How to be a customer obsessed food retailer
The Great Recession impacted consumers’ tastes and preferences over the last 10 years. If a retailer is not carefully monitoring the changing needs of customers, gaps can quickly emerge, which open the door to competitors. The biggest driver of changes in consumer behavior is income and for much of the post WWII period, real incomes (adjusted for inflation) have been rising. The chart below illustrates these income changes over the last forty years.
- In the 1980s and 1990s, growing incomes resulted in shoppers wanting higher quality items. Many retailers positioned themselves upmarket, focusing on more fresh products. This was a great time for many traditional retailers who grew rapidly during this time.
- In the 2000s, real incomes flattened, but many consumers supplemented their incomes by consuming the equity in their homes, resulting in no significant change in consumer behavior. According to the Center for Economic Policy Research, mortgage equity withdrawals resulted in $200-$300B in additional expenditures. During this time, Walmart Supercenters, Costco, Trader Joe’s, and the Dollar Stores continued to expand their store base.
- Then the derivatives and credit default swaps hit the fan in 2008. GDP bottomed out that same year at a whopping -8.4%. According to Pew Research, half of the households in the U.S. experienced work-related hardships, and the popping of the bubble reduced household wealth by an average of 20%. The National Bureau of Economic Research (NBER) stated that consumers saved by taking advantage of coupons, sales, private brands, larger pack sizes, making more trips, and shopping more at discount stores.
- In 2014, the economy and real incomes rebounded and have recently surpassed pre-recession levels.
The changes in real income also had a direct impact on grocery gross margins. The chart below shows grocery gross margins before and after the recessions. Prior to the recession, margins rose as shoppers demanded higher quality items. Margins levelled out in the 2000s and began falling post-recession. Pre-recession shoppers sought out quality, but in the post-recession shoppers transitioned to price and value.
We can clearly see there was a significant shift in pre- and post-recession consumer behavior, but what happened to gross margins when incomes rebounded? Did they return to pre-recession trends? Real incomes have significantly rebounded and now exceed pre-recession levels, but gross margins have only marginally improved, which suggests these consumer changes could be long-lasting.
Private brands and retailer growth by retailer type can also shed some light on the return to pre-recession behaviors. If shoppers were returning to pre-recession behaviors, we would expect private brand dollar share to fall back to pre-recession levels. The opposite is occurring, and private brand penetration continues to grow even as incomes have risen.
We know that real incomes began to aggressively rebound in 2014. So what types of retailers have been winning the last five years. If we were returning to pre-recession trends, quality and premium items should be growing relatively fast. Based on the 2019 dunnhumby Retailer Preference Index (RPI), that is not the case. Price-focused retailers in the bottom right quadrant of the chart below have strong price perceptions and weaker quality perceptions. On average, they are growing twice as fast as the premium banners in the upper left-hand quadrant over the last five years.
Finally, Bank of America declared that the last 10 years have been the “Discount Store Decade.” Their research found that lower income spending is growing faster than the higher income groups, and this spending is being focused on discount products and retailers. Bank of America concluded the report by saying that there is no-sign of a slowdown in low-income consumer spending.
Based on the significant changes that resulted from one of the biggest economic events over the last 100 years, many retailers are not moving “at the speed of consumers” in making significant adjustments to their value proposition or are moving in the wrong direction. Gaps between their value propositions and customer needs have grown, and these gaps have opened the door to many of the more value-focused banners like Aldi gaining market share.
Top Performing Retailers Understand What Drives Consumers’ Preferences
After the Great Recession fundamentally changed the customer and retailer relationship, in 2018, dunnhumby developed a model and a corresponding Retailer Preference Index (RPI) to gain some understanding around what drives consumer choice. With survey data from more than 7,000 US households, it looks at about 60 of the largest US grocery retailers and associates their customer emotional connection and financial performance with how they score on various preference drivers. These drivers include customer perceptions around price, assortment, store experience, convenience, speed, discounts/rewards, and operations. Associating the preference drivers with financial performance allows us to understand which preference drivers have the biggest impact on performance, both financial and emotional. Also, after ranking each retailer, we profiled the four quartiles to understand how those retailers at the top were different from those at the bottom.
Our first quartile retailers, seen in the table below, had more targeted value propositions and consistently performed better financially and emotionally. The top quartile grew 11x faster than the bottom quartile, 4x faster than the 3rd quartile and 2x faster than the 2nd quartile. Unlike the other three quartiles, the top quartile had larger swings in their preference pillar scores because they were making trade-offs to deliver in those areas that were most valued by their shoppers, while ignoring other areas that were not. That does not necessarily mean they are more Customer-focused but their strong performance does suggest they are meeting the most important needs of their Customers better than other retailers.
Trader Joe’s is a good example of this. They have been ranked number one the last two years and are likely the most profitable grocery retailer in the U.S. They win because they focus on price and quality, even at the expense of many “shiny objects” and consumer “trends” - convenient locations, winning big baskets, ready-to-eat, and digital.
Their locations are generally in older, second-tier strip malls that are near educated, middle-income neighborhoods with a high propensity of “foodies.” These locations are often less convenient, have less traffic, but also have lower rents.
- They also choose to offer a fraction of the SKUs in smaller, less expensive stores stocked almost exclusively with private brand items. All of these choices drive profit, build value perceptions, and aim to win the “first-shop” rather than the “full-shop.”
- Knowing that ready-to-eat is expensive and hard to deliver profitably, they focus on frozen, easy-to-prepare items. Frozen is much easier to transport than fresh and has a longer shelf life.
- Lastly, Trader Joe’s ended its NY eCommerce pilot about six months ago because they said they could not deliver groceries without increasing costs and prices for consumers, which from our perspective would weaken their value core. It is too early to tell if that was the right decision but based on our model, we would say they probably made the right decision.
In contrast, the bottom quartile retailers struggled with focus. They were often near average across the less important preference pillars – discounts/rewards, speed, operations - but then scored poorly on the most important ones - price and quality. In addition, many had relatively strong promotion scores but poor overall price scores, which suggests that promotion was the only lever they were comfortable pulling, and as a result, it had probably been pulled too much. We also hypothesize that promotion is the only lever they are comfortable pulling because they do not deeply understand their customers. Moreover, many of these poorly performing retailers are using their limited resources and investing them in eCommerce or repositioning themselves more upmarket. In both instances, this will only exacerbate their problems.
So, there is evidence that the top quartile retailers meet the needs of shoppers better than those in the bottom quartile. We can’t definitively say that they are more Customer-focused, but their business choices do suggest they understand their Customers’ needs better than others.
So, what does a Customer-focused retailer look like?
A customer-focused retailer assesses business decisions and investments through the customer lens first. It starts with a recognition that customers must be put first. Partners, vendors, and shareholders are important, but they can have goals and objectives that do not necessarily align with the customer or the retailer. If the retailer places the customer first, partners, vendors, and shareholders have the best chance of sustainable success.
A customer-focused retailer has a long-term view that maximizes value-added activities while minimizing value-deteriorating activities, even at the expense of short-term performance. Brand equity, the emotional connection, and financial growth are built incrementally over time. Short-term actions to raise prices in the back half of the year to hit the budget, adding SKUs to gain more back margin, or clogging the aisles with promotions may help with short-term goals but they are value deteriorating actions that erode brand equity and trust in the long run. Brand equity is a saving account and each action that delivers customer value adds to the account. And, each action that is counter to the customer results in withdrawals from the brand equity account.
A customer-focused retailer develops an organizational-wide strategy to align their value proposition with their key customers’ needs. Those that meet the needs of the customer the best will win the war for visits. The strategic process is a careful and candid assessment of your strengths and weaknesses versus key competitors. This process relies heavily on customer data, both behavioral and attitudinal. Understanding these gaps helps the retailer diagnose their key issues and focus finite resources on those areas that will improve the retailer’s value proposition.
Finally, a Customer-focused retailer can assess how their actions impact quality and price perceptions, preference, and financial performance. It is difficult to create meaningful change if one cannot connect actions and investments to results. Should you build out eCommerce, move upmarket, or improve price and/or value perceptions? Feedback loops are essential to understanding which actions work and which actions do not. Those that learn the fastest and convert that knowledge and insights into action first will have an advantage. For most retailers, this requires an investment in systems, data, and analytics. The Customer-focused strategy above will help to identify what the right success metrics to measure, and validate that, yes, your customers are worth the investment.
Erik Karlson is director of strategy and insights with dunnhumby