Retail grocery real estate: Optimizing returns in the new world order

By Andy Couch, DJM Real Estate

Grocers are operating in a rapidly changing environment — an exploding omni-channel marketplace in which competitive strategies that worked five years ago are obsolete. Smart, traditional grocers are rethinking priorities and redefining success. Wall Street is also changing how these companies are viewed. Total sales growth is less important than the need to increase, or at least “hold” comparable store sales and find operating efficiencies to maintain profitability and stay relevant with consumers.



While companies strive to minimize costs in labor, product and overhead, real estate holds tremendous untapped potential for optimizing profitability. The key to profit optimization, from a physical real estate perspective, is a disciplined, thorough and regular portfolio review to determine what to do with each store.



This is not your father’s grocery store

Consumers shop more frequently, from more sources, and with more “precision” to get exactly what they want, when and where they want it, at the lowest possible price. E-commerce and alternative format stores provide deep offerings for specialty products (gluten free, vegan, kosher, organic) that few physical grocery stores can match. Formats and distribution platforms exist today that were never envisioned five years ago. Price formats of all sizes are becoming more formidable as they evolve and multiply: Winco, Market Basket, Woodman’s, Aldi, Save-a-Lot, dollar stores, Walmart Neighborhood Market, and the wholesale clubs are updating their product assortment, adjusting pricing and expanding food offerings to stay relevant with consumers, encroaching on other traditional grocers.



Demand is finite, supply is not

Consumer demand can shift, but it is finite, at least in the grocery space. As big-box, specialty and discounters move in, they come to represent more and more slices in a fixed-sized pie. Something has to give, and it appears that the “give” will be at the expense of marginally located, traditional grocery stores in the 40,000-sq.-ft. to 70,000-sq.-ft. range as they face stiff competition and intense margin pressures.



These competitive factors (physical and virtual), paired with changing trade areas, will put pressure on sales for physical stores such that locations that are feasible now may not be in the future. Further, traditional grocery stores will likely shrink in size – perhaps with the exception of discounters and very special, large-format stores like Wegmans, Kroger or HEB that offer a compelling and unique combination of freshness and value.



But the talent, resources and “will to win” among traditional grocers cannot be underestimated. They are already investing heavily in big data, social media, mobile commerce, home delivery and click & collect pursuits in order to become even more relevant and profitable. While some store closures will occur, it won’t be for lack of investment, creativity, and a determined effort.



Growth is (not always) good

Based on these changes, growth is being redefined, and it looks very different than it did 10 years ago. Growth often is not profitable, nor is it sustainable – even though it may seem that way early in the cycle of adding stores. The growth curve for a new store is very high in the first three to five years, before flattening out. After that three to five year window, positive comparable store sales are very hard to come by, and by then, the stores are no longer fresh and shiny. Even worse, if a store performs well, it invites competition. Naturally, growth companies reach a tipping point where sales from new stores represent a smaller and smaller percentage of the total sales base. At that point, composite comparable store sales level off as a course of evolution and the sustainability of that business model can be called into question.



More offense, less defense

Current M&A activity is very different from in the past, and in many cases, current strategies are more effective at building a strong and sustainable business. From 1990 to 2010, chains would acquire a target that included all stores. Based on the theory that “the best offense is a good defense,” the acquirer would often control the weaker stores to keep competition out by holding them dark or turning them over to non-competing uses. Defensive real estate moves used to be a pivotal part of the competitive chess game, in combination with forward-looking “offensive” strategies to compete in merchandising, marketing and retail operations. Now, with competition from so many sources – defensive real estate moves are rarely supportable. It’s hard to defend against what can’t be seen and the old adage is sorely in need of updating, where today, “the best offense is … a good offense.” This approach also benefits consumers as it offers a more efficient market to serve and anticipate customer demands.



Surgical acquisitions & real estate implications

As a result of the need to play an offensive game, acquisitions are now surgical, where the buyer takes only the stores it needs, and leaves the seller with the rest. This was the case in a number of recent transactions, such as the sale of Delhaize stores in the Southeast, and the acquisition of former Fresh & Easy stores. A similar “surgical” process is playing out in the case of Safeway closing Dominick’s locations in and around Chicago. Roundy’s acquired 11 of the closing Dominick’s stores to be operated as Mariano’s stores, Whole Foods acquired seven locations, New Albertsons acquired a few, and about 10 stores have been acquired by various independent grocers. However, that still leaves somewhere in the range of 30 to 40 stores unclaimed for Safeway. In these surgical operations, buyers are more selective and not just chasing growth for growth’s sake.



Success breeds complacency

To be successful, grocers, and all businesses for that matter, need to continually question the relevance of their business today and in the future. Andy Grove, former CEO of Intel famously said that “Success breeds complacency. Complacency breeds failure, and only the paranoid survive.” In the semiconductor industry, Grove’s mindset was very true, and today, it applies to the grocery sector as it undergoes these major transitions. Complacent grocers will become obsolete and irrelevant in the new world order. Suspicion of the competition, virtual and physical, will be crucial. Innovation and adaptation will differentiate the winners from the losers. Grocers can never let their guard down.



Portfolio review: Hold, invest or divest

A smart strategy for avoiding complacency and staying ahead of these myriad threats is for chain grocers to conduct regular portfolio reviews to help drive decision-making and optimize profits. These store-by-store assessments are essential. Grocers need to ask themselves “How is a store doing today? How will it do tomorrow? Is it worth more now than it was a year ago? Will it be worth more next year than it is today? How can I continually add value? What is in the best interest of my shareholders?” Other questions include “Is it worth more for me to operate the store or to sell or to close? Is it worth more to a different retail operation (or a non-retail use) rather than being run as a supermarket?”



This “Portfolio Review” is not just an inward look, but a comprehensive analysis