Kroger-Owned Fry's Store Coupon Jujitsu Ensnares Tesco-Owned Fresh & Easy Neighborhood Market in Arizona

Analysis

We've written extensively about Fresh & Easy Neighborhood Market's chronic use of its 25%-off (pictured above) and 20%-off deep-discount store coupons as a way to create and maintain sales in its 155 stores in California, Nevada and Arizona. [Click: here, here and here for a selection of those past stories.]

As a current example of that chronic use, the Tesco-owned grocer currently has three versions of the 25%-off and 20%-off store coupons in distribution - one good for $5-off purchases of $20 or more (expires on November 30); another good for $6-off purchases of $30 or more (good until November 22); and a third offering $10-off purchases of $50 or greater (expires on November 22). The coupons are available online, which means shoppers can download the discount vouchers and use one each time they shop at a Fresh & Easy store in November.

The thrust of our writing about the Fresh & Easy store coupons, which give customers a full 20%-25%-off their total purchase amount if they buy the minimum amount required to redeem the coupons, has been three-fold.

Price perception: First, we've suggested that by chronically using the store coupons - Fresh & Easy has used them regularly with only a couple slight pauses since November 2007 when its first stores opened - the grocer has established to its detriment a retail pricing policy and related shopper perception that says because Fresh & Easy nearly always has the coupons in circulation, the everyday prices at the stores are too high. But with the coupons the prices are low.

We believe on some level Fresh & Easy's senior management has learned this to be true because when it attempts to stop issuing the store coupons for more than a few weeks at a time, store sales drop considerably. Additionally, customers complain about the lack of coupons on Fresh & Easy Neighborhood Market's Facebook and Twitter sites, saying that without the store coupons being available they will be doing far less shopping at the stores.

For example, at one point in 2009 Fresh & Easy stopped issuing the store coupons for nearly two months, the longest period it hasn't had at least one version of the discount vouchers in circulation. As a result, sales at the stores dropped significantly, and customer complaints went through the social media site roof. The result: Fresh & Easy Neighborhood Market started issuing the store coupons again regularly, and hasn't stopped doing so since then. [See - May 20, 2009: Breaking Buzz: Tesco's Fresh & Easy Issues Another New Discount Store Coupon ($10-off $50 Though); We Told You the Coupons Would 'Be Back.' Also - May 1, 2009: Fresh & Easy Brings Back $6-Off Deep-Discount Store Coupon; Latest Version Good For Nearly One Month; New Promo Strategy Didn't Last Long; and May 7, 2009: 'They're Back' in Full-Force: Tesco's Fresh & Easy Adds New $6-Off Online Coupon to Just-Recently Direct-Mailed $6-Off Coupon; Tough to 'Terminate.']

Fresh & Easy's senior management has compounded this problem by refusing to accept manufacturers' cents-off coupons in the stores, saying publicly in its marketing communications that the reason it doesn't accept the coupons is because its everyday prices are already low.

This argument doesn't hold water though because if that were the case, then why would Fresh & Easy need to regularly issue the deep-discount store coupons, which offer a far-higher percentage discount than manufacturers' cents-off coupons do? The Fresh & Easy-issued store coupons are a discount off a shopper's entire purchase, while manufactures' coupons are a discount off a single item. Grocer's get reimbursed by the manufacturers for the item coupons, while the discount from Fresh & Easy's store coupons comes out of the grocer's profit margin, which leads to our second argument as to why the chronic use of the store coupons has become a trap for Tesco's Fresh & Easy Neighborhood Market.

Gross Margin: In October Tesco reported its Fresh & Easy chain has a negative-38% gross margin. To put that in perspective, most healthy grocers have a gross margin that's at least in the plus-20% level. In order for Fresh & Easy Neighborhood Market to break-even by the end of 2013, as Tesco says it will, the grocer has to get its gross margin up from the current negative-38% to something at least close to what a healthy grocer produces in order to make a profit. Doing so is a huge task for Tesco.

In our analysis, one of the key contributors, but far from the only one, to Fresh & Easy's negative- 38% gross margin is the chain's chronic use of the deep-discount store coupons, which as mentioned earlier reduce a shopper's total market basket of purchases by a whopping 20% if the customer buys the minimum dollar amount - the $30 minimum purchase to get the $6 off, for example. Even if a customer buys $60 worth of groceries and gets the $6-off, that's still a 10% bite out of the market basket - $54 instead of $60 for the hypothetical purchase.

Since the store coupons are in distribution nearly always, and since shoppers use the coupons so often, Fresh & Easy is taking constant hits to its margins simply by virtue of having established the store coupons as a regular feature of how it does business. (This goes hand-in-hand with having created the price-perception in the minds of customers, which we detailed above.)

A vulnerable promotional tool: Lastly, we've suggested that in addition to the two key factors outlined above, the chronic use of the deep-discount store coupons by Tesco's Fresh & Easy - rather than using them as an infrequent (once a quarter or so) promotional tool as is the industry norm - is such a simplistic form of promotion that it presents an opportunity for competitors in a given market, particularly big ones with high market share, to make a defensive move, accepting the Fresh & Easy coupons in their respective stores, therefore rendering what has become Fresh & Easy's primary promotional tool, the deep-discount coupons, a seriously blunted one.

Fry's store coupon Jujitsu

Last year in Arizona, where Tesco's Fresh & Easy has 28 stores in the Phoenix metropolitan region, Kroger-owned Fry's Supermarkets did just that - it periodically excepted the Fresh & Easy Neighborhood Market store coupons in its 120 Arizona stores, as we wrote about in this February 2009 piece - February 3, 2009 Competitor News: 'Grocer-Gone-Wild:' Arizona's Fry's and its 'Bring it On' 'Take All Competitors' (Including Tesco's Fresh & Easy) Store Coupon Move.

Fry's did a handful of one-week promotions in 2009, in which it accepted the Fresh & Easy store coupons, along with those of all its other competitors, touting the move in its weekly advertising circular and in other forms of media advertising and promotion.

The direct or default target of Fry's in accepting the store coupons was Tesco's Fresh & Easy, since none of the other grocery chains in the market issue similar store coupons on a regular basis. (A couple do so on occasion.) In the promotion, Fry's also offered to round-up all manufacturers' cents-off coupons to a $1 value, regardless of the coupon's face value.

Fry's offered the deal a couple times early this year, once again. But beginning mid-year, the supermarket chain, which is the number two market share leader in metropolitan Phoenix, just a couple points behind Walmart Stores, went full-bore, offering to accept all competitors store coupons, along with offering the $1 value for all manufacturers' cents off coupons, nearly every week. Fry's has continued the promotion nearly every week, including at present, during the last half of 2010.

Since Fry's only accepted the store coupons of its competitors infrequently last year, the resulting loss of sales at the Fresh & Easy stores that can be attributed directly to the Fry's defensive move in 2009 wasn't all that significant or regular.

However, that's changed. Because Fry's has been taking its competitors' (which means primarily Fresh & Easy since it's the only grocer in the market regularly distributing such coupons) store coupons nearly every week since the middle of this year, numerous customers who normally shopped at Fresh & Easy because of the coupons have been and are now taking the deep-discount vouchers to Fry's, which has resulted in a significant blunting of what is Fresh & Easy Neighborhood Market's primary offensive promotional tool - the deep-discount store coupons.

We know this to be the case for a couple reasons. First, Fresh & Easy Buzz has talked to managers and grocery checkers at over 25 Fry's stores in metro Phoenix since the middle of this year. The store workers tell us their tills are overflowing with Fresh & Easy store coupons, which are being redeemed by shoppers who download the discount slips of paper from the Fresh & Easy site, print them out, but then use the coupons at a Fry's store instead of at a Fresh & Easy market.

Additionally, because of the regular acceptance of the Fresh & Easy store coupons at Fry's this year, Arizona's numerous grocery deal and coupon blogs have been recommending to their readers that instead of using the vouchers at a Fresh & Easy store, they instead use them at Fry's, in large part because Fry's runs its $1 value manufacturers' cents-off coupon promotion at the same time. Fry's lets shoppers first deduct the Fresh & Easy coupon from their total grocery purchase amount before then deducting the manufacturers' item coupons, which means even greater savings, which is what the Arizona blog sites are all about. [For some examples of what the numerous popular Arizona consumer coupon/grocery deal blogs are saying about using the Fresh & Easy store coupons at Fry's, take a look: here, here, here, here and here.]

Here's an example of the savings shoppers can get using both the Fresh & Easy store coupon and the $1 value manufacturers' coupons at Fry's: A customer buys $50 worth of groceries. She then uses the $10-off $50 Fresh & Easy coupon, bringing her grocery order to $40. She then can use her manufacturers' cents off coupons against the $40 total. Remember all of the coupons at Fry's are worth $1, regardless of their face value. Therefore, let's assume she has $10 worth of the single-item manufacturers' coupons, each worth $1 at Fry's. As a result, her original $50 purchase, reduced to $40 after using the Fresh & Easy $10 coupon, is now a mere $30, a whopping savings of $20.

Without a doubt the loss on profit for Fry's on these transactions is significant. Fry's eats the $10 discount from the Fresh & Easy coupon, plus the amount from each manufacturers' cents off coupon over the face value. For example, giving $1 off on a 50-cent item coupon results in a loss on the amount of 50% for Fry's. The manufacturer only reimburses the grocer for the face value amount of the coupon plus a small handling charge.

However, because Fry's is a close second to Walmart in market share in the region, and because Kroger wants to protect its turf, along with the fact that Fry's is a small (but important) piece of Kroger's overall revenue base, it's decided it can take the hit in order to protect and it hopes grow that market share, despite what will obviously be a negative effect on the Fry's bottom line. Think of it as Fry's version of Jujitsu applied to a competitors promotional program, in this case Fresh & Easy's store coupons, which to date has been its most important promotional tool in terms of generating sales, and therefore its most vulnerable one.

Additionally, the point of this analysis isn't how accepting the competitor store coupons will affect Fry's bottom line. Rather, it's to empirically demonstrate the trap Tesco's Fresh & Easy finds itself in, regardless if it knows it or not, in terms of the vulnerability of its chief promotional tool, the deep-discount store coupons.

Broader implications of Fresh & Easy's store coupon trap

For example, if Fry's can accept the Fresh & Easy store coupons in Arizona, so can Kroger-owned Ralphs, Safeway's Vons or Albertsons in Southern California.

Further, in Northern California, where Fresh & Easy plans to open its first batch of stores in early 2011, one or more competitors could decide to follow the Fry's model and as a preemptive strike against Tesco's Fresh & Easy Neighborhood Market announce a couple weeks before the first stores open - or even worse start accepting the coupons a couple weeks before the stores even open, doing an old fashion competitor pantry-loading scheme - that it will accept the Fresh & Easy store coupons in its stores for a month, or two, or three, for example. Doing so would likely significantly hurt sales, something no grocer particularly wants to happen when it's just entering a market for the first time.

One might suggest the fact Fry's is accepting the store coupons is a good thing for Fresh & Easy, since we argue the discount vouchers are a key contributor to its double-digit negative gross margin. But also recall we argue that without the coupons, sales at the Fresh & Easy stores drop like a ton of 10 pound Gold Medal Flour bags, which is why the grocer continues to issue them on a regular and even overlapping basis, as is the case this month. In other words, It's a store coupon "Catch-22" for Tesco's Fresh & Easy in our analysis: Can't live with the coupons, can't live without them.

If our analysis is wrong, then the simple thing would be for Fresh & Easy to stop issuing the store coupons, at least in the Arizona market. After all, if it's true the reason the grocery chain doesn't accept manufacturers' cents-off coupons is because its everyday prices are already low, which Fresh & Easy executives have said is the case, then the same argument should hold for not issuing its own discount coupons, which lower a shopper's total purchase amount (and Fresh & Easy's margin) far more than even a big stack of manufacturers' cents-off coupons do.

But that's far from being the case in everyday practice, as we've noted in Fresh & Easy Buzz for nearly three years. Additionally, the fact Fresh & Easy has three different versions of the store coupons in distribution this month is ample evidence the grocer needs the coupons in order to maintain sales at the present level. If not, it would use the coupons much more cautiously.

From a merchandising perspective, Fresh & Easy has created a serious price perception problem for itself in the minds of customers with the chronic use of the store coupons. Based on our research and analysis, many of the grocer's regular customers factor-in the discount from the coupon as the de rigueur price they should pay for their purchases at Fresh & Easy. Take the coupons away for any extended period of time and those shoppers will likely adjust that mental calculus, perceiving the non-coupon cost of shopping at Fresh & Easy to be too high, compared to some of its competitors. That's what experience has shown thus far, based on our research and analysis.

Added struggle in Arizona

Ironically, we don't think Fry's acceptance of the store coupons is directly aimed at Fresh & Easy, at least not from the perspective that Kroger thinks the Tesco-owned chain is a direct threat in metropolitan Phoenix. After all, Fresh & Easy isn't even among the top six-seven grocers in terms of market share in the region. But Fresh & Easy is owned by Tesco, which is the third-largest food and grocery retailer in the world. And that fact might just be good enough for Kroger Co. to want to make sure Tesco has a very difficult time gaining any sort of foothold in Arizona with Fresh & Easy, along with letting it know that attempting to do so will come at a significant cost.

Tesco's Fresh & Easy recently closed six stores in metropolitan Phoenix, leaving it with the current 28 units, down from 34. Additionally, the grocer plans to focus its new store openings in 2011 primarily in California, as we've previously reported. It will likely open a handful of new stores in Arizona next year.

Tesco's 28 Fresh & Easy stores in metro Phoenix have been struggling overall in terms of sales before the pressure from Fry's defensive store coupon acceptance move. The fact that Fry's is taking the Fresh & Easy store coupons during the crucial Thanksgiving holiday season - we're told it will continue to do so for Christmas as well - is exerting even more pressure on Fresh & Easy Neighborhood Market's Arizona operations.

And since metropolitan Phoenix is arguably the most competitive food and grocery retailing market in the U.S., or close to it, and it's only getting more competitive, the outlook for Tesco's Fresh & Easy in the region is a fairly poor one at present. The fact Fry's is blunting Fresh & Easy's most-popular promotional tool, its deep-discount store coupons, makes Tesco's struggle in the market an even more challenging one.

[Editor's Note: This is part one of a two-part analysis piece. In part two we will offer some ways in which Tesco's Fresh & Easy may be able to escape from the chronic store coupon trap it appears to have set for itself.]