Supermarket Smackdown

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Top This: Wegmans and other chains know that Wal-Mart is vulnerable in prepared foods and perishables

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But perhaps Wal-Mart's greatest industry legacy will be helping supermarkets wean themselves from a slew of so-called vendor allowances, which suppliers pay to cover everything from how an item is promoted to how much shelf space it gets to how much of it is sold. These allowances have little to do with consumers and add complexity to operations. Yet the industry has relied on them for profits — instead of, say, finding and selling the stuff that shoppers really want. Grocery manufacturers, who have leaned on the allowance system to help launch new products and unload unpopular ones, were forced to shift gears because Wal-Mart forgoes all allowances and simply negotiates — famously and ferociously — for a lower total price, or dead net cost.

Since then, Albertson's and other big chains have publicly vowed to follow suit. Safeway, for instance, has gone dead net with a few vendors but admits that the evolution is slow because it takes so long to sift through years' worth of byzantine allowances in order to compute — and compare — dead net. "It's a little bit like translating some ancient scrolls that you might find in the Dead Sea that are in a language that you don't know," Burd told analysts. It's an honest — and stunning — admission that Safeway doesn't know what its true costs are.

But even with the advent of dead net cost, supermarkets will never be able to go head to head with Wal-Mart on the price of every item. "That way lies madness," as one Wall Street analyst put it. The only viable alternative is to narrow the perceived price gap by bringing down the cost of a select group of products that customers are prone to use when comparing prices. "The art is knowing which items," says Bishop, who for a fee lets clients in on the secret.

Keep Customers Loyal
The new variable in this food war is that customer loyalty is either dead or very much divided. Last year Stephen Hoch, a professor at the University of Pennsylvania's Wharton School, published a two-year study of Chicago-area shoppers that showed 73% of consumers regularly bought grocery items at two or more stores. And cherry picking isn't just a metropolitan phenomenon. In Racine, Wis., for example, special-education teacher Stacey Goetz, 26, routinely treks to Sam's Club for meat, Aldi for dairy products and a health-food store for oat flour and sugar-free waffles. In between these trips, she scours supermarket flyers for good deals.

Despite this trend, the industry is still banking on the notion of good old-fashioned customer inertia. "For consumers that are not pure price or niche driven, location is the No. 1 reason for choosing one retailer over another," says Burd. "We have hundreds of locations that retailers would refer to as Main and Main."

It's no surprise, then, that Wal-Mart isn't content to stick with giant stores on the outskirts of town. For the past five years, it has been tinkering with a smaller Neighborhood Market that is designed to penetrate urban centers and, says Burt Flickinger III, managing director of New York City's Strategic Resources Group, "occupy the empty stores of bankrupt supermarkets."

This means that even as the big chains are scrambling to compete, they all know that Wal-Mart is just getting started. "We could be so much better than we are," Wal-Mart CEO Lee Scott told TIME. "We are not as good in food as we need to be yet, so there's a lot of upside." He rattles off expansion plans for the company's Supercenters, Sam's Clubs and Neighborhood Markets and notes that even in the Wal-Marts that aren't adding perishable sections, the plan is to sell more food. In other words, the grocery wars are just beginning. "You will see it on all fronts," Scott says, "in all the things we do, food will be a key part of it."

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