June 15, 2017 was a bad day for Kroger.
America’s largest supermarket chain losing its fight against Amazon, Walmart and other competitors,
slashed its guidance sending shares down 19%. After listening to today’s conference call,
one can only conclude that supermarkets are now in one gigantic race to the bottom and no one
will come out unscathed, perhaps least of all Kroger. But as bad as that day was, June 16 was much much worse. Amazon announced its acquisition of Whole Foods.
The news white roughly $40 billion off the market cap of the retail food industry. Amazon to buy Whole Foods.
You know, yesterday was a day for Kroger that was tough. Today, will be an even
tougher day. This is a game changer. This is it. This is what everybody thought
that happened. They will now dominate the food within the next two years. Wow! Suddenly, the world had changed for the more than a century year old grocer. Kroger’s origins date back to 1883, when Barney Kroger
opened a grocery store on 66 Pearl Street in Downtown Cincinnati. The store, then called the Great Western Tea Company, began
Kroger Grocery and Baking in 1902. Kroger quickly established himself as the first grocer to
offer in-house bakeries and meat departments. It saved money by making its own goods, like bread and sauerkraut
rather than buying it from third parties. The chain grew slowly but surely over the next two
decades. 40 stores in 1902. 157 stores in 1912. In 1917, Kroger bought four
chains in Detroit comprising 125 stores. Deal-making would go on to be a hallmark of the retailer’s existence.
Kroger’s acquisitions revved up even further when Mr. Kroger stepped down as
president in 1928 and was replaced by William H. Albers.
From the spring of that year through the next 16 months, Kroger bought 28 chains and 1,838 stores including Piggly Wiggly. It was fueled
with capital from Kroger’s ballooning share price.The deals free bought Kroger’s footprint up from roughly 5,600, growing it by more
than a third in just two years. Kroger also learned, after some stumbles,
the important art of moving slowly in integrating its acquisitions: allowing
grocers to maintain their identity by keeping management teams in place.
Through acquisitions over the next few decades Kroger moved into California, Texas, and
Charlotte. By the 1980s, it was the country’s second largest grocer. But the
1980s brought a new competitor and a new game plan. Walmart opened its first Super Center combining its discount stores and grocery in 1988. Creating a powerful new rival that combined Walmart’s cheap prices with the convenience of a grocery shop.
This new competition was particularly difficult for grocery giants like Kroger,
which in 1988 had 1,300 supermarkets in 20 states and 935 convenience stores. Its
size, once a strength, limited its ability to react quickly. I would say that Kroger
came through Walmart pretty well compared to many of its competitors. It
really understood that the economies of scale within the supermarket business
are not so much being big nationally. But being big locally. and if you’ve got a 40%
or 50% share of a local market, you can defend that pretty well. The
grocery industry wobbled. Their stock prices fell and private equity buyers
pounced. In 1986, the country’s then largest
grocer, Safeway, fell prey to private equity firm , Kohlberg, Kravis, Roberts & Co.
The deal made Kroger the country’s largest grocer as Safeway began to downsize. It also made Kroger KKR’s next target. KKR launched a bid for Kroger in 1988 but the grocer that built itself up through acquisitions was unwilling to
let itself become bait. Kroger rebuffed KKR’s offer with the restructuring
program that promised a special dividend of $48 a share which the grocer would
need to fund by loading on debt. The rebuttal ensured Kroger’s freedom. Now it
had to prove itself worthy. Over the next decade, it poured money into we doing it
stores. It invested in its store brands, growing its private label
brand Simple Truths to a billion dollars in 2014. It battled Walmart by not just focusing on
price, but also on product and service. All the while, it continued to gobble up competitors, including its $13 billion acquisition of Fred Meyer in 1999. The strategy worked. Kroger enjoyed 52 consecutive quarters of same store sales growth into the 2000s. Until, once again, its competitors
got better and stronger. In 2017, Kroger’s growth streak ended. Consumer
tastes had changed. People now preferred organic and natural food. Grocers like
Whole Foods had popped up, catering to that need. As a result, the competition
had to get better. Walmart began to make its stores nicer and stock them with
higher quality merchandise. The same went for Publix Supermarkets, Ahold Delhaize
and Sprouts Farmer Markets. European discount stores, Aldi and Lidl, threatened
expansion into the U.S. offering a new competitor who could fight on price
alone. Then, Amazon came along with the knife Amazon’s acquisition of Whole Foods upended the
grocery industry and changed the game. Amazon brought with it the threat of a powerful membership program in Prime, technology and automation to pair a Whole Food’s
store base and an investor set that didn’t bat an eye at investing at the
expensive profit. The deal sent a jolt through the grocery industry. It compelled
already powerful players like Wal-Mart to fuel even more resources into
technology and delivery. 70% of shoppers will be buying some portion of their groceries online within five to seven years, according to Nielsen. That equates to a $100 billion in total sales. Wal-Mart is re-outfitting fitting its
stores to support grocery delivery and racing to bring it to 1,600
locations by the end of fiscal 2020. Retailers like Target, which
struggled with its grocery business, have been forced to quickly make bets. Target
paid $550 million to buy same-day delivery service Shipt in
2017. I think everybody in the business is threatened by serious
changes in consumers preferences and the retailers really don’t know how to deal with this.
So it’s not just a question of Amazon and Wal-Mart being its biggest threats.
There are home delivery services that are significant threats to Kroger
because people are choosing to have dinner delivered rather than making
dinner themselves. Those changes are forcing Kroger to shift course. Buying more
stores won’t help it adapt. Instead, Kroger has begun to furiously invest in
technology. It bought meal kit company Home Chef and a stake and British online
supermarket, Ocado. It launched grocery delivery service Kroger Ship and
struck a partnership with driverless car company, Nero. It inked a partnership with
Walgreens in the U.S. and Alibaba in China. Some of these investments appear to have born results.
It’s digital sales grew more than sixty percent in the third
quarter of 2018. But that growth came at a cost. Its profit fell 20%.
Whether the sacrifice was worth it is yet to be seen. While investors wait, Walmart and Amazon are pouring their own money into winning
the grocery game. Barney Kroger’s vision to make his own
products and offer more in his stores helped fuel the grocer for the past
century and a half. Whether that legacy can match the titans
from Seattle and Bentonville is yet to be seen.