Hill District Grocery

Member Group : Allegheny Institute

(October 12, 2012)–Where’s the beef? Where is the chicken, the
bread, the canned soup, the detergent, or the coffee? Not in a Hill
District grocery store that’s for sure. And since the early 1980s
that has been the story. Aldi’s made overtures about building a store
in 2005 but was rebuffed because the store did not offer a full
service grocery.

In 2008, the Hill House Association began a renewed effort to attract
a major grocery store using money from a variety of sources to fund
the construction and equipping of the facility. The original plan
called for an $8.5 million project that would find a grocery chain to
ante up significant private capital and operate the facility. They
asked for proposals and initially opted to go with Kuhn’s, rejecting
a bid by the Sav A Lot chain that would have built a far less
expensive, basic grocery store.

Kuhn’s was unable or unwilling to meet the requirements imposed by
the Association and eventually withdrew in late 2009. In mid-2010,
the owner of Shop n Save stores stepped forward with an offer of $1
million to become the grocery store owner/operator. A ballyhooed
ground breaking took place in April 2011 with promises the store
would be finished by year’s end. It’s October 2012 and still no
store and no work on one.

In September 2011 the Pittsburgh Courier, in a report on the store’s
progress, repeated that the cost of the project would be $8.5
million. Then in June 2012, with still no construction underway, the
spokesperson for the project revealed that the cost had jumped to $10
million because of a change in the management team. As a result it
would be necessary to find $2 million more in funding. More rounds
with funding partners were anticipated. Adding to the store project’s
woes, it was recently announced that in just four months other
unforeseen cost increases have pushed the new total funding
requirement to $11.6 million, leaving the project $3.9 million short
of the amount needed to begin work.

Bear in mind that when the price tag reached $10 million several
developers and construction managers said that was too steep for such
a development. Will more developers now join the ranks of those who
were concerned about the $10 million price tag? This is beginning to
sound like the stadium and convention center escalating costs and is
close to the North Shore Connector cost explosion.

The big problem with the current plan is the lack of private risk
capital. Only $1 million in risk capital has been pledged–9 percent
of the total cost. Why is there so little private investment?

Questions must be asked if taxpayers and charitable groups are going
to fund most of this store. At $11.6 million a minimal rate of return
on capital of 5 percent would require net profits, after all
expenses, to be roughly $600,000 per year. Given the razor thin
profit margins in grocery retail, it will likely require roughly $30
million per year in sales. Of course, since there is no significant
level of private risk capital, the project organizers are probably
not concerned about any profits.

Has the group putting the project together ever estimated what the
annual sales would be? Or is that of no concern? The operator will
certainly be concerned about that number. Even though he will not
have to generate a return on the full $11.6 million, he will have to
produce enough revenue to pay for keeping the store up and running
and fully stocked. What will it cost him to fully stock the store
before customers are allowed in? With over 40,000 items typically
sold at a store this size, it could be a big investment in inventory,
perhaps a million dollars or more. Then he has to pay the help.
According to newspaper accounts it is estimated that as many as 100
people will be needed to maintain full service (with almost a
guarantee they will be unionized). Then there is all the other
overhead, power, water, insurance, heating and cooling, advertising,
security, restocking and maintenance as well as loss allowance for
theft and spoilage.

Let’s look at a scenario for the store. Statistics from the Food
Marketing Institute show that, on average, supermarkets have $172,000
in sales per worker and have a gross price margin of 40 percent over
costs of goods with cost of goods equal to around 71 percent of
sales. Labor costs are about 14.5 percent and other operating costs
are 12 percent of sales. Since a large fraction of grocery employees
are part time, the labor compensation will be around $2.5 million
and, if sales come in at the industry average per worker, annual
sales would have to be $17.2 million. Using a national average markup
of 40 percent, the store’s cost of goods sold would be 71.5 percent
of sales or $12.3 million. Total operating costs are around 26.5
percent of sales on average so those expenses would come to $4.5
million. Either way net margin would be 2.0 cents profit per dollar
of sales or $344,000 in total profits. All this assumes national
average performance can be achieved and sales reach $172,000 per

The question is: what is a reasonable forecast of sales? The absence
of grocery chains willing to put up a substantial fraction, say 70
percent of the project cost, indicates that most operators are fairly
certain that upward of $20 million and certainly $30 million in sales
per year are not likely. The fact that the project team has not
sought bank loans to fill in the gap in funding could be interpreted
to mean they assume the project will not produce nearly enough
revenue to cover operating cost and bank loan payments. Or perhaps
they have approached banks and been denied because the probable sales
and profit margins are just too low for the bank to take the risk.

If the project is completed and sales are well below $15 million a
year (about the national supermarket average) the store will likely
become a losing proposition unless it can strenuously control costs
and maintain exceptionally high price to cost margins. At numbers
below $10 million in sales, the store might not be viable as a full
service supermarket with all the bells and whistles because of the
inherent difficulty of lowering costs proportionally with sales.

At the very least, the organizations pushing this project need to
provide taxpayers and other funders with a reasonable and credible
forecast of sales and operating costs.

Jake Haulk, Ph.D., President

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