As Wal-Mart (NYSE:WMT) opened more supercenters nationwide, small supermarket operators like Roundy's (UNKNOWN:RNDY.DL) have been unavoidably affected. Roundy's only managed a three-year revenue CAGR of 1.6%, as Wal-Mart gained market share in its key markets--Wisconsin and Minnesota.
However, Roundy's management expects "the growth of competitors' market share in core areas to slow in 2014, as the market becomes more fully penetrated." Notwithstanding this positive development, Roundy's isn't necessarily disadvantaged vis-à-vis its competitors because of its smaller absolute size. Let's compare Roundy's with peers such as Kroger (NYSE:KR) and Wal-Mart, to draw further insights into the competitive grocery landscape.
Relative scale versus absolute scale
In the supermarket industry, profitability is very much correlated with local market share. According to its internal estimates, Roundy's local market share in its primary area of operations, Wisconsin, is approximately 35%, much higher than market shares of 26% and 24% for Kroger and Wal-Mart respectively. As a further illustration, Roundy's 42% market share in its largest market, Milwaukee, is three times that of Wal-Mart. The results speak for themselves--although Roundy's revenues are a mere 4% of Kroger's top line, its trailing twelve months EBITDAR margins of 7.1% beat Kroger's 6.6%.
Having dominated the local markets it operates in, Roundy's derives significant economies of scale and resulting cost savings in areas such as advertising & promotion and distribution. A single television or newspaper advertisement reaches out to the same number of potential customers in a local region, so Roundy's has a cost advantage over its peers. For the same dollar of advertising spent, Roundy's can reach out to a wider spectrum of its larger customer base.
With respect to logistics, Roundy's derives significant distribution efficiencies given its high density of stores in its key markets. Roundy's primary Oconomowoc Distribution Center, a 1.1 million square foot facility, serves all of its stores in Southeastern Wisconsin, including Milwaukee, Madison and Chicago.
There are some instances where absolute size matters, and one is purchasing power. Kroger obviously has stronger bargaining power with its suppliers than Roundy's, as it generates 25 times the sales of Roundy's. Kroger also has a sufficiently large revenue base to support its back office operations and data analytics efforts for its loyalty card program.The success of drawing insights from a loyalty membership program depends heavily on the law of large numbers--data analysis only works well if you have a sufficiently large sample size. Kroger has an edge over its other competitors here, with its loyalty cards used in over 90% of transactions and carried by about 50% of U.S. households.
Leveraging on the insights from its loyalty card membership program, Kroger has tailored its product assortment to the needs of its customers. One example was its natural and organic food brand Simple Truth, introduced in 2012, which uses clear and visible labelling in response to customer feedback. Kroger's customers have responded positively, with it achieving positive same-store sales growth for 41 straight quarters running.
Relative scale is more important than absolute scale in most cases when it comes to retail, as seen in the performance metrics of Roundy's.
Tweaking store format strategies
Besides relying on its core banners 'Pick 'n Save', 'Copps Food Center' and Metro Market' in the Wisconsin and Milwaukee markets, Roundy's is also expanding its presence in Chicago with its specialty food retail banner, Mariano's.
Unlike its core retail banners, Mariano's is uniquely positioned as a differentiated food shopping destination, with an expanded variety of premium perishable and prepared, organic & natural food offerings. Examples include dedicated sandwich stations and other unique offerings such as wood stone fired pizzas and premium fine cut meats,
The numbers validate the business model of Mariano's. Mariano's store-level Return on Invested Capital (ROIC) of between 35% and 40% are on par with that of other organic food retailers, despite its initial investment outlay per store of $5.3-$5.4 million being lower than the $6.9 million average capital outlay for five other organic food retailers studied.
Going forward, Roundy's has plans in place to more than double its Mariano's store count from 22 to 45-50 in the future. With the former second largest player, Dominick's exiting the Chicago market, there remains opportunities for Mariano's to grab more market share in U.S.' third-largest metropolitan market.
Roundy's isn't the only one exploring different store formats and concepts to grow in a challenging retail environment. The world's largest retailer, Wal-Mart, has drawn inspiration from the recent success of dollar stores, which is why it announced in February that it will be opening 270-300 small stores in the new year.
As more consumers choose to shop at the most convenient locations available, Wal-Mart has decided to expand its small store footprint to capture the share of customers doing quick fill-ins. Initial results have been positive, with Wal-Mart's Neighborhood Market stores increasing their fiscal 2014 comparable sales by 4%.
While Roundy's and Wal-Mart have made their tweaks to their store format roll-out strategy, the underlying principle of meeting customer needs is uncannily similar.
Foolish final thoughts
Bigger doesn't necessarily mean better. Roundy's is large in the markets it operates in and has capitalized on its relative scale in its dominant markets to generate higher margins than its larger peers. In addition, Roundy's is expanding its specialty food retail banner, Mariano's to capitalize on the increased consumer emphasis on premium and healthy food choices, particularly in Chicago.