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Food for thought

By Fiona Rotherham

Friday 1st August 2003

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Imagine this: you're the manager of a big Red Shed and a container arrives at the warehouse door. You don't know what's inside until it's opened. Let's say it's a shipment of cheap Chinese pots secured by one of the company's buyers. Terrific: customers will snap up these bargains, and there'll still be a tidy profit left over for The Warehouse.

It's called opportunity retailing, and it's the backbone of the 21-year-old company's success.
But selling food is a different story altogether. Consumers want to know that their favourite brand of breakfast cereal or baked beans will be on the shelves when they do their weekly shop, rather than a serendipitous array of bargains the food buyers happen to have procured. So can The Warehouse, the master of opportunity retailing, make the transition to food?

The company publicly flagged its interest in the food business after last year's Progressive/Woolworths merger created a supermarket duopoly and opened the way for a third player in the market. There's mounting speculation it will make its move soon, but The Warehouse bosses deny this, claiming the priority is fixing the Australian operation. Red Sheds general manager David Wilson says the move into food could still be two years away. "We're not ready yet. We're still in the conceptual stage, looking at various options."

The Warehouse already sells $130 million annually of consumable items such as chocolate and shampoo - just under 10% of total sales. That's 1.2% of the total supermarket category, but within specific categories The Warehouse's share is much higher; for example, 4.9% for snacks and confectionery and up to 9.7% for health and beauty. But Wilson says expanding into a full grocery range requires different skills, systems and infrastructure. "Having stock on the shelf all the time is the area we fall down in. We have too many 'out of stocks'. If we go into food, we have to have continuity of supply. That has traditionally not been our strength because we've had such an opportunistic background."

There's also the question of how to ensure grocery sales are profitable. The Warehouse would have to beat Pak'N Save and Countdown on price in order to live up to its reputation as the place where everyone gets a bargain. But margins on food are wafer-thin compared with the double-digit returns on general merchandising.

"Everyone thinks we should be quaking in our boots, but we don't," says Tony Carter, managing director of Foodstuffs, which has a 56% share of the grocery market (Progressive holds the balance). "We're doing a good job on low margins and I don't think they'll be able to buy better or even as well. What natural advantage do they have?"

Industry insiders predict the Warehouse will go with a dual strategy: a full supermarket offering in its new megastores, and an Aldi-type model with a limited range of dry goods and pre-pack perishables in around 40 to 50 exising stores. The German-based Aldi is the world's lowest cost grocery retailer and has gone for profitable market share rather than huge volumes. The main appeal of its stores, limited to just 600 items, is low prices.

One supplier claims The Warehouse has had teams virtually taking apart an Aldi store in Sydney, figuring out its low-cost system of basic shelving and full pallets on the floor. A trial early next year is predicted at a regional Warehouse store. Dannevirke is tipped as a likely location, allowing the company to develop the concept without too much local competition and with minimal risk of capital losses because of its small size.

While Wilson denies trials are imminent, industry players believe the company will make its move soon. Here's why:

Supplier pressure
Before the Progressive/Woolworths merger The Warehouse was not in a strong bargaining position with food suppliers because it lacked sales volume. Now suppliers are prepared to offer better deals after losing contracts with Progressive or being forced to give up some margin. But suppliers will have to be careful about the terms they offer the newcomer. Foodstuffs delisted the range of one fairly large supplier for a time, after it offered a discount to Progressive on part of its product range without offering or disclosing that discount to Foodstuffs.

Building bigger boxes
The Warehouse plans to increase its Red Shed retail space by 52%. It is building four or five megastores of between 12,000 sqm and 14,000 sqm in the next six years, with the first opening in Whangarei in late September. These stores will be enormous - up to three times the size of the average Red Shed. What will it fill the bigger boxes with? The Warehouse says it will expand existing categories, but adding groceries into the offer is not a huge leap in these new stores. However, it would be harder to convert existing stores for perishable food because of the need for large chiller space.

Ex-supermarket experience
The Warehouse management team contains a depth of ex-supermarket talent. Wilson himself was formerly general manager of Foodtown. He says two ex-Woolworths staffers have been hired this year, including Chris Nicklin, who was head of the supermarket's meat division. It's understood Woolworth's former head food buyer is also acting as a consultant.

Private label talks
The Warehouse confirms it has been talking to local suppliers and manufacturers about "creating more house brands and expanding existing categories". Suppliers were tight-lipped when rung by Unlimited. Hansells' managing director Stuart Walker confirmed his company is in negotiation with The Warehouse through its private label subsidiary, PLC, but he wouldn't reveal details. Walker says private labels (house brands) have become more popular with supermarket retailers because they offer margins of up to double digits in some cases. In New Zealand between 10% and 25% of any grocery category is now likely to be sold under private labels, compared with 40% to 45% in the UK. The Warehouse will be looking to go higher than both as a way of achieving price parity with Progressive and Foodstuffs. Private label accounts for 90% to 95% of Aldi's sales. The Warehouse already sells multiple house brands to give shoppers the illusion of choice, including some from the UK-based Tesco's that Wilson says will be retained.

Following Wal-Mart
The Warehouse has long modelled itself on successful US retailer Wal-Mart, which started selling food in 1988 following consolidation among grocers. It became the largest American grocer last year with more than $US53 billion in grocery sales. The Wall Street Journal says shoppers are seeing prices fall as Wal-Mart pushes rivals to match its low prices - some 8% to 27% cheaper than the competition. Its logic is simple: food attracts more regular weekly shoppers, lifts sales per square metre, and provides cross-selling opportunities, leading to an improvement in total revenue, despite the low margins. Wilson says Wal-Mart achieved a 30% increase in general merchandising sales as a result of shoppers coming in to buy groceries, but he's sceptical The Warehouse will get the same "halo effect".

"We already have 900,000 customers a week walk through our stores and don't anticipate food bringing in more." The idea is to increase the frequency of their visits, and how much they spend. On average Warehouse shoppers spend $27 weekly per basket, compared with $57 per basket in supermarkets but, as Wilson says, "they are not equivalent baskets" because the margins are so different.

Patch protection
What may ultimately force The Warehouse to expand into full grocery is the increasing threat from supermarkets encroaching on its turf. Internationally supermarkets are lifting sales of general merchandising because the margins are so much better than on food. In New Zealand supermarkets general merchandising accounts for around 3% of total sales, says Foodstuff's Carter - although Progressive's Ted van Arkel says his chain sells a higher percentage than that. An estimated 50% of Progressive's newest Auckland store is devoted to non-food items ranging from DVDs to condoms.

Industry analyst Timothy Morris, of Coriolis Research, believes The Warehouse could provide stiff competition for the supermarkets and achieve grocery sales of $1 billion (10% market share) within five years. As one supplier says, the clock is ticking. Competition in the supermarket industry remains incredibly tough, with both players constantly working with suppliers to bring costs down. The longer The Warehouse leaves it, the more formidable its opposition becomes.

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