Customers turn to cheaper grocery options

Consumers are finding ways to keep their grocery bills in check as food costs climb, trading down and changing how they feed their families.

This shift is showing signs of altering the competitive landscape for Canadian supermarkets.

Grocers have started to pass on to shoppers price hikes from suppliers whose own costs are surging. But they're finding they can't raise prices too much because consumers simply stop buying higher-priced goods and switch to cheaper alternatives. At the same time, discounter Wal-Mart Canada Corp. is pressuring its competitors with expanded food offerings, meaning their rivals must in turn bolster their own discount operations and promotions.

Statistics Canada reported earlier this week that food prices, measured by the consumer price index, are on the rise, but that inflation is only starting to help grocers, and only in limited ways.

Typically, a little inflation is a grocer's friend, since stores can pass on higher prices without much consumer resistance. But the rapid expansion of discount stores is moderating that. Supermarkets no longer have the luxury of just jacking up prices when their own costs rise, because discounters have trained consumers to hunt for deals. The retailers are racing to focus more on their own discount arms, straining their margins and forcing them to find savings elsewhere.

"Milk prices have gone up a bit, bread prices have gone up a bit, some produce [fruits and vegetables]is up because of the [growers' unseasonable]weather," Eric La Fleche, chief executive officer of Metro Inc. , the country's third-largest grocer, said Wednesday.

"But the big spike you see in CPI numbers for vegetables in March, for example, is not what we are experiencing in our [customers' shopping]basket, because when those things happen people just avoid those products and we don't even sell any, because of the switching going on."

At Metro, whose profit margins are among the best in the sector, second-quarter profit rose 3.7 per cent to $83.3-million or 80 cents a share - missing analysts' consensus forecast by 2 cents as its sales dipped 0.4 per cent to $2.57-billion, a result of food deflation and lower drug revenues, which were squeezed by generic drug reforms.

In the quarter, which ended March 12, the Montreal-based grocer said it faced food price deflation of 1 per cent ,which began to ease at the end of the period.

Statistics Canada reported that costs for food purchased from stores jumped 3.7 per cent in March, marking the biggest annual increase in 19 months, amid commodity price increases and bad weather in Mexico and the southern United States, which drove up vegetable prices.

Statistics Canada and the grocer are using a different basket of groceries to measure price changes.

Food costs make up about 17 per cent of the so-called basket of goods in Statistics Canada's consumer price index, with various items within that category weighted differently based on how frequently a typical family would buy them. Statistics Canada's numbers often vary from what grocers actually experience, said BMO Nesbitt Burns analyst Peter Sklar, because the agency "measures a fixed basket whereas in reality, consumers substitute for categories that are inflating rapidly, and seek categories that are deflating rapidly."

Mr. Sklar added that he's "concerned about the Canadian grocery sector with respect to the impact of wholesale food inflation and the potential inability of the grocers to entirely pass through those cost increases at the retail level due to competitive pressures."

Metro isn't alone in feeling the need to step up its discount groceries. Loblaw Cos. Ltd. , the top grocer in Canada, is focusing more than ever on its low-cost division, adding more discount No Frills stores across the country, while investing in its discount Real Canadian Superstores. Sobeys Inc., too, is pouring money into converting its discount Price Chopper stores to Freshco.

"They're investing more effort in the discount market," said Martin Gooch, director of Value Chain Management Centre at the George Morris Centre, an agribusiness think tank in Guelph, Ont.

Discount chains shave costs by carrying about one-third fewer products than a mainstream supermarket, Mr. Gooch estimated. A discounter often stocks just two brand options in a food category, while a conventional grocer has three.

Stocking fewer items reaps savings by reducing the complexity of the business, requiring less shipping, labour and logistics, he said. It also carries less risk because discounters can stock products that their customers are most apt to need and purchase.

Grocery executives also says that the proportion of promotional selling is at record highs. Mr. La Fleche said on Wednesday that the proportion of promotions is higher than ever on the discount side of the business.

Bill McEwan, chief executive of Sobeys, said last month that discounted selling had increased "at significant rates which has a corresponding net impact on margins clearly. That has been the case thus far. We see a moderation of that currently in the last part of the quarter."

Mr. La Fleche said Metro is beginning to see a return to modest food inflation in its current quarter. But while some consumer product suppliers have raised their prices, most have not, he said.

"So in general, the prices are pretty stable," Mr. La Fleche said. "It's my belief that most of these increases are moderate. Some have seen some spikes because of commodity issues. And what happens in those cases is that sales of those products suddenly dropped because people adjust and people avoid price spikes and switch."