Assessing the Big Picture

This article will explore the issues and historical precedents that are driving the massive changes in the manufacture, distribution and sales of food in the United States and worldwide. A follow-up article will focus on some ofthe programs and changes that cooperatives have begun and must complete to compete effectively.

Trends in technology

The grocery industry has entered an exciting, challenging and volatile period. It is exciting for all the changes and attendant opportunities that are being generated. It is challenging to manage and allocate the resources necesary to meet those opportunities successfully. And it is dangerous if we delay too long or do not move rapidly enough in implementing the necessary alterations.

Many of you have heard of, and may have begun to participate in, ECR or Efficient Consumer Response. ECR refers to a series of initiatives that are based upon new technology available to and predicated upon cooperation among grocery manufacturers, distributors and their customers. ECR has its roots in the general merchandise industry of the early 1980s. The lead time then for the creation, distribution and sale of garments was 180 days. It was cut to 30-45 days with a system developed that was called Quick Response. The system was constructed by studying all the transactions between the players, discarding non-value adding or duplicate transactions and then using modern technology to create a communication flow that was largely paperless.

The result was the following: early and active participants in change reaped the first and largest benefits. They experienced increased margins as their costs decreased and had the necessary gross profits to finance the capital intensive technological and retraining costs.

The second group adopted a "wait and see" attitude. They eventually caught up but lost market share, being less competitive in price than the first group. The second group had less capital to invest and had to invest more as a percent of their sales base, due to the margin/price pressures exerted by the first group as the latter's operating costs came down.

The third group came too late to the party. By then the margins were so squeezed by the more efficient players that members of the third group were not able to pay the catch up costs.

We all witnessed the consolidations, mergers and the demise of several department store chains. This same process of consolidation is happening in the grocery supermarket format now.

The following lists the average operating expenses for three formats: club and super stores (e.g., Wal-Mart); supermarkets; and natural food stores. It includes distribution and retail operating expenses. Operating expenses can vary widely by region, format, size and type of organization for the gross categories mentioned:

• A large club or super store with its distribution network has an average operating expense cost base of approximately 11 to 15%. This means they need to experience at minimum a 12+% margin to survive and prosper.
• A supermarket store with its distribution network has an average operating expense cost base ofapproximately 21 to 30%. This means they need to experience at minimum a 22+% margin to survive and prosper.
• A natural food store with its distribution network has an average expense cost base ofapproximately 31 to 63%. This means they need to experience at minimum a 32+% margin to survive and prosper.

Trends in profits

The last four years have seen a significant increase of competitive pressure from several sources for our stores. One ofthe largest is from the upscale mass market independents and chain stores such as Wegman's in the Northeast, QFC and Fred Meyers in the Northwest, and Ralph's, Raily's and Vons in the Southwest. This competitive pressure will only continue to increase. The nature of mass market grocery store business is changing rapidly, primarily due to the pressure from the low-price, large super and club store chain formats such as Wal Mart, Sam's Club and Price-Costco. These large store formats have half the operating expenses per square foot that a traditional supermarket format experiences. In addition, supermarkets face significant competition from low priced private label category killer formats such as Trader Joe's.

Additional pressures cause the mass market to focus upon our niche. The only areas of growth for the mass market are prepared foods and natural foods sales. Five years ago 30 cents of every dollar spent by Americans on food was for prepared foods. Today, that is 50 cents of every food dollar. Natural foods consumption is growing at 24 percent each year now. We will see sales of organic and natural foods continue to increase in consumption for the next 20 years as the population in general ages. The mass market operators understand this and will be actively pursuing what is to them a very lucrative niche market that will help differentiate them in the marketplace from the super stores.

In contrast, there is little to no growth in sales of traditional grocery and produce. Produce consumption is switching categories and presentation (fresh cut or value added is a rapidly growing category), but at the expense of cannibalization of the traditional sales categories and presentation.

The fundamental way that supermarkets, super stores and club formats measure success is twofold. Market share is the traditional measure of success in the marketplace. The stores that have the largest market share normally determine the marketplace dynamics and consumer expectations in a region, in addition to achieving certain economies of scale in that region. One viewpoint is that distribution from the manufacturer to the distributor to the consumer is ultimately, at some level, merely a game of economies of scale and the resulting efficiencies.

Net profit per cube inch over time is the emerging measure of success at the store level. Most of the ECR or Efficient Consumer Response initiatives at the supermarket level -- whether it is category management or flow through logistics -- are aimed at increasing net profit per cube inch over time.

The other major challenge to the cooperative retail segment is the growth of the natural foods retail chains that follow a mass market format, such as Bread and Circus. Fifteen years ago, independent natural foods single stores, in many cases a co-op, accounted for over 90 percent of the natural foods sold in the U.S. Today it is less than 67 percent. Of the remainder, health food chain stores control a 13 percent market share and mass market stores 19 percent. The chain stores, whether mass market or natural foods, are growing faster and taking market share from the single store operators. Many single store operators are selling their stores to the chains, witness the aggressive acquisition of independents by Cornucopia's Natural Retail Group, General Nutrition Corporation (which acquired Nature's Fresh Northwest in July for $17.5 million), and the Whole Foods chain (which acquired Fresh Fields in June for $134.5 million, after acquiring Mrs. Gooch's, Bread and Circus, and Wellspring).

This same process occurred in mass market grocery. In 1954 chain supermarkets had a 42 percent market share versus independents at 58 percent. In 1994 chains controlled 74 percent and independents 26 percent. It is projected that by 2008, independents will have less than 17 percent market share.

The same forces that have caused the above channel shift over a 40-year period in mass market business are operating in the natural foods business. But it is happening much more rapidly. The chains spread their infrastructure costs over many stores. They also are able to have common marketing, purchasing, management, training, and standardized procedures (which achieve economies of scale). It is clear that the single store independents ultimately will have a difficult time competing effectively on a variety of dimensions against integrated systems.

We in the cooperative natural products distribution and retailing system already are a partially integrated system. We have begun the process towards building the infrastructure needed to support a more fully integrated system ofindependent cooperative stores. We will compete successfully by having the synergies exhibited by a group of chain stores, but retain control and autonomy at the local level. And our surpluses will be returned to the members.

In the next edition I will focus on some of the initiatives we are engaged in to meet the challenges noted above.