Expert Column: Optimizing the Grocery Chain Portfolio

During the recession, many brick-and-mortar retailers had to pull back and re-evaluate their portfolios to guard profit margins. Traditional grocery stores were no different. Store consolidation and the shift of customer traffic to nontraditional grocers, such as online grocers, created the need for traditional chains to evolve, adapt and, in many cases, reduce store counts.

With modest economic growth, now is the time for grocers to refresh and reinvest in strong stores, as well as re-evaluate underperformers. Performing a strategic review focused on optimizing the real estate portfolio is necessary to reduce costs and provide the financial basis needed for reinvestment.

Grocery stores have long been anchors in large shopping plazas, creating the underpinnings of customer traffic. As competitors like Walmart, Target and large online retailers such as Amazon push to take market share, traditional grocers must push to be more competitive to retain their customer base and stay profitable or even survive. Optimizing the grocery chain's portfolio of leases should be a central part of the strategy used by management to improve sagging margins at underperforming stores, strengthen high performers and determine where to invest savings. Assessing store performance in the context of defined financial metrics and overall occupancy liability is a critical first step to creating a detailed plan to optimize the portfolio and remain competitive in the marketplace.

Assess Your Stores

A strategic portfolio review should be comprehensive of all stores within the chain and consider the important aspects of each store's operational strengths and weaknesses; along with key P&L and occupancy metrics compared with system averages. Management should then conduct a fresh operational review of past and current performance for each store and revisit future expectations. An assessment of lease liability, including rent, escalations and other occupancy charges remaining throughout the full term must also be taken into account. With a complete and thorough portfolio assessment, an effective strategic review will then categorize stores and determine which underperformers are fixable through reinvestment, restructuring or a combination of both. Tenants can often work together with landlords to obtain remodel capital and rent reductions with lengthened terms, which can improve the capitalized asset value of the center. In addition, a longer-term stable lease with a center’s anchor can support the landlord's efforts to attract and retain other tenants.

Execute a Plan

Finally, developing a plan of execution that addresses current issues and proactively manages store assets on an ongoing basis is critical to optimizing a portfolio and keeping it in top shape. Grocery retailers need to quantify aggregate lease obligations and understand which locations have the highest impact on occupancy expense with low contribution to the bottom line on a relative basis. In addition, it's important to focus on the internal process by which the chain manages lease obligations. Rather than addressing lease obligations at the outset or at the time of renewal, lease terms should be frequently reviewed to determine where opportunities may lie in conjunction with the operational performance of each location.

In addition to understanding market rents, it’s also important to develop effective metrics such as the cost of occupancy as a percentage of sales, and the portion of operating income going to occupancy. Often, stores that surpass a given threshold in these metrics will signal that a store is headed for trouble. Even stores with strong revenues can have unacceptably low profitability if occupancy costs are out of line.

When implementing a program to restructure leases, it's best to create a store-specific strategy. There are several approaches that can be used to successfully engage a landlord in an effort to revise lease terms and determine the correct approach, including studying the lease, local trade area and specifics of each site, as well as the landlord's situation.

Choose the Right Team

Another key factor in optimizing a lease portfolio and reducing occupancy costs is choosing the right team. When a portfolio consists of more than a few locations, a team is necessary to be successful. Engaging professionals seasoned in assessing real estate portfolios and well versed in negotiating with all types of landlords is a key complement to the internal team. A grocer's finance and real estate staffs are generally not best suited to engage landlords in lease renegotiations. Qualified outside professionals aren't vested in prior decisions and are more likely to be unemotional when dealing with landlords. The appropriate outside negotiator brings the right experience and can achieve the best result for the company while preserving a good relationship with the landlord.

Since the recession, there has been a dramatic shift toward remodeling grocery stores rather than opening new stores. The best way for stores to implement a remodel is by working with their landlords to see what terms would benefit both sides of the partnership. This could include negotiating lease terms for a lower rent, but with a longer term to raise the property value. In addition, joint ventures between landlord and tenant can minimize risk and expense while increasing the ROI for both parties involved.

The pressure is on for grocers to meet their customers' expectations and keep pace with the shift of a portion of volume to online sales, while at the same time protecting thin margins. With occupancy costs one of the primary cost-line items, behind cost of product and labor, it's critical for grocers to proactively manage their lease portfolios with periodic strategic reviews and ongoing tactical management. By assessing the store base and distinguishing outperformers from underperformers, and then aggressively acting to protect strong stores and either turn around or eliminate below-average stores, a grocery chain will maximize its likelihood of competing effectively and thriving in today’s ultracompetitive marketplace.