Will Upscale Supermarkets Have Egg On Their Faces?

Forget about Tesco, Whole Foods and Trader Joe's. The average American supermarket may have a new nemesis--food inflation that's moving faster than a speeding bullet.

As American tastes have moved upmarket, virtually every chain has responded, adding everything from organic private-label products to high-end prepared foods. In fact, you can buy a $40 bottle of wine or fresh-made lobster bisque just about anywhere. But there's some evidence that ever-upscaling supermarkets may be in a precarious position in the months ahead, as shoppers grapple with rapid price hikes in all kinds of food.

While rising fuel prices may get more headlines, the U.S. Department of Agriculture's Economic Research Service says the Consumer Price Index for all foods (both at home and in restaurants) jumped 4% between 2006 and 2007, the highest annual increase since 1990. And it forecasts an additional rise of 3 to 4% this year.

"Everyone's still gotta eat," says David J. Livingston, a supermarket consultant in Pewaukee, Wisc. "But stores are going to have to adjust to people trading down." And it's not that people will eat less, he says. "Even with gas prices rising, people aren't consuming less--they're just making other adjustments. They'll do the same for food," he says, for example, buying more private-label products.

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One beneficiary has already been the warehouse store sector, with such chains as BJ's Wholesale Club, Costco, and Wal-Mart's Sam's Clubs all posting solid gains in same-store sales in recent months. "People who are watching their money will start buying more in bulk," he says.

On the other hand, lower-income shoppers can't afford that luxury. "If you've lost your job, you can't go to a warehouse and spend $400 on bulk purchases," he says, pointing out that dollar-stores that sell food items are also faring much better than mainstream supermarkets.

The chains that are the most vulnerable, he says, "are that middle-of-the-road, plain vanilla supermarket," he says, such as Safeway and Publix. "It's an hourglass economy," he says. "There's room at the high end and at the low end, but in the middle, they are just getting squeezed tighter and tighter."

Kroger, for example, posted a decline in fourth-quarter profits on Wednesday, to $322.9 million, from $384.8 million in the same period a year ago. Sales, however, were strong, with same-store sales climbing increased 8.2% with fuel and 5.3% without fuel.

Overall, though, some experts predict that America's taste for finer foods will help stores ride out the storm. "Many of these retailers appeal to aspirational shoppers--people who aren't really quite upper-income, but aspire to those tastes," says Frank Badillo, a senior economist at TNS Retail Forward, a Columbus, Ohio-based retail consulting firm. "And those people may ratchet back their spending. But there should be enough sustained demand among the highest-income shoppers."

Still, he adds, it won't be painless. Take Whole Foods, which even its most loyal fans sometimes refer to as "Whole Paycheck." "With these prices," says Badillo, "even they are going to feel some fall off."

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