The Volume Incentive Fallacy

My telephone has been ringing a lot lately. And on the other end have been small grower/shippers looking for help. The problem is not low prices for the crops or high transportation costs due to oil price hikes. What these growers are looking for is help in dealing with “volume incentive plans” being introduced by some retailers.

The details of these plans vary. Some of the plans call for a set payment from the grower to the retailer on every dollar of business or every box of business over what the retailer purchased last year. But many of the plans are in reality nothing of the sort. In one possible case, shippers may be asked for an annual rebate of 15 cents per box on the total volume of business a retailer gives them. This requirement applies even if purchases do not increase at all over previous years.

And though participation in these plans is always described as voluntary, the plans are often only voluntary if the shipper can tolerate losing the chain’s entire business. For growers outside of these great national shipping points, which are often dependent on one or two regional chains for their livelihood, the programs don’t seem voluntary at all.

Now, of course, this is a free country, and if a supermarket wants to buy produce this way, it has the right to. However, it is interesting to consider why a chain wants to do this and what the effects on the industry and consumers might actually be if these programs gain sway over the field.

A vegetable grower in the Pacific Northwest was told to “join” one of these programs or lose 80% of his sales volume. The grower suggested instead that he just lower his price. The supermarket chain wasn’t interested. The grower didn’t understand why.

Well, the answer is that if shippers merely lower prices, supermarkets that try to maintain a fixed markup percentage actually make less money as the cost of goods is reduced slightly to the consumer. On the other hand, if the grower pays some sort of annual rebate, the markup is based on the full gross price. The rebate shifts 100% to the bottom line.

So, the purpose of the rebate, plain and simple, is twofold: A) To ensure that any bargaining power the big chains might have to get shippers to reduce prices realizes itself in better margins for the retailer and not lower prices for consumers, and B) To increase the bottom line on produce departments by allowing the supermarkets to keep a larger share of consumer produce expenditures.

Now all the above is really kind of silly. A basic tenet of business is knowing when you can make money and when you cannot. Obviously, if you are buying something under market, then you can make a big markup. If you are paying top of market prices for something, you need to work more closely. In a sense then, all that these rebate programs are telling us is that some retailers have trouble putting enough flexibility into the system by which they price to enable the stores to really take advantage of good deals to increase produce department bottom lines.

But, of course, the retailers also are hoping that the shipper will still sell them at market price and basically forget that he has to give them a rebate at some point in the future. In this way, the rebate represents an actual price reduction.

Whether this actually will happen is another matter entirely. The shippers know they are giving a rebate and may well try and make up for it through higher prices. The retailers could resist this, but, to some extent, the retailer who insists on these programs places himself in a Catch-22. After all, if a requirement for dealing with the chain is part of the program, then, pretty soon, all the major produce suppliers will be paying a rebate. As a result, the buyer may only get rebate-inflated prices. But if the produce buyer places priority on getting the best quality at the cheapest price, then this program will lose support, because there will be no advantage for a grower/shipper to be part of the program in order to sell to the chain.

This is really the rub and points out why these types of programs do not really serve the retailer’s interest.

The problem for produce retailers is the tightrope they have to walk. If having these special programs forces the produce buyer to buy substandard quality produce or accept inadequate service or overpay, then there is no sense in having the program. After all, the bread and butter is still the ability to attract consumers to the store because of the great produce department.

On the other hand, if the retailer insists on making the program secondary after price, quality, and service, then the program isn’t likely to mean anything. The only solution for the retailer is to have all the suppliers with the best price, quality, and service in the program. But with the vagaries of produce, affected by wind and rain and growing conditions, that is exceptionally hard to do.

The purchase of produce at market price is a whirlwind ride. For those who do it well, it is the best system yet known for combining the varied needs for price, quality, and service. The freedom to buy from whom you want and when you want is an enormous tool in the hands of a shrewd buyer. Retailers should think carefully before climbing up on the tightrope of “volume incentive programs.”