Retailnet Group The Legacy Store Challange - Investing Capex

RETAILNETGROUP STRATEGY ALERT No. 11 Issue Format Innovation - The Legacy Store Challenge

September 2008

Comparable store sales is the most watched number on Wall Street. Unfortunately on its own it is a terrible indicator that masks perhaps the biggest challenge that retailer CEO's face today: that is the declining returns that they earn on their older, mature stores - those that collectively represent at least 80% of their store and inventory net investment. In the days when chains ran 200-300 stores, having 60 dogs was not a big deal. Today when there are hundreds of dogs that need serious attention, investors, vendors and the entire retail community needs to pay very close attention. RNG would advocate for retailers to begin to report sales growth in stores under 4 years old vs. those that are 4+ years old. The current reporting standards mask the need for retailers to re-balance their assets-principally inventory, stores and technology -to optimize per-store economics. While there have been many advances, the single largest hidden drag on returns is "legacy stores." We have seen some great examples of retailers who have conquered this issue, at least in part. The following summarizes some of the key learnings that we can all take away from their great leadership. It's a new consumer and retailing era - what we call "Chain Retail 3.0." This is just one of the many hot topics that retailer CEOs have to begin to take on transparently and to teach their investors and suppliers what is really going on. Its going to be a very different time. Please let me know what you think ([email protected]) Dan O'Connor President & CEO Retailnetgroup.com

How Did We Get Here? For 25 years Construction and Real Estate were among the most powerful in the large retailer organizations. They were the critical players who found the sites, managed the store prototypes, and got the stores opened. It was all about speed. Get the site, build the store and plug it into a modern distribution network - WMT, Staples, Costco, Home Depot and many others all shared this strategy. Here's what would happen - in these "greenfield" days their new stores would often open at 70% to 80% of their expected "pro-forma" sales (i.e. expected sales at maturity). And over the course of the next 2-3 years these stores would naturally ramp up to their expected potential. In many cases at WMT and Costco in particular saw these new stores would ramp up to an even higher sales level than expected in 12 years providing 40% to 50% rates of return (which means the operating profits from these buildings was returning the capital in in about 2-3 years!). The growth was compelling as new, maturing stores elevated "like for like" or "comparable store sales" when added to the comp store based after their 1st year. The

In This Issue

How Did We Get Here? What Are the Leaders Doing? Food Retail Format Innovation New Format Introduction Selective Renewal vs. Market ReLaunch Format Innovation Success Drivers

Prior Strategy Alerts Goldman Sachs Global Retailing Conference Get a quick download of RNG's thoughts after hearing and meeting with leading retailers Chain Retailing 3.0 Over the next two years, branded manufacturers and retailers will be challenged to find new ways to prosper in the fastest changing food retail environment in a generation Mature Store Activation The new new thing

reality however is that these stores were not comping - they were maturing. Over the last 5 years as markets have saturated and alternative shopping outlets increased (store and non-store) we have seen three major themes 1. The new store ramp up times have increased to 4-5 years 2. Many new stores go sideways initially - few jump up as quickly as they did 5 years ago - so the growth curve is actually a bit inverted the 1st 2-3 years At some point between age 5 and 10, most stores begin to lose shoppers, share, and sales. It is common for a big box that drew 40,000 to 50,000 households in its region to face a "household deficit" of up to 10,000 households-that is, to have just 30,000 shoppers when 40,000 had been the average.

in retail growth is old stores, and how to unlock their potential to reach new shoppers and drive wallet share with existing shoppers Social Networks Online social networking allows marketers to connect with new and existing customers and deepen the level of engagement Pricing Optimization Retailers are developing pricing as a strategic capability, which also raises several opportunities for CPG firms Private Label

As a result, as much as half of the typical chain retailer's store base aged 5 to 10 years old has flat or declining sales growth in most markets, and the effect is greater for stores aged 10 years or older. For the past decade, most retailers' strategies for driving growth in legacy stores were aimed at driving higher dollars per trip, which is sustainable as long as the consumer is liquid. In today's marketplace, the ROI challenge for management is how to "reactivate" the shoppers they've lost and recover growth in those stores.

What Are the Leaders Doing? Retailers haven't thrown in the towel on new stores but have increased discipline aournd capital spending. We see retailers 1. Focusing capex and efforts to increase sales in current stores (the focus of this article) 2. Reducing the absolute # of new stores (good in saturated markets like most of the US, Canada, UK, major cities in Lat Am, etc.) 3. Reducing the size of their new store prototypes (some divergence here - WMT getting smaller while Target is increasing) 4. Taking a much more disciplined approach to real estate choices with a focus on "growth markets" WMT for example has indicated it is viewing its property in the context of its alignment with overall growth strategy as well as returns (ROA).

Strategic store brand programs are a significant growth strategy for retail leaders Express Stores Convenience food retailing is changing globally as consumers express their preference for healthy, fresh, and ready to go (or consume) foods Health Services Explore how retailers are trying to re-organize the way that health and wellness services are provided Mobile Retailing How mobile based

commerce and marketing strategies are being utilized by retailers worldwide

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Source: Wal-Mart company presentation

Source: Wal-Mart company presentation We have focused intently on the leaders efforts with existing stores. We see five major strategies here 1. Existing Store Rationalization - There are essentially five rationalization strategies retailers can pursue: · Close - self explanatory. At any given time some 5% of a national chains stores should be closed. · Remodel - often a real updating (not the traditional "splash & dash") will have a significant impact. · Remodel and expand - a favorite of many leaders - Costco for example finds that this is its winning'est strategy - take a great location and make it even bigger · Re-locate - necessary when traffic patterns or other factor reduces a locations overall traffic flow. When moving the retailer is trying to retain as much of the existing shopper base as it can · Re-format and banner - a few significant retailers have made the extremely

Dan W. O'Connor is the President & CEO of the RetailNet Group. He also is the Founder of Management Ventures, Inc. (MVI), a WPP Group company. Dan is a widely known industry speaker and thought leader. LinkedIn | Email

Aaron Chio is a Senior Analyst leading RNG's development of new research, insights and growth strategies in Latin America. LinkedIn | MSN |

mature decision that some % of its existing store base was no longer relevant as it once was and have re-bannered and re-positioned the box to meet a different consumer or trip. Food Lion in the US was a great example of this. Interestingly, the ROI on each strategy varies by retailer. Costco, for example, tends to get the highest payback from remodeling and expanding, while others get highest from re-models and/or relocation. Wal-Mart's ROI on Discount-to-Supercenter conversions is tremendous. 2. Re-prototyping existing stores to the latest designs - This is expensive as it requires stores to be closed during what is often a major re-model. Given that most large retailers formally re-launch new prototypes every 4 to 7 years. As part of this cycle RNG sees leaders carefully re-designing their boxes to incorporate the latest green, experiential selling, drive throughs, site and store departments and other useful upgrades. Of these the leaders are making the biggest deal out of their green movement.

Tim O'Connor is Vice President at RNG, currently responsible for RNG's Growth Strategies Curriculum and European market insights. LinkedIn |

For retailers LEED certification is just a part of the overall strategy. Companies like Carrefour have given deep consideration to re-positioning its buildings as the "most socially responsible" in the market. Keith Anderson is a Senior Analyst and responsible for RNG's North American research practice and transformational capabilities curriculum. LinkedIn | Twitter | Windows Live Messenger

Source: Carrefour.com Target stores for example has introduced its P2009 and S2009 (The P2009 is a general-merchandise store while the S2009 is a new SuperTarget format). The 1st P2009 and S2009 prototype stores were launched on February 12, 2008 and expected to open in October. They have a number of distinguishing factors. Each is LEEDcertified and larger than existing Target stores, with more space for food and electronics, The general-merchandise stores will measure 132,400 sq. ft., about 6,000 sq. ft. larger than the current model, while the new SuperTarget stores will be about 12,000 sq. ft. larger than existing locations, coming in at 186,000 sq. ft.

Source: Target company presentation · The new formats will both have more room for food, especially Target's privatelabel brands, and the SuperTarget stores will have more space for pre-prepared food. · The new stores will also feature expanded electronics departments to carry more products and selection. · Design features include updated facades of brick and stone, · Many environmentally friendly elements, such as low-flow fixtures to reduce water usage by 30 percent; HVAC systems that reduce energy usage 30 percent more than required by most cities; and light fixtures that require two less bulbs. · As part of the construction process, 75 percent of construction waste will be recycled or salvaged and more than 55 percent of construction materials will be manufactured using raw materials from within 500 miles of the project site. · Both prototypes are being developed as part of the U.S. Green Building Council's Portfolio program. "That means we can do not just one store, but a bundle of stores under this Portfolio program. So re-prototyping stores while making them "greener" is clearly part of today's capex rationalization strategy.

Food Retail Format Innovation For Food retailers re-prototyping can mean something entirely different. The enw format is often the gateway to an entirely new food strategy. We see lots of innovation in the new food oriented formats. A recent new store from Whole Foods for example included: · Dine-in Market Bistro, offering made-to-order foods including sandwiches, soups, salads, flat bread pizzas, and light entrees · An Asian Express Island offering hot teriyaki noodle bowls and made-on-site sushi, · The Fresh and Wild station, a full-service coffee bar featuring Whole Foods Market's own Allegro® coffee, · A Sausage grill with a variety of sausage sandwiches, and even fresh, hot pretzels. - free wireless internet access and over 116 seats for inside or outside dining · Prepared Foods * Hot and cold bars featuring world cuisine selections * Chef's case offering take-home salads, entrees and sides by the pound * Carvery and salad

toss station * Pizza made on site in stone hearth oven * Extensive rotisserie selections * Salad and soup bars * Made-to-order sandwiches * Pre-pack selection for grab-andgo options · Produce * Bins of hand-stacked fruits and vegetables, much of which are organic, with local growers well represented * In-house cut fruit and handmade salsas * Full line of local, exotic and staple Asian items like Thai papayas, sui choy, yua choy sum, shinseki pears, gai lan, moqua and banana flowers · Ready to go foods - "shortcut chef kits" for families on-the-go such as stir fry, fajita, and pasta sauce kits * · Expanded Meat * Widest selection of the freshest, highest quality meat raised to the strictest standards in the industry * Made-in-house oven-ready items for the grill or oven * Great selection of organic items, including beef, pork, chicken and turkey * Wide selections of smoked and cooked products made with no nitrites or nitrates * Over 20 types of handmade sausage * Tender dry-aged beef, dry-aged in the store the old-fashioned way · Seafood * Local fresh catches, along with a wide selection of both fresh and frozen varieties * Grab-and-go, Bistro Fresh oven-ready items such as taco tilapia, garlic salmon and shrimp cacciatore * Fresh seafood ceviche and marinated salads * Selection of live shellfish and whole fish * All sizes of shrimp and prawns, preskewered and seasoned * Large selection of locally smoked items · Specialty * Over 700 wines available, Over 250 hand crafted ales, lagers, and ciders. Over 400 artisan and everyday cheeses, olive/antipasti bar, chocolates and confectionary . Featured Cheeses from World-renown Affineurs-Herve Mons, Pascal Beillevaire, Neal's Yard Dairy, and Luigi Guffanti. Specialty spices, peppers, and sea salts from around the globe

New Format Introduction New format introduction - while these do not necessarily improve the existing store performance they often can help "stop the bleeding" by focusing on either different markets, shoppers or trips. The great majority of large scale retailers are persistently pursuing this strategy as the following shows. The fastest growing new formats could be characterized as 'specialty" and "in-fill" formats - that is formats that are highly targeted to a consumer or category of merchandise. By in-fill we simply mean formats like Express stores that are located more conveniently to the consumer. Fresh & Easy from Tesco is a great example here in the US.

Selective Renewal vs. Market Re-Launch When selecting stores for more complete renovation, most retailers prioritize stores based on volume. If a retailer operates in three different markets, it might selectively renovate its highest-potential store in each market. Several years ago, Food Lion pioneered an alternative strategy, which it called "Market Renewal."

Source: Retailnetgroup.com Food Lion's strategy is to re-launch all of the stores in a single market at once, leveraging marketing expenses and ensuring a consistent shopping experience and brand.

Format Innovation - Success Drivers RNG believes that the most successful legacy activation strategies · Reestablish a store or chain's positioning on the value/differentiation continuum in its market-e.g. as a price leader or a full-service shop-and clearly and consistently communicate that positioning · Target specific shopper segments and shopping occasions · Reallocate space based on a sound department/category portfolio management strategy · Enhance the store's ergonomics-improve sightlines, eliminate redundant SKUs to facilitate choice, enhance navigability, etc.

RetailNet Group is the leading insight and advisory firm focused on retail growth strategies and consumer-facing transformational capabilities. We are deeply experienced retail/consumer analysts and strategists working exclusively to help brand-led businesses and large-scale retailers grow. Sincerely, RetailNet Group Note: Articles contained in this newsletter are collected from a variety of sources and links can expire over time.

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