Saturday, March 17, 2007

Let's Go Krogering

It’s the weekend, so it’s time to analyze a particular retailer. Today, we will look at Kroger.

By almost any measure, Kroger is riding a wave of success. This past week Kroger announced a 36% jump in fourth-quarter profit. Same store sales are up an impressive 5.6% (5.3% excluding gasoline). Kroger is currently gaining market share against its rivals. Full year earnings per share were projected by Kroger to be up by around 9 to 12% compared to last year.

Kroger’s stock is up over 45% since the start of 2005. Kroger forecasts that the good times should continue (pending labor contracts up in 2007). In fact, Kroger is pumping out so much cash that it runs the risk of being gobbled up by some deep pocketed private equity firm.

Normally when a retail company is doing so well, one can point to a particular area of excellence that they own in the mind of the consumer. The retail consultants at McMillan Doolittle call it the EST strategy. In other words, they claim most successful retailers are either:

- Cheap-Est
- Big-Est
- Hot-Est
- Easy-Est; or
- Quick-Est

However, when you compare Kroger to its competition, it falls short on all of these factors. For most of the properties Kroger owns, someone else owns these attributes. Wal-Mart Supercenters are bigger and cheaper on an everyday basis. Usually there is someone in the market that has the hotter image with the upscale crowd, be it a Whole Foods or some other operator. Aldi’s and Save A Lot are quicker to shop and have lower prices. Convenience stores are also quicker. Kroger tends not to have the reputation for the best produce department or meat department in a market, either. It is very difficult to come up with an attribute where Kroger excels over its competition.

So what gives here? What’s Kroger’s secret?

I call it the “tennis racket” approach. If you want to get the most effortless swing from your tennis racket, you aim to have the tennis ball it the string bed in its “sweet spot.” This is the spot that creates the least vibration and least resistance to your physical efforts.

There’s a lot of complicated physics behind this, but the thing to understand here is that this sweet spot is not located at the extremes of the racket. Instead, it is located near the center of the string bed, usually just a few centimeters closer to your hand (your source of power) than dead center. This spot is called the COP or Center of Percussion.

If you try to hit the tennis ball near the extreme edges, it creates a lot more vibration in the racket as well as creating greater negative force of resistance against your hand and wrist. Between the vibration and resistance, using the extreme edges of the tennis racket makes it virtually impossible to have an efficient swing at the ball. Effort gets wasted.

Kroger seems to understand this principle. It knows that if it moves too far in any extreme, it loses a lot of efficiencies. It takes a lot of effort to have the absolutely lowest prices, or the absolutely best meat department, or the absolutely finest produce department. And the further you move in the direction of that extreme, the faster the costs and complexities rise. The incremental return on the increasingly tougher investment starts working against you if you move too far in the extreme. And ultimately, that extra effort has to be paid for, either in higher prices or lower profits.

Rather than strive to be the absolute best, Kroger seems to strive “not to disappoint.” If you can eliminate all of the negatives, you can do pretty well, even if you have no area in which you excel.

It’s not about creating maximum consumer satisfaction, but maximum efficiencies (the most benefit for the least effort). If you can become efficient enough, you can provide a reasonable experience and still keep your prices in line. There are two kinds of efficiencies here. There are the efficiencies in lowering costs and the efficiencies in getting extra sales.

Kroger lowers costs by not overinvesting in infrastructure, labor or amenities. Departments are sized “just big enough” with just enough labor not to disappoint. Kroger then efficiently gathers extra income by adding just enough high margin non-grocery products to skim off the best (in most of its stores). It gathers extra income from the pharmacy, its floral departments and a small general merchandise area. The general merchandise area is not so large that it makes the store a challenge to shop, but large enough to gather in some good impulse sales.

To counter the everyday low pricers, Kroger uses a rather efficient high-low strategy. The high and low extremes are kept relatively narrow, so the prices are never too high to gouge a customer, yet never so low as to attract hoards of cherry-pickers who will drain you dry by only buying the low items. And usually, the lows will be lower than the everyday low prices of the big box stores.

It’s a delicate balancing act between pushing for profits and not turning off customers. But just as tennis players practice so that they usually hit the sweet spot, Kroger has practiced long and found its sweet spot—just a little better than average in the direction of their strength.

So instead of trying to beat the supercenters at their own game, Kroger’s approach is to be more efficient than the other conventional operators. There will always be people and occasions when customers do not want to put up with the hassles of a supercenter to save a little money. For these people and occasions, Kroger positions itself the most reasonable alternative, because its cost and sales efficiencies mean that it can typically afford to offer better prices and fewer disappointments than the other conventionals in the market.

As a result, when the sales volume of the supercenters force a few operators out of business, what they have done is eliminated some of Kroger’s closest competition. And that is how Kroger is gaining market share.

Kroger’s efficiencies from playing in its sweet spot have been good enough at lowering costs and raising incremental high-margin sales, that Kroger last year was able to lower its prices. The gross margin % went down a bit, but the gross margin $ went up quite a bit. The strategic approach is working. It appears that people are picking up on the old slogan that says, “Let’s go Krogering.”

Elimination of a negative can sometimes be more powerful in appealing to a customer than adding a differentiating positive…and it can often be less expensive to do so. Rather than having a goal of excellence that results in merely creating higher expectations by the customer, just try to live up to their current expectations better than anyone else.

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