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RM 006 Forces Pushing Consolidation, and What's Next?1 Glen A. Terbeek and Allen F. Wysocki2 1. This is EDIS document RM 006, a publication of the Department of Food and Resource Economics, Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida, Gainesville, FL. Published August, 2000. Please visit the EDIS website at http://edis.ifas.ufl.edu. 2. Glen A. Terbeek, retired managing partner of Anderson Consulting and author of Agentry Agenda: Selling Food in a Frictionless Marketplace (published by Breakaway Strategies, Inc., Hilton Head Island, SC, 1999), telephone (843) 341-5052; and Allen F. Wysocki, assistant professor specializing in food distribution, Department of Food and Resource Economics, Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida, Gainesville, FL, telephone (352) 392-1826 x403, http://webct.nerdc.ufl.edu:8900/public/WysockiExtension/index.html The use of trade names in this publication is solely for the purpose of providing specific information. UF/IFAS does not guarantee or warranty the products named, and references to them in this publication does not signify our approval to the exclusion of other products of suitable composition. The Institute of Food and Agricultural Sciences is an equal opportunity/affirmative action employer authorized to provide research, educational information and other services only to individuals and institutions that function without regard to race, color, sex, age, handicap, or national origin. For information on obtaining other extension publications, contact your county Cooperative Extension Service office. Florida Cooperative Extension Service/Institute of Food and Agricultural Sciences/University of Florida/Christine Taylor Waddill, Dean. Introduction In this article I will summarize a presentation on the forces pushing consolidation given by Glen Terbeek at the 2000 Citrus Expo. The 2000 Citrus Expo Seminar, organized by the Southwest Florida Research and Education Center, was held on August 23-24, 2000, at the Lee Civic Center in Ft. Myers, Florida. The theme for one of the educational seminars was: Secrets for Citrus Survival in the New Millennium. The focus of this educational session was to present marketing strategies to increase grower profitability, to discuss the effects of consolidation in the 21st century and to explore the politics of agriculture and citrus cankers issues as the Florida citrus industry enters the 21st century. Food System Consoliation, What's Next? Glen Terbeek has worked for Andersen Consulting for 34 years. Twenty of these years have been spent on studying food production, marketing programs and food industry programs. Mr. Terbeek presented his ideas of why changes are going to alter the food system in the future. In Mr. Terbeek's view, it is not a matter of if, but when, economic factors or forces are going to make these changes take place. The remainder of this newsletter is devoted to excerpts from his presentation. Total store grocery sales in the U.S. is expected to increase by five percent (based on a study conducted by Cornell University), while the population growth is expected to remain flat. This flat population growth is true for every developed country in the world. Unless people begin to eat more per person, we will not see a lot of interesting growth in the grocery industry. Produce, however, is growing, and that is good news for citrus growers. The percentage of retail profits generated from produce is expected to generate as much as 40 percent of a typical grocery store's total profit during the period 1994-2004. This is a five percent increase over the ten-year period ending in 1994. Interestingly enough, produce appears to be even more important in generating profit for smaller, as opposed to larger, grocery operations. Smaller grocery stores generate 11 percent more of their profit contribution from produce than larger retail grocery stores. This is a good indication and a trend of what is going to happen. Significant consolidation is not necessarily
Forces Pushing Consolidation, and What's Next? 2 what everybody wants. There is a lot that can be learned from smaller grocery retailers. How did we get to where we are today and why must the industry change? We will offer one scenario of the future. In the future, food will be sold in a "frictionless marketplace." By a frictionless marketplace, we don't mean virtual, we don't mean the Internet. A frictionless marketplace is a market where there are no barriers between the buyers and sellers. We have all kinds of barriers in our industry today. No barriers between buyers and sellers means competition based on value and quality in the future. Some might call this "heaven"; it is what we call a frictionless marketplace. We believe it is happening very quickly. Let's look at the industry through a series of five development phases. Before 1945: Pre-Development Phase of the Industry During this era, the shopping experience in stores was personal, fun and customer-focused. It was based on highly decentralized management. The local store owner often bought his/her products (especially produce) from local wholesalers. In this era, manufacturers went to each store to deliver the products. This phase was characterized by the intimate customer knowledge possessed by the store managers. They knew their customers' names and their specific eating habits. Store managers would buy products that they thought their customers would want. The store employees assembled the orders for the shoppers. Therefore, the shopping experience was logical. The database of customer knowledge was in the store managers' heads. Although the retailing was very personal and close to the customer, it was very inefficient, at least logistically. 1945-1975: The Development Phase of the Industry This phase was built around national branded products. Retailers wanted to be distributors of national branded products marketed by the manufacturers. Television was new and instrumental in creating demand for national branded products. Manufacturers created the products, and sold and marketed these products to retailers and distributors, who distributed the products to the stores. Identical stores, identical store managers, identical store employees, and presumably identical consumers: that was the model. The value proposition was low prices on national brands as compared to the corner store. During this phase, supermarkets were very much run by centralized management. Efficiency was the driving force. Organizations were built around central buying and distribution; nobody was responsible for the shopping experiences of any one store and no one was responsible for any one store's marketing performance. So as the stores got bigger, the local marketing decisions decreased. Another change after 1945 was that we started to do all kinds of consumer research because retailers continued to get farther and farther away from the customer. 1975-1990: Saturation Phase of the Industry During this period, the population was growing less than one percent, while the industry's square footage continued growing at least five percent. Figure this one out. We have the saturation of stores, products, deals, advertising and new competitors selling national branded foods. Some saturation facts: the number of items in a store in 1950 was 8000 as opposed to nearly 40,000 in 1990; store size went from 16,000 square feet to 60,000 square feet; the average number of promotions or deals offered to retailers (and thus to shoppers) increased from 20-30 in the 1950s to over 10,000 in 1990; manufacturers increasingly have tried to buy their way into the stores; and the number of new items introduced annually increased from a handful in 1960 to 20,000 in 1990 (keep in mind that there are only 40,000 items in a typical grocery store). Every one is selling food today, even local hardware stores have begun offering food items to customers. The quest for more sales in a flat growth, over-saturated market continues to accelerate. At the same time, shopper interest in shopping and preparing food has gone down significantly. The time people spend on preparing meals has been reduced from 2.5 hours a day in the 1960s to only one-half hour today. According to Information Resources Inc, and Nielson, there are one million active items sold throughout the country in the food
Forces Pushing Consolidation, and What's Next? 3 industry. In an average household, 150 items make up 60-70 percent of annual purchases. Keep in mind, our 150 items are different than yours. We call these the core items. They include products such as bananas, detergent, bread, milk, etc. Retailers were making lots of money by controlling access to consumers. During this phase, another development of the industry was the saturation of central buying and distribution (the core competency of the supermarket model). Consider Chicago, where there are at least six or seven redundant distribution systems, all carrying national branded products. For example, General Foods has a distribution center right next to one of the Dominick's Supermarkets in Chicago. You could deliver a product with a forklift truck between the two. However, it used to take a week to ship products from General Foods to the Dominick's next door. An interesting fact is that retailers believe they are making money from buying versus selling; they must to explain why there is redundant logistics. 1990-1995: Decline Phase of the Industry There was a lot of anger in the grocery industry, in part, as a result of manufacturers selling "their" national branded products to all kinds of alternative store format retailers. The Efficient Consumers Response (ECR) movement came about as a result of this anger. This became a significant industry movement, whereby the grocery industry expected to take $30 billion from the supply chain through increased efficiency along four fronts: replenishment, promotion, assortment and new product introduction. The industry was trying to emulate the alternative store format's perceived efficiency. At the time, traditional supermarkets averaged a 25 percent gross margin and a 3.5 percent bottom line. On the other hand, warehouse club stores were operating with an 11 percent gross margin and 3.5 percent bottom line. The conclusion reached by many in comparing these numbers was that club stores must be really efficient. We maintain that the success of club stores has had little to do with supply-chain efficiency, but everything to do with marketing efficiency. The alternative format marketers focused on the national branded, core product categories to get traffic into the stores. Their plan was to sell selected core items at a low price (often below cost) and make profits on all kinds of non-core items such as apparel or general merchandise. For example, let's look at Wal-Mart discount stores. They selectively cherry picked the top five or so detergents (versus over 100 in a supermarket) and sold them at a very low price. They took a marketing risk in that they only carried five; but the low price, high volume items picked enabled them to have significant logistics benefits such as cross docking and shipping by pallet, not case. The profits they made on the other items that shoppers bought while in the store generated the profit yield of the store. The real risk to supermarkets is marketing performance, it is not logistics or supply chain related. So ECR is actually a failure. ECR was a good idea, but it was applied to the old model of the industry, and the "false economics" of the model would not allow it to work. In reality, sales per square foot have dropped 17.2 percent in grocery stores since ECR started. For example, Starbucks has opened at least 2,000 stores with little focus on logistics (the real focus of ECR). The focus at Starbucks has been on marketing. It has only been recently that grocery stores have begun to view restaurants as competitors to their business. The traditional grocery focus has been on competing against other retailers selling national brands. Since the early 1990s, consolidation has been increasing. It is an extension of the old model: If saturation and flat population growth won't let a retailer grow organically, they need to grow through consolidation. The reasons for consolidation are often stated as increased efficiency and better buying power and growth (more old model). The consumer, or shopper, is never mentioned as a reason for consolidation. The produce industry is not immune from the effects of retail consolidation. One trade magazine article stated that big retailers buy 57 percent of their sales volume from 10 produce suppliers. Yet, on average, these big retailers use 450 produce suppliers. Slotting allowances and other forms of retail power are beginning to happen in produce as well.
Forces Pushing Consolidation, and What's Next? 4 For those of you who think the answer is growth and buying power, consider Wal-Mart. In 1970, Wal-Mart had only 30 stores. The company did not win by having buying power in 1970. The Wal-Mart stores were smaller than most of the supermarket chains at that time. Wal-Mart won because of marketing. The retailers that are the most innovative, and the ones that growers need to get to know, are the independents. You may get volume from the big guys, but you will get innovation from the small guys. Agentry Agenda: A New Phase in the Industry There is a new industry phase based on marketing productivity. Marketing productivity is based on creating a moment desire for your product, or for any product, and then delivering that moment of value. The amount of money and waste in creating a desire and closing that gap is a significant amount. Let's look at some truths: National brands do not differentiate. Coca-Cola is the same worldwide. Consumers see over 3,000 promotional intrusions a day. All marketing dollars tend to be spent on getting people to switch. Manufacturers and retailers are doing this all the time even though we have a flat population. Shoppers do not go to stores just to buy one category. They buy a total shopping experience. Trade dollars are wasted. Look at the 1996 study we did on financial performance on trade dollars at The Smart Store: manufacturers spend at least $25 billion a year to get incremental sales of $28 billion. Consumer performance on these trade dollars and deals is even worse. Fifty percent of the shoppers bought items that were on sale and did not even know they were on sale. Another 20 percent said: "Yes, I knew the items were on sale, but I would have purchased these anyway." We could argue that trade dollars are wasted on up to 70 percent of the people who bought those items. The pre-tax profits of supermarkets average three percent or $12 billion, while trade dollars to retailers from manufacturers average $25 billion. This becomes a $13 billion loss without trade dollars. So we have a significant amount of waste of marketing dollars. The Internet lifestyle is becoming more and more real. We call the new phase, Agentry Agenda: 2000 and beyond. True to marketing productivity, Agentry Agenda starts with the retailers, manufacturers and suppliers working on a level playing field serving shoppers. If we build a new model for the industry, the first question we have to ask is: What does everybody want and what do they need? Shoppers want control over their shopping experiences and answers to food related questions. Shoppers do not want to stand in front of 100 products used for the same purpose; they want somebody to tell them what they should do to make this evening's meal. The whole model of industry needs to be turned upside down; that is, from the shopper's view. We are going to start with each shopper's 150 core items. The retailers are going to help us sort through the other million items appropriate or inappropriate for us. Retailers that compete strictly on price will be relatively short lived. Virtual marketing and virtual sales are becoming a reality, driving the core items' prices lower and lower. Core item pricing will reach a level based on the "least common denominator." The Internet will enable this to happen at lightning speed. When the price charged for core items declines, the retailer has to raise prices on non-core items to make up for this. But the suppliers and manufacturers of these items do not like this. They are effectively subsidizing the cheap sale of core items with higher prices on non-core items. If the new industry model is to satisfy everybody's needs, retailers, manufacturers and consumers need to create and match revenue to value created buying, reselling and distribution of national branded products without adding extra cost. The Agentry Agenda model starts with the shopper and an agent, who offers the shopper a trusting loyal relationship between a small store and a virtual shopping experience. The goal for retailers should be to serve the $100,000 lifetime shopper verses a $20 transaction. We have to get rid of the logistics redundancy, not only because of the cost, but also
Forces Pushing Consolidation, and What's Next? 5 because customers cannot get specialty items. Many manufacturers cannot currently get special items into stores' logistic systems. In the future, stores will be supported by what we call a "barrier buster." A barrier buster is the infrastructure that gets any product to any consumer. A barrier buster connects the shoppers, agents and manufacturers with products, information and fund transfers. As consumers, we need to have an agent to get the products. Manufacturers, or suppliers, need an agent to get their products to the shoppers. This is going to become a requirement within the next two years. What will happen is that retailers will pay for the products at the standard cost, and receive promotional dollars from the manufacturers and suppliers based on actual performance judged at the time of sale by consumers, not the quantity purchased by the retailers. For virtual sales, the manufacturers will give retailers an agent distribution fee and, in return, the manufacturer will receive and understand real marketing data and what is happening store by store. Conclusion In the saturated future, a retailer has two assets: financial assets (store square footage) and marketing assets (true loyal shoppers). These assets are developed at the individual store level, not the chain level. Retailers who understand this and get this right will be successful long-term. In the future, the industry is not going to be just a supply-side creature. What we really need to work on as both retailers and suppliers is: How do we maximize the "frictionless" marketing performance of each store? We face the issue of how to survive in the future. Will the answer to this question be based on supply chain management or in marketing productivity? There are a lot of things to be learned outside of the food and citrus industries. We would suggest the answer is not only supply chain management, but also marketing productivity. If you would like to read more about Agentry Agenda, you may purchase Glen Terbeek's book by logging on to his website at http://www.agentryagenda.com. Your comments and suggestions are always welcome and you may email me directly at firstname.lastname@example.org or respond via my extension web page at http://webct.nerdc.ufl.edu:8900/public/ WysockiExtension/index.html. As the need arises, I will post and respond to reader comments and questions regarding wholesaling and retailing.