Thursday, August 30, 2007

Thursday Talking Points Memo

What Wal-Mart Should Do With its Neighborhood Market Format
Wal-Mart introduced it's Neighborhood Market format almost 10 years ago in 1998. The format was designed in part to be the opposite of the mega-retailer's supercenters. Ranging from 42,000 to 55,000 square-feet the stores have easier parking, less crowded aisles and quicker checkout than a Wal-Mart Supercenter.

The Neighborhood Markets are complete supermarkets which offer a full selection of groceries and perishables, fresh meats and produce, non foods and all the other supermarket selections. The stores also have drive-through pharmacies and some have in-store restaurants as well.

Currently Wal-Mart as 118 Neighborhood Markets in the U.S. The stores merchandise about 28,000 items.

Neighborhood market history
Wal-Mart started off rather aggressively building Neighborhood Markets in the late 1990's to the early 2000's but has slowed down the pace considerably in the last several years. The format has been mildly successful--more successful in some regions and far less successful in others. Wal-Mart recognizes this fact, which is in part why they haven't been building very many new stores of late.

The Neighborhood Market is a small supermarket by today's standards. Wal-Mart designed it to be a niche format between their supercenters and their competitor's superstores. But the format really hasn't found itself. It's too big to be a true "convenience" format but too small in most cases to compete with the larger 65,000-90,000 square-foot new stores that most supermarket chains are building today.

Re-invigerating the Neighborhood Market format
This fact is partly why Wal-Mart is now looking at another new format, an approx. 10,000 square-foot upscale convenience-style store. It's also partly why the retailer continues to put its major focus on the supercenters which include a large supermarket in them. As such the Neighborhood Market is a relatively to not so successful format and its further development is receiving only minor attention from Wal-Mart.

This doesn't have to be the case for Wal-Mart and its Neighborhood Market format however. NSFM has an idea and positioning direction which we believe would not only re-invigerate the format at Wal-Mart but also allow the chain to express some of its more recent corporate and retail eithics and merchandising philosophies.

What we suggest is that Wal-Mart divide the Neighborhood Market format into two parts. In other words keep the basic Neighborhood Market concept (the store format) but create a two-part format out of it with the second format targeted to a specific retail category--natural and organic foods--and given its own banner (name). We call the current Neighborhood Market format one and the new Neighborhood Market format format two.

Format one would essentially be what the Neighborhood Market is today, with some additions and changes. First we suggest increasing the store footprint size. The current stores range from about 42,000 square-feet to about 55,000 square-feet. We would expand that to a range of about 55,000 square-feet (the smallest size) to a high-end size of about 80,000 square-feet. The smallest stores would be no smaller than 55,000 square-feet and the largest stores up to 80,000 square feet.

This increased store footprint is more in-line with what chain supermarket operators like Kroger, Safeway, Supervalu and others are building today. The larger stores would allow the Neighborhood Markets (format one) to better compete with these chains. With this larger footprint we suggest Wal-Mart expand the stores' produce departments, make an in-store eating place a standard feature, add an in-store cafe/coffee bar to all stores, make service meat and seafood a standard feature (along with self-service cases) and expand the stores' perishables offerings.

We also suggest they add more natural, organic and specialty groceries and integrate the items in these categories in-line with conventional and corporate/private label groceries throughout the core of the store.

Further, we suggest adding small but comprehensive health and wellness centers in each Neighborhood Market (format one). These centers would feature nurse practitioners who can provide minor medical treatment for a discount cost. They also would sell a complete selection of health products including vitamins, nutritional supplements, small medical equipment (especially for seniors) and related heath and wellness items.

This department can be tied-in with the format's current in-store pharmacies. The focus would be on health and wellness with minor medical care, professionals offering health advise and selling the products to supplement that advise. In addition to the upscale, convenience-style format Wal-Mart is currently developing the retailer also is developing a small footprint, stand-alone health and wellness stores Having the health and wellness departments in the Neighborhood Markets would create excellent synergies with the new stand-alone health and wellness stores once they are created and rolled out.

NSFM believes the changes and additions to the current Neighborhood Market format (format one) would dramatically improve the viability and shopping experience of the current and future Neighborhood Market stores

In our analysis we also think Wal-Mart might consider dropping the Wal-Mart name from the Neighborhood Markets. Instead of "Wal-Mart Neighborhood Market" the stores would simply be called "Neighborhood Market." This has a more community-oriented feel to it. It also takes the Wal-Mart brand off of what is designed to be an alternative to big box shopping which most consumers associate with Wal-Mart. We aren't 100 percent convinced this is needed at his point but strongly believe it should be seriously considered.

Format Two: A second Neighborhood Market format
It's format two though that has NSFM excited, and we believe offers excellent potential for Wal-Mart to re-invigerate and make successful its Neighborhood Market format.

Neighborhood Market format two is a medium-size footprint natural and organic products "category killer" grocery store. NSFM suggests Wal-Mart take the basic Neighborhood Market store footprint and shrink it a bit for the new format. The stores would be about 35,000 square-feet. They would feature a complete selection of natural and organic groceries, produce, meats and seafood, and perishables. The stores also would have an extensive selection of natural and organic nutritional supplements, skin care products and non-foods. A combination in-store restaurant/cafe/smoothie-type bar would be part of the format. A good way to look at the format is Whole Foods (with a few differences and limitations) in a smaller box.

The format's focus (or mission statement) would be "Natural and Organic Foods For Less" or something similar. The format would be a "category killer" for these products, beating Whole Foods and other natural foods stores and supermarkets significantly on the retail price points of organic groceries, perishables and non-foods.

The stores could be built in such a "less frills" but still upscale way as to keep operating costs down. And with Wal-Mart's buying, distribution and logistics systemt he chain would be able to beat the best retails currently out there while still making decent margins. After all being the price leader is Wal-Mart's strategy in terms of dramatically increasing its natural and organic product offerings in its supercenters.

The stores need to be upscale and attractive but also have the look of a "lower frills" retailer at the same time. This is important for the "category killer" positioning. A too upscale store suggests higher prices. However, a too bare-bones store isn't inviting and would discourage shoppers, as well as not keeping them in the store for as long a period of time as possible which is key for impulse buying.

The chain also can build the stores in such an environmentally sound manner that things likes energy use will be dramatically reduced compared to a typical supermarket. For example, lots of use of skylights for lighting, ceiling fans, top-grade insulation and other green building and energy-reducing principles. This is good for the stores positioning in addition to cost-reduction as environmentalism will be a big part of the format's draw along with it natural and organic product offerings.

This Neighborhood Market natural foods "category killer" format will need a name. And the Wal-Mart brand name should not be part of it. The name must evoke natural products retailing as does Whole Foods, Wild Oats or Supervalu's Sunflower Market stores. In fact Supervalu's Sunflower Market format is somewhat a model for what we are calling Wal-Mart's Neighborhood Market format two. There are major qualitative differences between our concept for Wal-Mart and the current Sunflower Market format however. Chief among these differences is size. Sunflower Market stores are only 15,000 square-feet. (See Tuesday's Talking Points Memo for a discussion about Sunflower Market.)

Why the category killer format will work
Why do we think this format would work for Wal-Mart? There are 4 basic reasons. First, the natural and organic products categories are moving from a niche market to a near-mainstream one. They aren't there yet but moving in that direction fairly rapidly. Wal-Mart knows this which is why they have launched a major natural and organic grocery initiative in their supercenters. Kroger Co., Safeway Stores and other retail chains, including Target, know this as well.

Second, Wal-Mart needs a way to re-invigerate its Neighborhood Market format as well as to be able to break out of its big box format in order to serve regions and neighborhoods where community members do not want--and fight against--supercenter stores. Format two allows for both these things in conjunction with our first point above.

Third, the natural and organic categories allow for higher margins even if the products are sold for a discount provided the retailer has the buying and logistics systems to make it work, which Wal-Mart does. The "category killer" natural foods stores for example can sell organics at substantially lower retails than Whole Foods or supermarkets can and do and Wal-Mart can still make a higher overall gross margin in these stores than they can make selling conventional groceries in a supercenter. (I'm not suggesting the gross sales between the two would be anything close to similar, merely that the margins would be higher on albeit significantly lower overall volume in the natural foods format stores vs. the supercenters.)

The last reason is "first-mover advantage." It might be in five years, ten years or perhaps a little longer, but a retail chain (or even a start up) is going to launch a "category killer" retail format focused on the natural and organic categories. We've seen this with specialty and gourmet foods, wine, beer and spirits and other categories. The natural and organic category is ripe for the picking at retail for this--and getting riper. (NSFM believes it will be closer to five years or less rather than ten for a "category killer" natural and organic foods retail format to emerge and begin to position its stores nationally on a selective basis.)

With it's buying and logistics advantages, corporate philosophy embracing natural and organic products along with environmentalism and sustainability--and its need to break out of the big retail box--Wal-Mart might just be the perfect candidate to be first in creating this "category killer" natural foods store Neighborhood Market format.

The existing retailer or start up that decides to become the "first mover" in this category in a significant way is going to have all the advantages. NSFM thinks it is worth further analysis, study, thinking and discussion by Wal-Mart.

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