Mercadona, the Spanish-owned supermarket chain, is recognized worldwide for its innovative business model, which has been studied widely at business schools. The company buys products directly from their source, without the usual intermediaries, and it adjusts warehousing and transportation based on its purchasing needs.

Mercadona uses a system called Total Quality Management, through which it has forged strong, long-term ties with its exclusive suppliers. It is constantly seeking to improve customer satisfaction through its philosophy of "Always Low Prices" and by hiring personnel who are well trained and committed. It minimizes the high employee turnover rate typical of the sector by using "labor conciliation" — flexible work/life balance policies — and by providing all employees with permanent job contracts that have an indefinite duration.  

All of this has enabled the company to be one of the few in Spain that avoided the worst impact of the recent global financial crisis. In 2012, its sales grew by 7% to 19.077 billion euros, the best results in its history. Net profits reached 508 million euros. In addition, the company created 4,000 new permanent jobs that year. Those figures are not easily dismissed, considering the high unemployment rate of the country – about 25% of its active population.

In 1981, Juan Roig became chief executive of the family-owned business, which had barely eight shops. By last June, that number had grown to 1,431 supermarkets throughout Spain. He achieved that through what is known as an "oil stain" strategy — that is to say, by starting out in one point and then expanding radially from that point, like an oil stain might expand.

However, not everything has gone smoothly for the leading Spanish retailer recently. Miguel Blanco, professor of business economics at King Juan Carlos University, cites Roig’s own words to describe the situation in 2008, when the company’s profits dropped by 5% from the previous year: “The crisis blew up in our faces and it helped us wake up.” In response to a more competitive and difficult environment, Mercadona enacted a series of initiatives, including lowering its prices and improving the efficiency of its supply chain for every product, according to Blanco.

Room for Improvement

The success has been only partial, considering that Mercadona’s market share in fresh produce – vegetables, fruit, fish, etc. – is only half of what it is in dry foods. “It sells 40% of the packaged food in Spain, but it only sells 20% of [the country's] fresh food,” notes Gerard Costa, professor of marketing at the ESADE business school in Barcelona. According to Costa, “Mercadona flaunts its culture of vertical integration aimed at getting more control of products. For example, it has its own brand of frozen pizzas, which enables it to save on costs and pass those savings on to the consumer. But that is not being applied to fresh foods, because they involve a more complex supply chain.”

Blanco agrees with Costa, adding that, “Until now, Mercadona treated the business of fresh foods like the business of dry goods, packaging all of its products on trays. But they have realized that these are two different businesses that need differentiated treatment.” Teresa Serra, professor of marketing at the IE Business School, adds that last year Mercadona carried out some moves in the area of fresh foods, such as throwing out the packaging of its fruits in order to sell them in bulk. “But it still seems that they have not managed to get customers to buy this category.”

According to Blanco, its approach to fresh foods has made it clear that Mercadona has not managed to complete the mission of the company, in which “the customer manufactures the total purchase.” Costa notes that over the past twenty years, the trend among consumers and housewives has been to avoid the fragmentation of their purchasing; that is to say, rather than go to different specialized shops to acquire different products, consumers have preferred to fill their shopping carts in the same supermarket. Nevertheless, the Spanish economic crisis has changed this situation. “During the past five years, purchasing has become fragmented because people want to buy more and to save more,” says Blanco. The consequence of that has been that “the fresh produce in supermarkets has lost its attractiveness.”

In that regard, Blanco notes, Mercadona has realized that it has room for improvement in fresh foods, and that it can still be more efficient in its supply chain by applying its own management model, which would mean better quality at a better price. Last March, the president of the firm made it clear in his presentation of the company’s results that “the commitment for an improvement of fresh products, and the agreements that have been made with both suppliers and various associations of fishermen, farmers and cattlemen, are contributing to provide the best round of improvements that we have had in this area.”

Two Sides of Dynamic Pricing

Some of the latest strategies directed at the fresh food section that are attracting attention because of their novelty are experiments in dynamic pricing that are taking place in some of Mercadona’s supermarkets near its headquarters in Valencia, Spain. The idea involves having the managers of the fresh food sections in each supermarket lower the prices of these products throughout the day, totally independent of what is happening in other locations in the chain. These price reductions can be accomplished electronically — for example, when fruit is being weighed. The goal is to not have to throw out products at the end of the day, but to replenish stock each day according to the historical records of sales in previous years.

Costa stresses that the main characteristic of the produce section is that you have to discard the merchandise that is spoiled, so it is a category that has a relatively high margin. But this approach is also risky because “you can suffer large losses if the freshness of the food is not well managed.” When well-managed, the strategy of dynamic pricing could enable the chain “to sell the product more cheaply, instead of having to throw it out, and to make more money as a result,” he notes.

In addition, Mercadona could manage to generate more demand as a result. According to Costa, fresh produce is a "destination" category for consumers. The consumer “decides to go to a specific supermarket based on the type of fresh produce that it offers. All Coca-Cola is the same, whether you buy it in French chain Carrefour or in Mercadona, but a banana can be different from one location to another.” That’s why the planning efforts of food chains in the last five years have recognized that “although [the chain] can lose money in this category, it can also manage to attract consumers with it, and perhaps that is the only way to differentiate one chain from another,” he notes.

According to Costa, the hardest thing about carrying out this strategy is the interpretation of department managers about when and how much they will need to vary their prices. “They will have to think like shopkeepers, and manage the section like a micro-enterprise, which includes thinking about contingency plans, and so forth.” For example, the person who is responsible for the department can consider whether it is better to offer its frequent shoppers the cheapest products during the first hour they are in the store, while the dynamic in another nearby store may be totally different.

Costa notes that there is a possibility that people will feel irritated if they know that other customers have paid less for the same product on the very same day. The reaction of consumers depends on the information available to them, a priori, he suggests. “If a customer is aware that there is a certain type of product, at whatever time of the day, that he can buy more cheaply if he so desires, then the negative perception disappears.” Another potential problem occurs when the variation in prices depends on the characteristics of the customer, but not of the product. “For example, if girls enter discotheques free of charge, but guys do not — even if you inform the [male] customer beforehand, he is left with the impression that he is being mistreated.”

Experts agree that Mercadona enjoys an advantage: Today’s consumers are getting more used to pricing that changes because of the experiences that they have already had when shopping in such sectors as transportation, telecommunications and entertainment. Serra adds that these experiences have revealed that in order to prevent customers from feeling “betrayed,” it is essential for “the product to maintain the quality standards promised by the company, and the buying experience must be positive for the consumer.”

As a result, Costa warns that Mercadona will have to pay a lot of attention to tactical details such as the possibility of mixing products with different levels of freshness on the same shelves. Otherwise, it may wind up communicating the wrong impression to customers by reducing prices too much. “The consumer will have to understand that the store is not going to reduce the price of products throughout the day, but the customer will not understand it or enjoy it if, an hour before the shop closes, there is a substantial price decline. He could interpret that to mean that the product was almost spoiled, and ready to be thrown out, and that this was the moment when it was offered much more cheaply.”

Costa argues that the success of the strategy of dynamic pricing that Mercadona wants to implement will depend a great deal on how managers respond to it. On the other hand, this complexity, when it is time to put the plan into operation, will be a barrier that prevents the competition from trying to imitate the model. “The manager of this department [of the store] needs to know about the freshness of the product, and must be able to change the prices in an automatic way. This is not something that can be done by all Spanish distributors. If someone can do it, that company is Mercadona, which is famous for the commitment and motivation of its employees. For others, this would be more difficult,” he notes.

An 'Apron Strategy'

According to Blanco, the strategy of dynamic pricing forms part of a broader global strategy within Mercadona’s model of co-innovation, “in which the company, along with the customer, decides to adapt its supply to the trends of the consumer.” In that regard, he mentions the company's “apron strategy,” which involves setting up a testing room in specific supermarkets where customers are invited in to show managers how to use various products. “For example, that’s how they found out that a lot of people were using wine vinegar in order to clean. Then, they got the idea to create a cleaning product made with vinegar,” he notes.

There are similar initiatives — such as with fresh fish — which are also being tested and considered for nationwide adoption. More specifically, Mercadona “has partnered with 40 associations of fishermen to develop a process that will enable it to bring fresh fish three times a day into each supermarket,” notes Costa. Fish sold in the chain was brought by plane every day from Namibia, because it was a low cost supply chain. However, that approach may not be the most successful option from the viewpoint of Spanish consumers. “In order for people to speak well of [Mercadona], it is much better for them to buy on the Mediterranean coast,” he says. He adds that no other business sector in Spain would be capable of establishing a supply chain of that complexity. "There is a good reason why the Mercadona supply chain is analyzed around the world.”

The chain “innovates constantly, and it makes mistakes,” Costa adds. “For example, it was selling fruit on trays, self-service, and it changed to selling it in bulk, using employees that served people. It made this change, and now it is also setting up the policy of dynamic pricing. One of its professional merits is to repeatedly make new innovations and add them on to others.”

That’s possibly why Mercadona “is growing in the number of stores it is opening, the number of its customers and, most significantly, in the loyalty of its customers,” notes Serra.