermarket industry yet again. The industry's responses to these external changes have come in two broad categories: process innovations and service innovations. ECR is a managerial initiative aimed at improving the use of information to control the supply chain. ECR also involves significant changes within a store. Many supermarkets are currently trying to reduce the number of items they carry. By replenishing their stocks continuously, in a way not possible without electronic information-man
GROCERY RETAILING 175 agement systems, grocery stores are trying to reduce inventories and associated costs. Many of the innovations witnessed in the industry are purely service ori- ented. Changes in store layout, for example, designed to make shopping easier for the hurried shopper, do not require significant technological inputs. How- ever, consumers respond to these changes. Supermarket companies have ex- panded the number of non-food departments in their stores. These innovations attract consumers who face many options for purchasing the items once thought to be the supermarket's special domain, such as soft drinks or household paper products, but who can now shop for them at discount general merchandisers and other retail outlets. Consumers shop differently than they did a decade ago, and they also buy different types of foods. Families who have little time for food preparation in- creasingly choose to buy prepared foods. These include whole-meal replacement and ready-to-eat foods. Supermarkets have responded to consumer changes and to the new pressures from innovative competitors by increasing their offerings of ready-to-eat and ready-to-cook foods. These items have led to many changes in store operations. Convenience requires space, and increasing store size has caused a reduction in sales per square foot of selling space. Sales per labor hour, like- wise, have fallen over the past several years as labor-intensive departments such as the deli have become larger and more important. Savings due to ECR may offset these additional costs. The necessary data on a national level are simply not available to definitely assess the impact of service and process innovations in grocery retailing, and in particular ECR practices, on productivity and performance. With this in mind, The Retail Food Industry Center (TRFIC) intends to initiate a major data-gather- ing effort using supermarket panels. A panel will be composed of a sample of similar stores across the country that will complete an annual questionnaire on a confidential basis. The panel data will allow TRFIC researchers to compare in- novations and practices across comparable stores and track the impact over time. An ultimate goal is to be able to evaluate their impact on productivity and perfor mance. The source of innovation in the grocery store industry is as eclectic as the innovations themselves. The majority of electronic technologies employed by supermarkets are developed by third parties, which market them to the industry. Many service innovations are developed by consultants and trade associations as well as by supermarket operators. These innovations are so diffuse that it is virtually impossible to capture their costs and to get a clear picture of what would be called "research and development" in many product-oriented industries. Food retailing is in a period of consolidation with a substantial number of mergers and acquisitions. Several European food retailers have purchased U.S. supermarket operations. Royal Ahold of the Netherlands, for example, recently bought Giant Food. The consolidations may stimulate innovation as the firms
176 U.S. INDUSTRYIN2000 seek to cut costs and improve performance. More capital may also be available to large operations to finance innovation. The innovations outlined in this chapter require changes in the supermarket labor force. The industry has long been known as a low-tech industry. It draws much of its labor from the younger, less-educated portion of the population. As the use of technology increases, this traditional view has changed. A major con- stra~nt to the implementation of ECR practices has been the education and skill level of people in the industry, especially in the area of information technology at the store level (Kurt Salmon, 1996~. The grocery industry, like so many others, is increasingly in need of employees with technical abilities, particularly computer- onented skills. Firms are making increasing use of technology, such as com- puter-based courses and videos, in training and also screening their employees. The ultimate measure of productivity in a service industry like the supermar- ket industry is consumer welfare. This is very difficult to measure, especially when one considers the quality component of the industry's output. Consumers spend less of their income on food than their parents did, but this is natural given that real incomes have risen over the past quarter century. Today's consumers pay for the convenience engineered into their food items. Evidently they find this to be a good buy, or more people would be cooking their meals from scratch. Clearly changes in prices are not a sufficient measure and consumer satisfaction is what really ought to be measured in order to determine how well this service industry, with its many changes, is performing. REFERENCES Blattberg, R. C. (1996). "Changing Store Image Through Category Revitalization." Paper presented at Food Marketing Institute Conference. Chicago, IL. May 7. Photocopy. Capps, O. Jr. (1997). "New Competition for Supermarkets: A Case Study." Working Paper 97-05, The Retail Food Industry Center, University of Minnesota, St. Paul, MN. February. Dreze, X., S. J. Hoch, and M. E. Purk. (1994). "Shelf Management and Space Elasticity." Journal of Retailing 70:301-326. Food Institute. (1996). Food Retailing Review, 1996. Fair Lawn, NJ. Food Institute. (1998). Food Institute Report, No. 24. Fair Lawn, NJ. Food Marketing Institute. (1997). The Food Marketing Industry Speaks, 1997. Washington, DC. Kahn, B. E., and L. McAlister. (1997). Grocery Revolution: The New Focus on the Consumer. New York: Addison-Wesley. King, R. P., and P. F. Phumpiu. (1996). "Reengineering the Grocery Supply Chain, in Changes in Retail Food Delivery: Signals for Producers, Processors and Distributors." Working Paper 96- 03, The Retail Food Industry Center, University of Minnesota, St. Paul, MN. Kinsey, J., and B. Senauer. (1996). "Consumer Trends and Changing Food Retailing Formats, in Changes in Retail Food Delivery: Signals for Producers, Processors and Distributors." Working Paper 96-03, The Retail Food Industry Center, University of Minnesota, St. Paul, MN. Kurt Salmon Associates. (1993). Efficient Consumer Response, 1993: Enhancing Consumer Value in the Grocery Industry. Washington, DC: Food Marketing Institute.
GROCERY RETAILING 177 Kurt Salmon Associates. (1996). ERC 1995: Progress Report. Joint Industry Project on Efficient Consumer Response, Grocery Manufacturers of America. Washington, DC. Larson, R. B. (1997). "Key Developments in the Food Distribution System." Working Paper 97-08, The Retail Food Industry Center, University of Minnesota, St. Paul, MN. Phumpiu, P. F., and R. P. King. (1997). "Adoption of ECR Practices in Minnesota Grocery Stores." Working Paper 97-01, The Retail Food Industry Center, University of Minnesota, St. Paul, MN. Senauer, B., and J. Kinsey. (1997). "The Efficient Consumer Response Initiative: Implications for Vertical Relationships Throughout the U.S. Food System." Paper presented at the International Conference on Vertical Relationships and Coordination in the Food System, Piacenza, Italy, June 12-13, 1997. Stickel, A. I. (1996). "Dominick's Changes Mix to Cut Out-of-Stocks." Supermarket News 46(June 3):20. U.S. Department of Agriculture. (1996). "Food Consumption, Prices, and Expenditures," Research Service Bulletin Number 928. U.S. Department of Commerce, Bureau of the Census. (1996). U.S. Statistical Abstract. Washington, DC. Willard Bishop Consulting. (1991). How Consumers Are Shopping the Supermarket 1991. Food Marketing Institute, Washington, DC. Woolf, B. P. (1996). Customer Specific Marketing. Greenville, SC: Teal Books. Zwiebach, E. (1997). "Filling Out the Bottom Line." Supermarket News 47(May 12): 14,19.