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Friday April 30, 2010

Statement of Deborah L. Feinstein

On Behalf of

The Kroger Co.

Before the Federal Trade Commission

May 24, 2007

Thank you for inviting me to speak today about competition in the grocery industry. My

name is Debbie Feinstein and I’m with the law firm of Arnold & Porter LLP. I have been

counsel for Kroger for over a decade and am making these comments on their behalf.

I. Overview of Kroger

Kroger has come a long way since the opening of its first store in 1883 and, as of the end

of Fiscal Year 2006, Kroger operates 2,171 combination food and drug stores throughout the

United States under a range of banners, including Kroger, Ralphs, Dillons, Smith’s and 1"Fry’s.

Kroger operates 145 warehouse stores under the Food 4 Less and Foods Co. banners. Kroger’s business includes multi-department stores, convenience stores and supermarket fuel centers.

Kroger’s revenues last year were $66 billion with $1.1 billion in earnings.

II. America’s Changing Shopping Habits Over time, customers’ shopping habits have changed. Gone is the once a week visit to the nearby supermarket. Customers now shop for groceries 1.9 times a week on average and typically have one store for perishables and one for center store items.1

Supermarkets are losing share of the food dollars to other formats every year and the trend shows no signs of reversing.2 According to Nielsen Data, shoppers choose to visit grocery 1 Food Marketing Institute, US Grocery Shopping Trends 2007.

2 Id.

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stores 57% of the time for their purchases, while choosing to visit mass merchants 27%, drug

stores 11%, dollar stores 7%, club stores 5%, and C-stores 5% of the time.

Consumers now, more than ever, have shown a willingness to shop at multiple locations

in order to find the best prices. This new trend in shopping habits has blended the distinction

between the different store types.

III. Competitive Landscape

A. Overview

The grocery industry has always been competitive and must be, given that price is the

overriding reason consumers select a supermarket, according to a recent FMI study.

It is also a vibrant industry with new stores opening regularly and new competitors, such as Tesco, Britain’s largest grocery operator, planning to enter in the U.S. later this year.

B. Competition from Other Formats

A key competitive force constraining Kroger is the supercenters operated by Wal-Mart,

K-Mart, Target and Meijer. Indeed, a recent UBS report found that while consumers are increasing the number of trips they take to supercenters, they are decreasing the number of trips to grocery stores.3 The FTC has, for many years, recognized that supercenters are part of the product market in which Kroger competes, so I will turn to those in a minute. However, the FTC often has not recognized other formats as placing any constraint on the pricing ability of Kroger.

Because Kroger consistently monitors and vigorously competes against these other formats, I want to take a minute to explain their significance to Kroger and the industry.

a. Club Stores

3 UBS Investment Report, “Tesco’s US Entry a Watershed Event?”, dated 2/7/07.

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We understand that in some transactions, the FTC has included club stores, such as Sam’s Club, Costco or BJ’s Wholesale, in its definition of relevant markets. We believe it is appropriate in all relevant markets. Kroger sees club stores as very real competitors, and as such price checks these stores and looks to them for ideas.

b. Mass Merchandisers

Mass merchandisers, such as a traditional Target, Wal-Mart or K-Mart, are increasingly stocking food items, including refrigerated products and prepared food mixes, even when they are not operating the store as a supercenter. Mass merchants also typically stock a significant number of househood goods. Indeed, 54% of all dollars spent on laundry supplies, 25% of all dollars spent on snack items, and 20% of all dollars spent on carbonated beverages are sold at mass merchants.4 Target has plans to move to self-distribution of food items which will likely fuel even more growth of their food sales.5 Kroger views mass merchandisers as direct competitors to its stores, and believes it loses significant sales to mass merchants just for dry grocery items.6

c. Drug Stores Drug stores, such as Walgreens and CVS, are increasing the amount of food -- both shelf stable and refrigerated -- that are offered in their stores. Again, these are dollars that in years past would be spent in grocery stores, and Kroger must aggressively compete for these sales.

d. Other Formats And for an industry that has existed for hundreds of years, it is hardly stagnant. New competitors are always looking for way to take a piece of the dollars spent on food and 4 Id.

5 Citigroup Food Retail Industries Analyst Report.

6 U.S. Scan Data.

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household items. For instance, Tesco, Britain’s largest grocery store operator has plans to open a number of stores on the West Coast beginning in the 3 quarter of this year. It is believed that Tesco will bring to the U.S. their “Express” store concept, which it touts as offering customers great value, quality and fresh food close to where they live and work, and combines the convenience of a c-store with many of the typical items available in a grocery store, such as fresh produce. Tesco has three other store formats in other countries ranging in size from 10,000 sq. feet to as large as supercenters. If Tesco commits to the U.S. market, these larger formats could follow as well.

e. Kroger’s Recognition of The Impact of Other Formats

Kroger keeps a keen eye on its competition by price checking traditional supermarkets, club stores, and drug stores, and tracking the entry and expansion of these stores. Kroger uses this information to make its day to day business decisions.

Dave Dillon, Chairman and CEO of Kroger, said it best at a recent speech at the Lehman Brothers retail conference:

“As the retail food industry evolves, one certainty remains: the environment in which we operate continues to be intensely competitive, and we believe it will become even more competitive in the future . . . Kroger faces a wide variety of competition for the customer’s food dollar. In addition to traditional supermarkets and supercenters, we also compete with a variety of non-traditional formats -- including natural foods retailers, drug stores, convenience stores, dollar stores, warehouse clubs . . . even restaurants.”

IV. The Significance of Wal-Mart One of the most significant changes in the industry has been the entry, and vast and rapid expansion, of Wal-Mart into the supermarket industry. A. Wal-Mart Supercenters

1. Background Wal-Mart opened its first supercenter in Washington, Missouri in 1988. Within 10 years,it had 544 supercenters. Today it has over 1,900 supercenters nationwide and most traditional Wal-Marts constructed since 1988 have had room next to it them to expand into supercenters.

2. The Strategy Wal-Mart’s stated chief objective is to offer consumers “low, low pricing.” It can offer such pricing because its economies of scale provide it with a number of advantages. Wal-Mart keeps its costs down by securing the most favorable product pricing in the industry from vendors in exchange for extremely large orders. Wal-Mart also promotes strong and long-standing partnerships with its vendors which also provide very favorable pricing.Wal-Mart has invested in an automatic replenishment inventory management system that helps it manage inventory on the basis of need rather than demand. It also has an extensive and detailed database covering virtually every product it sells -- which was once described as being only second in size to that of the U.S. Government and only second in capacity to that of the Pentagon.7 This heavy investment in efficiency-enhancing automation, distribution and information technology systems has allowed Wal-Mart to generate high inventory turnover while maintaining low inventory levels.

Further, Wal-Mart supercenters supplant their “low, low pricing” by frequently pricing many grocery products as loss leaders to draw customers into their stores to purchase other items, particularly higher margin durable products outside of the grocery section.7 “Why Wal-Mart sings, ‘Yes, we have bananas.’” Wall Street Journal, Oct. 6, 1998; see also “Discounting Dynamo Sam Walton: Wal-Mart brought low prices to small cities, but its creator also changed the way big business is run” Time, Dec. 7, 1998. -6- Last, Wal-Mart has a major competitive advantage in that its employees are non-union, resulting in lower wage, retirement, and health care costs. This, along with Wal-Mart’s use of part-time employees to control costs, gives it significantly lower costs. 3. Wal-Mart’s Impact Once a Wal-Mart supercenter opens, grocery competition in a given market is never the same. Many operators in that area suffer sharp declines in sales and profits. To combat these declines and remain viable they must lower prices and/or take actions to help differentiate themselves. Accordingly, competitors typically offer enhanced customer service, upgraded perishables, increased variety, additional production promotions, and most importantly reduce prices further to the extent that is possible, especially on the most popular products. The mere announcement of a Wal-Mart supercenter creates an immediate discipline on grocery competition. Months before the entry of a Wal-Mart supercenter, Kroger often increases advertising, reduces prices, and/or remodels or expands stores. And it develops plans to combat the entry of Wal-Mart. 4. Other Supercenters Following Wal-Mart’s lead, both Target and K-Mart entered into the supermarket business by opening supercenters. Today, Target has 180 supercenters and K-Mart has approximately 55. Meijer also operates over 170 supercenters across the Midwest. 5. Wal-Mart Neighborhood Markets In the late 1990’s Wal-Mart began developing Wal-Mart Neighborhood Markets. This design concept focused on smaller stores, more likely to be in cities rather than suburbs, and also capitalizes on Wal-Mart’s economies of scale, extensive distribution and auto-replenishment technology, allowing these stores to offer low-low prices. Currently, there are more than 95 -7- Neighborhood Markets nationwide and Wal-Mart has plans to open 12-20 new Neighborhood Markets in the next year. V. Acquisitions A. Kroger/Fred Meyer In 1999 Kroger responded to the increasing threat of Wal-Mart by deciding to grow. By 1999, Wal-Mart operated over 500 supercenters and was growing significantly. Kroger entered into an agreement to acquire Fred Meyer’s, which at that time had approximately 800 supermarkets and multi-department stores. The transaction was almost exclusively complementary from a geographic standpoint. The overlaps occurred primarily in Phoenix and Tucson. After an extensive second request investigation, the Commission determined that divestitures were required only in a few small towns. In Phoenix and Tucson, the FTC required no remedy because Wal-Mart Supercenters were in the process of entering and expanding - something that did indeed occur. At the time of the transaction, Kroger anticipated merger-related synergies eventually totaling $225 million by year 4. In addition, it expected to continue the synergies anticipated to be realized from prior Fred Meyer transactions. Of the merger-related synergies, Kroger anticipated that $115 million would come from better purchasing of food, drugs and general merchandise The company also planned to coordinate volume purchasing of various operating supplies, capital equipment and raw materials for manufacturing. The balance of the efficiencies were to come from lower costs due to integration of production facilities, distribution, manufacturing, advertising and rationalization of various general and administrative expenses. Kroger realized those efficiencies and then some. For the combination of Fred Meyer and Kroger, it achieved aggregate synergies of $75 million by year 1, $150 million by year 2, and $225 million by year 3. It beat the combined synergy savings goals for both Kroger-Fred -8- Meyer and the on-going Fred Meyer savings from prior transactions of $260 million by fiscal 2000, $345 million by fiscal 2001 and $360 million by fiscal 2002. B. Kroger/Winn-Dixie Two years later, Kroger entered into an agreement to acquire the Dallas-Fort Worth operations of Winn-Dixie. The transaction was motivated by Kroger’s and Winn-Dixie’s historically poor performance in Dallas-Ft. Worth. Despite attempts by Kroger to cut costs and lower prices, sales at their Dallas-Ft. Worth stores still lagged behind other Kroger divisions in sales per square foot. Winn-Dixie’s efforts to improve their sales by infusing capital into their stores also failed. If this acquisition had been approved, it would have allowed Kroger to expand its store base, spread its overhead among stores and lower its prices even more. The merger would have created synergies of approximately $40 million yearly as of year three from the following sources: • Consolidation of advertising • Reducing division level administrative overhead • Consolidating warehouses and transportation • Cost savings from increased private label purchases and a reduction in overhead at Kroger’s manufacturing facilities. Kroger also projected a one-time savings of approximately $20 million from the reduction of inventory that would have occurred from the closing of Winn-Dixie’s Ft. Worth warehouse. Kroger had every reason to believe it would be able to achieve these synergies. For example, Kroger achieved $3.8 million in annual cost savings when it had merged the administrative functions of its Houston and Dallas-Ft. Worth operations. More significantly, as just described, Kroger’s synergies from its merger with Fred Meyer exceeded its projections. -9- Albertson’s, Safeway, Kroger and Wal-Mart all operated in Dallas-Ft. Worth at the time. Others such as Minyard’s, Brookshire and Whole Foods, along with a number of smaller and independent operators also competed. As if that weren’t enough competition, Wal-Mart had plans to add up to 15 supercenters, 5 Sam’s Club stores and numerous Neighborhood Markets. SuperTarget had begun construction on 5 sites in Dallas-Ft. Worth and HEB had announced plans to build stores in Dallas-Ft. Worth as well. Kroger planned to acquire 73 stores and operate virtually all of them. Kroger’s price checking evidence showed that its stores had routinely lower prices than the Winn-Dixie stores,which were also deteriorating because Winn-Dixie had stopped investing in them. Kroger planned to change those stores over to the Kroger banner, which would have meant an immediate price decline at those stores. The Commission decided to block that transaction. It defined the market as limited to Ft. Worth, deeming it separate from Dallas. It determined the market share to be in the mid-30% range after the acquisition. The press release merely said that the transaction combined thesecond and third largest players in Ft. Worth to create a “dominant” competitor. The assertion that Kroger would be dominant came despite the presence of Safeway, Albertson’s, Wal-Mart expansion, HEB entry and SuperTarget entry. We believe history has shown that blocking that transaction did not benefit consumers. Several years later, Winn-Dixie in fact went out of business, selling those stores it could. Some of them were acquired by Kroger, with the FTC’s approval. Other competitors bought a couple of stores here and a couple of stores there. Yet, many of them were never acquired, instead going dark. -10- C. Kroger/Raley’s The Commission’s investigation in Kroger/Raley’s shows the importance of recognizing changing competitive conditions. In 2002, Kroger sought to acquire Raley’s stores in Las Vegas in a transaction that was not reportable. The Commission had previously obtained a consent order requiring the divestiture of stores in Las Vegas in the Albertson’s/American Stores transaction. Raley’s entered Las Vegas by acquiring the divested stores. For that reason, the Commission staff told Kroger it would seek an injunction if Kroger did not voluntarily hold up the closing to permit it to investigate. In 1998, the parties had apparently argued that Wal-Mart was coming, but the argument was met with skepticism. By 2002, in fact, Wal-Mart had come. It had entered with 5 stores and had a share higher than Raley’s at the time of the transaction. Wal-Mart planned 5 more Supercenters and 4 Neighborhood Markets. This time, the Commission, after a brief investigation, allowed the transaction to proceed. D. Transactions Going Forward As smaller operators continue to flounder in the face of increased competition from Wal- Mart and those responding to Wal-Mart, they will want to sell. Kroger will be interested in buying stores from some of these operators to increase its size and scale. When Kroger acquires these stores, it is to operate them. Typically, it will close only a store or two, often to upgrade one of its existing stores or because it was required to buy a store that is not making money is part of a package. Kroger believes such transactions are procompetitive. They will result in efficiencies, allowing Kroger to spread advertising, marketing and promotional expenses over a greater number of stores. They will allow Kroger to bring its low prices to the stores it acquires. And -11- fundamentally such transactions will keep these stores open. The alternative in many cases is that stores will simply go dark, something that cannot be viewed as a benefit to consumers. VI. Where FTC Analysis of Transactions Could be Improved In thinking about supermarket transactions, we think the FTC should be mindful of a number of issues. First, Competitors are not just Traditional Supermarket Operators and Supercenters: Over time, the FTC has come to recognize that supercenters and, in some cases, club stores are part of the competitive set supermarkets face. We believe they should not stop there and recognize the extent to which there is a blurring of the channel distinctions, with supermarkets increasing their product range and other formats, such as mass merchants and drug stores increasing their food sales - both shelf-stable and refrigerated. Second, Competition is not just within Narrow Geographic Areas: The FTC’s case in Winn-Dixie was premised on the notion that Dallas and Fort-Worth were different markets, notwithstanding that they were in the same price zone with minor neighborhood exceptions, had the same newspaper, advertising and promotions. In other cases,the FTC has focused only on whether stores had a Wal-Mart supercenter within 3 miles,notwithstanding industry evidence that consumers travel farther to go to a Wal-Mart supercenter. We believe it is important that FTC staff consider the overall geographic area in which a supermarket operator considers its strategy and competition and not focus on overly narrow areas of competition. Third, Entry and Expansion Continue to Occur: Although a number of supermarket operators are being forced out of business, other operators are continuing to expand. Along with traditional grocery store operators, Wal-Mart -12- Supercenters, Whole Foods, Costco and Trader Joes stores are continuing to expand and enter into new markets. Even Tesco, a British retailer, is planning to enter the U.S. with new stores. Fourth, Increased Concentration Doesn’t Mean Increased Prices: We have heard some on the staff express concern that Wal-Mart has led to increased concentration in the industry, and that increased concentration leads to higher prices. True, Wal-Mart’s entry has increased concentration in some areas -- but by forcing out weak, inefficient small competitors and replacing them with low-priced Wal-Marts. That in turn has led the traditional supermarkets to become more price competitive. Concentration does not inevitably lead to higher prices. Wal-Mart’s entry and price pressures on others benefits consumers, even if the market is more concentrated looking at the measure of market shares and the number of players. The entry of Wal-Mart simply cannot be considered to have hurt consumers. Fifth, Price Increases as a Result of Acquisitions Are Counter to the Rationale of These Transactions: Transactions in this industry are being done to lower costs to enable competition, not to increase prices. In none of the Kroger transactions, including the challenged Winn-Dixie transaction, did staff point to a single document that suggested that Kroger planned to increase prices post-transaction. To the contrary, the evidence showed that Kroger’s prices were lower than that of its acquisition target and Kroger planned to reformat the acquired stores to be Kroger stores, leading to an immediate price reduction, even if not a single efficiency were realized. We urge the Commission to think hard about whether coordination could ever occur in this industry in the face of Wal-Mart and other supercenter competitors. Wal-Mart and the other supercenters have no incentive in the world to collude. If they wanted to raise prices, they would do so - and would still be below the prices of the vast majority of the market. Their incentives,-13- however, are not to do so. By keeping supermarket prices low, supercenters provide incentive for people to come into their stores to buy general merchandise at higher margins. And the rest of the industry is just trying to keep its prices as low as possible in order to compete. For the same reasons, it is difficult to imagine a situation in which a supermarket would unilaterally increase prices after an acquisition unless accompanied by increased services of value to customers. Certainly, Kroger would not increase prices in an anticompetitive fashion after a transaction. Its goal is to survive against the numerous competitive thr eats to its business. Lastly, Efficiencies are Real: Finally, I have outlined the type of efficiencies that Kroger seeks in a transaction and how it has achieved them. These are real, as demonstrated by the Fred Meyer transaction among others, and should be given substantial credit. VII. Concluding Remarks I hope my remarks today have been helpful, and I want to thank the Bureau of Economic again for allowing me to speak here today.