For years, Wall Street, consumers and the manufacturing community have had a love-hate relationship with A&P. Once the powerhouse of US retailing with as many as 15,000 stores nationwide, the chain has had its fiscal ups and downs. Now, though, with Christian Haub at the helm, A&P looks poised for recovery.
Elsevier Food International, Vol. 5, Number 1, February 2002
Len Lewis

With fresh new management, a vast store renewal programme in progress and closer ties with the Tengelmann Group, A&P is poised for recovery and future growth. Elsevier Food International sat down with CEO Christian Haub to discuss The Tea Company's progress.

Let's talk about corporate structure. In the past there's been considerable autonomy between A&P and Tengelmann. Will this continue?

"We need to look for quick wins in order to get people excited about what can be done. You can't just mandate from the top."

"In deference to other players that have interests on both sides, A&P is still a publicly traded company with a large group of minority shareholders who have to be protected. With me as CEO here, and my brother the CEO in Europe, there's a greater closeness developing than in the past when third-party independent people ran the company.
We've both had to deal with our own turnarounds and restructuring over the past couple of years in the US and Germany. Now that we've reached a successful conclusion, we'll be working together more closely over the next few years. We have yet to look at leveraging the synergies on both sides such as product purchasing, technology, marketing and private label. There are vast opportunities."

Will we see more strategic alliances between A&P and Tengelmann?
"Definitely. A couple of weeks ago [in early December 2001] we had the first top management meeting between the two executive teams. I want these people to learn each other's business. The European team will also be coming here in February 2002 when we present the annual business plan to our board of directors. It's to build an appreciation of what our business is all about and what we're going after."

What alliances are you looking at near-term?
"We need to look for quick wins for both sides in order to get people excited about what can be done. You can't just mandate from the top.
In the past, we've picked up some ideas from each other, but never really leveraged the potential. This will be more formal because of the investment of people and capital. We have to develop a business case to look at opportunities for reducing the cost of goods. We both import products from Asia using the same suppliers. We can lower the price significantly if we double the amount we buy. In the end, it doesn't matter who negotiates as long as the benefits flow equitably to both sides. Some of the biggest wins will be in areas not transparent to the consumer - those in sourcing or technology that may have an impact on global promotions down the road."

In the end, who's got more to learn - A&P from Tengelmann or vice versa?
"It's tough to say. I expect there's much to learn on both sides. They are strong in the discount area. When the two teams met, our team gained more in that area. When it comes to the supermarket side, there are more opportunities to look at what we've accomplished. But it has to come out favourably for both sides. Only then it will work."

What's been the reaction to your recent closing of 39 stores?
"It's been positive all around, particularly from Wall Street. It was expected since we've been talking about reviewing under performing stores. This was one of the things that Beth Culligan [CEO] initiated when she came to us. The stock went up 25 per cent 10 over US$24 on that move alone. And we've been upgraded by two of the five Wall Street firms following us. Credit Suisse/First Boston has upgraded us to a 'Buy' and Merrill Lynch raised our long-term rating from 'Neutral' to a 'Buy'. "

Were these unprofitable stores?
"Yes. We felt a remedial programme would be either too expensive and would not get these stores to a level where they would ever make money again. We decided it was better to cut our losses. We have implemented remedial programmes in other stores to improve sales, profits and reduce costs."

How much of a drain were the stores?
"Once the closing programme is fully implemented, we expect the net benefit to be about 35 cents a share annually and about $15 million in EBITDA. About two-thirds of that will be achieved in 2002."

Are you selling or just closing the stores?
"We are planning to sell them to food and non food operators. It makes no difference to us as long as we reduce the liability on these stores to the minimum. But the expectation is that some stores will sell faster than others. Some may be sold shortly after they're closed. But it may take six months or a couple of years to dispose of them completely."

Would you use any of the stores for a new A&P under one of your other formats?
"That's not likely. We've done extensive research on each of these locations in terms of alternative uses or conversions to other banners. We're doing it in some stores that have future potential. We felt there was no opportunity for any of these 39 stores to be considered for other programmes. But we may reconsider if we have difficulties disposing of the real estate."

You're now down to about 700 stores. Are you finished with closing programmes at this point?
"There will always be an on-going review of all stores. We think this takes care of the under performing ones as far as we can see today. But, like any other retailer, we will continue to close smaller outdated stores in the normal course of business."

On a recent call with securities analysts, you said that less than 50 per cent of A&P stores fell into the 'under performing' category.
"We purposely did that. Everyone uses different definitions so we wanted to be vague. We define it as having stores that are not performing they way we would like. Certainly, the worst of them were losing money. But that doesn't mean all under performing stores are unprofitable money. We just don't want to get into all the details."

Of the under-50 per cent number, what percentage is improving under the remedial programme?
"The vast majority of them are improving and contributing to the overall performance we're now experiencing. In some cases, it's just a matter of improving the stock loss performance. In others, it's a matter of turning sales around, increasing labour productivity or refining merchandising."

On average, how much time does a remedial store get to turn itself around?
"In the case of the 39, we looked at them for seven or eight months and finally concluded that they weren't going to make it. Others were making substantial progress and had greater strategic importance."

Would some stores simply do better under another banner like Food Basics?
"That is an alternative and clearly a possibility. Right now, Basics is being tested in the US. A second opened in January, and I believe a third will open this spring. Then, we'll evaluate the performance of the three stores for at least six months versus the launch in Canada six years ago. It seems to be the right time for this strategy. We've segmented consumers and realised we were not even present in markets where frugal shoppers and value hunters predominate. Supermarkets in general have not penetrated many of these areas and we think there's an opportunity is for us."

Can the concept be transplanted from Canada?
"Not exactly. We've tried to use many of the same elements. But, the assortment is broader than it is in Canada because US grocery stores, in general, have broader selections. But we're using the same private label called Basics for Less. A one-store test in the US did not warrant an investment in another private label line."

How big is Basics in Canada?
"It’s up to 80 stores generating about Can$30 million a week. In US terms it's a billion-dollar business. We call it discount, but it's really limited assortment discount stores. They are typically 20,000 and 30,000 square feet with about 8,000 items. Pricing is about 15 per cent below supermarkets. It's a very simple, streamlined operation with low labour and facility costs that enable us to sell cheaper. The big difference between Basics, Aldi and Save-A-Lot (owned and franchised by Supervalu) is that fresh produce is a signature department for us and it's much more ethnically focused. Our biggest opportunity in the US is to further penetrate the Hispanic, African-American and Asian markets."

Does that mean a store-specific marketing program for each Basics unit?
"It's more in the assortment and sticking to a value proposition. We want people to know they can fulfil all their household needs in a Food Basics and for considerably less than a grocery store."

Taking Basics a step further, would you consider again trying limited assortment stores like Plus?
"This is a different era and Basics, to a large degree, is a limited assortment store - 8,000 items vs. 35,000 in a regular supermarket. I wouldn't rule out (an even smaller footprint) but we're focusing on Basics. In Ontario, about 25 per cent of the grocery business is in the discount centre. Wal-Mart is in Canada. But they have not moved as aggressively in groceries as in the US. One reason is the already strong presence of discount food operations like Loblaw and Sobey's Price Chopper format. There are over 200 discount stores in Ontario alone."

Will renegotiation of the labour contracts for Basics be a big boost to A&P's bottom line?
"Yes. But it's also about leveraging our existing infrastructure on distribution and purchasing. It's a growth vehicle that can leverage the existing infrastructure without spending money for new distribution centres."

Would you franchise Food Basics?
"We have 80 per cent of the stores franchised in Canada. We might consider it in the US We will study it closely once the concept is rolled out."

How are operating results shaping up for third quarter?
"We see improvements, but have not given any additional details yet. Earnings will be at the upper end of analysts' expectations, driven by positive comp-store sales, stronger gross margins and stricter cost control."

Are you still looking for accelerated earnings due to closings in fiscal 2002?
"So far, we've not indicated any guidance for 2002 and probably won't do that until we see how we finish the year. We still have the fourth quarter ahead of us. It's not that we don't have confidence in our ability to keep improving the business. But there's been more uncertainty in the market due to the economic environment and the events of September 11. Now, some economists see a recovery next year, but much more slowly than predicted. I don't think we'll experience growth rates that we've seen in the past until 2003. The first quarter will be a telling time for what 2002 will bring. There will be few bonuses paid and people will really be questioning their expenses. This means that variable spending for items like food will be closely scrutinised."

What can A&P do to offset the impact?
"We have spent a lot of time putting together a recession plan. Clearly, consumers will be looking for greater value on basic items. We have to make sure our pricing is as sharp as it can be on the staples. We also looked at the importance of private label - an area that consumers will be looking on more favourably. They want the same high quality brand experience but at a lower price. In our case, private label penetration has been about 12 per cent, significantly below the industry. Best in class operators are north of 20 per cent. Increasing private label penetration is the right things to do in this environment and offers an opportunity to improve our profitability. We've been able to increase our penetration by one percentage point this year - and that's with very little effort."

How are you adjusting A&Ps private label programme?
"We have a three-tier programme: a premium label under Master's Choice; a more traditional America's Choice label; and Savings Plus, a discount label, which we have not developed very well at this point. We're looked at whether it is the right tiering and the right positioning for each. We've been working on upgrading our packaging and quality. Additionally, we're looking at our approach to category management as well as a stronger marketing programme to consumers.
We have too much variety in certain categories - not just the national brands - but secondary and tertiary brands, which are real competitors to private label. We feel we can rationalise the assortment and eliminate a lot of tertiary and secondary brands and give private label a more prominent position on the shelf. With that, we'll introduce a lot of new private label items. I don't think we've kept pace with new products that have been introduced by national brand manufacturers."

Are you cutting back on national and regional brands?
"Yes. That's something we've been doing for a while already. And we may reconsider the entire third tier of private label. There are other opportunities in private label to increase penetration and improve profitability while offering consumers better value."

Will expansion take place in particular product categories?
"We're under-represented in most categories. The one in which we do very well is coffee. But Eight O'clock really isn't a private label. It's a national brand. In our stores, 50 cents out of every dollar we sell in coffee is from Eight O'clock."

Is there an aggressive marketing programme for private label?
"We're in the process of putting that together now for all divisions. We converted from banner-specific labels in the early 1990s and now have Master's Choice and America's Choice across all store banners. Actually, our Canadian business has been more successful in private label. We're in the high teens there and we know we can do better. Loblaw's for example, is in excess of 30 per cent."

Would you want to get to 30 per cent?
"I don't know. If we can get to 20 per cent, we'll assess the market and we might push it further. But we have to find the right balance."

Could you transform other labels besides Eight O'clock coffee into national brands?
"Our first priority is to do whatever we can to support our own business. I don't want anyone to be distracted with ideas about selling our brands outside the business. In the next three years, we will be too busy getting our own private label business into the right situation. Our core business is retailing."

Will there be new store growth in Fiscal 2002?
"We're not as focused on growth as we are on improving the efficiency and underlying profitability of the company. The increase will be 20-25 new stores a year. But real growth has to come organically. Our average basket size per customer is a lot smaller than best of class retailers. We can probably sell 20-30 per cent more to existing customers before we have to attract new ones. Therefore, we'll put more emphasis on remodels and keeping the existing store base in shape. New stores will be located in our core markets: New York, Ontario and Michigan. Our capital expenditure for 202 will probably be in the $250-$300 million range ¬half for remodels and half for new stores."

Which formats will see the bulk of growth?
"Waldbaum's has been a big success story for us over the last few years. We'll add two or three new stores a year, mostly in Nassau and Suffolk. A&P stores will be generally be in suburban New Jersey, although we're looking for the right opportunity in Westchester County. We have to be very careful expanding Food Emporium. We'll focus on upgrading the stores. The Bridge Market Food Emporium has been a showcase store and we're very pleased with the results. It's been generating sales increases in the 20-30 per cent range in its second year."

Are you changing the criteria for new store development?
"Actually, we've improved the new store development process to avoid making mistakes. From here forward every dollar we spend really counts and we have to make sure every project we develop is successful. We're more carefully scrutinising the way we analyse locations, consumer in those areas and the competition. It's a more fact-based approach and there's a lot more work prior to a launch to make sure we know what the competition's doing and what consumers expect. We're talking about a 20-year commitment and huge investments in dollars, equipment and inventory."

Are there changes in remodeling activity too?
"Our model says a store needs a major remodel every seven years and a minor refreshment every three or four years. A major remodel means a couple of million dollars and a refreshment is probably $250,000-$500,000. About 40 per cent of our stores were opened or remodelled in the last five years. Our goal is to drive that to 80 per cent. So there will probably be 50-75 remodelings annually over the next few years."

Does that mean a major increase in capital investment?
"It means a shift from opening 40-50 new stores a year to 20-25. But absolute spending will not increase dramatically. It will probably be $260-$270 next year and maybe into the $300 million range in fiscal 2003."

You've mentioned that A&P is below industry benchmarks. How do you plan on improving? "Category management will play an important role. We must work on having the right assortments, promotions and pricing so customers feel comfortable doing all their shopping in our store. We've improved. But we still have a lot of complaints about poor service, long lines and rude employees."

Does increasing basket size mean a move to higher margin products?
"Private label is part of the answer. The other piece is getting customers to buy more items. This means a larger and better mix than just items that being promoted that week. It means selling more fresh foods like produce and deli. We promote ten to 12 items a week. But those are the loss leaders. We have to get customers to buy centre-of-the-plate items, produce, health and beauty care and to fill prescriptions from our pharmacies. When that happens, the customer is in your store thee times a month and spending an average of $75-$100."

Part of Great Renewal project has been the search for economies of scale. What's been done so far?
"We have the supply chain business process initiative, which is geared to common systems and processes. Many were old and outdated. But that was due to the decentralised way the company operated for so many years. There are a lot of inefficiencies that must be streamlined-like taking inventory four or six times a year rather than every six weeks."

Does strategic sourcing mean a change in relationships with vendors?
"That's different than systems and processing. It focuses on all the goods and services we buy. That's where we think we have the opportunity to leverage the scale of the company chain wide to get cost savings. On the product side, we have implemented category management best practices, meaning more fact-based decisions in order to get the right products and categories and eliminating duplication in stores.
In the first year, we removed a couple of thousand items from the assortment. We have a lot more to go on items and at looking at promotions in a more fact-based way."

Does this mean a change in the relationship with vendors?
"We have not been as good as we should be in executing programs with suppliers. We didn't have the discipline and process in place to promote a specific cereal in every store on end number three. In many cases only 75 per cent of the stores had the product on that spot at the price that we agreed. We've had improvements in tactical initiatives to regain credibility with suppliers. Better execution will get us better support down the road.
Inefficient systems also make it expensive to do business with us. Matching invoices and receipts lead to a lot of disputes. We also need to work on logistics to get costs out of our system and those of our suppliers. It means taking administrative and logistics costs out, thereby lowering our cost of goods and driving the volume that will enable us to lower price points. And better gross margins will also fall to our bottom line."

Is this a matter of investing in new technology?
"Partly. But it's also a matter of sitting across the table with the right people on the manufacturing side. I've seen some progress over the last couple of years as we've focused on big manufacturers like Proctor & Gamble. Now we have a CEO, Beth Culligan, who understands the manufacturer's side. She worked there and knows what drives them."

What investments are being made in new technology?
"We have a four-year initiative that will cost upwards of $330 million. Part of that would be hardware and software, but also people and consultants to design new systems, implement them and to help our people with training. We focused on three key areas: improving store operations, merchandising and distribution. We've implemented new transportation management and warehouse management systems that are increasing productivity, giving us more accurate order fill and reducing warehouse inventory."

How many distribution centres does the chain operate?
"Twelve. But we're constantly looking at opportunities for consolidating or building -new facilities. We haven't invested a lot of money in distribution over the last 15 years. A couple of months ago, we opened a new fresh food distribution centre in Detroit for the Midwest operation. That was probably the first ground up construction in over 20 years."

What do you see as the major issues facing retailers in the US?
"Wal-Mart is the biggest driver of change in this sector and has had a tremendous impact. Meanwhile, the Neighborhood Store concept remains in a test phase and add to that all the alternative channels. Everyone is selling foods, but the pie is not growing fast enough to absorb the growth. It's a big strategic challenge for the industry."

How do you compete against Wal-Mart?
"We don't compete with them in many locations yet. We can't compete on price but we've looked at differentiating ourselves in other ways such as fresh departments and service and through our loyalty and promotional programmes with customers."

What about food safety?
"It's important and, internally in the light of terrorist scares, so is food security. Cameras monitor everything in our stores."