In which SA contemplates giving its lunch money to the playground bully
Last year, shortly after the disclosure of intense talks with H-E-B over the construction of a downtown supermarket, City Hall announced $1 million in taxpayer monies to attract an unspecified banner-name operator. It went unsaid but residents knew exactly which storefront planners envisioned: the chain Mayor Julián Castro has referred to as San Antonio’s “official store.” So the release this week of an RFI for companies tantalized by the incentive feels like a dog-and-pony show designed to deflect the criticism of citizens who might oppose a handout to one of San Antonio’s richest corporations.
In no other metropolitan area in the United States do shoppers patronize a supermarket chain that wields such dizzying market dominance. Outside of South Texas, any metropolis you care to name is plied by myriad local, regional and national supermarket chains. Kroger, Albertsons, Publix, Vons, Ralphs, Safeway, Food Lion, and other major banners constantly compete for customers. A national survey by Consumer Reports published last May revealed that, “[o]ne-third of subscribers surveyed said they had given the heave-ho to a nearby grocery store.”
Good luck with that here. With rare exception, H-E-B – which declined requests for an interview for this story – provides virtually the only traditional supermarket service, even though groceries remain big business in the U.S. According to a research report on retail by Wells Fargo Securities last August, “The vast majority of people (more than 80 percent of those we surveyed) indicate that they still shop at a traditional grocery store (i.e., Safeway, Kroger, Albertson’s, etc.) as one of their primary grocery destinations.” Locally, the competition H-E-B faces comes not from supermarket powerhouses such as those, but indirectly from niche or natural chains like La Fiesta or Whole Foods, hypermarket formats operated by Walmart and Target, and military commissaries.
“H-E-B is a San Antonio institution that has forced out every major competitor that has come to town,” said one longtime industry observer. “It would be unlikely in the short term that another conventional grocery operator could really challenge its home market because it would need a lot of locations to make a major impact across the market, and I doubt there are enough spaces available for a competitor to move in and make that to happen. It would be difficult for anyone other than Walmart, with its strong price reputation and deep pockets, to pose any sort of challenge to H-E-B In San Antonio.”
Walmart has indeed been the only chain that has successfully drilled into H-E-B’s homebase at any depth. Its first local foray landed on Nacogdoches Road in 1984, but Walmart began accruing an accelerating share of the grocery business only in the 1990s and 2000s after the company began adding supermarket stock to its inventory. The Arkansas retail juggernaut came late to the game, incorporating a grocery section in 1988. But by the end of the last decade its total sales of supermarket items rang to $188 billion, head and shoulders above second-place Kroger with $76 billion, which was followed by Safeway with $41 billion. As these ambitions became a strategic priority, the world’s largest merchandiser has unrelentingly squeezed H-E-B, building out to 14 supercenters in the San Antonio area with half a dozen more in the pipeline.
In most regions, Walmart has meant nothing but pain for supermarkets. In San Antonio, though, its presence served to shore up H-E-B’s home turf against other competitors. As Walmart encroached, H-E-B circled its wagons around suburban belt highways. The feud created a discount tandem that blunted the entrance of Target and ground down conventional chains large and small.
Defending its Walmart flank has been bruising, but H-E-B’s unique, ubiquitous, unyielding local footprint enabled it to finance a campaign that included opening bigger stores, slashing stickers on thousands of items, and pouring investment into its highly rated own-brand product development. In 2012, it slated $100 million in capex to open new San Antonio stores and cut prices even more aggressively. It also launched 551 new own-brand products, according to industry magazine Progressive Grocer. That topped any other U.S. supermarket by a wide margin; even mighty Walmart only cranked out 291. H-E-B claims that, thanks to these actions, in the past several years it not only resisted the Bentonville blitzkrieg, but actually reclaimed Alamo City terrain. President Craig Boyan recently boasted that H-E-B’s share of the local supermarket business rose by 5 points to 71 percent.
H-E-B’s portion could actually be even larger, because tracking market share in food retail is difficult. The Food Marketing Institute defines “traditional supermarkets” as stores offering a full line of groceries, meat, and produce with at least $2 million in annual sales. It distinguishes them from “the small corner grocery store, the supercenters, and military commissaries.” But analysts often parse the industry from different lenses, since non-restaurant food is purveyed by dollar stores, convenience stores, membership warehouse stores, mom-and-pop corner stores, farmers markets, grocery markets, supermarkets, hypermarkets, wholesalers, and so on. The boundaries between formats often blur, and companies often operate in more than one sphere.
The Shelby Report on market share of the $14.42-billion South Texas food retail region (an area comprising cities such as San Antonio, Austin, Waco, Laredo, Corpus Christi, McAllen, and Brownsville) ranks the top three firms as H-E-B (62 percent), Walmart (24 percent), and wholesaler Grocers Supply (6 percent). But if you slice out hypermarkets and wholesalers from Shelby’s accounting, the volume of consumer spending tabulates to $8.94 billion in South Texas alone, of which H-E-B claims an astounding 89 percent.
“Grocery shoppers generally speaking look to supermarket operators for solutions, whether it's what to cook for dinner, how to keep their cholesterol in check or ways to support local businesses, among many other expectations. They also are seeking value, particularly since the recession,” said Terrie Ellerbee, associate editor of Shelby Publishing. “H-E-B is a strong and smart operator that delivers on each of those and more. It knows who its customers are and caters to them by offering different store formats: H-E-B, H-E-B Plus!, Central Market, Mi Tienda and Joe V's Smart Shop.”
The fiefdom has reaped a huge fortune for its overlords. Crowding our geography with more than 300 stores, the company raked in revenues of $18.7 billion in its last fiscal year, placing it at number 12 among the nation’s largest private companies. Chairman and CEO Charles Butt sits on an estimated net worth of $6.9 billion, according to the most recent Forbes list of America’s 400 wealthiest people, making him the 50th richest individual in the United States, sixth in Texas, and unrivaled in San Antonio.
Building the bunker
The absence of non-H-E-B supermarkets in San Antonio neighborhoods has not always been such. Maggot, a downtown mom-and-pop grocery, opened in 1883. Handy Andy was founded downtown in 1926 by the Becker family. Both still hang on. Comments in an online forum at Yuku.com which asked, “Grocery stores, how many can you name? Who was here before the H-E-B monopoly?” recall more than a dozen others.
H-E-B, conceived in Kerrville in 1905, did not even open a store here until 1942. In his first successful expansion, Charles’ father Howard purchased Piggly Wiggly franchise rights in Del Rio in 1926. Business boomed and he extended into the lower Rio Grande Valley, opening two dozen new stores and moving headquarters to Harlingen in 1928. Through the Great Depression, Howard’s stores flourished thanks to steep discounting and the vertical integration of new bakery and cannery subsidiaries.
After honing his skills during the tough times, Butt stormed up the Gulf Coast, shifting headquarters to Corpus Christi in 1938 and opening his first big city location in Austin. In the early 1940s, about the time it initiated its presence in San Antonio, the chain rebranded from Piggly Wiggly to H-E-B. Its first supermarkets, consolidating a fish market, butcher shop, pharmacy, and bakery under one roof, began appearing in the 1950s.
In the years that followed, as H-E-B worked to become a household name in the region, current CEO Charles worked his way through University of Pennsylvania's Wharton School and a Harvard MBA. He took the helm of what had become a sprawling South Texas chain in 1971 at the age of 33, during a precarious time of industry growth and evolution. President Richard Nixon imposed price and wage controls the same year. Sweeping industry reorganization framed the scion’s rookie period, with regionally dominant chains linking larger and going national through a series of acquisitions and mergers. Butt’s masterful leadership during this phase of the industry’s hectic evolution shaped his philosophy of “restless dissatisfaction,” which has become the firm’s operational mantra.
In 1980, Ohio-based Kroger Co. publicized plans to spend $50 million to storm San Antonio. Charles quickly countered out of Corpus with an announced $46-million San Antonio-centered expansion. The ensuing scorched-earth price war failed to repel Kroger, but instead decimated numerous smaller competitors. Charges of unfair trade practices quickly followed.
“Coincidentally or not, since March 1981 one six-store chain, Deluxe Stores, has gone bankrupt and liquidated its holdings, California-based FedMart has left San Antonio and Texas altogether, and the Lucky chain has closed down the three Eagle stores,” read an article in the August 1982 edition of Texas Monthly. “The biggest bombshell fell in September, when Handy Andy, the 48-store chain that traditionally had dominated the market along with H-E-B, also filed for bankruptcy.”
In 1982, Handy Andy and other San Antonio-based entities filed federal lawsuits against H-E-B for predatory pricing, the deep-pockets gambit of selling product below cost in the short term to eliminate the competition and then recuperating lost profits by absorbing market from former competitors. In the space of two years, the suit complained, H-E-B boosted its market share from 30 percent to 32 percent. The plaintiffs also claimed that H-E-B set its Alamo prices at an average of 12-percent below levels in its stores outside the city. “Thirty miles from San Antonio, their prices are 11 to 14 percent higher,” Centeno chain owner Eloy Centeno was quoted as saying in Texas Monthly. “Now, that’s predatory pricing. It’s black and white.”
H-E-B settled out of court.
H-E-B moved its headquarters to San Antonio in 1985 after accumulating a 43-percent market share. It emerged from the price wars profoundly entrenched. Centeno folded. Handy Andy downsized and went on the auction block. Kroger opened its stores, but they were among the worst-performing of its entire national chain.
This pattern would be repeated again and again. In 1993 Kroger beat the retreat, selling its 15 stores to discount warehouse retailer Megafoods Stores of Arizona, which spent $9 million to remodel and rebrand them as low-price, low-overhead Texans’ Supermarkets. Evidently, Megafoods hadn’t done their homework.
"H-E-B would not concede the title of lowest-priced operator in the marketplace, and you can't run a warehouse market without everyday low prices," Jack Walker, chief financial officer of Megafoods, groused in an interview with trade publication Supermarket News in 1994. “As a result, nine weeks after we opened in San Antonio, we've thrown in the towel."
Unable to compete with H-E-B’s pricing strategy, the Mesa-based grocer ditched the Texans’ banner and warehouse format and snapped up the Handy Andy chain, convinced that it could lock horns on location. “With the Texans' Supermarket stores changing to Handy Andy,” said the April 1994 press release, “we will have 31 Handy Andy stores in San Antonio and five stores in New Braunfels, San Marcos, Corpus Christi and Alice." But these Alamo ambitions met with mega-failure, too. In August 1994, Megafoods filed for bankruptcy.
At the same time, subsequent to a 1992 buyout of partner Skaggs, Idaho-based Albertsons had begun consolidating a Texas presence and rebranding 10 stores in San Antonio, which held some 13 percent of the market. It outlived Kroger and Megafoods, and by the end of the 1990s, the Albertsons banner had become the second-largest supermarket chain in San Antonio behind H-E-B. Far behind. It had more than doubled its store count to 23, but wrangled merely two additional share points to 15 percent of consumer spending, while H-E-B had increased its market share to 60 percent with only 42 stores.
Struggling nationally to grow scale enough to confront Walmart’s entry into the supermarket business, Albertsons had become overextended and in need of restructuring by the year 2000. New management, appalled at its costly beating at the hands of H-E-B, shuttered all San Antonio stores in 2002, calling it an “underperforming market.” In 2006, a lingering New Braunfels location became the property of private equity firm Cerberus Capital Management. H-E-B, tightening its stranglehold on San Antonio supermarkets, purchased and liquidated the New Braunfels store in 2011. This final coup de grace also bundled and eliminated an Albertsons Kerrville grocery, surely a moment of supermarket schadenfreude for Butt.
Not your father’s monopoly
Defenders of H-E-B refute charges that the corporation qualifies as a monopoly predicated on the simple fact that it faces competition, even if very little of that comes from traditional supermarkets.
“Look at how many military commissaries are in San Antonio. Look at how many Walmart Supercenters there are in San Antonio – a lot of them. SuperTargets, Whole Foods, Trader Joe’s,” David Livingston of DJL Research, said. “There’s no way H-E-B can get away with raising prices because of having a monopoly. H-E-B has perfected its business model catering to the Tex-Mex culture. Other retailers just never were able to adapt.”
But monopoly power is considered potentially harmful to both commerce and consumers even in the absence of a pure monopoly and unbridled pricing power. The Federal Trade Commission also keeps an eye on “anticompetitive conduct in the marketplace, including monopolization and agreements between competitors.”
One simple rule of thumb the FTC uses is the “four-firm concentration ratio,” summing the market shares of the top four companies in a particular industry. Any share ratio higher than 60 percent indicates market concentration, and the likelihood of oligopolistic behavior. H-E-B easily clears that four-firm benchmark ― and it does so as a single company.
Alternatively, trust-busters employ the Herfindahl-Hirschman Index, calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. An index of 1500 marks the threshold for a moderately concentrated market; 2500 and higher is considered highly concentrated. Based on the Shelby Report, the South Texas food retailing region hits a staggering HHI of 4470, even when supermarkets, wholesalers, hypermarkets, niche and natural food retailers are included in the calculus.
Under prevailing San Antonio conditions, competitors could be expected to engage in conduct that tilts the market in their favor. The bigger players have more gravity with which to tilt. This behavior may take many forms, including dumping or predatory pricing, limit pricing, and exclusive dealing. But it takes egregious examples for the government to intervene, and in civil suits brought by private companies, courts maintain a high burden of proof.
In 2011, San Antonio supplier Delta Produce and sister company Atled sued the H. E. Butt Grocery Company in the U.S. District Court for the Western District of Texas, alleging that H-E-B had prohibited Delta from selling avocados, watermelons and tomatoes to competitors as part of a supplier contract that dated back to the late 1980s. According to the complaint, H-E-B enforced this exclusivity even as it diversified its own suppliers, reducing Delta’s revenues. The exclusivity agreement compelled Delta to forgo potential contracts with Walmart in 2003 and Albertsons in 2006, since the H-E-B contract was “too big to lose.” By the time H-E-B lifted the limit in 2008, Delta complained, its business was irreparably harmed and well down the path toward bankruptcy.
H-E-B lawyers moved for dismissal of the suit on the basis of statute of limitations, and a federal judge agreed in January 2013, stopping the lawsuit in its tracks. In his ruling, however, Senior U.S. District Judge Harry Lee Hudspeth concluded that Delta’s grievances gave it standing on an antitrust basis. “HEB’s restriction on trade caused Delta to lose business and ultimately fail, which is the very injury that the Sherman [Antitrust] Act intended to prevent,” he wrote.
Relaxing the rearguard
Nearly a year ago last April, just as H-E-B opened its largest store to date, an 182-thousand square-foot Plus! format on Bandera and Loop 1604. Massive, modern, and, like its stores everywhere, finely tuned to its proximate demographic, the new facility is a monument to the chain’s strategic pushback against Walmart Supercenters. H-E-B had accomplished what perhaps no other U.S. retailer has been able to do: beat back a Walmart offensive. At the biannual strategy meetings in its stores, managers assured employees: “We’re winning.” Restlessly.
Within months, though, the vulnerability of the emphasis on big-box battles became manifest. While clawing back market share from hypermarket competition, H-E-B’s traditional supermarket segment, the core of its business, has come under attack.
In September, Whole Foods opened a new store nearby in The Vineyard plaza; in October, Target inaugurated its “Fresh” concept, a smaller format with an emphasis on grocery inventory, in Alamo Heights, while during the same month Seabrook-based Arlan’s Markets announced it would take over remaining Handy Andy stores here. In November, Trader Joe’s cut the ribbon on its first San Antonio location in The Quarry. In January, Walmart announced that it will introduce a series of its Neighborhood Market stores to the city, and it has acquired property on Military Drive and Hunt Lane for the first.
Traffic and volume is already rising at Arlan’s Markets, which has nearly finished rebranding and remodeling three Handy Andy stores in San Antonio and one each in Schertz, Seguin and New Braunfels. “I’m not really concerned with H-E-B,” owner Ames Arlan said. “They do a great job but we’re not really trying to be an H-E-B. We’re a family-owned business focused on good customer service and fair prices. We’re probably not as cheap as H-E-B and we don’t claim to be. There’s a lot of value in just going around the corner to shop. Some people don’t want to go into a big 100,000-plus square-foot store that’s half a mile away. It’s nice to be able to give people like that a decent option. What we’re trying to do is revitalize the neighborhood supermarket.”
Meanwhile, the City’s economic development planners are focused on revitalizing the city center, not fostering metropolitan-wide supermarket competition. Unfortunately, because supermarket competition is excessively concentrated in the city, planners face limited options.
A city-commissioned report carried out in 2011 by New York consultancy HR&A named six candidates that could successfully build a downtown supermarket: H-E-B, La Fiesta, Sprouts, Green Fields Market, Super S Foods, and Walmart (either through the new Express format or its Neighborhood Market). Notably, it explicitly discounted the viability of a newcomer, whether a startup or an existing national chain not presently in San Antonio.
The city will rely on the report to justify its $1-million – or perhaps even a larger – incentive. HR&A estimated that higher rent and development costs would merit a 10-year subsidy of between $1.1 million and $2.7 million to cover the “[cost] gap between the Center City and the regional models.”
HR&A listed four urban-core supermarkets that have helped anchor other downtown renaissances, including Ralph’s Fresh Fare in Los Angeles, Schuck’s Culinaria in St. Louis, Rouse’s in New Orleans, and Urban Market in Dallas. Only the latter required public funding, and that was only provided after the fact to shore up the store’s finances ― not as cash on the barrelhead beforehand. But San Antonio has a particularly low residential density in its immediate city center.
“The city would very much like to have a more vibrant downtown, which they see as depending on people living there, but people are reluctant to live there if they have to go a long way to the grocery store,” Richard Butler, professor of economics and chair of business administration at Trinity University, said. “But then on the other hand it’s hard to get a grocery store to come until people are living there. So what the city’s trying to do is break that cycle and put the grocery store there and hope that the people will come. From a policy perspective this could really be something of a game-changer, and in fairness $1 million in subsidies for a supermarket would probably do more to attract people to live downtown than spending 200 times that much on a streetcar.”
County Commissioner Kevin Wolff, who is currently contemplating plans for a small downtown grocery store, has criticized the subsidy, calling it unjustifiably large versus the capital investment and jobs it could detonate. “If you go beyond [the financial payoff] and instead take the strategic idea of building downtown San Antonio, and being willing to make a bigger sacrifice...” he said. “I can see some people’s point of view, it’s just not one I share.”
Wolff’s venture, conceived by his wife Sandi before either knew about the incentive, will not apply for public funds. He predicts that many others will. “As I’ve watched this unfold and learned about the number of others who want to put their hat into the ring, politically I’m glad I’m not on the City Council right now.”
Whether or not H-E-B is the natural heir to downtown supermarket funding no longer seems a foregone conclusion. But despite the flurry of press reports regarding a bumper crop of contenders, end-game candidates will have to demonstrate the capacity to overcome the gargantuan operational and financial complexities of building the 15,000-square-foot city-center store that HR&A recommends as a minimum size. The last thing City planners need on their receipt is a $1-million failure. “The big boys, be they H-E-B or someone else, will have considerable advantage over the small entrepreneurial guy,” Wolff said.
Most everyone loves a home team champion, so it stands to reason that San Antonio residents might prefer that a local powerhouse with distinctive Tex-Mex flavoring fill the downtown niche. Mayor Castro clearly does. As the City was developing its RFI, Dya Campos, H-E-B director of corporate affairs, told the Express-News, “The City specifically contacted us and asked us to please develop a concept that would work for the downtown area. They desperately want us to build a store, and we've heard that loud and clear.”
Ultimately it will be up to City Council to approve any incentive, but the Office of the Mayor is sure to lead a lobbying charge. (Charles Butt has donated to Castro’s campaigns for office and both he and H-E-B as a corporate entity contributed handsomely to the Mayor’s pet political initiative, Pre-K 4 SA.) But given H-E-B’s outsized market share, does it really merit a massive monetary incentive, money that could be allocated toward other downtown renewal programs? Tex-Mex fare with a side of desperation might not be the best dish for Alamo City. It’s a good time to reflect on how we ended up with a prix-fixe menu.