Another One Bites the Dust

Why Regional Grocers are Fading Away

Another regional supermarket was swallowed by a national banner with Kroger's agreement to acquire the 95-year-old Giant Eagle for about $1.65B. The grocery market was largely stable and well-behaved for about 60 years but has seen significant changes over the last 25. The Great Recession and COVID fundamentally changed how grocery shoppers see food and how they feed their families. Shoppers put more effort into finding the items they want at the price they are willing to pay. The proliferation of new grocery stores and online options made this easier. Consequently, shoppers have become less loyal and spread their grocery dollars across more retailers. Since the early 2000s, regional grocers have lost nearly 40 share points to Walmart, Costco, Amazon, and Aldi, which is about $400B-$500B.

This significant shift is due largely to price, which is mostly a function of scale. Bigger is simply better for business. In any market where organizations carry the same or similar items, price becomes more important. Brawny paper towels are the same at retailer A and retailer B, except for the price. Retailer B carries them at a lower price because they are larger, more efficient, and pay CPGs a lower per-unit price for goods. Think volume discount. Thus, the larger you are, the lower your prices, the more trips you win. There are other factors that drive trips, like quality, convenience, and the overall shopping experience, but it’s price, first and foremost, that determines where people shop for most of their groceries.

We have already seen dozens of regional grocers absorbed by Kroger, Albertsons, and Aldi over the last 25 years, and there are more on the horizon. Some regionals will survive, but their path has little wiggle room and must be shaped by key economic and marketing principles.

There are two high-level differentiation strategies:

1. Move upmarket and close those stores that do not align with premium shoppers

2. Reduce the big-box price gap to a level that will make it difficult for shoppers to drive by

And if neither of those options is viable, then it may be time to look for a buyer.

I spent five years working in a neighborhood grocery store in high school and college, and it was the best job I ever had. During the holidays, people would bring cookies and cakes, and on Sunday mornings shoppers would watch football on a little portable TV as they checked out. It was more than a little Mayberry-like. It is where I fell in love with food, cooking, and supermarkets. I spent the last 13 years working as a regional grocery consultant. During that time, I had a front-row seat, watching long-standing retailers slowly become irrelevant.

I started as a data scientist, wading through billions of rows of shopper data, and based on the patterns, it was clear our clients were losing the war. Most regional grocers were built to move product from the manufacturer, into their distribution network, and onto their shelves. They were a well-oiled supply chain machine, but they lacked depth when it came to understanding their shopper and how to navigate an increasingly competitive market.

Understanding Shoppers

To help our clients with this evolving market, we created a retail strategy team and the Retail Preference Index, or RPI. We wanted to better understand why consumers pick one retailer over another. The study is in its 10th year and has spread to over a dozen countries. Prior to the RPI, almost all grocery ranking studies were largely satisfaction studies. Consumer Reports was the most cited, but every year Walmart would be in last place. How could the largest grocery retailer be in last place? Were people being forced to shop there? To deal with this unsatisfying result, we built the RPI to capture not just satisfaction but also financial performance.

The study uncovered several key principles that have stood the test of time.

1. The key finding is that value creation is what drives shoppers to visit a store. Value is the combination of price, which is the cost to the consumer, and the benefits received for that cost — quality, convenience, and a pleasant shopping experience. Some create value by focusing on the benefits side, like Publix. Some focus on the price side, like Aldi, and some are balanced, like Trader Joe's or H-E-B. Shoppers vote with their dollars, and they vote for those who provide them with the most value.

   
   

2. As mentioned in 1, value creation is based on several attributes, but the biggest driver for most shoppers is price. This can be seen in the RPI, where the impact of price on where people shop has varied over the years but is always on top. The gap shrank versus convenience and safety during COVID, but it has slowly returned.

   
   

3. From the initial RPI report, we have also seen the continued importance of private brand. Those at the top of the RPI also tend to have the best private brand perceptions — Costco, Trader Joe's, H-E-B. It is the one area where a retailer can move value perceptions by impacting both quality and price perceptions. Also, it is one of the few areas where a retailer can truly differentiate itself over time. This is the slippery "sustainable competitive advantage," which separates a truly differentiated brand like Market Basket from just another supermarket.

   
   

4. The importance of digital and convenience has also grown, particularly for higher-income shoppers, and has been dominated by Walmart and Amazon.

   
   

Price as a driver also gets stronger as household incomes fall. If we assume a somewhat normal distribution, we are likely looking at about 67%-75% of households falling into the lower- and middle-income brackets and 25%-33% falling into the upper-income brackets. And as we have seen over the last few years, the top 10% of households have driven much of the consumer spending growth. These numbers are important and key in defining which strategic path a retailer can take.

The economic reality is that scale, cost efficiency, and lower prices are a sustainable competitive advantage for retailers with scale. How many enjoy taking a trip to Walmart, Costco, or Aldi? It is not the experience, particularly for Walmart, which is by far the largest grocery retailer in the world, and navigating a Costco on a Saturday requires mental preparation. As Yogi once said, "Nobody goes there anymore, it's too crowded."

Technology

And since price is the key trip driver, national banners have a big competitive and, more importantly, sustainable advantage. To further rub salt into the regional wound, there are three ongoing technology trends that favor scale — ecommerce, AI, and retail media.

1. Ecommerce is complex and very difficult to do properly. It requires a big chunk of capital up front with the hope that it will eventually become profitable. It also requires a robust, expensive, and talented team to make it work, and the economics are further elevated if shoppers can buy more than just groceries.

   
   

2. This also holds for the next round of tech — AI. The big national banners can hire the people and the talent to make it work, which is currently being used to drive down costs and prices. In the future, it will increasingly be used to better connect with shoppers.

   
   

3. The third is retail media. The more scale, the more eyeballs you can access, the more your online media is worth. This is a small percent of revenue (less than 1%), but it is very high margin, which matters financially when profit rates are only about 3%.

Private Brands

Private Brands are yet another area where scale wins. It might be a bit of a sleeper, but it is likely the most important benefit of scale today. The national banners often have their own factories and distribution. These are massive investments in capital. The bigger the production, the lower the per-unit costs, and this is not lost on Kroger. One of the first things Kroger does when it buys another retailer is load its private brand onto those new shelves. In a battle for shelf space, what a masterful way to get your items on more shelves. Private brand is one of Kroger's key strategic pillars and is one of the key reasons why it buys smaller regional grocers.

In contrast, a regional grocer must work with private brand brokers who aggregate smaller regional retailers to build out enough units to produce a private brand product. Shoppers probably don't fully understand the scale required to consistently place one item on a shelf over time. It can require tens of thousands of units to make it work economically. Yes, scale rearing its head again. And when a regional retailer wants to build out its private brand, it must partner with the broker and other retailers, which means it loses some control over ingredient quality, packaging, price, and distribution. When Costco had issues with its rotisserie chicken supply chain, it invested about $400 million to build a poultry processing complex. It is safe to say that Costco's rotisserie chickens are simply better and less expensive than any other grocery retailer's. This type of scale-enabled action clearly differentiates a brand and builds equity in a way that is not possible for most regionals.

Strategic Land Mines

The path ahead for regional grocers is not an easy one. The key question many regionals are considering... should I sell or make this work? Giant Eagle did the former, but there are still dozens of regionals trying to make it work. Given the market dynamics and the disadvantages, there are some clear paths that will help regionals survive and even potentially thrive, but there are also some paths that are littered with land mines.

The first mine is the notion that if I cannot win at price, I should reposition upmarket. This often includes an elevated shopping experience as well as more premium and healthy products. This is a good idea for differentiation, but only if customers value it. This path is also more difficult financially because it pushes up fixed costs and capex to deliver the elevated experience, as well as pushing up COGS, so both gross margins and net income take a hit, particularly if unit growth/velocity slows.

The key mistake is forgetting Marketing 101. Marketing starts with the customer target, and, for a retailer, that is where the store is located. Based on that store location, the surrounding neighborhoods will have needs — pricing, quality, convenience, and the overall shopping experience. Marketing tells us to first define our target and then build out the product to align with those needs. If a retailer moves upmarket, does this align with the store's target customer and that local neighborhood?

From my vantage point, most retailers shift to a more premium product and store experience but fall short of trimming stores to align with this new position. There is a reason why there are fewer premium retailers in most industries. There are simply fewer premium shoppers, so if premium is the new position and you want to build the brand in that direction, be prepared to close stores. As mentioned above, about 25%-33% of markets can support a premium banner, but the share of true premium households is likely closer to 10%.

I have also seen regionals try to localize to better align with the local neighborhoods, but this is more complex, expensive, and largely ineffective because the brand associations often do not stretch enough to compete with other discount or quality retailers. I have also experienced the buy scale via M&A strategy.  This sounds good but how big does one need to be to benefit from scale? And absorbing other retailers adds complexity, cost, and requires a skillset that few regionals possess.

Path Forward

If regional retailers cannot win at price, what should they do? The good news is regional grocers do not need to win at price, but they do need to carefully consider how they will generate sustainable value. This may require repositioning upmarket, but it also might mean becoming more efficient and keeping prices "close enough." Remember that most big-box national banners are often on the outside of town. They were built on cheaper land, which was part of the business model when these national banners were expanding in the 1990s and into the early 2000s. As such, shoppers often drive past their closer neighborhood supermarket to visit a big-box retailer because it saves them money. The key question is "how close do our prices need to be so that shoppers won't drive by as often?" If the regional retailer can define this for most of its shoppers and can deliver on this pricing level, these neighborhood locations and the corresponding value proposition are a sustainable advantage that regionals can use.

For most regional grocers to differentiate themselves and survive the national banner onslaught, it comes down to two fundamental paths — move upmarket and close stores, or close the price gap. These are two high-level paths that most regionals must consider as they plan the way forward. This choice requires a careful and unbiased view of the retailer's strengths and weaknesses versus key competitors.

• Where do we fit in the shopper's mind?

• How are we similar and different?

• What do shoppers value?

• How is the competition trending — discount, middle, premium?

• Where and why are we winning and losing?

  
  

Clearly understanding these core questions is key to defining clear assumptions about your organization and the market. If the assumptions are wrong, then all downstream efforts will struggle.

The next decision is to sell or make it work. If the retailer must close too many stores to be competitive, or if the retailer cannot close the price gap enough, then it is likely time to sell. When units and margins are declining, every year a retailer waits, the less the organization is worth. The price a national banner will pay is greatly influenced by the discounted profit stream estimate. This simply means the more profit you are expected to make over the next 5-7 years, the more the business is worth. Getting out of a business that has been in the family for generations is unfathomable but delay also comes at a price.