Executive Briefing: All change please!

The slump in the global economy, and resulting hit on sales, has forced companies to change the way they conduct business and to experiment with new strategies. One trend retailers are turning to is diversifying into different store formats, channels and locations.

Office Depot, Costco and Wal-Mart are all taking such actions. Depot is collaborating with convenience store supplier Lil’ Drug Store Products to distribute its office supplies for sale in convenience stores throughout the US. While Wal-Mart is looking at smaller format stores and Costco has opened a new store in the upmarket Manhattan area of New York City.

The idea of using smaller format stores, and teaming up with other retailers as a good way to reduce capital expenditure, is nothing new. It was Staples that pioneered a compact, urban version of an office superstore when it opened its first Staples Express on Court Street in the heart of Boston’s financial district way back in the 1990s. Since then both Staples (through its collaboration with Ahold) and OfficeMax (via its association with Safeways) have also embarked on store-in-store deals.

Office Depot was also involved in a pilot retailing agreement in 2003 with Albertsons, under which it provided office and school supplies to 18 Albertsons stores in three markets (Chicago, Los Angeles and Phoenix). Depot chose not to continue with this agreement.

However, Depot is keen to push its new broader alliance with Lil’ Drug Store. Through this deal Depot will offer an assortment of more than 25 frequently used Depot-branded office products, sized and packaged for convenience stores. Products being offered start around $1.29 and will include pens, scissors, envelopes, notebooks and more. Lil’ Drug Store will redistribute those products to convenience stores nationwide.

The move is a timely one for Office Depot. A National Retail Federation (NRF) survey revealed that drug stores will benefit from a recession-driven shift in spending patterns, which has seen consumers concerned less with product range and more with value. The NRF also says that drug stores have increased in popularity as its product mix has expanded to comprise school supplies.

Office Depot spokesman Jason Shockley said the long-term deal with Lil’ Drug Store deal is part of a general plan by the company to uncover more routes to the market. "We want to make office products available wherever a business or a consumer wishes to make a purchase," Shockley explained to opi.net.

The more routes a company has to market, then the more likely it is they will get a better return. But Shockley explains that Depot has not set any targets for revenue from this venture, but did explain the company’s goal in terms of the number of outlets they are targeting by year-end.

 "Our goal is to be in thousands of convenience store locations nationwide by the end of the year," Shockley said.

Shockley explained that the deal brings many benefits for the Depot in terms of reach and brand awareness.

"Depot’s partnership with Lil’ Drug Store meets the needs of both small business customers and consumers which is always good for Office Depot," said Shockley. "Additionally, this partnership enables Office Depot to expand the company’s reach into an additional channel, as well as the presence of the Office Depot brand."

Shockley indicated that deals like this might become more commonplace for Depot, as the company looks to alternative ways to improve its top line in a poor economy.

"Office Depot is always looking to serve our customers in the ways that are most convenient for them," said Shockley. "With that said, new opportunities and channels to serve our customers are always an option."

Writing on the wall?

While Depot explores this new channel with customised products in Lil’ Drug Store, OfficeMax has started its own trial of a small format store with Ink Paper Scissors in Seattle (WA).

Smaller format stores allow companies to enter new markets in urban or rural areas that they may have bypassed during a boom. During its trial ‘Max can get into the Washington State market, test a new concept and get out quickly if it doesn’t work.

"Obviously, it’s not an optimal time," Ryan Vero, OfficeMax’s Chief Merchandising Officer told the New York Times. "But this makes for a great test – it can’t be any worse."

Like ‘Max, Wal-Mart has decided the best way to grow its business is through developing new and innovative, and, yes, smaller store formats as it looks to penetrate urban and city locations.

Wal-Mart CEO Mike Duke told investors during a two-day analyst meeting that the Wal-Mart super centres, which carry food as well as general merchandise, are to shrink to 150,000 sq ft from a typical 195,000 sq ft, and will get even smaller.

Wal-Mart will feel the benefit in a move like this due to the fact that smaller format stores offer lower running costs and rents.

The company already operates Neighborhood Market, a chain of traditional supermarkets; Marketside, four small-scale food markets it is testing in Arizona; and two Supermercado stores for Hispanic shoppers. So it does have experience in the area, which should help in launching a new range of small format stores.

But Wal-Mart has not neglected the importance of pricing in trapping custom by offering more goods in smaller stores. Duke promised investors that the retailer will also continue with its aggressive price-cutting strategy to capture market share, and he predicted that decision will not hurt the company’s stock price.

It’s a wise decision as Wal-Mart can ill afford to change its pricing policy now at a time when consumers have little money to spare.

Not to be left behind, Costco has been active too. But the company is not looking at new store formats to drive growth, but to areas outside of its usual operating footprint. Costco has opened its first store in Manhattan and is considering other sites.

During an interview with Bloomberg at the opening of the new store the company’s EVP and COO of its Eastern and Canadian division Joe Portera said the opening of a Costco in Manhattan was "a big deal" for the company. "We’ve been trying to get in forever," Portera explained. "It’s very important that we do another one."

Costco has been searching for a site in the sought-after area for some time to focus on the Island’s higher-income residents, according to Portera. It may well pay off as consumers’ shopping behaviour has changed because of the recession. Consumers are now much less concerned with product range and are more concerned about price.

Tracy Mullin, NRF’s President/CEO, agrees that consumer behaviour had been impacted. "The economy has clearly changed the spending habits of American families," said Mullin. "As people focus primarily on price, strong promotions and deep discounts will ultimately win over shoppers this year."

It’s quite clear that Costco’s new store is a direct effort to tap into that change in consumer spending with an initiative in an area that houses some extremely wealthy residents. Household income in the three-mile radius around the store averages $100,000, Portera said. That compares with about $85,000 for the retailer’s typical US shopper, he added. The other three existing Costco stores are in areas of New York with a much lower average income, namely Queens, Brooklyn and Staten Island. Another store is to open in Queens in 2010.

Costco is banking on its highest-volume store within three years (with sales per square foot of $2,000, double the company’s average) to crack the Manhattan market. However, the area’s higher costs will mean that the store’s profitability will probably be half of a typical Costco, Portera added.

In summary

It’s not difficult to see why retailers are turning to such options. Depot is seeking to tap into a growing market for convenience stores. Any growth market must surely be a target in this climate; and Depot’s move is a reflection of that. Costco is looking to take advantage of greater consumer use of discount stores in an affluent area, while Wal-Mart’s move to use smaller format stores also follows the direction of many retailers. Small format stores are cheaper to run and evidence suggests they can generate good revenue. This is what every company must be looking to do during a downturn in the economy.