RETAILNETGROUP STRATEGY ALERT No.

11 Issue
September 2008
Format Innovation - The Legacy Store Challenge

Comparable store sales is the most watched number on Wall Street. Unfortunately on In This Issue
its own it is a terrible indicator that masks perhaps the biggest challenge that retailer How Did We Get
CEO's face today: that is the declining returns that they earn on their older, mature Here?
What Are the
stores - those that collectively represent at least 80% of their store and inventory net
Leaders Doing?
investment. In the days when chains ran 200-300 stores, having 60 dogs was not a Food Retail Format
big deal. Today when there are hundreds of dogs that need serious attention, Innovation
investors, vendors and the entire retail community needs to pay very close attention. New Format
Introduction
RNG would advocate for retailers to begin to report sales growth in stores under 4 Selective Renewal
years old vs. those that are 4+ years old. The current reporting standards mask the vs. Market Re-
need for retailers to re-balance their assets-principally inventory, stores and Launch
technology -to optimize per-store economics. While there have been many advances, Format Innovation
the single largest hidden drag on returns is "legacy stores." Success Drivers

We have seen some great examples of retailers who have conquered this issue, at
least in part. The following summarizes some of the key learnings that we can all take
away from their great leadership.
Prior
It's a new consumer and retailing era - what we call "Chain Retail 3.0." This is just one
of the many hot topics that retailer CEOs have to begin to take on transparently and Strategy
to teach their investors and suppliers what is really going on. Alerts
Its going to be a very different time. Please let me know what you think
(dan@retailnetgroup.com) Goldman Sachs
Global Retailing
Dan O'Connor Conference
President & CEO Get a quick
Retailnetgroup.com download of RNG's
thoughts after
hearing and
meeting with
How Did We Get Here? leading retailers

For 25 years Construction and Real Estate were among the most powerful in the large Chain Retailing 3.0
retailer organizations. They were the critical players who found the sites, managed the Over the next two
store prototypes, and got the stores opened. It was all about speed. Get the site, build years, branded
the store and plug it into a modern distribution network - WMT, Staples, Costco, Home manufacturers and
Depot and many others all shared this strategy. retailers will be
challenged to find
Here's what would happen - in these "greenfield" days their new stores would often new ways to
open at 70% to 80% of their expected "pro-forma" sales (i.e. expected sales at prosper in the
maturity). And over the course of the next 2-3 years these stores would naturally fastest changing
ramp up to their expected potential. In many cases at WMT and Costco in particular food retail
saw these new stores would ramp up to an even higher sales level than expected in 1- environment in a
2 years providing 40% to 50% rates of return (which means the operating profits from generation
these buildings was returning the capital in in about 2-3 years!).
Mature Store
The growth was compelling as new, maturing stores elevated "like for like" or Activation
"comparable store sales" when added to the comp store based after their 1st year. The The new new thing
reality however is that these stores were not comping - they were maturing. in retail growth is
old stores, and how
Over the last 5 years as markets have saturated and alternative shopping outlets to unlock their
increased (store and non-store) we have seen three major themes potential to reach
new shoppers and
1. The new store ramp up times have increased to 4-5 years drive wallet share
2. Many new stores go sideways initially - few jump up as quickly as they did 5 with existing
years ago - so the growth curve is actually a bit inverted the 1st 2-3 years shoppers

At some point between age 5 and 10, most stores begin to lose shoppers, share, and
Social Networks
sales.
It is common for a big box that drew 40,000 to 50,000 households in its region to face Online social
a "household deficit" of up to 10,000 households-that is, to have just 30,000 shoppers networking allows
when 40,000 had been the average. marketers to
connect with new
and existing
customers and
deepen the level of
engagement

Pricing
Optimization
Retailers are
developing pricing
as a strategic
capability, which
also raises several
opportunities for
CPG firms

Private Label
Strategic store
brand programs are
a significant
growth strategy for
As a result, as much as half of the typical chain retailer's store base aged 5 to 10 retail leaders
years old has flat or declining sales growth in most markets, and the effect is greater
for stores aged 10 years or older.
Express Stores
For the past decade, most retailers' strategies for driving growth in legacy stores were Convenience food
aimed at driving higher dollars per trip, which is sustainable as long as the consumer retailing is
is liquid. In today's marketplace, the ROI challenge for management is how to "re- changing globally
activate" the shoppers they've lost and recover growth in those stores. as consumers
express their
preference for
healthy, fresh, and
What Are the Leaders Doing? ready to go (or
consume) foods
Retailers haven't thrown in the towel on new stores but have increased discipline
aournd capital spending. We see retailers Health Services
1. Focusing capex and efforts to increase sales in current stores (the focus of this
article) Explore how
2. Reducing the absolute # of new stores (good in saturated markets like most of retailers are trying
to re-organize the
the US, Canada, UK, major cities in Lat Am, etc.)
way that health
3. Reducing the size of their new store prototypes (some divergence here - WMT
and wellness
getting smaller while Target is increasing)
services are
4. Taking a much more disciplined approach to real estate choices with a focus on provided
"growth markets"
WMT for example has indicated it is viewing its property in the context of its alignment
with overall growth strategy as well as returns (ROA). Mobile Retailing
How mobile based
 commerce and
marketing
strategies are
being utilized by
retailers worldwide

Meet Our
Analysts

Dan W. O'Connor is
the President &
CEO of the
Source: Wal-Mart company presentation RetailNet Group.
He also is the
Founder of
Management
Ventures, Inc.
(MVI), a WPP Group
company. Dan is a
widely known
industry speaker
and thought leader.
LinkedIn | Email

Aaron Chio is a
Senior Analyst
leading RNG's
development of
Source: Wal-Mart company presentation
new research,
insights and growth
We have focused intently on the leaders efforts with existing stores. We see five major strategies in Latin
strategies here America.
1. Existing Store Rationalization - There are essentially five rationalization strategies LinkedIn | MSN |
retailers can pursue:
· Close - self explanatory. At any given time some 5% of a national chains stores
should be closed.
· Remodel - often a real updating (not the traditional "splash & dash") will have a
significant impact.
· Remodel and expand - a favorite of many leaders - Costco for example finds that
this is its winning'est strategy - take a great location and make it even bigger
· Re-locate - necessary when traffic patterns or other factor reduces a locations
overall traffic flow. When moving the retailer is trying to retain as much of the existing
shopper base as it can
· Re-format and banner - a few significant retailers have made the extremely
mature decision that some % of its existing store base was no longer relevant as it Tim O'Connor is
once was and have re-bannered and re-positioned the box to meet a different Vice President at
consumer or trip. Food Lion in the US was a great example of this. RNG, currently
responsible for
Interestingly, the ROI on each strategy varies by retailer. Costco, for example, tends RNG's Growth
to get the highest payback from remodeling and expanding, while others get highest Strategies
from re-models and/or relocation. Wal-Mart's ROI on Discount-to-Supercenter Curriculum and
conversions is tremendous. European market
insights.
LinkedIn |
2. Re-prototyping existing stores to the latest designs - This is expensive as it
requires stores to be closed during what is often a major re-model. Given that most
large retailers formally re-launch new prototypes every 4 to 7 years. As part of this
cycle RNG sees leaders carefully re-designing their boxes to incorporate the latest
green, experiential selling, drive throughs, site and store departments and other
useful upgrades. Of these the leaders are making the biggest deal out of their green
movement.

For retailers LEED certification is just a part of the overall strategy. Companies like
Carrefour have given deep consideration to re-positioning its buildings as the "most
socially responsible" in the market.

Keith Anderson is a
Senior Analyst and
responsible for
RNG's North
American research
practice and
transformational
capabilities
curriculum.
LinkedIn | Twitter
| Windows Live
Messenger

Source: Carrefour.com

Target stores for example has introduced its P2009 and S2009 (The P2009 is a
general-merchandise store while the S2009 is a new SuperTarget format). The 1st
P2009 and S2009 prototype stores were launched on February 12, 2008 and expected
to open in October. They have a number of distinguishing factors. Each is LEED-
certified and larger than existing Target stores, with more space for food and
electronics, The general-merchandise stores will measure 132,400 sq. ft., about 6,000
sq. ft. larger than the current model, while the new SuperTarget stores will be about
12,000 sq. ft. larger than existing locations, coming in at 186,000 sq. ft.
Source: Target company presentation

· The new formats will both have more room for food, especially Target's private-
label brands, and the SuperTarget stores will have more space for pre-prepared food.
· The new stores will also feature expanded electronics departments to carry more
products and selection.
· Design features include updated facades of brick and stone,
· Many environmentally friendly elements, such as low-flow fixtures to reduce water
usage by 30 percent; HVAC systems that reduce energy usage 30 percent more than
required by most cities; and light fixtures that require two less bulbs.
· As part of the construction process, 75 percent of construction waste will be
recycled or salvaged and more than 55 percent of construction materials will be
manufactured using raw materials from within 500 miles of the project site.
· Both prototypes are being developed as part of the U.S. Green Building Council's
Portfolio program. "That means we can do not just one store, but a bundle of stores
under this Portfolio program.
So re-prototyping stores while making them "greener" is clearly part of today's capex
rationalization strategy.

Food Retail Format Innovation

For Food retailers re-prototyping can mean something entirely different. The enw
format is often the gateway to an entirely new food strategy. We see lots of
innovation in the new food oriented formats. A recent new store from Whole Foods for
example included:

· Dine-in Market Bistro, offering made-to-order foods including sandwiches,

soups, salads, flat bread pizzas, and light entrees
· An Asian Express Island offering hot teriyaki noodle bowls and made-on-site
sushi,
· The Fresh and Wild station, a full-service coffee bar featuring Whole Foods
Market's own Allegro® coffee,
· A Sausage grill with a variety of sausage sandwiches, and even fresh, hot
pretzels. - free wireless internet access and over 116 seats for inside or outside dining
· Prepared Foods * Hot and cold bars featuring world cuisine selections * Chef's
case offering take-home salads, entrees and sides by the pound * Carvery and salad
toss station * Pizza made on site in stone hearth oven * Extensive rotisserie
selections
* Salad and soup bars * Made-to-order sandwiches * Pre-pack selection for grab-and-
go options
· Produce * Bins of hand-stacked fruits and vegetables, much of which are organic,
with local growers well represented * In-house cut fruit and handmade salsas * Full
line of local, exotic and staple Asian items like Thai papayas, sui choy, yua choy sum,
shinseki pears, gai lan, moqua and banana flowers
· Ready to go foods - "shortcut chef kits" for families on-the-go such as stir fry,
fajita, and pasta sauce kits *
· Expanded Meat * Widest selection of the freshest, highest quality meat raised to
the strictest standards in the industry * Made-in-house oven-ready items for the grill
or oven * Great selection of organic items, including beef, pork, chicken and turkey *
Wide selections of smoked and cooked products made with no nitrites or nitrates *
Over 20 types of handmade sausage * Tender dry-aged beef, dry-aged in the store the
old-fashioned way
· Seafood * Local fresh catches, along with a wide selection of both fresh and
frozen varieties * Grab-and-go, Bistro Fresh oven-ready items such as taco tilapia,
garlic salmon and shrimp cacciatore * Fresh seafood ceviche and marinated salads *
Selection of live shellfish and whole fish * All sizes of shrimp and prawns, pre-
skewered and seasoned * Large selection of locally smoked items
· Specialty * Over 700 wines available, Over 250 hand crafted ales, lagers, and
ciders. Over 400 artisan and everyday cheeses, olive/antipasti bar, chocolates and
confectionary . Featured Cheeses from World-renown Affineurs-Herve Mons, Pascal
Beillevaire, Neal's Yard Dairy, and Luigi Guffanti. Specialty spices, peppers, and sea
salts from around the globe

New Format Introduction

New format introduction - while these do not necessarily improve the existing store
performance they often can help "stop the bleeding" by focusing on either different
markets, shoppers or trips. The great majority of large scale retailers are persistently
pursuing this strategy as the following shows. The fastest growing new formats could
be characterized as 'specialty" and "in-fill" formats - that is formats that are highly
targeted to a consumer or category of merchandise. By in-fill we simply mean formats
like Express stores that are located more conveniently to the consumer. Fresh & Easy
from Tesco is a great example here in the US.
Selective Renewal vs. Market Re-Launch

When selecting stores for more complete renovation, most retailers prioritize stores
based on volume. If a retailer operates in three different markets, it might selectively
renovate its highest-potential store in each market.

Several years ago, Food Lion pioneered an alternative strategy, which it called "Market
Renewal."
Source: Retailnetgroup.com

Food Lion's strategy is to re-launch all of the stores in a single market at once,
leveraging marketing expenses and ensuring a consistent shopping experience and
brand.

Format Innovation - Success Drivers

RNG believes that the most successful legacy activation strategies
· Reestablish a store or chain's positioning on the value/differentiation continuum in
its market-e.g. as a price leader or a full-service shop-and clearly and consistently
communicate that positioning
· Target specific shopper segments and shopping occasions
· Reallocate space based on a sound department/category portfolio management
strategy
· Enhance the store's ergonomics-improve sightlines, eliminate redundant SKUs to
facilitate choice, enhance navigability, etc.

RetailNet Group is the leading insight and advisory firm focused on retail
growth strategies and consumer-facing transformational capabilities. We are
deeply experienced retail/consumer analysts and strategists working
exclusively to help brand-led businesses and large-scale retailers grow.

Sincerely,

RetailNet Group
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