Datamonitor Kroger

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The Kroger Co.

Company Profile

Publication Date: 21 Aug 2011

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The Kroger Co.


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TABLE OF CONTENTS

Company Overview..............................................................................................4

Key Facts............................................................................................................... 4

SWOT Analysis.....................................................................................................5


The Kroger Co.TABLE OF CONTENTS
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COMPANY OVERVIEW

The Kroger Co. (Kroger or "the company") is one of the leading grocery retail chains in the US. Thecompany operates a chain of supermarkets and multi-department stores under a number of banners,including Kroger, Ralphs, Fred Meyer, Food 4 Less, Fry's, King Soopers, Smith's, Dillons, QFC andCity Market. In addition, Kroger operates 40 manufacturing plants in the US. The company isheadquartered in Cincinnati, Ohio, and employs 338,000 people.

The company recorded revenues of $82,189 million during the financial year ended January 2011(FY2011), an increase of 7.1% over FY2010.The operating profit of the company was $2,182 millionin FY2011, compared with $1,091 million in FY2010. The net profit was $1,116 million in FY2011,compared with a net profit of $70 million in FY2010.

KEY FACTS

The Kroger Co.Head Office1014 Vine StreetCincinnatiOhio 45202 1100USA

1 513 762 4000Phone

Fax

http://www.kroger.comWeb Address

82,189.0Revenue / turnover(USD Mn)

JanuaryFinancial Year End

338,000Employees

KRNew York Ticker


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SWOT ANALYSIS

The Kroger Co. (Kroger or "the company") is one of the leading grocery retail chains in the US. In2011, the company was ranked 25th on the Fortune 500 list of Americas largest corporations, and76th on the Global 500 list of worlds largest corporations. Kroger is among the top three marketshare holders in 38 of the 42 major markets in which it operates. Kroger's size provides significantpricing power with food producers, giving the company economies of scale over smaller supermarketoperators. However, the companys revenues may be adversely affected due to the low confidencelevels among consumers in the US, which is depressing the demand for discretionary items.

WeaknessesStrengths

Overcharging customers in Ralphs storeshurt consumer confidence and exposes thecompany to penalties

Large and established presence led tostrong performanceEffective differentiation measures

Lower margins compared to competitorsPresence in several formats increasesaddressable market

ThreatsOpportunities

Low consumer confidence affects demandfor discretionary items

Growing private label market will lead togrowth in revenues and profitability

Intense competition from discounters will

pressurize margins

Increased popularity of retail clinics

Growing influence of Hispanic populationHigh degree of unionization will increaselabor costs against a backdrop of risingwages and healthcare costs

Strengths

Large and established presence led to strong performance

Kroger is one of the largest retail grocery chains in the US. Kroger is among the top three marketshare holders in 38 of the 42 major markets in which it operates. At the end of FY2011, the companyoperated 2,460 supermarkets and multi-department stores, 784 convenience stores, 361 jewelrystores, and 40 manufacturing plants. In 2011, the company was ranked 25th on the Fortune 500 listof Americas largest corporations, and 76th on the Global 500 list of worlds largest corporations.Kroger's size provides significant pricing power with food producers, giving the firm economies ofscale over smaller supermarket operators.The company's resilience in an extremely challengingoperating environment can be witnessed from the positive identical store sales growth of 2.8%(excluding fuel) it recorded in FY2011. Kroger recorded a revenue growth rate of 7.1% in FY2011,


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while Wal-Mart's growth was 3.4%, and Safeway's revenues increased by only 0.5%. Furthermore,the company's market share increased by nearly 80 basis points in FY2011, according to industryreports. Kroger has been able to increase its market share in an extremely competitive environmentwhich has been characterized by price wars from value retailers and other competitors, who havebeen gaining popularity owing to their price positioning.

The company being a large retailer enjoys advantages of scale, which can be passed on to theconsumers. Additionally, its established presence enabled it to increase market share and revenuesin a tough operating environment.

Effective differentiation measures

Kroger has in place a strategy which has evolved to incorporate more elements of differentiation on

factors other than price.The company has, in recent years, tried to identify various factors that drivecustomer visits and loyalty and has made several targeted investments to achieve the same. Onesuch move is the increase in gasoline stations.The company has increased the number of storeswith fuel centers to 1,014 in FY2011 from 227 in FY2002. Having more than 1,000 fuel centers is akey advantage for Kroger, enabling the company to drive traffic to its stores. Kroger also uses severaltargeted promotions on gasoline to lure customers into its stores. In 2010, the company teamed upwith Shell to roll out the grocer rewards program in Cincinnati, Dayton, Knoxville, Nashville and SanDiego.This program allowed customers in participating markets to earn points and redeem themfor savings on gasoline at Kroger Fuel Centers and participating Shell stations. Additionally, customerswere given an opportunity to earn rewards including a minimum of 10 cents off a gallon of gasolinefor every 100 Fuel Points they earn by using their free loyalty card when purchasing a variety ofproducts inside Kroger and Ralphs stores. More than 80% of Americans live within five miles of a

Shell station and through this tie-up Kroger was able to substantially enhance its customer base.

Investing on private label program is another way the company increased its exclusivity anddifferentiation.The company over the years has built a strong private-label program which caters topremium and value segment markets. Kroger focuses on providing high quality products through itsprivate label program and engages in manufacturing about 40% of the proprietary brands it sells.Kroger also differentiates itself by providing individual attention to its customer needs andrequirements.This is facilitated by the intelligence provided to the company on its customer behaviorby dunnhumbyUSA, a joint venture between Kroger and dunnhumby (a company engaged in datamanagement, customer analysis, and insight-led planning) in 2003. dunnhumbyUSA provides Krogerwith in-depth analysis on its customersshopping pattern.The information so gained is then usedto develop a basket of customized offerings and coupons specific to a particular customers

requirement.This acts as a compelling proposition for its customers and results in repeat purchases.

These efforts are attributed to the strengthening of Krogers foothold in the supermarket industry.Its targeted promotions focus on products and services in line with customer preferences andmeasures to enhance customer experience will enable the company to sustain severe price wars.Additionally, these measures also increase the companys potential customer base and averagespend which will contribute positively to the top line growth.




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Presence in several formats increases addressable market

Kroger follows a multi format model to offer the customers a wide variety of merchandise. Itssupermarkets are generally operated under one of the following formats: combination food and drugstores (combo stores), multi-department stores, marketplace stores, or price impact warehouses.Combo stores are typically in a food store format and the target customers are usually in two to twoand a half mile radius. While maintaining the convenient food store aspect, these stores are largeenough to have a specialty department. Through such departments Kroger has established thesestores to offer one stop shop positioning along with a convenience retailing positioning.Multi-department store is an extension to the combo stores and additionally offers generalmerchandise items such as apparel, home fashion and furnishings, electronics, automotive products,toys and fine jewelry.These stores diversify revenues across several product categories. Kroger'smarket place stores are similar to the multi-department stores offering full-service grocery and

pharmacy departments as well as general merchandise which include outdoor living products,electronics, home goods and toys.The Price impact warehouse operates a low cost warehousemodel catering to the value segment. Additionally, the company through its subsidiaries operatesconvenience stores and specialty jewelry stores.

The presence across several formats increases the addressable market as Kroger is able to caterto the varied customer preferences. Large addressable market facilitates increased potential customerbase which in-turn enables the company to drive top line growth.

Weaknesses

Overcharging customers in Ralphs stores hurt consumer confidence and exposes the company topenalties

Ralphs has been charged with overcharging of prepackaged food in recent times. Between January2010 and March 2010, the County Department of Weights and Measures conducted 14 undercoverinspections at Ralphsstores across Los Angeles and found that customers were being overpricedfor prepackaged and weighed products including fried chicken and salad. Most of the violationsinvolved the store illegally charging for the weight of the package, or including the ice glaze on frozenproducts in the net weight. Some prepackaged items also were found to be under the weight on thelabel. Following the investigation, the City Attorneys Criminal Branch filed a multi-count criminalcase against Ralphs. Both Ralphs and Kroger faced fines and penalties of up to $256,000. However,

the charges against Kroger were dropped later. In March 2011, Ralphs was ordered to pay $67,600in fines against these charges.This is not the first time that Ralphs paid penalties for false labelingand overcharging prices. During 2008 Ralphs paid $6,500 in fines after it was found that the chainwas overcharging customers, including short-weighing packages. In 2009, 30 Ralphs stores werecharged of similar violations and had to pay $10,400 in fines.

Such charges against the company severely hurt consumer confidence. In a market where consumersare attracted to low price high value products, over pricing will erode Kroger's brand image.




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Additionally, fines and penalties will divert significant amount of valuable resources and increasethe expenses for the company.

Lower margins compared to competitors

Though the companys revenue has shown a steady increase in the recent times, its profit marginshave not been able to keep pace with the margins of its competitors.The company's operating profitmargin declined to 2.6% in FY2011 from 3.2% in FY2009. In comparison, the operating profit marginof Krogers competitor, Wal-Mart, has been steady and grew to 6% in FY2011 compared with 5.6%in FY2009. For another competitor, CVS Caremark, the operating profit margins have been above6% throughout the last three financial years (ending in December). To gain and retain customers,the retailers have been investing in low prices. While Kroger is cutting costs, they are not alignedwith the price cuts, which, in turn is pressurizing the margins. The tightened consumer spending is

estimated to further lead to price wars which will be detrimental to Kroger's bottom line. Also, thecompany has to rely on top-line growth to remain profitable amidst the severe competition and risingcustomer attrition to discounters and other competitors, who can engage in severe price warsconsidering their higher margins.

Opportunities

Growing private label market will lead to growth in revenues and profitability

The growing preference of customers to buy value oriented merchandise is expected to boost the

demand for private label goods in the US. According to industry estimates, the market for privatelabel branded products is worth $90 billion in the US; private label brands accounted for 17.4% ofthe US food product sales in 2010 compared to 15.2% in 2006.The share of food products in privatelabels has been increasing. A key reason for the growing consumption of private label brands hasbeen the recent economic slowdown, which has kept price the top concern for consumers. Insteadof expensive brands, consumers across the industry are turning to generic and private label products.Even upper-income shoppers are more willing to buy generic, which has traditionally appealed moreto shoppers with limited budgets.

Kroger has highly focused on private labels as part of its merchandising strategy. Its supermarkets,on average, stock nearly 11,000 private label items. Kroger follows a three tier approach (PrivateSelection, banner brand, and Kroger Value) to cater to varied customer requirements. It offers Private

Selection, a premium quality brand designed to be a unique item in the category of gourmet orupscale brands.The banner brand (Kroger, Ralphs, and King Soopers among others), comprise themajority of the company's private label items and are quality products. Kroger Value is the valuebrand, designed to deliver good quality at a very affordable price. In FY2011, corporate brandsaccounted for nearly one-third of Krogers total grocery unit sales, indicating the popularity of itsprivate labels. The gross margins on private brands are higher than that of national brands andincreased acceptance of these brands will lead to increase in sales and will in turn impact thecompanys bottom line positively. Additionally, as these brands are offered exclusively in thecompanys stores, it is a strong differentiator and will offer competitive advantage.




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Increased popularity of retail clinics

Retail clinics, which are typically walk-in clinics located in the pharmacies or grocery stores, havebeen gaining popularity in the US. According to the industry estimates, the number of retail clinicsin the US is expected to grow from 1,220 in 2011 to 3,380 in 2015. Factors such as demand forconvenient healthcare at affordable prices are expected to drive the growth in this segment. Lowcost entry points and extended hours of operations compared to hospitals are the primary driversfor growth of retail clinics.

Another area where retail pharmacy channel continues to play an increasingly important role isimmunization against flu. Pharmacist-administered seasonal flu shots grew by 36% in the flu seasonof 2010, accounting for approximately 10% of the total administered nationwide. According to theCenters for Disease Control and Prevention, approximately 12% of the surveyed population received

seasonal flu shots from a drugstore or pharmacy.

Kroger operates nearly 2,000 retail pharmacy locations and also The Little Clinic retail clinics. Thecompany has also been actively offering convenient access to seasonal flu vaccines at an affordableprice. These flu vaccines are administered by trained pharmacists and nurse practitioners. Duringthe 2009 flu season, the pharmacists at Kroger administered more than 1 million flu shots to customersand associates. Additionally, the companys $4 generic prescription program has saved its customersmillions of dollars on drugs. The increasing popularity for in-store retail clinics and immunizationprograms will increase the footfall and the potential customer base for Kroger.

Growing influence of Hispanic population

The US is one of the most popular destinations for Hispanic population. The growing Hispanicpopulation in the country is likely to increase the level of consumer spending considerably, in timeto come. According to the US Census, Hispanic population increased to 50.5 million in 2010 from35.3 million in 2000, representing an increase of 43%. Accordingly, Hispanic population now accountsfor 16.3% of the countrys overall population. By 2050, the Hispanic population in the US is expectedto reach 127 million and account for 29% of the countrys overall population.Though a large numberof Hispanics live in the Mexican border states such as California, Texas, Arizona and southernFlorida, they have been moving to other parts of the country as well. The economic influence ofHispanics is also expected to be profound in the future. According to industry sources, the Hispanicpurchasing power accounted for 11% of total purchasing power in the US in 2010. It is estimated toincrease to 15% by 2015 (approximately $1.5 trillion or more than 70% of all minority purchasingpower). Market research shows that Hispanic consumers spend more on groceries, make more

frequent shopping trips, prefer bulk over smaller packaged foods, and eat at home more often thanthe average American.

Kroger has a strong presence in the US market, with stores in 31 states. The companys widepresence across states can be leveraged to cater to the household needs of the growing Hispanicpopulation in the US.

Threats




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Low consumer confidence affects demand for discretionary items

The retail markets in the US have been witnessing low consumer confidence. The consumerconfidence in the US has registered a decline during recent times. The level of consumer confidenceis what determines if the US customers are likely to spend more, and the confidence has been lowin the recent times, albeit slight increases comparatively. The US consumer confidence indexincreased slightly and reached 59.5 in July 2011, compared with 57.6 in June 2011. However, thisfigure is very low compared with the consumer confidence index of above 100 in the first half of2007. Since purchases of the company's products are dependent upon discretionary spending byits customers, the company's financial performance is sensitive to changes in overall economicconditions that affect consumer spending. Although consumer spending is seeing some positivegrowth, Americans seem cautious and are not willing to increase spending, one of the reasons whythe pace of the recovery is estimated to be more subdued than in the past. High unemployment rate,

sluggish wage gains and credit crunch are all expected to keep consumers relatively cautious. Allthese factors are expected to hinder shoppers to spend on big ticket items and remain value-orientedin the near future. The low consumer confidence is depressing demand for several discretionaryitems and the company's multi-department stores and marketplaces, which sell several discretionaryitems such as furnishings, electronics, automotive products, outdoor living products, electronics andhome goods will be severely impacted. Any further deterioration in the consumer confidence will bedetrimental to Kroger's revenue and profitability.

Intense competition from discounters will pressurize margins

Food retailing sector is the US faces stiff competition leading to price wars. Non-existent switchingcosts for consumers, who are largely driven by price, increased the appeal of discounters and other

value retailers. Wal-Mart's entrance into the grocery market and its ongoing expansion has provedto be a major disruption to traditional operators, whose cost structures are higher and cannot matchthe low prices that Wal-Mart offers. Merchandise offered at Wal-Mart's stores are priced at muchlower range than the prices offered by its competitors. Grocery stores, amidst such competition havebecome price takers. As consumers' purchasing power is decreasing in this weak economy, pricingmatters more, which plays into the hands of the low-price leaders.

Although Kroger has been reducing prices to handle pressures from discounters, it has not beenimmune. Kroger's economies of scale are trumped by discounters such as Wal-Mart and Costco.Kroger, to improve market share, has been forced to become more promotional, which has led toreduced profitability. Although historically Kroger has been able to keep remarkably stable margins,FY2010 saw more margin compression as a result of heavy price competition and the market share

growth came at an expense of profitability. Competition for the consumer's food dollar continues tointensify as supercenters and warehouse clubs have increasingly promoted lower prices on food todrive traffic.With gross margins and operating margins below that of Wal-Mart's, the company mightface further pressure on profitability as the competition intensifies.

High degree of unionization will increase labor costs against a backdrop of rising wages and healthcarecosts




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The labor costs for companies have been rising as the healthcare costs and wages increase in therecent times.Tight labor markets, increased overtime, government mandated increases in minimumwages and a higher proportion of full-time employees are resulting in an increase in labor costs,which could materially impact the company's results of operation. In the US, the government increasedthe minimum wage rate from $6.55 per hour in 2008 to $7.25 an hour in July 2009. Furthermore,many states and municipalities in the country have minimum wage rate even higher than $7.25 perhour due to higher cost of living. In addition to this, the health care costs for employers in the USare increasing. According to industry estimates, healthcare costs for the US employers are estimatedto increase by 8% in 2011 and by 8.5% in 2012. Increasing number of consolidations in the healthcaresector, and an expected rise in the medical claims from workers are some of the reasons that wouldkeep the healthcare cost high in the coming two years.

A majority of Kroger's employees are covered by collective bargaining agreements with unions, and

the company is a party to nearly 300 collective bargaining agreements, with an expiry term of threeto five years. Several of these labor agreements were negotiated in 2010, and some more will benegotiated in 2011. In all of these contracts, rising healthcare and pension costs will continue to bean important issue in negotiations.Yielding to the demands by these unions may lead to increasein health care, pension and wage costs and the company may experience increased operating costswhich will have an adverse effect on future results of operations. Additionally, the issues may leadto strained relationship with unions.The company has endured labor strikes in the past and theresistance to incur increased costs may lead to prolonged work stoppage affecting a substantialnumber of locations. Rising costs of healthcare and rising labor costs will increase the costs forKroger. Furthermore, high unionization of its labor might affect the operations in case the companyand the unions do not reach a consensus.




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