The Next Great American Grocer

Glenn is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The American grocery industry has been a hot topic for Wall Street as of late. With new organic value competitors like Sprouts Farmers Market (NASDAQ: SFM) and Fairway Market (NASDAQ: FWM) entering the ring, the odds of picking a true winner become lower. If one looks back in history to the 1950's when similar radical grocery industry shifts occurred, however, you can glean some investing insights.

David vs. the grocer Goliath: Kroger battles A&P

As Jim Collins describes in Good to Great: Why Some Companies Make the Leap...and Other Don’t, Americans’ grocery shopping values shifted in the 1950's along with increased affluence. Shoppers preferred larger, nicer (and pricier) one-stop grocers over traditional corner-store operations. Two grocers were aware of this emerging trend: A&P, which was then the industry giant, and Kroger (NYSE: KR), a much smaller player. A&P owned a concept store, the Golden Key, where the company tested innovative store models with customers. It thus had the knowledge required to adapt.

Of the two grocers, however, only one made the leap to investing in stores that shoppers valued. That grocer was Kroger. Its changes paid off: over the next 25 years, Kroger would generate cumulative returns at 10 times the stock market average and 80 times those of A&P. Kroger’s willingness to “confront the brutal facts” and respond in turn made it, in Collins’ estimation, a great company (and great companies, by definition, give investors great returns).

History repeated: Grocery shoppers' tastes change

Enter 2013: the American grocery industry is seeing rapid changes in consumer preferences. As with the 1950s, shoppers are seeking out a higher-value grocery store experience. Tastes are trending toward organic, local, healthful foodstuffs: the Nutrition Business Journal forecasts that USA natural/organic food sales will grow 10% annually between 2011 and 2020. 

Supermarket shoppers are now making multiple smaller trips for food each week, and preferring fresh foods over center-aisle processed stuffs. Grocers must also ensure to reflect local food culture, matching product offerings and prices with socioeconomically appropriate store locations.

These taste changes appear favorable for grocers like Whole Foods and Sprouts Farmers Market, which operate more as European food markets than pantry-stocking wholesalers. The trends are also good news for Fairway Market, which is betting the farm on strategic store localization throughout New York. As new players to the natural grocer industry, Sprouts and Fairway will have to distinguish themselves to compete with the established, expanding Whole Foods.

Sprouts may do this by straddling the line between value and price, undercutting both Whole Foods and Kroger. According to the company, it is "sort of a hybrid between a natural foods store, a farmers market and a conventional supermarket" that focuses on improving food quality and offering low prices.

Fairway may play up its quality game. The company offers store-roasted, high-quality coffee beans as well as a diverse offering rare products. This helps it to cater to its target customer base of niche Northeastern foodies.

There's ample room for these natural grocers' growth. This growth will be based on a cycle of growing demand and lower price points for quality food, combined with Fairway and Sprouts' presently limited geographic distribution. Some or all of these higher-end grocers may prevail; regardless, it's clear that Sprouts, Fairway, and Whole Foods threaten to marginalize middle-road grocers like Kroger.

American grocers: Bifurcation of the middle-class

"It's time for [grocery] stores to ditch the middle class," warns a recent industry report. Middle-class shoppers are prepared to shop at stores that cater either to high food quality or low prices, but not a diluted combination of the two. The just-mentioned market grocers are well-positioned for quality-seeking shoppers, and companies like Costco and Wal-Mart have the low-prices end covered. So what of grocers stuck in the middle?

Kroger’s role now seems reversed: the company’s position as industry goliath faces threats from natural grocers on one hand, and ruthless wholesalers on the other. Sure, Kroger has added a token organic section to store aisles -- but what’s its long-term game? In February, the company acquired the upscale regional Harris Teeter grocer chain, which many hailed as a step in the right direction. Yet this Fool must question Kroger’s strategic interests when the company’s CEO states that Kroger won't start emulating Harris Teeter.

To Kroger, Harris Teeter equals what the Golden Key was to A&P: a concrete indication of shoppers’ shifting grocery store preferences, which spell danger for middle-class grocers who avoid specializing on either high quality or low prices. For Kroger to ignore these brutal facts, or even react too slowly, invites conscious-capitalism companies like Whole Foods to become this century’s great American grocer (and Wall Street’s best investment bet.)

Let the battle of the grocers begin.

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Glenn Singewald owns shares of Whole Foods Market. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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