A Pyrrhic Victory?

Wal-Mart stores and Costco Wholesale are disrupting markets again. The market they are disrupting today is the grocery industry. In truth, they have been disrupting the grocery industry for the last several years, to the point that Wal-Mart is now the largest grocery store company in the country. These two competitors drain their competition of their life blood by using low prices. The recession, along with the pressure applied by Wal-Mart and Costco, has reduced the consumer pricing index for food by nearly 3% over the last year.

So, what is an industry leader to do when faced with the Wal-Mart challenge? Kroger answered right away. The company reduced its prices along with those of Wal-Mart. (See “Audio Tip #180: The Real Low-Cost Competitor” on StrategyStreet.com.) The result is that Kroger expanded its market share. This growth in market share came at the expense of other industry leaders, such as Safeway and Supervalu, who did not cut their prices as deeply. (See the Symptom & Implication “As large competitors match low prices, other competitors face difficulties” on StrategyStreet.com.)

There is a rub, of course. Kroger’s margins declined in the face of the price deflation. Predictably, Wall Street pummeled Kroger’s stock.

Wall Street is wrong here. In the long term, the increase in Kroger’s size will enable it to reduce its cost structure compared to that of its smaller rivals. The easiest way to reduce a cost structure is when the company’s sales aren’t growing and you can find opportunities to improve the productivity of the cost structure by increasing efficiency and effectiveness. (See “Audio Tip #196: Why Economies of Scale Exist” on StrategyStreet.com.) It is much harder to reduce costs when the business is shrinking. In a shrinking business, company morale tends to be bad and companies almost inevitably cut muscle as well as fat.

A growing business will also allow Kroger to fine tune its value proposition in the face of the Wal-Mart price challenge. The customer buys Function, Reliability and Convenience before Price. Kroger’s ability to tailor its offerings for a broad swath of customers, and its local presence, are powerful advantages, even in the face of a competitor with lower prices. (See “Video #56: Design to Value as an Approach to Cost Management” on StrategyStreet.com.) Kroger is right.

Couponing and Price Leaders

In the bleak economy in the first half of 2009, coupon redemption rose 19% compared to the same period in 2008. Even the largest Price Leaders (see Audio Tip #83: Price Leader Products and Companies on StrategyStreet.com) have had to go along with this development. The three largest discount clubs, Costco Warehouse, Sam’s Club and BJ’s Wholesale Club have increased their couponing to club members. (See Audio Tip #120: Using Low Price to Gain Share in Hostile Markets.)

Each of these three clubs carries a membership fee to join the retailer. These club membership payments entitle the retail shopper to take advantage of the large scale purchase economies each of these stores enjoys. The stores pass on these purchasing economies in the form of low prices for their members. Often these low prices alone are enough to provide these club-oriented retailers with attractive sales growth. However, even they have suffered in the bad economy of 2009 as consumers have spent less on discretionary items.

Now each chain is offering tailored coupons to selected members. Sam’s Club offers electronic coupons through kiosks at its stores. Today these coupons are offered to its highest paying membership categories, the Advantage and Business Plus cardholders. With the new coupon program, these selected members will receive three new coupons, good for about a month.

BJ’s has traditionally accepted manufacturers’ coupons which Sam’s does not accept. In the last few years, it has also provided members with coupons available at its web site for purchases in its stores.

Costco has been offering once-a-year coupon books, containing discounts with expiration dates staggered throughout the year. This keeps customers coming back to take advantage of the discounts. About a year ago, it began sending monthly coupon books with discounts expiring after four weeks.

In a tough market, even the lowest-priced of the Price Leaders have to offer something extra to keep the customers coming in.

A coupon is a form of discount (see Audio Tip #114: The Key Components of a Price on StrategyStreet.com), the method a company uses to convey a discount to a customer. Our research has determined that there are eight other forms of discount. Many of these forms reduce the cost of the discount to the company, while giving the full value of the discount to the customer.