I don't know about you, but the grocery store is among one of my few kryptonites. I'm not a huge fan of shopping, so getting in and out of the supermarket quickly is often my goal.

But the truth of the matter is I'm heavily in the minority here, even if quite a few of you are nodding your head in accord. Grocery stores provide basic life necessities, and they're also a major source of consumer spending.

Graph by author. Figures in billions of U.S. dollars. Data source: Statista.

With the exception of 2009, which marked the worst recession the U.S. has seen in seven decades, supermarket and grocery store sales have steadily climbed higher, reaching nearly $547 billion in cumulative sales in 2013, according to Statista. Given that our population is only growing, sans a depression in the U.S., I would suggest this figure will continue to march ever higher.

Running a grocery chain is no easy business
However, just because consumers are spending more in total sales on grocery products each year doesn't mean the grocery business is easy in any way. There are a number of challenges supermarket chains face on a daily basis.


Source: U.S. Dept. of Agriculture, Flickr.

To begin with, competition within the grocery sector is fierce. It's no secret that people need to buy food, detergent, toothpaste, and other basic-needs products, so grocery chains have attempted to open your pocketbook by setting up in as many convenient locations as possible. According to Progressive Grocer Magazine, there were a whopping 37,459 supermarkets generating $2 million or more in annual sales in operation last year. This means grocery stores often need to advertise heavily or promote certain items or rewards programs aggressively in order to stand out from the crowd.

Secondly, and building on the first point, margins in the grocery business are razor thin. To consistently attract consumers, grocers have to first get them in the door with what are perceived to be low and/or competitive prices. Unfortunately, a highly competitive and promotional environment often leads to low margins, making the supermarket industry a highly capital intensive, but generally low return business model.

Third, grocers have little control over product pricing, even if it appears that they do. As food and consumer goods costs rise grocers can either choose to absorb these higher costs at a detriment to their gross margin in order to keep customers coming into the store or pass along price hikes to consumers and hope they remain loyal to the brand. With the Food Marketing Institute's data from last year showing that the average supermarket carried 43,844 items, maintaining control over product pricing can sometimes prove practically impossible.

Lastly, debt can be a genuine concern for grocers. Because they're generally working with low margins, free cash to be used for opening new stores can be tough to come by. This is why many grocery chains turn to debt offerings to fund their expansion -- although for some, like SUPERVALU, it can get you in a lot of trouble. Because of debt levels that exceeded $6 billion, SUPERVALU was forced to sell a number of its chains, including Albertsons and Jewel-Osco, to privately held Cerberus last year for $3.3 billion. In other words, not all grocers expand within their means and they sometimes get punished for it!

Differentiating a crowded field
Long story short, differentiating the winners from the losers in the space can sometimes be difficult.

Luckily for us, research firm Market Force conducted a study last month on the supermarket sector, which reached more than 6,200 respondents and looked at various operational and product attributes for 12 supermarket chains. The goal of Market Force's study was to not only discover what grocery stores shoppers frequented the most, but also to understand which chains excel in customer satisfaction. Chains that go beyond consumer expectations are more likely to forge an emotional bond with consumers and keep them loyal regardless of food and product cost fluctuations. Thus, chains that performed well in Market Force's survey could present an intriguing investment opportunity, while those that performed poorly might make investors think twice. 


Source: Cathy Stanley-Erickson, Flickr.

Topping the list for a second straight year was down-to-earth grocer Trader Joe's, which is owned by privately held Aldi. As Market Force summarizes, "Trader Joe's has amassed a loyal following of shoppers looking for an unconventional grocery shopping experience with a neighborhood feel." Trader Joe's really stood out when it came to service and business sustainability, placing fourth in "low prices," second in "courteous service" and "inviting atmosphere," and tops by a mile in the "natural/organic choices," "good private-label brands," and "sustainable policies" categories.

Costco (NASDAQ:COST) was another solid performer, finishing fourth in Market Force's study. Specifically, Costco ranked highest with consumers for its meat quality, though it also placed in the top five for all other product attributes including "natural/organic choices," "high-quality produce," and "sustainable policies," to name a few. After it also ranked as America's favorite gas station, I'd suggest that Costco's customer loyalty ranks high up the list.

The surprising grocer that's America's least favorite
Perhaps the biggest surprise of all is the supermarket that came in dead last of the 12 companies that had enough votes to qualify. Before I reveal which company this is, would you care to venture your own guess?

Did any of the majors like Kroger (NYSE:KR) or Safeway (NYSE:SWY) come to mind? If so, you selected the seventh and 10th best performers, respectively. Safeway's "inviting atmosphere" saved it from the ignominy of finishing last, which is a direct reflection of its costly interior store remodels, while Kroger's "natural/organic choices," "sales and promotions," and "fast checkouts" ranked it among the top five in each category, pulling it to a middle-of-the-pack ranking.

The company pulling up the caboose in Market Forces survey was actually -- drumroll, please -- Wal-Mart (NYSE:WMT).

Walmart Produce
Source: Wal-Mart.

I know we don't often think of Wal-Mart as a grocery store, but within the U.S. (and excluding fuel sales), groceries make up 55% of Wal-Mart's total revenue. Add in health and wellness products, which are typically found in every supermarket as well, and you'll see that 65% of Wal-Mart's revenue is tied to these basic-needs items.

Walmart Milk

Source: Wal-Mart.

So by now you're probably scratching your head and wondering how the largest company by revenue could be America's most hated grocery chain. On one hand Wal-Mart does do a good job of attracting consumers based on price. Of Market Force's 12 reviewable categories, Wal-Mart actually placed third in "low prices" and first in "one-stop shopping." Wal-Mart's size makes it very difficult for smaller businesses to compete since its product selection is unsurpassed, and its size allows it to negotiate hefty discounts when buying products from vendors in bulk. The end result is prices that tend to be far below the industry average.

We also have to consider the demographics that Wal-Mart and this survey targeted. Wal-Mart's bread-and-butter consumer base is the low-income customer which is more attracted by price and less by product or service quality. As Market Force notes in its study, nearly 60% of respondents earned more than $50,000 annually, so that bias could certainly skew the results away from Wal-Mart.

Wal-Mart's trio of troubles
However, there are tangible problems with Wal-Mart's business model that have recently come to light. Wal-Mart has delivered four straight quarters of year-over-year same-store sales declines, and it may be on account of competitive online sales growth, dollar-store expansion, and poor company image.

Although not all lower-income individuals have online access or the ability to purchase goods online, websites such as Amazon.com have the pricing clout and lack of overhead costs to compete with and sometimes even undercut Wal-Mart's prices. Plus, Internet sales are considerably more convenient than getting in a car and driving to the store, perhaps with kids in tow. Growing online competition represents a serious concern to Wal-Mart's already shrinking operating margins.

Dollar General Food

Source: Dollar General.

I'd suggest that the rapid expansion of dollar stores such as Dollar General (NYSE:DG) is also proving to be a thorn in Wal-Mart's side. Dollar stores will never be able to match the product selection of a Wal-Mart superstore, but the mere understanding that consumers know what they'll be paying for a majority of products before heading into the store (i.e., $1 or less) proves to be enough of a lure to drive steady traffic and sales increases. If consumers purely care about one-stop shopping, they'll continue to choose Wal-Mart, but price-conscious customers are likely going to add a dollar store such as Dollar General into their shopping mix as well, which only works to reduce Wal-Mart's growth potential.

Finally, a low public opinion of Wal-Mart is likely a hindrance to its sales. Last year Wal-Mart dealt with international bribery allegations, it's suffered through accusations that it's not doing all it can to be environmentally friendly by purchasing predominantly from overseas vendors, and it's contended for years with labor unions that have claimed its wages and labor practices are unfair or unethical. With few positive opinions to be found, it's difficult for Wal-Mart to forge bonds with consumers beyond heavily discounting its merchandise to attract shoppers into its stores. 

It's possible that Wal-Mart's move to open smaller Wal-Mart Express stores could make the brand seem more down-to-earth, especially in smaller towns that tend to have negative views toward large corporations. What is for certain, though, is that Wal-Mart is going to need to remain innovative, because it's clearly not optimizing its consumer reach as of now. Prices alone aren't the only consideration for shoppers, and even a company like Wal-Mart could find itself and its share price struggling if it fails to improve its image with shoppers.

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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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