Early investment in automated customer fulfillment centers gives the Cincinnati-based Kroger chain a huge head start in the race for e-commerce supremacy.
When the pandemic first hit the United States more than a year ago, the definition of retail excellence changed dramatically. Forget small footprints, curated assortments and prepared food offerings. Big stores able to keep the shelves stocked or, better yet, pivot to online ordering and curbside pickup were good enough for most consumers. But now that the country is beginning to emerge from the COVID crisis, retailers focused on meeting shoppers’ immediate needs can finally start to look ahead again. However, one chain in particular has been doing that all along, giving it a huge head start in the race to the future. For that reason, Cincinnati-based Kroger is our 2021 Retailer of the Year.
BLAZING TRAILS SINCE ‘03
The nation’s largest supermarket chain and third-largest food retailer (after Walmart and Amazon) has always been a trailblazer. When Kroger first partnered with dunnhumby in 2003 to analyze shopper data gleaned from its loyalty card program, “the competition was still using an abacus and slide rule,” says Gary Stibel, founder and CEO of Westport, Conn.-based New England Consulting Group. Not everyone was convinced the investment would pay off. But last year, Kroger’s 84.51 data intelligence subsidiary used those findings to create 500 billion personalized offers to digital shoppers, generating an additional $150 million in incremental operating profits from its retail media group, Kroger Precision Marketing (KPM).
“Kroger is the best in grocery for personalizing offers for consumers,” says one manufacturer partner. “It knows everything you buy, how often you buy it and when you’ll need it next.” Beyond that, it can predict what else you might be willing to buy and then deliver just the right incentive to get the sale, ensuring the most efficient use of CPG dollars.
“The only retailer that does tailored offers better is Amazon,” says Stibel. “But Kroger knows the food business better.” As a result, “It has the ability to be not just the nation’s leading grocery store but the nation’s leading food provider.”
As if that wasn’t enough, Kroger upped the ante a few years ago by inking an “unprecedented” deal with U.K.-based online grocer Ocado to open up to 20 automated customer fulfillment centers (CFCs) for online orders. And that was before the pandemic hit, turning online grocery shopping from a time-saver to a life-saver for some consumers.
The locations of 10 such facilities have been announced so far, and two are already up and running — one in Monroe, Ohio, deep in Kroger country, and one in Groveland, Fla., where the chain has few brick-and-mortar stores but good name recognition. About a third of orders will ship directly from CFCs to customers within a 90-mile radius. The other two-thirds will go to smaller “spoke” sites where they’ll be transferred to vans for delivery to households possibly even further afield. As a result, Kroger’s reach will expand from the 45% of Americans who live within a few miles of a store to the 75% who live in proximity to a CFC.
MULTIFACETED MODEL ‘MOST COHERENT’
“The chain’s multifaceted model, which includes a network of big automated fulfillment centers supported by smaller store fulfillment operations, is the most coherent way of servicing the rising tide of digital demand in the grocery sector,” says Neil Saunders, managing director, retail, at New York-based GlobalData. While the capital investment is huge (the Ohio CFC alone ended up costing around $55 million estimate), “Over time, the CFC model will help Kroger reduce some of the traditional costs associated with online fulfillment. It also takes some of the pressure off the store network.”
Able to fulfill the same online order volume as 20 brick-and-mortar stores but at 60% the cost, “CFCs solve so many of modern retailers’ challenges that they’re going to be impossible to ignore,” says Ken Morris, managing partner at Plymouth, Mass.-based Cambridge Retail Advisors. “We see Kroger’s all-in commitment as a way to meet evolving customer expectations around delivery and speed and still deliver profitability.” He adds that experts believe every viable retailer will be converting to the CFC model within five to 10 years. “This is the future of retail. And Kroger is already there.” But being first in the race to automatic fulfillment doesn’t necessarily make it a winner, says Morris.
“What if another CFC provider — and there are several out there — leapfrogs Ocado in efficiency, cost or some other aspect?” he asks. Could Kroger’s exclusive deal turn out to be a long-term weakness? Time will tell. In addition, same-day delivery remains a question mark. For at least the time being, it will still be handled by third-party providers like Instacart, which does little to distinguish Kroger from other grocers using the same model. There’s also the question of how well the company executes on delivery of frozen and refrigerated products. “That will be the true differentiator,” says Morris.
Kroger’s reach will expand from the 45% of Americans who live within a few miles of a store to the 75% who live in proximity to a CFC.
‘KROGER NEVER RESTS’
Kroger’s recent investments in technology highlight its strong commitment to continually move forward. “Kroger never rests,” says Jennifer Bartashus, senior equity research analyst, retail staples and packaged food, at New York-based Bloomberg Intelligence. “One of the chain’s biggest strengths is its adaptability combined with a culture that’s always striving to anticipate customer’s needs. So by the time you realize you want something — whether a product or a service — Kroger already has it.”
“It’s definitely not risk-averse,” confirms Stibel, citing a willingness to try new things, make some mistakes and then learn from them.
Ironically, though, that philosophy doesn’t appear to extend to category managers. In fact, one of the few weaknesses mentioned by manufacturers we talked to is Kroger’s over-reliance on data, “which sometimes stifles the buyer’s ability to take calculated risks on innovative products,” says one.
“Even when they know they’re on to something good, they don’t always trust their gut,” adds another. “So they double- and triple-check the data, which just slows speed to market.” Combine that with fairly tight review windows that make out-of-cycle additions difficult, and being first to market becomes even harder.
An even bigger challenge that’s only worsened with the pandemic is limited access to category managers. “They’re so slammed with internal meetings and heavy workloads that it’s difficult to secure face time, even through a Zoom meeting,” says one manufacturer partner. While it’s bad enough for existing vendors, “It’s been even more difficult for new brands to get an audience.” A recent push for innovation is reportedly opening more doors. However, heavy slotting and other fees for new items can slam them shut just as easily.
“Slotting fees average $600 to $700 per store for a new item,” explains one vendor. “Even if you swap out an existing flavor, which is often required, you still pay full slotting. And then you get hit with clearance reclamation costs to discount the discontinued item. Plus, you pay a percentage of sales each month for reset costs. And if you want signage and new item tags, those are all incremental. So, to be honest, I’m not sure what slotting even covers since there are all of these other fees.” He adds, “Kroger wants to boost speed to market on new items and double its share of market on new items but with the manufacturer covering all of the investment.”
WHY THEY SHOP KROGER
Other vendors are more blunt. “It’s a shakedown, pure and simple,” says one long-time supplier, who calls Kroger “a terrible partner.” No matter how justified, “The chain hasn’t taken a price increase in three years,” he adds. “They just don’t want to hear it. We continue to do business with Kroger, but I certainly don’t admire them.”
Fortunately, most of Kroger’s manufacturer partners don’t see it that way, characterizing the chain as tough but fair. And it executes better than just about anyone in the business, says one vendor, so CPGs do get what they pay for. “Its supply chain works, and it’s laser-focused on being in stock,” she says.
“Compliance with weekly promotional endcap display plans is beyond comparison to other retailers,” adds another manufacturer. “Plus, top stores average 10 to 14 frozen endcaps apiece, often twice what competitors allocate.”
UNIQUE BANNERS LEVERAGE KROGER CLOUT
Manufacturers also give Kroger props for allowing its various banners to retain their uniqueness. “No one in Chicago knows Mariano’s is owned by Kroger, and Roundy’s in Wisconsin didn’t suddenly feel like a different chain after Kroger acquired it,” explains one. “It has allowed banners in different marketplaces to keep their own identity while still leveraging its size and scale and volume.” So it’s the best of both worlds.
That said, the condition of stores under the same Kroger banner can vary widely, says Saunders. “Newer ones are pleasant to shop with lots of counters and inspiration. However, some of the older stores are in desperate need of investment and provide, at best, a very average shopping experience.”
But the assortments are solid, according to observers. Guided by 84.51 data, “Kroger offers the right balance of everyday and on-trend products,” says Bartashus. A few manufacturers groused about centralized buying and lack of autonomy at the division level, which sometimes leads to mismanagement of products with strong regional appeal. And we heard some complaints about the shift to shelf-ready packaging, which will save on labor but is less aesthetically pleasing and could lead to SKU rationalization that eliminates small brands. But for the most part, manufacturers are pleased with Kroger’s decision-making, citing a good mix between national brand and own brand products as well.
However, cautions one, “You can expect that if any branded innovation is successful in frozen or refrigerated, Kroger will copy it under private label within the first six months.”
Own brands account for a little more than 25% of Kroger’s total sales, reports Bartashus. “But long term, there is the potential for that to rise as high as 30%.” Last year, the chain’s total private label sales jumped 13.6%, surpassing $26.2 billion, while sales of the five-year-old Simple Truth natural and organic brand climbed 20% to $1 billion, aided in part by strong sales of the new Simple Truth Plant Based and Emerge Plant Based Meat collections. Meanwhile, Kroger’s expanded Home Chef meal solutions business skyrocketed almost 120% in 2020, putting it on the path to becoming a billion dollar brand as well. “The Our Brands business, if it were a stand-alone company, would rank eighth on the Fortune 500 listing of CPGs,” according to Kroger chairman and CEO Rodney McMullen.
Last year, Kroger’s 84.51 data intelligence subsidiary used shopper data to create 500 billion personalized offers to digital shoppers, generating an additional $150 million in incremental operating profits.
“Kroger’s ability to pivot into growth areas such as plant-based is impressive and helps differentiate it from rivals and improve margins,” says Saunders. In addition, “Its strong top-tier Private Selection brand underlines the chain’s expertise in food and also increased average basket values as consumers trade up to treat themselves.” However, more than one observer wondered why Kroger hasn’t yet created separate own brands for on-trend categories such as keto and paleo.
“Kroger own brands have been successful even in categories like salty snacks and frozen entrees where store brands have never been a factor,” says Stibel, who credits product quality as well as the creation of multiple tiers with solutions for all shoppers. “Everyone is a private label buyer in certain categories,” he explains. “The difference is Kroger knows what categories you already buy own brands in and how to entice you to buy them in categories where you don’t.”
To make its own brands even more attractive, Kroger recently expanded its Simple Truth Recycling Program to include all of its private label brands. Consumers simply fill a box with flexible plastic packaging, which isn’t accepted in curbside programs, and mail it to Kroger partner TerraCycle using a free pre-paid shipping label. Points for every pound sent can then be redeemed as donations to participating charitable organizations.
COMPS UP 14.1% IN 2020
So what’s next for Kroger? Well, comp store sales, excluding fuel, were up 14.1% in 2020, so the company will be hard-pressed to find any growth during the next few quarters as the industry laps year-ago numbers. And CFCs won’t break even for three years. But unlike other companies, says Stibel, Kroger won’t stop investing in its future in order to meet short-term goals. “It’s like Amazon,” he explains. “Profit isn’t always the highest priority.”
For the next year, much of Kroger’s focus will likely be online, which Saunders calls “the new battleground for grocery.” As of Feb. 2021, the retailer had the eighth highest e-commerce sales of any U.S. company, and it’s the only pure grocer to make the top 10. Pick up and delivery now reaches 98% of Kroger households, and digital sales were up 116% last year, helping the chain grow its online market share. But every other retailer out there is gunning for it, which means there’s no letting up.