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    PG PROFILE - Safeway: Back to Basics

    A high-flyer of the Nineties, the chain has been stung by competition, the economy, and its own acquisitions. Now it's focusing on business fundamentals to revitalize its top and bottom lines.

    By Richard Turcsik

    It seems there's a Starbucks on every corner. Soon there might be one in every Safeway too. Because adding specialty departments like Starbucks coffee bars--385 cafes and counting--is just one of the things Safeway is doing to revitalize its business and win back market share. The third largest supermarket operator after Wal-Mart and Kroger, Safeway, headquartered in Pleasanton, Calif., operates 11 divisions and 15 distribution/warehouse facilities servicing some 1,700 stores in the western United States, western Canada, Texas, and the Mid-Atlantic states. The chain also maintains a 49 percent ownership of Casa Ley, which operates 102 food and general merchandise stores in western Mexico.

    What sets Safeway apart from the competition? Service; convenient locations in some of the fastest growing regions in North America; expanded offerings like gas stations, in-store banking, ready-to-serve meals, and one-hour photo labs; a stellar private label program centered around the Safeway Select line of superior upscale products; and a loyalty card that has been in place since 1998, allowing the chain to better understand and micro-market to its customers.

    Internet sales

    Safeway has also taken a leadership position when it comes to Internet sales, maintaining a 52.5 percent ownership interest in GroceryWorks Holdings, Inc. In January service was expanded to Las Vegas, via its vons.com online grocery service. A big advantage of vons.com is that customers placing orders before 10 a.m. can get same-day delivery. The Web site also features a Nutrition Center that is filled with information about product ingredients, tips on increasing produce intake, and easy recipes using healthy ingredients.

    "Over the next few years we intend to stay focused on the fundamentals of our business—resuming identical-store growth, continuing to reduce and contain costs, spending our capital wisely, and generating significant free cash flow," says David Bowlby, Safeway's director of external affairs.

    "Our customers cite convenience as one of the leading reasons for choosing where they buy their groceries," Bowlby says. "With that in mind, we work hard to provide quick, efficient checkout service during peak periods. We continue to expand our product and service offering as a way to expand our definition of service and deliver a memorable shopping experience."

    Safeway is also modernizing its store base. "In 2003, we expect to invest between $1.1 billion and $1.3 billion in cash capital expenditures and open 50 to 55 new stores, while completing between 100 and 125 remodels," Bowlby says, adding, "We don't view acquisitions as a priority at this time."

    What is a top priority is a renewed emphasis on perishables merchandising. "We remain committed to superior quality and strive to be known as the destination for perishables across the store," says Bowlby. "Generally, we will look to tighten up our product specifications in how we accept product at the warehouse and the store. We are also trying to ensure the cold chain is maintained through the distribution process, to enhance quality. We will look for ways to enhance and build on our selection. We are working on ways to improve the appearance of product—both the look and the feel of the perishables department at all hours."

    Despite all of these improvements, the worst recession in years and cutthroat competition from supercenters and club stores have cut into sales and profits. Same-store sales for the first quarter of 2003 declined by 0.5 percent, and Safeway's switch to a centralized marketing organization has had a greater impact on gross margins than anticipated. A&P and the former American Stores faced similar difficulties when they adopted centralized buying.

    "One of the biggest challenges facing Safeway, probably because they did it the best, is how to replace a trade-up merchandising strategy," says Chuck Cerankosky, managing director at McDonald Investments in Cleveland. "When the economy was rocking and rolling, Safeway did an outstanding job of getting their customers to buy more. They made them think of Safeway as the place to bring their film for processing, to get a better piece of fish, to buy a better bottle of wine, or just buy any bottle of wine when they weren't planning to buy any."

    That problem isn't unique to Safeway, Cerankosky says, noting that sales growth at membership clubs, which thrive on impulse purchases, has slowed dramatically.

    "A more cautious consumer is a more price-sensitive consumer, and the challenge for the company is to react to the consumer and rebuild that sales momentum," he says. To that end, Safeway has adjusted everyday pricing on some key high-volume items and has enhanced its club card specials. The chain operates on a "culture of thrift," encouraging employees at every level to search for ways to reduce expenses and increase productivity.

    "Safeway is a chain in a big transition mode," says Jack Russo, a securities analyst with A.G. Edwards in St. Louis. "They were very successful for a long period of time, but they hit a lot of speed bumps recently, mostly due to failed acquisitions, the economy, and a tough industry. They are now trying to find their way and figure out what to do and what they want to be going forward."

    In the last half-dozen years Safeway has snapped up a bunch of regional chains, including Vons in Southern California, Randalls/Tom Thumb in Texas, Dominick's in Chicago, Carr-Gottstein in Alaska, and Genuardi's in Philadelphia. With the bulk of its store base concentrated in the western U.S. and Canada, Safeway has largely been shielded from Wal-Mart, which is strongest in the eastern half of the country. But while Vons and Carr's are doing well, Wal-Mart, Super Target, H-E-B Central Market, and Costco have been eating into Randalls in Texas.

    Dominick's has suffered from such labor troubles that Safeway wrote off the 113-store chain in November and is looking for a buyer. "We decided to sell our operations in Chicago after we were unable to reach agreement with the unions representing our store employees on a restructured labor contract that would have addressed a significant labor cost disparity problem with our main unionized competition in the Chicagoland market," Bowlby says.

    Safeway has not specified what it will do with proceeds from the sale, but may use the money to pay down debt or repurchase stock.

    Non-union Genuardi's has been a target of union organizers, and it faces tough competition from Acme, ShopRite, and Pathmark. "At Genuardi's the service has gone down, the presentation has gone down, and everything has changed," says one Philadelphia-area market observer. "I find them too expensive. For what they are, they are just overpriced." Management says it is working to restore customer confidence in that market.

    In October, Safeway's labor contracts in Southern California will come due, along with those for Ralphs and Albertsons, setting the stage for another possible showdown.

    "One thing that has really been borne out is that just trying to grow the top line through acquisitions is not the answer to Wal-Mart for the large chains," says Pat Turpin, managing director/head of Food & Beverage Group, at USBX Advisory Services in Santa Monica, Calif. Turpin believes that the supermarket industry as a whole has seen its share of the food market drop from over 60 percent in the mid-1990s to below 50 percent today. He says it may drop to 34 percent by 2011 if current trends continue and consumers keep shopping for their groceries at Wal-Mart, membership clubs, drug stores, and dollar stores.

    "Safeway is no different than the other chains in that they are getting hit from all sides, not the least of which is labor," Turpin says, adding that Wal-Mart can have a labor cost advantage of up to 30 percent.

    Nonetheless, the long-term outlook for Safeway is highly positive.

    "To the company's credit, they have really capitalized on competitors' missteps," says Burt P. Flickinger III, managing director at Strategic Resource Group in New York. "In southern Arizona they did a great job buying stores from ABCO and other competitors, and they've done a good job in Alaska by buying Carr's and taking market share as Kmart pulls out of the state."

    Safeway also gets high marks for being a founding member of the WorldWide Retail Exchange, a Web-based business-to-business exchange for retailers established in 2000, and operating in the food, general merchandise, and drug sectors.

    "In terms of sourcing the best quality at the best price, Safeway is one of the better retailers worldwide," says Flickinger.

    Safeway operates some of the nicest stores in the business, averaging 44,000 square feet, and its new prototype is 55,000 square feet. It owns about one-third of its stores and is seeking to own as many of the new ones as possible, because ownership provides control and flexibility with respect to financing, remodeling, expansions, and closures, according to its annual report.

    The chain has been adding specialty departments, including Starbucks coffee shops, free-standing fuel centers, floral departments, and bakeries, to its stores. Today, 93 percent of all Safeway supermarkets contain a bakery, 91 percent a floral department, and 70 percent a pharmacy.

    "Over the past decade, Safeway was a great cost-cutting, market-expansion turnaround story," says Lisa Cartwright, managing director at Smith Barney, a division of Citigroup Global Markets, in New York. Cartwright believes that Safeway, like its peers, overpaid for its acquisitions, and "stumbled a little bit," but it is now addressing those issues and working to build its stock price back up by using a number of strategies.

    Safeway Select

    One of those strategies is the private label program, centering on the upscale Safeway Select line.

    "Safeway's most salient strength is that they have arguably the best private label program of any retailer in the U.S., including Target, Wal-Mart, Costco, Walgreens, Wegmans, and Ahold," says Flickinger.

    Safeway is one of the few retailers still manufacturing private label goods in-house. The company operates plants that make dairy products, ice cream, baked goods, cheese, luncheon meats, cookies, crackers, pet foods, soft drinks, preserves, peanut butter, refrigerated juices and drinks, dry pet food, canned goods, and deli dips and dressings. Approximately 28 percent of Safeway's private label merchandise is manufactured in-house, with the remainder sourced from third parties.


    Operating out of Walnut Creek, Calif. under the Omnibrands, Inc. name, the division sells and markets its products to a wide range of retailers in addition to Safeway's own stores. In an effort to build outside sales, Omnibrands operates a booth at the annual convention of the Private Label Manufacturers Association.

    "Both Safeway and Kroger consider their private label manufacturing a competitive advantage," says Cartwright. "There are significant economies of scale with private label."

    "Safeway obviously has put more emphasis on their private label program than other chains," says Turpin. "For most chains private label is 23 percent of sales. I would say at Safeway it is 26 or 27 percent. Safeway has a three-tier private label, featuring a value, middle of the road, and a premium label."

    "We continue to operate 34 manufacturing plants in the U.S. and Canada because these facilities give us an adequate return in the manufacturing and processing of high-volume private label products such as milk, bread, ice cream, and soft drinks," says Bowlby. "We are able to develop unique products that customers cannot buy elsewhere, like salsa. Also, the knowledge we gain in regard to raw ingredient and packaging costs helps us in negotiating with national brand vendors."

    Introduced in 1993 with the typical cola and chocolate chip cookies, the premium Safeway Select line has grown to feature more than 1,265 items, including ice cream; unique salsas; bagged salads; whole bean coffees; Verdi frozen pizzas, fresh and frozen pastas, pasta sauces, and olive oils; NutraBalance pet foods; Ultra laundry detergents and dish soaps; Artisan breads; and the Primo Taglio line of meats, cheeses, and sandwiches.

    "We have created a brand presence across the store with a range of items," says Bowlby. "We recently added 43 new SKUs of restaurant-quality, frozen prepared meals under the Safeway Select Gourmet Club line. We have also created a presence in the wine section of our stores with a premium line of Diablo Creek wines, and our superpremium Firefly brand."

    Despite its extensive private label program, Safeway still takes time to nurture name brands. One of those is the Coffee Bean & Tea Leaf line of coffees that it began selling in the 32 Vons Pavilions stores in late February, even though the chain has a relationship with Starbucks and stocks its own Safeway Select.

    "I love dealing with Safeway; they are very together," says Lisa Pandolfini, brand manager at Coffee Bean & Tea Leaf, which is based in Los Angeles and operates some 200 coffeehouses in California, Arizona, Nevada, and nine foreign countries. "They run like a well-oiled machine. They are very connected and everything just sort of flows there. They treat you like you're important and the highest merchandising item on the floor."

    In the case of Coffee Bean & Tea Leaf, that may very well be. Safeway allowed the company to install wooden center island displays to introduce its products instead of placing them in line on the shelf with other coffees, as other retailers have done.

    But, at least according to one supplier, Safeway is not so cutting edge when it comes to organics. "It appears Safeway is still in a developmental phase with natural and organic foods," says the supplier. "I'm not sure they fully understand the category." He adds that Safeway lags behind Kroger, Wegmans, Harris Teeter, H-E-B, and Publix when it comes to promoting and growing the natural and organic foods category. "They are really not into doing lots of displays, and the pricing tends to be high," he says.

    While Safeway may get only a passing grade when it comes to organic foods, one area where it gets an "A" for effort is in its charitable work. Last year the chain launched the Safeway Foundation, through which it supports charitable organizations that improve the quality of life in the communities where its employees live and work. The foundation was funded by an initial grant from the company and is sustained by fund-raising events and an annual employee giving campaign.

    "The foundation complements our existing activities in the community," says Bowlby. "Our main priorities will be hunger relief, education, special needs, or charities that support people with disabilities, and health services."

    By Richard Turcsik
    • About Richard Turcsik

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