Groceries get cheaper, to retailers' dismay

The takeaway from last week's quarterly results from Supervalu was that analysts and investors weren't expecting much but still got disappointed.

CEO Mark Gross had to repeatedly explain on his investor conference call that it was a "challenging" or "difficult" time to be running a chain of grocery stores. And in fairness to him, he's far from alone in his industry in holding these views.

For those not up on industry news, it can be puzzling at first just what he could be talking about.

Unemployment is half of what it was during the Great Recession, median household income was up 5 percent last year according to the government and housing prices have about made up all the ground lost in downturn. And, of course, we all eat. How could selling groceries be a tough business?

Well, it can if selling prices keep slipping, as they have for Supervalu's retail business as well as just about everybody else.

This is great news for shoppers, of course, but for anyone in the food business it is a new and serious problem. At least in the past 30 years, grocery store price declines across the board have not happened outside of an economic recession.

"It's a fairly sustained bout of deflation," said Jim Hertel, a senior vice president with Illinois-based consumer products and retailing consulting firm Willard Bishop. "It's been a long time since we've seen anything like this."

Declining prices for commodity products like meat and milk are most of the story, Hertel said, yet the government data show that's not the whole story. "Over the last 12 months, the food-at-home index has slipped 2.2 percent, the largest 12-month decline since December 2009," noted the Bureau of Labor Statistics in its most recent consumer price index report. "All six major grocery store food group indexes declined over the last year."

This isn't just store managers putting items on sale, either. "In some of our recent visits, we have noticed items such as Coffeemate and Pepperidge Farm Cinnamon Bread where the list price has fallen," retailing analysts at Wolfe Research wrote in a recent report. "For food manufacturers, this is an especially concerning trend if it was to continue."

Wolfe's Scott Mushkin also noted that cutting prices hasn't led to an increase in sales by volume, a basic observation that in economics is known as price inelasticity. That is, if the price of Coffeemate gets cut 5 percent, few people seem to think they need to use more of it in their coffee.

Grocery-store operators who are forced to cut prices can sometimes buy from producers and wholesalers at cheaper prices, saving some profit margin. But the far bigger problem for the finances of a retailer is that rent and property taxes, hourly payroll, snow removal service and every other cost of doing business won't decline just because the store decided to cut its prices on Coffeemate. What declines is the operating profit of the store.

As to why the price declines are happening, one big explanation is simply more intense competition. A generation ago about 90 percent of food prepared at home was purchased from supermarket companies. Now it is less than half, Hertel said.

"Across the nation, new demand from grocery-oriented users has propelled much of the new retail construction," real estate consultants Jones Lang LaSalle wrote in a research report earlier this year. "Of the more than 81 million square feet of new retail space built in 2015 … more than two-thirds of new construction occurred in categories dominated by daily-needs retailers, including traditional grocers, limited assortment grocers and super centers."

The title of this Jones Lang LaSalle report sums up its thesis: "Grocers Compete, Retail Real Estate Wins."

The competitive dynamic varies by regional market, and here in the Twin Cities there has been aggressive expansion as well. Aldi, a limited assortment discount retailer, has been expanding in Minnesota. Hy-Vee is just getting started on ambitious plans for the Twin Cities. Sturdy local players like Kowalski's Markets have not been standing still, either.

Retailers just about everywhere in the United States have to contend with Wal-Mart, and lately it has decided it needs to regain its market position of having the lowest prices in town.

Wal-Mart's "price investment" strategy has had a predictable effect. Mushkin looked at greater Atlanta, where Wal-Mart Stores, Kroger and Publix Super Markets each hold roughly the same share. Kroger seemed earlier this year to hope to sit out the price-cutting battle in Atlanta but finally decided it had no choice. Mushkin's 70-item basket of popular items cost about $17 less in September at Kroger than it had in July, as Kroger tried to respond to Wal-Mart.

As for when grocery prices turn around, published forecasts seem to fall all over the board, as market forecasts typically do. "A rosy view would be we have 18 more months of this," Hertel said. "And it could be a lot longer than that."

One factor clouding anyone's crystal ball is uncertainty about when the current economic expansion runs out of gas. Given how long it has lasted already, it seems more likely that we are closer to the start of the next recession than we are to the end of the last one.

The start of a new recession, of course, won't be the time to try across-the-board price increases.