The Branded Pantry

I was struck by some of the financial news regarding big retail in the last 7 days. At Supervalu analyst Scott Mushkin of Banc of America Securities reportedly changed his rating of Supervalu’s stock from “sell” to “neutral,” and urged the company to respond to “contracting earnings, eroding margins and higher capital expenditures” by selling off its distribution business“Supervalu could divest non-core assets such as distribution (we believe worth about $10/share) and use the capital to accelerate remodel activity and subsidize lower prices,” Mushkin wrote in a note. “While current market conditions may make this more difficult, such a move by management could yield significant upside.”At the same time Edward Lempert, Chairman of Sears Holding the company that owns Sears and K-Mart, announced that he was reversing a decision that he had made two years earlier to centralize and combine the power of the brands. He will now break the brands into physical retail outlets by banner, online banners, and consumer brand banners such as Kenmore. The rationale is that the rejuvination of the brands has never occured, the share price is in the toilet despite massive buy-back efforts and so its time to break the assets up, and see what can be salvaged. Not the best real-estate market to try and tap that asset, but..Sears and K-Mart were facing a tough future made tougher by stronger competitors at every turn, by unclear positioning against every form of competition, against old-increasingly irrelevant facilities, against online (althought they had some interesting online properties) and against ongoing strategy and staffing revisions that left an increasingly mediocre store service crew facing a dimishing audience.

The food distribution business has become more consolidated over the years with distributors cycling through periods of owning actual stores in addition to their distribution network and divesting themselves of those stores. It tends to be low margin, and the innovation that has been brought to the industry from a technology and business model basis tends to be transparant so that if SUPERVALU does something that works and lowers costs, C&S does the same, providing they can afford the price of entry. Over time the smaller guys, become more specialized or live on thinner pieces of the distribution pie. At the same time the small chains and independent grocers which have been the heart of the Independent distributors business, are becoming more and more squeezed out by big chains and other outlets.

Both scenerios are tough. It is clear that some of the same “easy” fixes were available to each ownership/managment team. Both could consolidate with competitors (and did), eliminate redundancy (did that), cut underperforming assets and stores (yep), harmonize systems and gain efficiencies in procurement (sure), centralize some functions to improve performance and cut costs (absolutley). Both companies have done this or are still doing it.

In Lemperts case he reaped the benefits of his consolidation moves in terms of stock price…for a while. Then the market, and one suspects the team, figured out there was no real ongoing innovation in marketing, merchandising, customer service, technology or any place else that would reverse that pesky same store sales decline, indicating that the customer did not approve. Unless that team could come up with additional big retailers with whom to consolidate, the writting was on the wall before the ink on the origional deal was dry. The consolidate-cost/reduce cycle only works as long as there are viable consolidation candidates. If there is not a legitimate, ongoing, effort to make the company and its products/stores relevant to some group of consumers it will simply drift into oblivion. In the case where margins are slim and ongoing infrastructure costs are high (like retailers) the drift will be abrupt. In this case the owners-shareholders knew one thing (consolidation) and were not willing to pay for, hire the talent to do the very hard thinking necessary to come up with ongoing, innovative ideas to become relevant once again….. No one said it was easy, but no real effort was obvious in this case.

In the case of Supervalu and their distribution business. This isn’t, wasn’t the case at all. Managment, under Jeff Noddles guidance, had worked very hard at thinking about innovation in the distribution business. Not all the efforts worked, the ones that did were copied by those big enough to follow, and the acquistion of 2,000 supermarkets may well have taken managments eye of the distribution business (probably appropriately so.), but by and large there is a culture of innovation and hard thinking about the customer that exists at Supervalu that was not in play in the Hedge Fund, PE world of Sears Holding. Difficult to say what will happen at Supervalu. The hard thinkers may not get it right, or the complexity of the business as it now exists may tax the resources of innovation into mediocrity. Or, more likely the shareholders, led by analysts or the corporate investors, hedge funds, PE companies and the like may not view innovation and hard thinking as the way to short term profits.