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Safeway Inc.

Company Profile

Publication Date: 19 Aug 2011

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Safeway Inc.


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TABLE OF CONTENTS

Company Overview..............................................................................................4

Key Facts............................................................................................................... 4

SWOT Analysis.....................................................................................................5


Safeway Inc.TABLE OF CONTENTS
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COMPANY OVERVIEW

Safeway (or the company) is one of the largest food and drug retailers in North America. Thecompany also operates an extensive network of distribution, manufacturing and food-processingfacilities to support its retail operations. It is headquartered in Pleasanton, California, and employsmore than 180,000 people.

The company recorded revenues of $41,050 million during the financial year ended December 2010*(FY2010), an increase of 0.5% over FY2009.The operating profit of the company was $1,159.4million in FY2010, compared with an operating loss of $628.7 million in FY2009. The net profit was$589.8 million in FY2010, compared with a net loss of $1,097.5 million in FY2009.

*Safeways financial year ends on the Saturday nearest December 31. The FY2010 and FY2009consisted of the 52-week period ended January 1, 2011 and January 2, 2010, respectively.

KEY FACTS

Safeway Inc.Head Office5918 Stoneridge Mall RoadPleasantonCalifornia 94588 3229

USA

1 925 467 3000Phone

1 925 467 3323Fax

http://www.safeway.com/Web Address

41,050.0Revenue / turnover(USD Mn)

DecemberFinancial Year End

180,000Employees

SWYNew York Ticker


Safeway Inc.Company Overview


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SWOT ANALYSIS

Safeway (or the company) is one of the largest food and drug retailers in North America. Thecompany has strong in-house manufacturing and distribution capabilities which enable it to exercisehigh quality control and flexibility over its business process. However, sluggish consumer spendingin the US may adversely impact the top-line growth of Safeway.

WeaknessesStrengths

Focus on high end products and customerservice has impacted the price positioning

and Safeways competitiveness in Canada

Strong manufacturing and distributioncapabilities

Products in line with the "eating at home"trend Questionable recall practicesSpecialty departments facilitate increasedfootfall and differentiation

ThreatsOpportunities

Unionization of labor amid concerns of risinghealthcare costs and increasing wages

Positive trends in online retailing willincrease sales from the channel

Sluggish consumer spending in the USnegatively impacted the top-line

Rising demand for organic and health foodsIncreased acceptance of private labelmerchandise Intense competition from discounters will

pressurize marginsPositive trends in the ancillary service ofgasoline sale

Strengths

Strong manufacturing and distribution capabilities

Safeway operated 20 manufacturing facilities in the US and 12 in Canada at the end of FY2010. Interms of sales dollars, 14% of Safeway's private-label merchandise is manufactured in these plants.In order to ensure high standards of quality in the products manufactured by the company, Safewayoperates laboratories at some of its plants and corporate offices.These laboratories engage in qualityassurance and research and development. The company also has a strong network of distribution

/ warehousing centers. At the end of FY2010, Safeway operated 13 distribution / warehousing centersin the US and four in Canada. A majority of products to Safeway's 12 retail operating areas (Chicago,Denver, Eastern and Northern California, Phoenix, Portland, Seattle, Texas, Vons, Alberta, Vancouver,and Winnipeg) is sourced through these centers.


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Strong in-house manufacturing and distribution capabilities enable Safeway to exercise high qualitycontrol and flexibility over its business process. Furthermore, direct control over the back operationsallows Safeway to make prompt product changes according to customer preferences and changesin market demand.

Products in line with the "eating at home" trend

In times of recession, the tendency to eat at home increases to reduce spending on eating outside.In the past few years, customers in the US have been increasingly opting to eat at home. In responseto this emerging trend, Safeway has increased its focus on offering prepared meals.The companysSignature Cafe line features custom-made sandwiches, soups, fresh salads, and a large variety ofentrees. Additionally, Safeway also offers Waterfront Bistro line of products (launched in 2009) whichfeature more than 100 seafood selections, entrees and complementary items. Some of thedo-it-yourself

entrees and appetizers are offered with simple recipes while others are pre-madeentrees which can be prepared in a few minutes. Furthermore, to boost this trend of eating at home

Safeway publishes recipes on its website. By increasing focus on ready to eat, high quality packagedfood, Safeway has positioned itself well to respond to the emerging trend of eating at home.Thecompanys wide product offerings in the particular food category would act as a compelling propositionfor customers who prefer to dine at home.

Specialty departments facilitate increased footfall and differentiation

The company operates specialty departments within its stores.These specialty departments includedeli, floral, bakery, seafood, pharmacy, Starbucks, and fuel stations. These specialty departmentsallow Safeway to attract wider customer base at its stores. Pharmacies are operated at 78% of the

companys stores.These pharmacies offer services such as prescription-filling, health-related advice,immunizations, travel medicines, medication therapy management, and point-of-care screening,among others. Increasing number of people find these pharmacies and immunization programattractive as the pharmacies do not require any appointments and also offer healthcare services atlower price compared to the hospitals. Additionally, Starbucks being a popular brand in the US alsodrives customer footfall. The fuel stations operated by Safeway also help in deriving demand forother consumer goods offered by the company. Safeway can leverage on these specialty departmentswithin stores to drive footfall and increase the average sales as well. These specialty departmentsalso act as a differentiating factor between Safeway and other players in the industry.

Weaknesses

Focus on high end products and customer service has impacted the price positioning and Safewayscompetitiveness in Canada

Safeway, over the years, has invested in differentiating itself on service, "lifestyle experience" andhigher-end products.The company introduced "Lifestyle Concept" which focuses on the ambienceof the stores to remodel its stores. Safeway did not compete on price. In Canada, it has been years




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since the company competed on price leaving the price-conscious market to its competitors suchas Price Chopper.This positioning although led Safeway to gain high loyalty in the past, the pricepositioning has adversely impacted the company as customers started to trade down and havebecome more price conscious. According to a study conducted in 2010 by industry sources, lowprices and discounts were the primary reasons most consumers quoted for remaining loyal to theretailers they used in the grocery, personal care, mass merchandise, department store, and specialtyretail categories. Compared to a similar survey conducted in 2009 customers had very different view.Customers then said that although low prices ranked first for department stores and mass merchants,customer service was the biggest value in grocery, personal care and specialty stores. This indicatesa clear shift in consumer behavior and also high preference for low price products.The 2010 surveyshowed that Wal-Mart led the grocery category in the Northeast and Northwest regions in the US,leaving behind Safeway and Albertsons. Safeway and Albertsons had the highest level of loyaltyscore in their respective regions among the grocery brands in the 2008 loyalty survey.

Safeway has been slow in adjusting its positioning with the changed customer behavior and hencehas been unable to maintain its loyalty leadership.Though Safeway introduced several price cutsand value oriented programs in 2009 and 2010, it will be a long time before customers respond tothis shift in positioning. Till then the company faring low on customer loyalty will suffer pressurizedmargins and low revenue growth amid the shift in consumer preference for value retailers.

Questionable recall practices

Safeway's recall practices were questioned by its customers in the recent times. In February 2011,a class action lawsuit was filed against the company by two consumers and The Center for Sciencein the Public Interest (CSPI) for failing to notify loyalty cardholders who have purchased recalled

food. Previously, in May 2010, Safeway was issued a notification by CSPI to provide adequate noticeto its Club Card customers about the recalled products.The notification was issued after investigatingthe company's recall practices and finding nothing suggesting that loyalty cardholders are contactedin recall situations. This practice of Safeway violated state consumer protections laws.

Over the years, Safeway has focused on building its brand through quality perception. However, inthe light of the recent events with respect to its recall practices the consumers will doubt thecommitment of the company towards customer satisfaction.

Opportunities

Positive trends in online retailing will increase sales from the channel

Over the years, the preference to shop online has been growing among the US based customers.According to the US Department of Commerce, the e-commerce sales in the US totaled $166.5billion in 2010 compared with $45 billion in 2002, representing a compound annual growth rate(CAGR) of 18% for the period FY200210. e-commerce sales accounted for 4.3% of the total retailsales in 2010. In comparison, in 2002, e-commerce sales accounted for only 1.4% of the total retail




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sales. Further, the nations retail e-commerce sales reached $46 billion in the first quarter of 2011,representing an increase of 3.4% over the previous quarter.

According to industry estimates, the online sales of groceries account for less than 2% of total grocerysales in the US. The market is however growing. Increasing number of grocers such as Wal-Mart,Ahold, Kmart, and Publix among others have started testing the online service for sale of groceries,based on the in-store, pick-up model. Moreover, Amazon.com, a non-traditional retailer, has alsobeen expanding its household goods and groceries category, and is testing a grocery delivery servicecalled "Amazon Fresh" in Seattle.The growing spread of broadband access across the US, and thetrend among shoppers to research products prior to making the final purchase is further expectedto boost online retail sales. The online channel has several counter recessionary characteristicssuch as low infrastructure costs which can be passed on to the consumers, and convenience. Inaddition to the direct sales, dissemination of information through the website can also be used to

drive sales.

Safeway owns and operates GroceryWorks.com Operating Company, an online grocery channelwhich operates business through the Safeway.com, Vons.com and Genuardis.com websites. Byleveraging its online retailing platform Safeway can target larger audience and increase the revenuesfrom the channel.

Rising demand for organic and health foods

Customers in the US are more health conscious now than before and the trend has impacted thepreference of food products. It has been observed that majority of consumers (more than 70%) readingredient statements on packaging and are using nutritional information to make their purchasing

decisions. Due to the increased health consciousness, there has been a spurt in demand for all-naturaland organic foods. According to industry estimates, organic food and beverages industry was valuedat $26.7 billion in 2010. While the total food sales grew by less than 1% in 2010, organic food andbeverages sales increased by 7.7%. Consumers prefer organic food products because of concernsregarding health, the environment and animal welfare and therefore are willing to pay price premiumsassociated with the products.

Safeway was early to recognize this trend and in 2005, introduced its first wellnessbrand, OOrganics. Currently the product line offers more than 1,300 organic food and beverage productscertified by the US Department of Agriculture. The O Organics line includes, among other products,milk, chicken, salads, juices and entrees. In 2007, Safeway launched O Organics for Baby and OOrganics for Toddler products. In the same year, the company introduced its Eating Right brand for

health conscious consumers. Eating Right products feature a unique nutritional icon system thathelps consumers to identify product attributes that they seek. This line currently includes more than230 items. Further in 2010, Safeway introduced the Open Nature line of products.This line offersmore than 100 products made with 100% natural ingredients.

The company through its varied offerings in the organic and health product category can cater tothe customers who are increasingly seeking nutritional values in their meals.




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Increased acceptance of private label merchandise

The private label market in the US is expected to grow at a fast pace. According to industry estimates,private label brands accounted for 17.4% of the US food products sales in 2010 as against 15.2%in 2006. The private-label branded products industry in the US is estimated to be worth $90 billion,and account for nearly 30% of the total servings of food products sold. This represents a huge gainas compared with the period between 1984 and 2003, when the market share of private label productsremained in the range of 20%. One of the main reasons for growing demand for private label goodshas been the recent slowdown in the US that has kept price the top concern for consumers. Insteadof expensive brands, consumers across the industry are turning to generic and private label products.Even upper-income shoppers are more willing to buy generic, which has traditionally appealed moreto shoppers with limited budgets.

Safeway offers a wide range of private label products that are sold at its stores, as well as tonon-competing retailers in the US and abroad. These private label brands are divided into fourcategories: core, expertise, aspirational, and wellness. Under the core category, the companysSafeway brand offers over 4,000 items across 350 categories, including cereal, spaghetti, handsanitizer, and laundry detergent. Another core category brand Value Red, which will be transitionedto Pantry Essentials in 2011, offers more than 100 items over 45 categories, including dairy, meat,canned vegetables, and paper goods among others. Under the expertise category, Safeway offersthe following brands: Lucerne (comprises more than 400 dairy related items), Snack Artist (a newline of snack items launched in 2010), and Primo Taglio (a full line of premium meats and cheeses).The aspirational category comprises the following brands: Safeway SELECT, Ranchers Reserve,Signature Cafe, and waterfront BISTRO. Under the wellness category, Safeway offers products thatare focused towards consumers who consume more nutritional and organic products.

Increased penetration of private labels will enable the company to increase sales from these products.Additionally, private labels typically have higher margins and rising demand for these products willalso impact bottom line positively.

Positive trends in the ancillary service of gasoline sale

The demand for gasoline in the US market is expected to increase. According to industry estimates,in 2010, the sale of motor fuels accounted for more than two-thirds of the convenience store industryssales. The recovering US economy indicates further increase in revenues from the motor gasolinesegment. According to the US Energy Information Administration (EIA), the consumption of motorgasoline totaled 9,034 thousand barrels per day in 2010 compared with 8,997 thousand barrels per

day in 2009. Further in 2012, the total consumption of liquid fuels is expected to increase by 170thousand barrels per day, and the consumption of motor gasoline is expected to increase by 50thousand barrels per day.

Safeway operates gas stations at 23% of its stores. At the end of FY2010, the company had 393fuel stations in the US. The growing demand for motor fuel will not only increase sales but also drivetraffic to its stores. Therefore, the positive trend in this sector will convert into high customer footfallat the companys stores.




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Threats

Unionization of labor amid concerns of rising healthcare costs and increasing wages

The labor costs for companies have been rising as the healthcare costs and wages increase in therecent times.Tight labor markets, increased overtime, government mandated increases in minimumwages and a higher proportion of full-time employees are resulting in an increase in labor costs,which could materially impact the company's results of operation. In the US, the government increasedthe minimum wage rate from $6.55 per hour in 2008 to $7.25 an hour in July 2009. Many states andmunicipalities in the US have minimum wage rates even higher than national level due to highercost of living. In addition to this, the health care costs for employers in the US are increasing.According to industry estimates, healthcare costs for the US employers are estimated to increase

by 8% in 2011 and by 8.5% in 2012. Increasing number of consolidations in the healthcare sector,and an expected rise in the medical claims from workers are some of the reasons that would keepthe healthcare cost high in the coming two years. Though, industry consolidation would increaseefficiency and reduce costs in the long term for healthcare companies, it can also reduce competitionamong the service providers and lead to increased service charges. Additionally, the medical claimsfrom workers are expected to go up, as they feel the pressure of the uncertainty with respect to thefuture source of income in the scenario of high unemployment rate, and a troubled financial marketin the country.

Approximately 80% of Safeway's employees in the US and Canada are covered by collectivebargaining agreements negotiated with union locals affiliated with one of nine different internationalunions.The company is a party to approximately 430 collective bargaining agreements. In FY2010,

contracts covering nearly 32,000 employees were ratified. In May 2010, nearly 1,400union-represented grocery workers in Kitsap County and 25,000 in Puget Sound were affected bythe contract negotiations between themselves and Allied Employers.These employers includedretailers such as Safeway, among others. The employees demanded for changes in their sick payamong other things. Negotiations with labor unions with respect to rising health care, pension andwage costs, among other issues, are some of the important topics. Amid the rising healthcare costsif the company is unable to negotiate acceptable contracts with labor unions, it could result in strikesby the affected workers and thereby significantly disrupt operations and result in increased operatingcosts.

Sluggish consumer spending in the US negatively impacted the top-line

The retail market in the US, the geographical region where the company derives most of its income,has been witnessing low consumer confidence. The consumer confidence in the US has registereda decline during recent times. The US consumer confidence index increased slightly and reached59.5 in July 2011, compared with 57.6 in June 2011. However, this figure is very low compared toa consumer confidence index of above 100 in the first half of 2007. Since purchases of Safewaysproducts are dependent upon consumer spending, its financial performance is sensitive to changesin overall economic conditions that affect consumer spending. Although consumer spending is seeingsome positive growth, Americans seem cautious and are not willing to increase spending, one of




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the reasons why the pace of the recovery is estimated to be more subdued than in the past. Highunemployment rate, sluggish wage gains and credit crunch are all expected to keep consumersrelatively cautious. According to the industry estimates, the number of trips customer make to buygroceries decreased to 1.69 trips per week in the first half of 2011. People shopping for groceriesonly once a week increased to 34% in 2011 compared with 29% in the previous year. Additionally,it is estimated that shoppers would put off spending on big ticket items and remain value-orientedin the near future. A survey on retail trends indicates that even the financially sound families wouldcut short on their spending, and the young population has also become conservative in their attitudestoward shopping and their willingness to spend as older shoppers. Based on survey data, it wasalso observed that as many as one-third of shoppers with incomes more than $150,000 per yearare cutting spending and avoiding places where they tend to overspend. Also, more than half of allages and income groups feel that the economic recovery will be slow, and may take them sometime after that to recover their financial stability.This indicates an adverse customer sentiment whichwill pressurize spending in medium term.

The current economic environment has made consumers more cautious and led to reduced consumerspending. Increasing number of customers are trading down to a less expensive mix of productsand to discounters for grocery items. Further deterioration of any macro economic factors impactingconsumer spending will be detrimental for the companys top line growth and profit margins.

Intense competition from discounters will pressurize margins

Food retailing sector is the US is highly competitive. Non-existent switching costs for consumers,who are largely driven by price, increased the appeal of discounters and other value retailers.Wal-Mart's entrance into the grocery market and its ongoing expansion has proved to be a major

risk to traditional operators, whose cost structures are higher and cannot match the low prices thatWal-Mart offers. Merchandise offered at Wal-Mart's stores is priced at much lower range than therange offered by its competitors. Grocery stores, amidst such competition, have experienced pricingpressures. As consumers' purchasing power is decreasing, pricing matters more, which plays intothe hands of the low-price leaders. Although Safeway has been reducing prices to handle pressuresfrom discounters, it has not been immune. Competition for the consumersfood dollar continues tointensify as supercenters and warehouse clubs increasingly promote lower prices on food to drivetraffic. Increasing competition may lead to price war in the industry and pressurize Safeways margins.




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