Consolidation Need Not Lead To Margin Compression

The news that the team controlling Albertsons would acquire Safeway is very meaningful for those vendors that sell to either one of the companies. If they lose the Safeway or Albertsons business, it is hard to see where they can pick up the volume on such scale.

Yet as a sign of consolidation in the industry, it is not as dramatic as it once would have been. Take a look at the chart on this page from The Wall Street Journal. The gap between Safeway and Kroger is sizable, and the gap between everyone and Wal-Mart is gigantic.

The shocking thing is not the consolidation, but that Safeway simply gave up. There was no sturm und drang; no fighting for independence; no proclamations that shareholder value could be enhanced by letting Safeway management build the company. They just gave up.

The roots of this lie in Wal-Mart’s move into Safeway’s territory. Whereas Kroger elected to fight, lowering prices and determining to be competitive, Safeway did not so much fight Wal-Mart as get out of its way. So it renovated every store with its upscale Lifestyle concept, rolled out the high-end O brand organics and crusty bread, and closed stores in marginal neighborhoods, leaving the clientele for Wal-Mart.

The conventional supermarket business, though, isn’t what it once was. Today, many a supermarket is under stress without any new conventional competition. Imagine a healthy supermarket, then a deep discount ALDI opens nearby, an epicurean Trader Joe’s, a big warehouse club such as Costco, a supercenter from Wal-Mart, while the local Target adds a grocery concept. The local Walgreens adds a fresh food assortment as does the local Dollar General, and, oh, Amazon Fresh decides to enter the market while Whole Foods seizes the local university clientele and Fresh Market does the same with a nearby upscale suburb.

None of these retail concepts are directly competitive to a supermarket, but they don’t have to be. If each concept peels off just 1 percent of the supermarket’s business, the end is near. Retailers have high fixed costs, and they can’t lose 10 or 20 percent of sales without moving into the red.

For vendors, there are many directions to go: One is to focus on the special needs of various market sectors. In the past, the vendor might have sold an identical product to many different chains that were similar but operated in different geographies. Now vendors may have to focus on the needs of individual retailers. So Whole Foods may want Fair Trade product, while ALDI is looking for an off size so it can get high-quality fruit at a bargain-basement price. Packaging may be the key to Costco and logistics the key to penetrating Walgreens.

Another option is looking for other buyers — export, foodservice, wholesale and independent retailers. Still another possibility is to enter the big chains but under a “local” program, where a vendor may only supply particular stores or divisions.

These are all good ideas, but they are somewhat stop-gaps. In order for producers to deal with retail consolidation and come out victorious, they need a game-changing dynamic — the answer is genetics.

There are two great competing models for avoiding margin compression due to retail consolidation: Driscoll’s and Sun World. Both have proprietary produce with unique characteristics. Driscoll’s grows berries on its own and brands product with the Driscoll’s name. Sun World grows a base and then licenses out its varieties and gives each variety its own brand — such as Midnight Beauty, Scarlotta Seedless, and Honeycutt, to name a few.

The apple industry also has engaged on this tactic through so-called “club” varieties.

What is right for each company will vary depending on its resources and goals, but the key elements of a successful approach are the same: First, have a unique variety with distinctive consumer attributes. Second, limit the acreage planted so that there is always unfulfilled demand, and thus pricing can be kept at a premium. Third, restrict the growing to land that will produce optimal quality, and restrict the growers to those who will use the finest horticultural practices. Fourth, make sure the marketers are strong and able to handle the volume.

Once the product is developed this way, it needs a brand so consumers can identify it and ask for it or require it. That brand, of course, needs to be promoted.

Then you wind up with a new world; a world turned upside down because the retailers need the product more than the vendor needs any given retailer.

We are far from there yet, but every produce shipper should be thinking about where it is going to get its proprietary genetics in 10 years and how that product is going to be branded. Retailers tempted to push for the last nickel should remember that in a not very distant future they may be pleading with those same producers for an allotment of their proprietary — and very popular — produce.