Agribusiness, Research and Development/Tech Change/Emerging Technologies,

Kaufman, Phillip R.

English

Research Papers in Economics

What's Driving Food Distribution --  Forces for Change
Phil R. Kaufman
This  morning, we were given expert insights  External  costs  are  those  costs  that  result
about the state of the food industry, both from the  when  food retailers  and wholesalers  interact with
view  of  the  manufacturer  and  the  distribu-  other  participants  in  the  marketing  and  distribu-
tor/retailer.  We heard  about the challenges  facing  tion  channels.  These  include  upstream  entities
the  industry,  and  how  the  participants  intend  to  such  as  brokers  and  agents,  manufacturers,  and
respond.  We  were  also  told  about  many  of the  even  commodity  suppliers.  Retailers  must  also
important changes taking place  in the food  system  interact  with  downstream  entities,  namely  con-
and their implications for its members. This after-  sumers.
noon,  I would  like to add my perspective,  from  a  Rising external  costs  and  inefficiencies  have
vantage  point outside  the industry,  but  still  very  prompted  the  food  industry  to  make  major
close to  it. As a food retailing  analyst for USDA,  changes  to improve  coordination  among the vari-
my perspective  is somewhat  different  from those  ous entities of the  food  system,  through mutually
industry  members.  Our  concerns  stem  from  the  agreeable  methods  that  produce  benefits  for  all
need  for informed  public  policy,  which  involves  involved.  The term Efficient Consumer Response,
relevant  economic  information,  research,  and  or  ECR,  was  coined  a  few years  ago  to  capture
analyses.  This  afternoon,  I  would  like  to  share  the  principles  of  reducing  external  transaction
with  you  some  insights  into  the  complexities  of  inefficiencies.  One of the overriding principles  of
the  food  distribution  and  retailing  industries.  ECR  is to  end  adversarial  relationships  between
These  insights  take  the  form  of three  observa-  upstream  and  downstream  entities  and  to  work
tions,  and  identification  of the driving forces  be-  together to seek mutually beneficial  means to re-
hind them.  duce their  respective  transaction  costs.  Means  to
The title  of my  presentation,  "What's  Driv-  achieve this goal are being developed, tested, and
ing Food Distribution  -- Forces  for Change,"  re-  adapted  in the  food industry. For example, better
quires  that  I  sort  out  cause  and  effect  --  not  so  inventory  management,  such  as  continuous  re-
easy  a  task,  but  hopefully  it will  help  others  to  plenishment,  cross-docking,  and  more  uniform
better  understand  the  important  developments  supplier pricing policies  can discourage  stockpil-
taking place today, and to better understand their  ing  by  wholesalers  and  retailers.  The  manufac-
implications for tomorrow.  turer can achieve savings through  long-term  pro-
Observation:  Food Retailers and Distributors  duction  planning  and  reduction  of  promotion
are  aiming  to  reduce  both  internal  and  external  costs. Retailers  can  benefit through reduced  cost
costs  through ECR and  Other  Means.  Efforts  to  of goods, and through reduced inventory  require-
reduce  internal  (within-company)  costs  are  a  ments.  Procurement  coordination  and  streamlin-
guiding  principle  throughout  the  industry.  New  ing can  lead  to automated  ordering,  such  as  the
technology,  innovation,  and  better  use  of  re-  use  of Electronic  Data  Interchange  (EDI),  that
sources  have  produced  a  continuing  stream  of  reduces  paperwork,  ordering  errors,  and  related
internal  cost savings. But as the marginal  returns  transactions costs between entities.
to  internal  costs  reduction  efforts  have  dimin-  Adoption  of these new  external  efficiencies
ished,  and  new  sources  of  competition  have  also has implications  for retailers and consumers.
emerged  in recent  years, the industry  has  looked  As  the  importance  of promotions  and  deal  pur-
to  additional  efficiency  gains  through  external  chasing between  suppliers  and  retailers  is dimin-
cost reductions.  ished,  cost savings to  suppliers  could,  in  theory,
be  passed on to wholesalers and  retailers. Retail-
Author  is with  the  Economic  Research  Service,  USDA,  ers would have greater pricing flexibility resulting
Washington, D C.  from lower cost of goods from suppliers that have26  February 1996  Journal  of Food Distribution  Research
adopted  ECR  principles.  The  effect  can  benefit  by calling  their  outlets  a  "Club"  and  charging  a
consumers  in the  form  of consistently  lower  and  membership  fee.
uniform  pricing  practices.  This  approach  has  Although  warehouse  supermarkets  offered  a
come to be known  as Every Day Low Pricing, or  similar  no-frills  orientation,  the  club  stores  had
"EDLP"  to the trade.  also  identified  small  business needs for bulk  and
Driving Forces:  The  forces  driving retailers'  larger  package  sizes  on  a  cash  and  carry  basis.
efforts  to  reduce  internal  and  external  costs  are  The club stores also offered products  that had not
many  and  varied.  The  recession  of  1990-91  and  been  previously  made  available  to  the  public.
the  subsequent  slow  growth  rates  and  low  infla-  Although  consolidation  has  reduced  the  number
tion levels  since then have limited retailers'  abil-  of clubstore  retailers,  growth  rates  are  still  very
ity  to  raise prices  in  response  to cost  increases,  good,  according  to forecasts  by William  Degen.
This period of slow sales growth largely dispelled  In  response,  many  supermarket  operators  have
the myth that food  is  a recession-proof industry.  added bulk and institutional package  sizes to their
The  consumer's  food  dollar  is one  of the  largest  offerings. But warehouse  clubs still surpass in the
spending categories that is not a fixed expenditure  variety  of non-food  categories,  especially general
in the short term,  unlike mortgage and installment  merchandise  and consumer durables.
payments.  Consumers  apparently took control  of  Mass  merchandisers  and  discounters  such  as
their food spending to an unprecedented degree  in  Wal-Mart, Kmart, and Target, have extended their
the early  1990's,  giving rise to growth of the non-  product  lines  to  include  an  increasing  array  of
traditional  sources  of  retail  grocery  products.  food and non-food  grocery products  in a new su-
These  outlets  include  the  warehouse  clubstores,  percenter  format,  which  includes  a  largely  self-
and  mass  and  discount  mass  merchandisers.  The  contained supermarket within the larger store.
growth  of non-traditional  food  retailers  selling  Depending  on  the  format,  the  percent  of
grocery products  has engaged many food retailers  sales  in  direct  competition  with  traditional  food
in  unexpected  heightened  competition,  adding to  retailers can  be as much as 30 percent.  Mass mer-
pricing and cost reduction pressures.  chandisers and  discounters  bring their knowledge
At  the  same  time,  slow  and  below-normal  of procurement  efficiencies,  coupled  with buying
industry real growth rates coupled with  low infla-  power as a result of large sales volume to the  re-
tion  levels  has heightened  price  competition  be-  tail grocery products marketplace.
tween food  retailers. As a result, cost reduction--  Driving  Forces:  But  what  are  the  driving
in  order  to  protect  store  profit margins--has  be-  forces  behind  this development?  The motivation
come  an  added  priority.  Pricing  is  relied  on  to  differs  somewhat,  depending  upon  the  type  of
stimulate  sales  growth,  where  under  more  infla-  non-traditional retailer. Both mass merchandisers
tionary  times,  it  had  served  to  maintain  store  and warehouse club stores are pursuing locational
margins.  and product  mix  strategies  in  a quest  for greater
Observation:  Non-traditional  grocery  retail-  sales  volume.  Mass  merchandisers  have  devel-
ers  have  grown  considerably  in  recent  years,  oped their  supercenter  format  in  low  cost,  low-
providing  an  additional  source  of competition.  density, rural areas where  large-scale  competitors
The  introduction  of food  and  nonfood  grocery  were previously nonexistent.  They also required a
products on a large scale by non-traditional retail-  very  large  trading  area,  which  depended  upon  a
ers  has had a major  competitive  impact  on  food  super-low  price  image  coupled  with  unprece-
retailers,  most  industry  members  would  agree.  dented  product  variety.  These  factors  generated
The  non-traditional  retailers  are  meeting  the  high  growth  rates  in recent  years, giving  grocery
needs  consumer  segments  that  were  either  not  retailers much consternation.  The traditional food
identified  or thought to be marginal in importance  retailing  industry's  concern  is  evident  when  we
by traditional food retailers.  look  at  the  sales  of grocery  products  by  ware-
Warehouse  club  stores primarily  serve  con-  house club stores'  and mass merchandisers'  sales
sumers who buy in bulk or large  quantities in or-  of  grocery-related  products,  courtesy  of  James
der  to  achieve  greater  savings.  These  retailers  Degen  &  Company  consultants  (Figure  1).  To-
gave consumers an added image of exclusiveness  gether, these two formats  registered $29.3  billionKaufman, Phil  R.  What's Driving  Food  Distribution  -- Forces  for Change  27
in  sales  in  1994,  up  from  $26.5  billion  in  1993.  ing  mass merchandisers  and  discounters  to enter
As  we  can  see  from  Figure  1, Club  stores  cur-  metropolitan  area  markets.  There  they  will  find
rently account for a major share of non-traditional  established traditional grocery  retailers already  in
grocery  sales.  But  as  the  number  of mass  mer-  abundance,  occupying  the  most  desirable  loca-
chandiser  supercenters  are  opened,  their  growth  tions, and protective of their market shares.
will  take  precedence.  Supercenter  formats,  such  One  of the  likely  outcomes  of these  devel-
as those currently  operated  by Wal-Mart,  Kmart,  opments  is illustrated  in Figure 2.  We see grocery
and Target, will see sales jump from an estimated  products  supply  and  demand  curves  represented
of $6.7  billion  in  1994  to  $32.6  billion  in  2000.  in  a typical functional  form.  With the  growth of
The  combined  grocery  products  sales  of  these  non-traditional  retailers  selling  grocery  products,
non-traditional  retailers  is forecasted  to reach  al-  the  industry  supply  curve  has  shifted  outward,
most $70 billion in  2000--amounting  to about  14  from  S1  to  S2.  But  consumer  demand  for retail
percent  of total  grocery  products  sales.  (Note:  grocery  products remains  largely  unchanged.  The
Foodstore  sales  projection  to  $441  billion  in  result  is  a new  equilibrium,  in which  total quan-
2000,  with  total  grocery  products  sales  of $511  tity  has  increased  from  Q1  to  Q2.  But  average
billion.)  price  has  fallen,  from  P1  to  P2.  The  Wal-Mart
However,  the likelihood  of sustained growth  slogan "watch out for falling prices" seems highly
rates at these high  levels  can be called into ques-  relevant for the entire industry as well.
tion,  as rural  locations  become  saturated,  requir-
Figure 1. Grocery Products Sales  by Non-traditional Retailers.
140
120  0 Total
*  Supercenter
69.9
100-  Clubstore
I______________________I  i  —  1  ~ ~63.7
56
80
§  47.8
m  60-  1  40
34.5
420-  265  29.3
40  -I  26.5
20 
1993  1994  1995  1996  1997  1998  1999  200028  February  1996  Journal  of  Food  Distribution  Research
Figure 2. "Watch Out for Falling Prices."  greater  workforce  participation.  Time  resources
for food  preparation  have become  limited.  Dual-
Price  income  households  are  more  likely to depend  on
Sl  food preparation  outside the home. Rising house-
hold incomes have accompanied  the expansion of
the  foodservice  industry,  and  analysis  has  shown
\  /  S2 ^  'that  growth  in  personal  disposable  income  is
PI .--..------- ....  highly correlated with growth in food-away-from-
P2 ........  ...... '  home spending.
Figure 3. Share of Food Expenditures.
100%
Qi  Q2  Quantity  9
80%
70%--  il"  i  I  II  I1  i Observation:  A  growing  proportion  of  the 
consumers'  food dollar is devoted to the foodserv-  60%
ice industry. The long-term trend in the allocation
of the  consumers'  food  dollar  has  favored  the  50%
food-away-from-home  sector,  which  consists  of  40%
commercial eating and  drinking places,  and insti-
tutional  food service,  such as food  served in em-  30%
ployee  cafeterias,  hospitals,  and  schools.  Mean-  20% 
while,  food-at-home  spending  in  retail  outlets
such as foodstores  and  other  retail  outlets selling  10%
packaged  food  have  not  enjoyed  comparable 
growth rates.  In Figure  3,  we see total per capita 
food spending  divided between  the two  principal  1  O 
sectors.  In  1970,  consumers  devoted  on  average  * Food at Home  0 Food away from Home
about 66.0 percent  of their food dollar to food-at-
home  purchases,  mostly  in  foodstores.  The  re-
maining  34.0  percent  was  spent  for  meals  and
snacks,  primarily  food  service  outlets.  By  1995,
the  share of the  consumer's  food  dollar spent  in  The  foodservice  industry  has  responded  to
foodstores  and  other  retail  outlets  had  fallen  to  the  resulting  preference  for  greater  convenience
less that 53.0 percent of the total.  in food preparation  in a variety of formats, rang-
This  phenomenon  is  fairly  well  understood  ing  from  full  service  restaurants,  to  fast-food
in  the  food  industry.  However,  the  causes  and  carryout  outlets.  Food retailers  must  realize  that
consequences  of this  long-term trend may not be  the  preference  for  convenience  in  food  prepara-
fully appreciated.  tion  is here to stay. Although  many food retailers
Driving Forces:  Although natural  population  view their business  as  serving primarily  food-at-
growth  has  provided  sales  growth  for  both  the  home  consumption,  greater convenience  through
food-at-home  and  food-away-from-home  sectors,  value-added products, such as prepared  foods, has
consumers have exhibited  a strong preference  for  been  well  received  by  consumers.  Although  a
convenience  both  in  food  preparation  and  con-  number of food retailers offer prepared foods that
sumption.  Traditional  gender  roles,  especially  rival those of a high quality food service operator,
among  women,  have  been  displaced  by  their  the industry  broadly  speaking,  does  not measure
up  to the  variety  and  quality  found  in  the  foodKaufman, Phil R.  What's Driving  Food Distribution  -- Forces  for Change  29
service  industry.  Retailers  have  yet to  offer com-  retailers  can  offer  greater  convenience  at  lower
plete prepared meals, although  many in the indus-  costs  compared  with  food  service  operators.  By
try view this as the next challenge.  responding  to  these  driving  forces  for  change,
Another  food  retailer  innovation  that  offers  food  retailers  can  begin  to  make  gains  in  their
time-saving  benefits  is home  shopping  and deliv-  quest for the consumer's food dollar.
ery services.  Combined  with  ease  of preparation,

WHAT'S DRIVING FOOD DISTRIBUTION - FORCES FOR CHANGE

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Research Papers in Economics