Tke Real Challenge
of Food Discounters
ROBERT J. MINICHIELLO
How do discount food
stores compare with conventional supernnarkets? Can
they underprice and still
operate profitably? Are
they able to reduce operating expenses? Is the food
discounter a threat to the
conventional supermarket?
This article provides some
insights into these questions
based upon the practices of
three nonconnpeting companies engaged in both conventional supermarket and
discount food operations.
The author also reports
the actual operating figures
of connparable discount and
conventional outlets.
Journal of Marketing.
1967). pp. 37-42.
Vol. 31 (April,
I N RECENT YEARS, retail food outlets called discount food
* stores, or discount food departments, have appeared claiming to
sell food at prices lower than those of conventional food supermarkets. Some of these outlets are food departments within or
beside general merchandise "discount houses"; others are freestanding stores.
To date, the food discounter has not been the subject of detailed
analysis. Many articles on food discounting in food trade publications have typically been reports about particular companies becoming involved in discount food operations and the manner of their
entry. 1
Leiman and Kriesberg have reported; "Little information is
available on how efficiently food departments of discount houses are
operated . . . Operating ratios such as sales per man hour and labor
costs as a percentage of sales are not now available. Nor is there
good information on prices and margins for items sold in discount
houses to compare with information of this type for the same or like
items sold in conventional supermarkets."- They further reported
that little has been published on the economics of discount operation.-^
McNair, Applebaum, and Salmon also refer to the lack of research in this area. They raise the question: "To what extent can
and do the food discounters undersell the conventional food supermarkets?" They report that no comprehensive price studies of food
discount stores and conventional supermarkets are available for
comparison. They further ask: "How is it possible fbr the food
discounter to offer significantly lower prices?" They report that
again specific information is lacking. Among other basic questions
which they state "stand unresolved" they ask: "What merchandising and operating advantages are unique to a supermarket in a
discount house or to a free-standing discount supermarket that
cannot be adopted by a conventional supei'market?"^
The Methodology of This Study
This article summarizes the results of an exploratory study of
selected discount food stores that was undertaken in an effort to
' Martin Leiman and Martin Kriesberg, "Food Retailing by Discount
Houses," Marketing and Transportation Situation, Economic Research
Service, United States Department of Agriculture, (February, 1962),
pp. 38-41, at p. 41.
- Same reference as footnote 1, at p. 39.
•^ Same reference as footnote 1, at p. 40.
•* Malcolm P. McNair, William Applebaum, Walter J. Salmon, Cases
in Food Distribution (Homewood, Illinois: Richard D. Irwin, Inc.,
1964), pp. 21-22.
37
38
develop some specific data about and understanding
of discount food operations.-'^ The author sought to
determine how selected discount food operations
differed from conventional supermarkets; how, if at
all, food discounters were able to reduce operating
expenses; and whether there were operating economies inherent in food discounting that were not
adoptable by conventional supermarkets.
The findings reported are based on the practices of
three non-competing companies active both in food
discounting and in conventional supermarket operations. The companies included were chosen because
of their willingness to cooperate and to reveal confidential operating data. There is much reluctance on
the part of food discounters to reveal the type of
operating data collected in this study. Within their
respective trading areas, the discount food outlets of
these companies were considered by knowledgeable
trade sources to exemplify discount food operations.
These companies represented three corporate types
reflecting thi'ee of the important food distribution
institutions in the United States: a large chain,
operating over 100 stores; a small chain, operating
less than 25 stores; a voluntary chain, two of whose
member independents agreed to participate.
The data reported in this article were gathered by
means of intensive field investigations by the researcher. They were obtained by interviewing company executives and store personnel, by observing
operations at store level, and from company records.
Within each company a discount food outlet and a
conventional supermarket were studied in depth.
Effoi'ts were made to include a pair of stores within
each company considered comparable so that meaningful comparisons of operating results could be
made. Ideally, the matching pair of stores would
have the same sales volume, be of the same size, be
operated by managers of equal skills, be of the same
age, and have similar types of locations in the same
trading area. Such perfect matches of discount and
conventional food outlets could not be achieved in
the real world of food retailing as was anticipated.
The best matching pair of stores within each company was selected for in-depth analysis. But although the matched pairs of stores were not perfect,
the differences did not significantly impair the conclusions that could be made after the stores had been
analyzed.
Summary of Findings
Store Facilities and Assortments
The discount food stores were attractively decorated outlets providing a shopping environment on a
^> A complete report of the research with a detailed
analysis of the findings is contained in An Exploratory Study of Selected Discount Food Stores, a doctoral dissertation submitted at the Harvard Graduate
School of Business Administration by Robert J.
Minichiello.
Journal of Marketing, April, 1967
par with the conventional supermarkets. Each discount food store offered substantial varieties of fresh
fruits and vegetables, fresh meats, processed meats,
frozen foods, dairy products, and baked goods.
The discount food store of the voluntary chain had
much less variety than the conventional supermarket
in groceries; but the grocery assortments of the discount outlets of the large chain and small chain,
initially less than the conventional supermarkets,
had been steadily increasing and were even greater
in some categories, especially at the small chain.
Nonfood assortments were similar at the outlets of
the voluntary and were also available at the large
chain's discount outlet, but with somewhat reduced
variety. Nonfoods were not stocked at the small
chain's discount food outlet.
Retail Prices and Gross Margins
The discount food stores consistently underpriced
the conventional supermarkets. At the large chain
and the voluntary, almost all identical items were
sold at lower prices in the discount food store. At
the small chain, many items were sold at lower
prices in the discount food store, but all produce and
certain items in other merchandise categories were
sold at the same prices in both types of stores.
Gross margins were from 4.2 to 6.0 percentage
points less at the discount food stores. See Table 1.
Expenses
Operating expenses were from 2.5 to 3.6 percentage points less at the discount food stores. See
Table 2.
Trading Stainps. The elimination of trading
stamps was the greatest source of expense reduction
for the discount food store of each company. The
cost of trading stamps ranged from 2.1% to 2.7% of
sales."
Labor. At each company, labor expenses were
lower at the discount food store. But most of the
difference could be accounted for by the absence of
The 2.l9f figure for the large chain did not include
the cost of extra stamps awarded for the purchase
of certain featured items. The exact amount was
not determinable.
• ABOUT THE AUTHOR. Robert J.
Minichiello is Associate Professor of
Marketing at Northeastern University.
A graduate of Harvard College, he received his MBA from Boston University
and his DBA from the Harvard University Graduate School of Business Administration.
Dr. Minichieilo has acquired expenence in food distribution as an employee, a consultant, and a researcher.
He prepared several of the cases published in CASES IN
FOOD DISTRIBUTION by Malcolm P. McNair, William Applebaum, and Walter J. Salmon (Irwin, 1964).
The Reai Challenge of Food Discounters
39
TABLE 1
GROSS MARGINS, WAREHOUSE, TRANSPORTATION AND SUPPLIES EXPENSE OF DISCOUNT
FOOD STORE AND CONVENTIONAL SUPERMARKET OF LARGE CHAIN,
SMALL CHAIN AND VOLUNTARY CHAIN'
Large Chain
Disc.
Conv. ('Diff.)'
Grocery Gross Margin
Meat Gross Margin
Produce Gross Margin
Total Gross Margin
Warehouse and
Transportation Expense
Supplies Expense
Adjusted Total Gross
Margin
17.39!?'
21.1
31.7
19.4
2.5
16.6
21.6%
25.6
33.8
23.8
(4.3)
(4.5)
(2.1)
(4.4)
2.5
.3"
21.0
Small Chain
Disc.
Conv.
12.2%
17.6
27.5
16.2%
22.6
32.8
14.7
18.9
(Diff.)
(4.0)
(5.0)
(5.3)
(4.2)
In Cost of Goods Sold
In Cost of Goods Sold
(4.4)
14.7
18.9
(4.2)
Voluntary Chain
Disc.
Conv. (Diff.)
14.5%
15.8
24.9
20.0%
23.3
29.5
15.5
21.5
2.0^
1.1
12.4
(5.5)
(7.5)
(4.6)
(6.0)
1.9*^
1.0
18.6
(6.2)
' For fiscal year most recently completed at time each company was studied.
'Number of percentage points that gross margin of discount food store is below that of conventional supermarket.
• Grocery includes diary, baked goods, non-foods and frozen foods, except for frozen meat and fish which are included in meat.
'For large chain, supplies expense is for grocery department only; meat and produce supplies in cost of goods sold.
Warehouse and transportation expense for members of the voluntary chain assessed as a percentage of the cost of
merchandise purchased plus a freight charge based on distance from the warehouse. Both stores studied were near
warehouses of the voluntary. On a cost basis both experienced the same expense, 2.47f. The warehouse and transportation expense of the larg'e chain's stores was an allocation on the basis of total sales of the total expenses incurred by the company.
certain service departments or other customer
services at the discount food stores, and/or by differences in average hourly labor costs. The conventional supermarkets of the large chain and small
chain had higher average hourly labor costs than did
the discount stores. Employees of these conventional supermarkets tended to have longer seniority
and, therefore, higher wage rates in accordance with
union contract provisions than did employees of the
discount stores.
Advertising. The discount food stores of the large
chain and the voluntary experienced much higher
advertising expenses than the conventional supermarkets primarily because of the use of direct-mail
circulars by the discount outlets. Discount food
store advertising at the small chain was mostly in
the newspapers and the advertising expense was only
slightly above that of the conventional outlet.
Profits
Reductions in operating expenses by the discount
food stores did not compensate fully for the differences in gross margins; consequently net profits
before taxes were from 1.4 to 2.6 percentage points
less at the discount stores. See Table 3.
Return on Selected Store Assets
Opportunities for the discount food stores to reduce significantly the investments in store facilities
or increase the turnover of inventory and fixed
assets were not found. Thus, as a concomitant of
lower profits, the discount food stores, although
showing pretax returns of from 27.4% to 30.6% on
the investments in these selected store assets, had
lower returns than the conventional supermarkets.
Customer Shopping Behavior
Customers of the discount food stores tended to
travel further to shop, to shop at these stores less
often, and to buy more per visit than did customers
of the conventional supermarkets. Differences in
the relative movements of selected product categories
at the two types of stores tended to support an
earlier finding that discount food store customers
were younger and had larger families."^
Conclusions
Essence of Discount Food Operations
The findings of this study indicated that discount
food stores, as exemplified by the outlets studied,
have reduced operating expenses primarily by eliminating trading stamps. These discount stores underpriced the conventional supermarkets, and the lower
prices appear to have attracted a segment of the
market motivated more by a low-price appeal than
by the merchandise premiums obtainable by saving
and redeeming trading stamps.
There was no convincing evidence that the discount
food stores had developed operating economies or
People and Food Discounting Today, 196^ (New York,
New York: Look Magazine, Cowles Magazines and
Broadcasting, Inc., 1964), p. 24.
Journal of Marketing, April, 1967
40
TABLE 2
DIRECT OPERATING EXPENSES OF DISCOUNT FOOD STORE AND CONVENTIONAL
SUPERMARKET OF LARGE CHAIN, SMALL CHAIN AND VOLUNTARY CHAIN'
Small Chain
Conv.
Disc.
Large Chain
Disc.
Conv,
(Average Weekly
Volume)
Labor :
Wages
Fringe Benefits''
Trading Stamps''
Reg-ular
Extra
Voluntary Chain
Disc.
Conv.
($62,000) ($60,000) ($57,000) ($47,000) ($50,000) ($49,000)
Advertising
Promotions
Supplies''
Utilities
Repairs
Building Rental
Equipment Rental
Depreciation
All Others'
6.0%
7.0%
1.1
1.2
....
1.4
.7
1.4
.3
.9
.2
1.7
2.1
.8
.4
6.1%
5.1%
5.9%
.4
.3
.4
.5
1.6
1.0
....
....
1.8
2.6
.8
.1
1.4
.9
1.9
.2
1.4
.9
.3
.7
12.6%
12.1%
15.7%
.2
1.3
.2
1.2
....
....
.7
.6
.6
.B
.6
.8
.6
12.8%
15.9%
10.1%
.9
2.7
.7
.2
1.0
.5
.2
1.2
1.2
.1
1.5
In Cost of Goods Sold
.4
In Rent
.3
.7
.4
....
Total
5.9%
....
1.1
.6
.2
' For fiscal year most recently completed at time each store was studied.
'• For large chain, vacation pay included with fringe benefits; for other companies, vacation pay included with wages.
' Regular denotes distribution of one trading stamp with each 10** in purchases. Extra
denotes distribution of additional stamps to customers making certain minimum total
purchase and redeeming coupon or buying certain featured items, except for large
chain. For large chain, extra does not include stamp expenses from purchases of certain featured items. This expense is included in promotion expenses for grocery items
and was added to cost of goods for meat items. Exact amount was not determinable.
•" For large chain supplies expense represents only grocery department supplies; meat
and produce supplies in cost of goods sold.
*• Includes window and fioor washing, snow removal, over and short, bad checks, laundry,
ice, donations and other sundry expenses; interest for the discount store of the small
chain and both stores of the voluntary; and building taxes and building insurance for
the conventional supermarket of the voluntary only, othervnse included in building
rental.
TABLE 3
SUMMARY OF DIFFERENCES IN GROSS MARGINS, OPERATING EXPENSES AND NET PROFITS
OF DISCOUNT FOOD STORE AND CONVENTIONAL SUPERMARKET OF
LARGE CHAIN, SMALL CHAIN AND VOLUNTARY CHAIN
Gross Margin"
Store Operating Expenses'
Net Profit Before Taxes
Large Chain
Disc.
Conv. (Diff.)''
Disc.
19.4%
12.8
2.2
14.7%
10.1
3.0
23.8%
15.9
3.6
(4.4)
(3.1)
(1.4)
Smalt Chain
Conv. (Diff.)
18.9%
12.6
4.7
(4.2)
(2.5)
(1.7)
Voluntary Chain
Disc.
Conv.
(Diff.)
15.5%
12.1
1.4
21.59;:
15.7
4.0
(6.0)
(3.6)
(2.6)
' Number of percentage points discount food store below conventional supermarket.
"See Table 1.
^See Table 2. •
Note: Store Operating Expenses and Net Profit Before Taxes do not total to Gross Margin because Store Operating Expenses do not include Warehouse, Transportation and General Office Expenses, whereas Net Profit Before Taxes is net of these expenses plus other income.
The Real Challenge of Food Discounters
merchandising methods that were not readily available to conventional supermarkets.
Changes at Both Types of Stores
Initially the food discounters may have had other
advantages over conventional supermarkets, but
these have been disappearing as the discounters have
yielded to customer desires and/or pressures to raise
margins and limit costs, and the conventional supermarkets have adopted methods first employed in the
discount food stores.
Thus, this study revealed that:
Grocery department variety, at first substantially
less at the large chain's discount outlet and somewhat less at the small chain's, was increased in response to customer demand. The large chain's private-label line of groceries and some private-label
items at the voluntary were added to assortments to
increase gross margins.
Parcel pickup and bottle return services, considered for elimination at the small chain's discount food
store, were included in recognition of customers'
wishes. Hours were extended at the large chain's
discount outlet in response to customer demand. The
large chain was experimenting with service departments in some of its other discount food stores.
High costs led the small chain and large chain to
shift from the initial use of direct-mail advertising
to regular newspaper advertising for the discount
food stores studied.
The large chain's conventional supermarkets
quickly adopted a replenishment system for groceries initially conceived for the discount outlets.
Meat wrapping machines, in use only at the discount food stores studied, had been approved or were
under consideration for the conventional supermarkets.
Conventional supermarkets of the large chain and
voluntary were employing mass display techniques
initially used almost exclusively in the discount food
stores.
The small chain's conventional supermarkets were
making more use of tray-pack stocking, a technique
initially restricted to its discount outlets.
Why Operate Discount Food Stores?
In view of the relatively-lower profits and the lower'
returns on selected store assets of the discount food
stores, why are the companies studied operating
them? At the time these companies first opened
discount food outlets, there was vddespread interest
in discount food operations among food retailers and
wholesalers, as Leiman and Kriesberg have pointed
out.s McNair, Applebaum and Salmon have referred
to efforts of food retailers and wholesalers to become
involved in discount food operations.^" These sources
8 Same reference as footnote 1, at p. 38.
8 Same reference as footnote 4, at p. 22.
41
noted the unavailability of specific information about
discount food operations. The companies studied,
therefore, seeking to learn about discount food retailing, had to become actively involved in it in order
to do so.
Furthermore, the large chain and the small chain
had been approached regarding their interest in
operating discount food departments in combination
general merchandise-food discount stores. So in addition to seeking firsthand knowledge about discount
food operations, these companies also desired to keep
competitors from getting a foothold, if they instead
operated the food departments in these general merchandise-food discount stores.
Moreover, discount food stores were found to be
achieving higher sales volumes, reaching breakeven
levels more quickly and showing a greater return on
the investment in selected store assets than many of
the companies' newer conventional supermarkets.
Prior to expanding with discount food stores, each
company had been experiencing difficulty in finding
locations for profitable new supermarkets. The pretax returns on selected store assets earned during
the first full fiscal year of operation by new conventional supermarkets of the large chain opened approximately two years prior to the large chain's
concei-ted entry into food discounting were as
follows:
Pretax Return
on Selected
Store Assets
Above 40%
20 to 30%
Less than 10%
Losses
Percentage of
New Supermarkets
39%
15
31
15
The pretax returns on selected store assets earned
during the first full fiscal year of operation by new
conventional supermarkets of the large chain opened
approximately one year prior to the large chain's
concerted entry into food discounting were as
follows:
Pretax Return
on Selected
Store Assets
Above 40%
20 to 30%
Around 10%
Losses
Percentage of
New Stores
7%
7
29
57
New conventional supermarkets of the small chain
opened shortly before that company's concerted entry
into food discounting were showing pretax returns
on selected store assets of about 15%; those of the
voluntary were approximately breaking even or
showing losses.
In writing about the problems of food chains just
prior to the time that the companies studied entered
food discounting. Professor Robert D. Buzzell of
Harvard Business School pointed to "the apparently
increasing difi^iculty in finding profitable locations
42
Journal of Marketing, April, 1967
for new stores. In a survey made by Super Market
Institute of new stores opened by its members in
1961, actual sales were found to have fallen short of
planned levels in 58% of the cases. Profits of the
new stores also were disappointing. The president
of one food chain expressed the effects of this situation as follows: 'Two years ago, we would expect a
new store to become profitable within three months.
Today the average is about nine months'."^"*
Thus, by operating discount food stores the companies studied have acquired firsthand experience
with this type of outlet. They have been able to continue their expansion. While not earning as high a
return on selected store assets as was earned in some
older conventional supermarkets, the companies have
been able to earn better returns on selected store
assets than were possible in most new conventional
supermarkets. As the companies have opened additional discount food stores and are seeking locations
for others, it seems reasonable to infer that the
return on selected store assets earned by operating
discount food stores is considered satisfactory by
the managements and is greater than the cost of the
funds involved.
Moreover, the companies studied have been able
to capture business that could have been lost if,
instead of they, competitors had operated the food
departments in the combination general merchandise-food discount stores in which they located.
Market shares of the companies studied increased as
a result of the sales achieved in the discount outlets.
Using the companies' market shares just prior to
their entrance into discount food operations as bases
of 100, indices of the changes in market shai*es,
attributable to the discount operations determined by
studies of newspapers and of the large chain's and
voluntary chain's mai'ket research departments,
follow:"
Large
Chain
Market share prior to
opening discount
100
outlets
Market share when
125
studied
Change in market
share attributed
to discount
-f-25%
food outlets
Small
Chain
Voluntary
Chain
100
100
117
177
-f-17%
+77%
Robert D. Buzzell, Operating Results of Food Chains
in 1961 (Boston, Massachusetts: Division of Research, Harvard Graduate School of Business Administration, 1962), p. 37.
Figures for the large chain and small chain are for
their principal market areas. Both also have successful discount food stores in areas where they had not
previously had any stores. Figures for the voluntary
are for the market area in which the independent
member whose discount outlet was studied operates
discount food outlets and refiect his sales volume and
that of other conventional supermarkets sponsored by
the voluntary.
Food Discounting a Marketing
Strategy
The results of this study indicate that food discounting is actually a marketing strategy. Consider
that each of the conventional supermarkets studied
spent between $65,000 and $70,000 on trading
stamps during the fiscal year for which data were
reported. Are there other ways in which these sums
could have been used to promote business for the
stores? Obviously there are. The money could have
been used for more advertising or for other premiums, besides trading stamps. It could have been
given to customers with cash drawings. Giveaways
of "One Thousand Dollars Per Week for an Entire
Year" would not have exceeded the amount each conventional supermarket spent on trading stamps. A
$2,500 automobile could have been given away every
other week.
Giving the money to customers in the form of
lower prices was essentially the route chosen by the
discount outlets. The managements of the companies studied thought the distribution of trading
stamps to be the best use of the money at the conventional supermarkets. The profits and returns on
selected store assets that were earned attest to the
merits of this use for the conventional supermarkets.
Likewise, the profits and return on selected assets
attest to the merits of promoting lower prices for
the discount stores.
In effect, the companies studied have become like
two product firms with the principal differentiating
factor between the two being the award of trading
stamps for patronage of one and lower prices for
patronage of the other. This is a distinct departure
from traditional food chain operation wherein a mix
of assortment, price, promotion, and service tends to
become standardized in all stores presenting a uniform chain-wide appeal to a heterogenous market.
The food discounter, as exemplified by those
studied, does not appear to pose a threat to the conventional supermarket because he possesses operating advantages not available to the conventional
supermarket. The food discounter has no inherent
operating advantages over the conventional supermarket. The real challenge of the food discounter
is that he may be fulfilling customer wants not being
met by competing conventional supermarkets; that
is, a desire for lower food prices.
The ability of these companies to expand their
market shares by opening discount food stores, while
earning higher returns on selected assets in discount
outlets than were possible in most new conventional
stores, indicates the existence of customer desires in
their markets that were not previously being
satisfied.