Elk Grove Case Study

From Home Run to Strike Out

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The Sacramento Natural Foods Co-op (SacNat) location in Elk Grove, Calif., was a long anticipated state-of-the-art second store that opened with high expectations in June of 2005, but closed in January of 2007.

SacNat seemed to have it all: experienced management, a good board of directors, and a profitable, established location to cushion the second store’s development. The Elk Grove location’s market research revealed an up-and-coming community with great potential. SacNat was thriving, with a 9,000-plus membership and over $22 million in annual sales. Given the co-op’s track record, everyone expected a home run.

What follows is a retrospective of what happened to Elk Grove, and the lessons learned that can be applied to similar projects.

Elk Grove’s back story

When Sacramento Natural Foods Co-op decided in 2001 to explore the feasibility of a second store, they garnered the opinions of over 2,000 members. Out of that process came a five-year plan and a vision to serve the greater Sacramento community. The plan was backed by an overwhelming majority of the members.

After reviewing a number of sites, the co-op settled on the Elk Grove location in 2003 and set out to build a 20,000-square-foot ‘‘green’‘ store. Elk Grove was a brand new development and one of the fastest growing communities in the U.S. The market research from Chuck Perkins, a consultant who had been a researcher with Dakota Worldwide, and Pete Davis, a location and site analysis consultant with Cooperative Development Services (CDS), both projected annual sales between $8 and $11 million the first year. “We all felt enthusiastic about the site,” said SacNat general manager Paul Cultrera.

The day after the board approved the lease for the new co-op, however, the city of Elk Grove increased traffic impact fees by 260 percent in order to build roads and install traffic lights. The co-op was able to negotiate with the city to grandfather the project with the old fees, but was only allowed 90 days to file architectural plans and hire a contractor for the project. “That put the co-op project on the fast track,” said Cultrera. “That was problem number one.”

The co-op had to rush to find an architect and contractor who could fulfill the co-op’s vision and build a green store. It ended up using the developer’s architect and contractor because of the time constraints—both cost more than the firms the co-op originally wanted to hire. The price of concrete and steel went up significantly because of the building boom in China. All these issues combined added another $800,000 to the price tag for the project.

Meanwhile, the developer started construction, adding another degree of urgency. Despite the red flags, the co-op didn’t want to back out.

“We still believed in the project,” Cultrera said, and asked the National Co-op Bank for additional financing, a $900,000 loan, which NCB granted. “We felt certain we’d do $10 million the first year.”

Once building started, there was a huge learning curve with the architect and contractor. “The other tenants were national chains with store templates,” Cultrera said. “They didn’t really understand the co-op’s plan, and they charged us even more for changes. That’s when we started running into roadblocks.”

Though the store was slated to open in October 2004, it didn’t actually open its doors until June 2005. Every month beyond the original opening date cost the co-op dearly. Cultrera hired new managers in January in anticipation of opening and didn’t want to cut them.

What was supposed to be a $2.8 million project ended up costing $4.7 million. By opening day, SacNat had no cash left.

The first week the Elk Grove location was open, the store hit sales projections. But from then on, sales tanked, going down, down, down. The co-op couldn’t attract more shoppers.

Problems grew exponentially: The store was overstaffed and labor costs were high. Perishables took the biggest hit from lack of customers. Margins suffered. Occupancy costs were upward of 9 percent because there were not enough sales. Elk Grove lost about $60,000 per month. “We were dumbfounded and shocked,” Cultrera said.

The co-op began to conduct focus groups and advertise more aggressively. It redirected its marketing in January 2006. From the focus groups it learned the co-op had a poor price image, and people didn’t understand it, assuming it was “hippies and tofu.”

“We realized the co-op and price image were perceived as a barrier,” Cultrera said. SacNat changed its approach, using more direct mail and adding discount days and promotions. But they couldn’t get traction. Sales would go up on promo days and drop the rest of the time.

In addition to trying to attract customers and rein in the free-fall, the co-op tried other strategies to help the operation. The management team took voluntary pay cuts. Cultrera negotiated with the co-op’s union for pay concessions, which were granted and helped save the co-op $40,000 per month. The Western Corridor and other members of the National Cooperative Grocers Association (NCGA) deposited a half million dollars in January 2006 into a credit union as security on a loan. SacNat also approached NCGA at the General Assembly with a plan to sell the store to the association and buy it back when its operations were stable, but that idea was turned down.

Throughout it all, SacNat’s board and management felt that if they just had more time and deeper pockets, they could weather the rough start and survive.

“But everything was a little too late,” Cultrera said of their efforts. In the summer of 2006 he quietly approached a real estate agent with the prospect of finding someone to take over the Elk Grove location’s lease. There were no interested takers. In the months to come, Cultrera prepared to close the store and face the prospect of dire consequences, including filing Chapter 11 bankruptcy for the co-op.

Help arrived, and complete disaster was avoided, thanks to Grocery Outlet, a purveyor of cheap foodstuffs, which deserves recognition for its role in helping keep Sacramento Natural Foods Co-op afloat. Grocery Outlet took over the entire cost of the lease and paid 65 percent of the asking price on the equipment. “We got lucky,” Cultrera said of the lease situation.

The co-op held a liquidation sale at Elk Grove on January 15, 2007, and, sadly, had its best sales day ever. Meanwhile, since the closing of Elk Grove, the Sacramento location has seen a surge in sales of over $50,000 per week. “As quickly as we were losing it, we’re making it. But now we have a $3 million dollar debt we need to pay,” Cultrera said.

Lessons learned

For food co-ops with urban locations, expanding into the suburbs can seem like a logical choice for growth. As urban properties get prohibitively expensive and density makes it harder to find a suitable location, the suburbs are a good development prospect. Land is more plentiful and cheaper, and the suburbs can be where the population growth is occurring. However, the suburbs represent a whole new set of challenges, especially brand new suburbs.

Elk Grove attracted people from Sacramento and the Bay Area in search of more affordable homes. The demographics for the location looked excellent: professionals with high education and incomes. Population growth was at a whopping 12 percent a year. Businesses wanted to be there. A high-quality grocery store seemed to have immense potential and appeal.

However, most of the people who live in Elk Grove are commuters. They are time-pressed and over-leveraged. Since it is a new development, community patterns and buying habits are not well-established. In such an environment, it is more difficult to predict what will happen in the marketplace.

In recent months, according to Sacramento Natural Foods Co-op board president Barbara Mendenhall, Elk Grove has been hit hard by the subprime mortgage crisis. “People bought on speculation and are bailing out. Lots of houses are abandoned by their owners and issues of upkeep and vacancy are bringing down property values. It’s a very significant issue,” she said. “The perception over our prices overwhelmed their concern about healthy food…the person we were going after was going to be a hard sell.”

Pam Mehnert is the general manager at Outpost Natural Foods, a co-op with one suburban and two urban locations in Milwaukee, Wisc. Mehnert sees going into a brand new development like Elk Grove as very risky. “It’s a big difference,” said Mehnert concerning operating in the suburbs versus in the city. Outpost’s Wauwatosa location is an inner-ring suburb of Milwaukee with a long established community.

People have different expectations about grocery stores in a market that revolves around the chain experience. The co-op’s visibility in suburbs is often low, and understanding of it is limited. Raising awareness and appealing to a mainstream shopper requires a different approach than for an urban core.

“Build it and they will come”

In the case of Elk Grove, the market studies indicated that it would be a successful store. Does its failure mean the research was bogus? No. But given today’s competitive market and what’s at stake, perhaps the model for identifying market opportunities for co-ops needs to be revised.

From Mehnert’s perspective, the marketplace is changing so fast that relying on demographics is not enough anymore. She thinks market studies could provide more insight. “The model doesn’t take into account population trends, property values, or other development.”

Pete Davis, the CDS site analyst who worked on the Elk Grove projections, said the real issue around suburban markets is that some expanding food co-ops can take market predictions as a given, neglecting their responsibilities for bringing along the community. “Generally speaking, when a co-op forms it’s because people are committed to it and its values. Years later, when that store expands, a lot of those co-op oriented activities are not done. Assumptions are made that people will automatically accept the co-op.”

When it comes to the research model, Davis believes that there’s not enough comparative data available for food co-ops and suburban stores. The analogue database he’s constructed from working with food co-ops is skewed toward urban markets. “The suburban market is new to the food co-op community, so we have a very limited analogue. It’s new territory. But if food co-ops are to survive they have to learn to do business in the suburbs,” he stated.

One of the things the Elk Grove failure taught SacNat is that they probably didn’t do enough to engage the 1,000 members of the co-op who lived in Elk Grove or reach out to the community adequately. “One thing we’d do differently is to work with people in the Elk Grove community—do house parties, focus groups, surveys—ask people about their attitudes toward food,” said SacNat’s board president Barbara Mendenhall. “We needed to get some more input from the people in the community.”

Cultrera also regrets that they didn’t push member loans and investment in the co-op’s project, a critical part of member buy-in, by only raising $185,000 from the membership. When the co-op found itself in trouble and needing that financial support, they didn’t go to the membership for money, fearful that it couldn’t be paid back. They did ask the members to raise their fair share from $200 to $300 in order to raise equity in the co-op, but it was another move that might not have been soon enough.

Hurry up and wait caused overextension

Most sources believe that the Elk Grove store could have overcome whatever problems it had connecting with the community if it had not run out of cash at the outset.

The problems caused by the traffic impact fees debacle set in motion a chain of events that cost the co-op a lot of money. In addition, laying off idle staff and cutting back when the price tag rose could have counteracted the cost of delays and cash outlay.

“Had Elk Grove stayed on budget,” Mehnert said, “that could have bought more time. The co-op wanted to hang on, and that was the right decision, but it had no resources left to do it.” If the agreement with the developer and the city could have been negotiated more favorably for the co-op at the beginning, that might have also helped the co-op protect its investment better. “That was the biggest problem, in my mind,” Mehnert said. “It left them without a fallback.”

Get help sooner

It’s also important to be proactive when problems arise. In Elk Grove, solutions started to develop when the problems came to light, but a little too late. By contrast, big challenges cropped up for Outpost after the opening of its Bay View location last year, and asking for help at the first sign of trouble probably prevented an unfortunate outcome.

When Outpost opened the Bay View location, the co-op knew it would lose money at the outset. But it didn’t anticipate that Outpost’s other two locations would experience a drop in sales and lack of profitability as local competition intensified. Suddenly, what looked like a good long-term move for the co-op escalated into a crisis. In February 2007, Mehnert invited NCGA Central Corridor members to conduct an audit of Outpost marketing and operations.

Robynn Shrader, CEO of the NCGA, said store auditing as a best practice is the wave of the future, especially because the audit for Outpost was very effective. “It was candid feedback that really helped them turn things around,” she said. “A third-party view can be very illuminating.” Shrader thinks that as the level of trust is built in the system through greater collaboration, being willing to share and accept critical feedback will provide food co-ops with much more accountability and support for expansions.

Lack of site characteristics and visibility

Site analyst Davis thinks that one of the critical factors for food cooperators to consider when expanding into the suburbs is that the site characteristics have to be top notch. For a community of drivers, you have to be easily seen from the road with aggressive signage, easy ingress and egress, and plentiful, upfront parking. “When you go into the suburbs, there’s a high degree of uncertainty about who you are. You don’t want your site characteristics to be worse than your better-known competitors.”

It didn’t help that you couldn’t see the Elk Grove store very well. From the road, you couldn’t tell that a grocery store was even there. Signage was too small and not well executed. Parking was on the side of the co-op instead of in front. The facade was really lovely, but too understated for the location. The place was just plain invisible to the average resident. What probably would have been a huge hit in Sacramento was a dud for Elk Grove.

In a community like Elk Grove, SacNat had little reputation as a go-to food store. People moving to the area wouldn’t be familiar with it, and one of the primary drivers for moving to the suburbs is comfort and convenience. Davis said, “Safeway is a store they are very familiar with and when they see one, they may be thinking ‘that’s where I want to shop.’” A food co-op in that market is competing head-to-head with mainstream chains.

Along with good site characteristics, this market environment requires delivering on customer expectations for a high-quality food store. People want sales and promotions and a good understanding of the products and services offered. The words on the side of the building—“food,” “inspiration,” and “community”—led some Elk Grove residents to believe the store was a church. (See cover photo.) The co-op brand means little to many suburban consumers, so being skewed toward natural foods promotion will likely bring more people in the door. As the co-op gains acceptance in the community, co-op values will have more resonance.

Share the risks as a sector

The law of averages says not every store will be a success. Chain operators have had to close stores or carry out major overhauls in certain markets. The difference is that the successful stores in a chain can carry an underperformer until it gains profitability. Everyone agrees there has to be a way for food co-ops to carry out expansions that helps minimize the risk to the individual co-ops.

When Sacramento Natural Foods Co-op approached the NCGA last September for assistance, it raised the issue of accountability and joint liability to a new level in the sector. One of the positive reverberations from the Elk Grove store closing is a growing recognition within the NCGA that more needs to be done to share risk.

The NCGA has since ramped up its programming for Support Our Success and peer review activities. The NCGA also has created a joint liability fund and hired a director to establish a development corporation to address growth in the food co-op sector.

As NCGA looks to the future, CEO Shrader thinks that for co-ops to manage growth better, the time period for expansions and profitability needs to be shortened, and sharing financial risks as a sector has to be explored.

What went right after all

The faith that the board and management had in the Elk Grove location, despite the missteps, wasn’t misplaced. As coach Vince Lombardi said, he never lost a game, he just ran out of time.

A number of decisions made in the course of the crisis enabled the whole co-op to survive, including: proactively seeking a real estate agent who was able to attract a top notch tenant, negotiating wages and benefits with the union, management taking voluntary pay cuts, approaching the NCGA for assistance, and making the painful admission that things just were not working.

“Other stores have been in crisis. They just don’t have the visibility of Elk Grove. For a co-op that was in trouble, they’re doing a good job of getting out of it and protecting their original co-op,” Shrader said.

What has set the tone for Sacramento’s ability to move forward after closing Elk Grove is the co-op’s faith in its manager and board leadership that did not panic and fall apart.

Barbara Mendenhall, Sacramento’s board president, said that board members had been well-informed of the project’s challenges and supported their manager’s decisions throughout the process. Unlike some co-ops in crisis, they were able to, and wanted to, retain their general manager. “We knew it would be a long haul to make it work,” she said. “It was clear people were working their hardest and trying everything they could. People want someone to blame, but we were in this together.”

See other articles from this issue: #133 November - December - 2007