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Chronicling Kroger’s Reinvention

WGB's August 2018 cover story tracks the progress of how The Kroger Co. is getting a little help from its friends via investments in strategic partnerships.
Serge Seidlitz

When Kroger Co. announced its Restock initiative last year, the big company didn’t lack for lofty goals— “to serve America though food inspiration and uplift,” was how CEO Rodney McMullen put it—nor for the hefty price it would pay to achieve them.

At the kickoff presentation at the retailer’s Cincinnati headquarters, McMullen and his team explained how the company would invest nearly $1 billion over three years to help regain the pace that for a dozen years produced remarkably consistent and industry-leading performance, only to have it ground to a near-halt upon a combination of calamitous conditions, sharpening competition and a rapidly changing consumer that had outdated its venerable “Customer 1st” strategy.

The ambitions of the Restock plan, McMullen said, were to be built upon four pillars, one of which had a decidedly dull description—“Partner for Customer Value”—that stood out for its relative vagueness and passivity beside its three easier-to-grasp, action-oriented elements of the Restock initiative: Live Our Purpose; Develop Talent; and Redefine the Customer Experience.

While the company has taken action in all of those arenas since the plan began late last year, observers say Kroger’s investments in partnerships may have the best chance at changing the trajectory of the industry. Moreover, the partnerships illustrate how business itself is bending to conform to a world rapidly transformed by technology; in effect, businesses like Kroger are moving to become networks in and of themselves.

“We live in a networked world,” says Andrew Wolf, a financial analyst covering Kroger with Loop Capital in Chicago. “Once you get to the abstract, and really think about what’s going on, what the internet does in a big way is create networks. You go to a website, and you get better networks and better information. So in a networked world, where everything is connected, it only makes sense to test partnering up.

“In a practical sense,” he continues, “partnerships also make sense, because you can’t go around throwing money after every good idea.” Hot on the trail of a cost-efficient “network” designed to transform the role grocery stores will play in this new world, Kroger, which may be only just getting started, has generated headline after headline this year, choosing partners with whom to connect, such as:

  • An alliance with British e-commerce company Ocado to bring to the U.S. the technology underpinnings of the Ocado Smart Platform, which includes online ordering, automated fulfillment and home delivery capabilities.
  • An agreement with noted fashion designer Joe Mimran to launch an exclusive apparel line to be available at select stores later this year. A deal with a Silicon Valley robotics company called Nuro to pilot an on-road driverless vehicle designed to make grocery home deliveries later this year.
  • A merger with Chicago-based Home Chef to take over and expand Kroger’s nascent meal-kit program in stores and online.
  • An expansion of its Scan, Bag and Go shopping program to as many as 400 stores this year.

 

Kroger’s partnership model in some ways is ripped out of the pages of the technology world that has so disrupted grocery, says Diana Sheehan, director with London-based Kantar Retail’s grocery channel research team.

“Basically, how so many software, technology and logistics companies make their money today is in creating unique IP (intellectual property) and then, through partnerships, expanding their reach,” she says.

Kroger is now doing this quite literally: As part of Restock, it has set up a subsidiary, Sunrise Technologies LLC, that is pursuing alternative revenue streams through licensing of its proprietary technologies such as its Kroger Edge digital shelf-tag program and Zigbee router. Seen another way, Kroger’s IP could also be its concentration of stores and geographic locations; its store traffic; shopper data; fresh merchandising skills; management and employees; and so on. Teaming those with the skills and capabilities of its new partners will build the new Kroger.

Not all industry observers WGB spoke with for this piece agree on how successful the Restock initiative will ultimately be. Some argue the competitive environment is deteriorating under the strain of price competition and slackening demand, while the cost of doing omnichannel business in the face of competition from Amazon and Walmart could rise beyond what even a scaled giant like Kroger can absorb while preserving profits. Others are circumspect over grocery e-commerce in general and say Kroger might be better served pursuing other priorities, while other onlookers argue the initiatives may not go far enough. (Kroger officials were unavailable for comment.)

However, what all industry watchers agree on is the general idea that the time had come for a new approach from Kroger. Or, as McMullen put it while revealing the Restock initiative: “What got us here won’t get us where we need to be.”

Bring On the Sheds

Years of speculation as to where Ocado would make a stateside landing ended when Kroger in May announced an exclusive deal:

The retailer would partner with the innovative British retailer to build as many as 20 fulfillment centers that use proprietary picking and delivery technologies, which Ocado officials boast can provide cost-effective and profitable online grocery at a cost to consumers of about $2 per order. While some details of the rollout are not yet known, the partnership calls for Kroger to take a small equity stake in Ocado. It said three locations for the company’s “sheds” would be revealed this year. This, sources say, could prove prescient given continued uncertainty over exactly how much grocery sales will ultimately go to online channels.

“Kroger’s decision to tiptoe into the field of true consumables e-commerce, with an option to jump in if the market proves out, seems wise strategically from a capital deployment standpoint,” Scott Mushkin, an analyst with New York-based Wolfe Research, wrote in a recent note to clients. “It is very unclear from our research what model or models will ultimately win out in the U.S., so a measured approach seems appropriate.”

Neil Stern, senior partner with Chicago-based McMillan Doolittle, believes “there are three options companies can take: build, borrow or buy. I think Kroger is looking more to the partnership model to accelerate their timelines with companies which are already leaders in an area. It also allows them to hedge their bets a bit versus a straightforward acquisition,” Stern says.

U.K. native David Rogers of Northbrook, Ill.-based DSR Marketing Systems describes Ocado as a “conservative” successor to the ill-fated Webvan model that flamed out nearly 20 years ago in the U.S. Rogers suspects the Kroger partnership would resemble the deal Ocado made with U.K. grocer Morrisons, whereby Morrisons funded much of the joint venture’s infrastructure.

“In my opinion, the Kroger-Ocado relationship is an expensive test of the future potential of internet-based home delivery—to keep Kroger in touch with a technology that is being led by Amazon and Walmart,” Rogers says. “It provides an extra upgraded service to those Kroger customers who need and/or can afford it, which, if well-executed, could gain market share for Kroger from the quality and service operators in its markets.”

Like other large e-commerce companies, Ocado has struggled to achieve or maintain profitability, especially as it embarks upon an expansion that includes Kroger as well as retailers in Canada, France and Sweden and will grow the company from the four warehouses it operates today to dozens. Reported sales of nearly $2 billion last year account for about 1.2% of the overall U.K. grocery market, Rogers says.

That said, Ocado’s proprietary technologies are so well-regarded—and its service levels so well-performing and innovative—that it has forced competitors to reassess their own approach to e-commerce, says Steve Dresser of North Yorkshire, U.K.-based Grocery Insight. “They are constantly top for customer metrics; customers are fiercely loyal [and] they do ever so well in London,” Dresser says.

“They will offer a very good service for Kroger with industry-leading tech,” Dresser says. “Their picking centers are the best of breed.”

While some have expressed concerns about whether Ocado’s model can successfully port into a country with vastly different geographic characteristics than dense London, there’s also been no indication that the partnership couldn’t help Kroger reach such markets themselves in the U.S., in which case the partnership could prove to be a new means of geographic expansion. Asked by an analyst about that in a recent earnings call, McMullen said Kroger’s goal with Ocado was to reach a “flexible” solution that can support e-commerce “whether it’s 5% of share or 30% of share.”

Not all observers are expecting so much.

Kurt Jetta, whose firm Tabs Analytics, Shelton, Conn., has conducted studies indicating the online opportunity in grocery has been overblown, is skeptical, saying Kroger’s partnerships “misdiagnose” the e-commerce challenge. “It’s not a supply efficiency problem; it’s a demand problem,” Jetta says.

“Preoccupation with working out these deals gets them further away from figuring out why e-commerce grocery still has trouble attracting shoppers and keeping them once they get them.”

The partnership with Nuro, in the meantime, will offer Kroger a chance to test one method of addressing high costs of the “last mile” for delivery. Some skeptics—industry consultant Brittain Ladd, for one—are already asking how Kroger and Nuro intend to solve the “last 60 feet” problem of delivery, but that might overlook the reputational value Kroger may gain for getting in front of an emerging technology, as Amazon did with its cashierless Amazon Go store and Walmart is seeking from its text-based shopping app Jetblack. None of them are likely to have huge influences on grocery right away.

“Nuro is something of a moon shot,” says Stern of McMillan Doolittle, “but it shows they are thinking of the future.”

Fix Stores, Take Share

Whatever aspirations for online sales Restock envisions, the plan is also considering the effect that online expansion can and will have on stores. Partnerships can help here as well.

“The biggest issue I see for Kroger is that if online takes sales away from stores, your stores are going to have to do something else,” says Wolf of Loop Capital. “If 10% of your stuff is now being sold online, your store has to be 10% smaller. You have to respond to that reality.”

Kroger’s initiatives in this regard include a plan to optimize space in stores, primarily through expanding the use of proprietary customer data to even more parts of its business. The company plans to reset up to 30% of its stores this year, with an eye toward expanding space devoted to high-performing categories such as pets, fresh food, prepared foods and natural/organic and reeling back selections in about a quarter of all categories in the store, officials say.

This is also where the newly announced meal-kit and apparel partnerships can come into play. The apparel deal with Mimran calls for the creation of a line of casual and affordable clothing known as Dip, scheduled to roll out to about 400 Kroger Marketplace and Fred Meyer stores this year. Dip will replace up to a dozen current Kroger private labels and appears to be taking cues from Kroger’s private food brands, specifically its Simple Truth brand emphasizing freshness and simplicity. Mimran joins Kroger having proven the concept of a grocery-aligned clothing brand could work: A dozen years ago, he was behind Loblaw’s Joe Fresh brand, which the Canadian chain developed as it prepped to take on more supercenter competition.

“What we are finding right now is that good grocers are expanding as they lose traditional trip-driving categories,” Sheehan says. “Smart, innovative retailers are looking to general merchandise as a way to make up those trips.”

Apparel may also provide Kroger with the kind of nonperishable, higher-margin items that build more profitable delivery baskets.

Similarly, Kroger is looking at the Home Chef acquisition to expand its offering of convenient meal kits in stores and online. Financial terms called for an initial price of $200 million for the company, but the price could climb by about $500 million based on what the company said were “significant growth” targets for the category.

Where to Next?

Kroger’s last major strategic undertaking, which pioneered data analytics in the U.S. as a means of driving sales, share and customer loyalty through the commercial partnership with dunnhumby and its 84.51 successor, had something of an ally in a fresh-deficient and underinvested Walmart.

That’s no longer the case today: Walmart, spooked by Amazon for world domination, hounded in price by expanding discounters and racing to improve fresh, has also invested millions in its own reinvention. Some analysts suspect the ongoing arms race between Walmart and Amazon—shelling out billions for investments in China and India, for example—could eventually force them to reduce emphasis on the U.S., but that’s a hard thing for Kroger to count on. Strong regional players—H-E-B and Publix, primarily—also tend to a local appeal that can overwhelm scale advantages: Sheehan of Kantar Retail believes Kroger still needs to address the issue of “personalization vs. localization.”

But Restock also acknowledges Kroger’s competitive set has widened beyond supermarkets and may provide its next big opportunity.

Company officials have said for some time that food retail’s shrinking “share of stomach” relative to foodservice indicates there’s more opportunity for Kroger to gain share from the latter than from the former. The company is already dabbling in restaurant operations; it opened a “new American comfort food” restaurant called Kitchen 1883 last year and is prepping a second location. Analysts studying the Restock initiative acknowledge additional restaurant partnerships would hardly be out of the question.

“Walmart getting better was a push. Amazon getting into grocery was a push. But one of the biggest drivers in moving to Restock was the channel blurring—not just from e-commerce, but the shift of consumers spending more on food away from home than food at home for the first time in decades,” Sheehan says. “Kroger had great competition, both local and national, but it was also the unexpected competition from foodservice that got them really asking ‘Who am I?’”

For Kroger, “redefining the customer experience” has come with an effort to more closely align its “network” behind the idea of food as content. McMullen often refers to the company—and its shoppers—as “foodies,” and many of the layout changes in stores, and accompanying messaging to consumers, highlight options along the “What’s for dinner?” spectrum.

“Kroger’s strengths are risk-taking and the ability to embrace an uncertain future, as their latest moves suggest,” Stern says. “Its weaknesses are that they are still big and predicable from a shopper standpoint.

“They understand that winning in the future won’t just be about being the best supermarket chain,” he says. “They are going to need to be the best retailer.”

 

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