Thursday Talking Points Memo

The Invasion of the "Small Marts"-- Will There Be a Small Format Revolution By U.S. Retailers?

Yesterday at the Lehman Brothers Back-to-School Consumer Conference in Boston Steve Burd, Chairman and CEO of Safeway Stores, said the nation's third largest grocery chain is prepared to open smaller format stores if Tesco's 10,000 square-foot upscale Fresh & Easy Neighborhood Market format is successful. "If the smaller store format works we think we could do that and probably do it more effectively simply because we're a well known name in the market," Burd said.

Burd said the key to making a smaller format like Fresh & Easy work is to be able to sell lots of private label products. He said Safeway's private-label brands are much better known than Tesco's which would give the chain a big advantage in its operating areas with smaller format stores vis-a-vis Tesco's Fresh & Easy stores.

At the Lehman conference Burd said based on the anticipated Fresh & Easy locations (which are in Safeway's key operating areas in the Western U.S.) Safeway is doing its research: putting together traffic counts, doing demographic, ethnic and income studies of the areas and preparing to defend Safeway's business.

Burd's comments come on the heels of Wal-Mart Inc. recently beginning to plan and develop two small format stores: an upscale convenience-style market and a small footprint health & wellness format store. Natural-Specialty Foods Memo (NSFM) has named this overall format "Small-Marts" regardless of the retailer involved. It's good shorthand for the format.

Additionally Whole Foods Market, Inc. announced last week it was creating a "Small-Mart" of its own, converting a former Wild Oats store in Boulder, Colorado into a new format called Whole Foods Market Express.

This potential "Small-Mart" invasion was kicked off by UK-based Tesco with its Fresh & Easy Neighborhood Market format. These stores, a number of which are currently under construction, average about 10,000 square-feet and feature high-quality grab-and-go prepared foods, natural, organic, specialty and mainstream groceries and perishables, fresh produce and meats, and other offerings, all in an upscale retail format. The first Fresh & Easy stores are scheduled to open in November.

It looks like the giant retailer (Tesco) from across the pond (UK) has triggered a potential "Small Mart" retail format invasion in the U.S.--especially in the Western U.S. where the first Fresh & Easy stores will open in California, Nevada and Arizona.

The Wal-Mart folks are doing their planning in the San Francisco Bay Area, where Safeway is based and where Tesco is likely to open some Fresh & Easy stores after it opens its first initial batch in Southern California where the retailer has located its headquarters. Going north in California is a logical step along with Southern California, Nevada and Arizona.

The West--especially California--also is one of Whole Foods' top regions. The supernatural grocer just last week opened its largest Western U.S. store in Cupertino in the South Bay Area. The Bay Area is a natural location for some Whole Foods Market Express stores if the grocer has success with the concept. Therefore, California--known for being innovative in many fields--looks to be ground zero for this potential "Small-Mart" invasion.

NSFM's Talking Points Memo believes the jury is out on whether or not the "Small-Mart" format will blossom and become a widespread success. We see a niche for such stores like Fresh & Easy, which combine a basic grocery selection with upscale offerings, especially prepared foods, in a 10,000 square-foot or so footprint.

Many shoppers are tired of huge big box store shopping but also aren't happy with the traditional American convenience store format. These consumers cut-across age, income and other demographics. Seniors, busy working moms, young people, working couples--all are looking for convenience, faster shopping times and quality grab-and-go prepared foods offerings. Trader Joe's has proven this as has the trend of supermarkets to increasingly focus on prepared foods offerings.

The key will be to get such shoppers to make regular trips to and spend a significant amount of money per-purchase at these "Small-Marts." Wawa Markets in the Eastern U.S. has been operating small footprint, traditional C-store/upscale C-store hybrid stores for over a decade. They've had huge success drawing a more upscale customer to their stores as well as the traditional C-store customer, who are primarily men in their mid-twenties to late fifties.

Wawa Markets' success with this type of format is a good model when evaluating the "Small-Mart" potential in terms of Tesco, Wal-Mart, Whole Foods and now perhaps Safeway Stores, Inc. The Wawa stores aren't as upscale as the Fresh & Easy format or the Wal-Mart format from what we've heard from industry observers who've talked with the Wal-Mart "Small-Mart" development team. And the Wawa stores are obviously different from the Whole Foods Market Express format in that Wawa isn't a natural foods-based retailer. However, the similarities between Wawa's stores and these "Small-Mart" formats are enough that Wawa's success in the Eastern U.S. suggests to us that the potential for success is high for the Fresh & Easy and similar formats.

An interesting aspect of Tesco's Fresh & Easy format is that it's not an urban-only based format. In fact the majority of the stores currently being constructed and on the drawing board for Southern California, Arizona and Nevada are in suburban areas. There are some urban stores in Las Vegas, Pheonix and Los Angeles but the vast majority will be near--but outside--the urban core. From what we hear Wal-Mart's plans for its "Small-Mart" format are similar in terms of format and store locations.

NSFM's Talking Points Memo expects to see other large retailers look closely at and even getting into the "Small-Mart" format. We especially believe there's a niche on the East Coast. Thus far all three players--Tesco, Wal-Mart and Whole Foods, and one potential player, Safeway--are focused on the Western U.S. The east coast with it's demographics and mix of large cities and suburbs is wide open. I

It makes since to us that a well-known Eastern U.S. retailer might think about testing a format similar to Fresh & Easy in the East. Tesco likely has plans to locate stores in the East but it will be some time before they can do so. An established Eastern U.S.-based retailer (especially a large supermarket chain) could gain "first mover" advantage by doing this say beginning next year--in addition to being able to leverage its existing brand to the smaller format stores.

NSFM's Talking Points Memo isn't predicting a full-fledged "Small-Mart" invasion just yet. However with Tesco, Wal-Mart, Whole Foods (and possibly Safeway) getting into the game we think it qualifies as at least a mini-invasion. The last time the British invaded the U.S. with a concept (monarchy) they were defeated. Wal-Mart, Whole Foods, Safeway and others don't want to allow this British invader (Tesco) to win the "Small-Mart" format battle. Therefore they are taking it very seriously.

We suggest other retailers will need to do the same. There hasn't been a major retailer who invested billions of dollars like Tesco is in a new format in the U.S. for some time. Tesco has done its homework and the "Small Mart" format just might create some significant changes over time in U.S. consumer shopping behaviors. It also might trigger an internal U.S. retailer format invasion as well as the foreign one it has started.