February 20, 2013 3:58 pm

Pet owner points to Kroger’s dilemma

As David Dillon, Kroger’s chief executive, sits talking by the cheese counter in one of his supermarkets, a man sporting a baseball cap and a bushy beard interrupts. “Are you guys working in high places with this organisation?” he says.

“Why do you ask?” replies Mr Dillon, head of the world’s fifth-biggest retailer by sales, which occupies a gap between low-cost Walmart and high-end Whole Foods, and prides itself on paying more attention to the needs of customers than investors.

Awkwardness ensues as the man complains about the price of Old Yeller dog food, seemingly debunking an earlier claim Mr Dillon made to the Financial Times that – contrary to suspicions on Wall Street – Kroger is not raising prices.

The dog food went from $16.99 to $17.99 and is now $18.29, says the man, who had told a store worker: “I’m sick and tired of being gouged.” But he then saves Mr Dillon’s blushes: “It’s a 50 pound bag compared to a 40 pound.” Kroger’s only fault had been to not make clear that the bag had got bigger.

“Customers give us some of the best ideas ever, and he was a good illustration of that,” says Mr Dillon, speaking in a rare interview at a store in Newport, Kentucky, across the Ohio river from Kroger’s headquarters in Cincinnati.

But redoing price signs for the benefit of customers costs money, and Mr Dillon wants to increase profitability too. Such is the permanent bind he faces: how to make stores better, and cut prices, while also improving margins?

The rising cost of healthcare under President Barack Obama’s landmark law will make it harder.

Many stock market investors are wary. In the past five years Walmart shares were up 38 per cent, Whole Foods has soared 122 per cent, but Kroger shares have risen by slightly more than 4 per cent.

As US inequality has risen, it is assumed that some shoppers have moved up to gourmet chains led by Whole Foods, and some have moved down to Walmart, deserting Kroger and the other listed supermarkets, Safeway and Supervalu.

Mr Dillon says that is wrong. “Lots of analysts talk about ‘The middle space is not where you want to be’. They talk about the high end and the low end and we’re left in the middle. The problem for them is that the middle is the biggest. We love that part.”

But Kroger is not confined to the middle. It also sets prices to attract people from Walmart and Whole Foods.

In the jam section, Kroger sells a product under its Private Selection brand that is made with whole fruit and cane sugar for 31 cents an ounce. Nearby, jam from its Value brand, made with grape juice and corn syrup, is less than 6 cents an ounce.

It’s not my game. My game is running a better supermarket chain and giving our shareholders a better long-term return

- David Dillon, Kroger chief executive

“We’re doing well in both of those categories and in all the stuff that’s in between,” he says. Kroger has posted 36 straight quarters of rising like-for-like sales and the only retailers with more revenue than its $90bn last year are Walmart, France’s Carrefour, Tesco of the UK and Germany’s Metro.

Other US supermarkets are doing well too, Mr Dillon adds, but most of them are privately owned – Publix, HEB, Hy-Vee and WinCo.

“If you were to pick any strategy we’ve done at Kroger over the last 10 years that I think is really important, [it is that] we have behaved more as a private company than as a public one,” he says.

Kroger does not give quarterly earnings guidance and Mr Dillon says he does not make decisions to satisfy Wall Street analysts and their short-term forecasts.

“It’s not my game. My game is running a better supermarket chain and giving our shareholders a better long-term return.”

The financial lives of his customers, however, remain tough. Very price-sensitive shoppers are growing faster than any other group, he says, and even among the rest sentiment is “fragile”.

“What’s the Congress going to do next? Or what’s going to happen with inflation next? . . . They get nervous about ‘What does that mean for me?’ and they get tentative in their behaviour.”

In 2001 Kroger realised it was losing customers having raised prices too far, so it spent the next decade cutting them. But last year it decided it had gone too far in the opposite direction. Its operating profit margin fell as low as 2.5 per cent last year, having stayed comfortably above 3 per cent from 2005 until the financial crisis.

Mr Dillon’s decision to “back off a little” on price cuts, announced last October, was interpreted by analysts as a sign that he was about to raise prices. He says that prices will keep falling, but at a more measured rate so they don’t run ahead of cost cuts wrought from “process changes”. That should yield a small margin gain.

One process change was scrapping a tradition of having night-shift employees move products to the front of depleted shelves to create neat lines of merchandise for the next morning. Kroger asked customers about it and it turned out they did not care.

“One of our favourite phrases is we want to offer things that customers are willing to pay for. If they’re not willing to pay for it, why would we offer it?” he says. The shopper with the bushy beard and an eye on dog food prices would no doubt agree.

Copyright The Financial Times Limited 2015. You may share using our article tools.
Please don't cut articles from FT.com and redistribute by email or post to the web.


Sign up for email briefings to stay up to date on topics you are interested in