$how Them the Money
By John P. Abbott
Retailers drive some exceptionally hard bargains; questionable fees have vendors crying foul.
Not long after
Rite Aid confirmed its $3.4 billion deal to buy more than 1,800 Brooks and
Eckerd drugstores, it summoned all the confectionery suppliers that had
provided products to the Brooks chain to offer them a “special
opportunity.” Rite Aid told the suppliers they would need to pay
$9,000 for every SKU they had in Brooks Drugs if they wanted to maintain
their placement in the new combined chain. They also asked them for a
purchase allowance (based on a percentage of annual volume) and extra
dating for payments — 90 days above regular terms. In addition,
suppliers were required to pay Rite Aid a sum equivalent to 1.5 percent of
the last year’s sales of products to Brooks. This
“conversion” fee was intended to defray the costs of revamping
old Brooks’ stores to their new Rite Aid banner, including signage,
racking and store remodeling.
“Our first reaction was, ‘This is going to
be very expensive,’” says one of the vendors involved, who
requested anonymity. He estimated it would cost him 50 percent of the
total of last year’s sales to Brooks to “participate” in
the offer. Moreover, he was fearful that if he didn’t participate,
the products that he currently had on the shelves at Rite Aid were in
jeopardy of being pulled.
“We were paranoid,” he admitted. “If
Rite Aid could do this in the drug arena and get away with it, then
what’s to stop other retailers in grocery and mass from doing it in
their channels? They might be thinking, ‘All we have to do is
ask.’ And then we’ll be strapped by all our retailers.”
Fairness questioned
Another manufacturer, who also requested anonymity,
was able to whittle down the fee through negotiation, but only after the
sobering recognition that if it lost its presence in Rite Aid, another
supplier with deeper pockets would take its place. “There are only
three major drug chains, and as a supplier we’d better be in all
three,” he said. “We didn’t want to lose our presence in
their stores and have some other supplier take that business.”
The end result was that some candy makers paid a
larger percentage of the fee than others, further calling into question the
equitability of the fee. But when pressed for details, nearly all of the
suppliers contacted were reluctant to speak on record about
acquisition-based fees. They all agreed they were unjustified — if
not discriminatory—but refused to publicly criticize them for fear of
reprisal.
Rite Aid isn’t the only retailer that has asked
its suppliers to help it shoulder the financial burden that accompanies a
major acquisition. When CVS bought 1,200 Eckerd stores in 2004, it
approached its suppliers with a request for purchase-based allowances. In
the grocery industry, “pay to stay” fees are prevalent in many
categories, and have been so for more than a decade. (Both Rite Aid and CVS
declined our request for an interview. We contacted eight other retailers
in various channels, but all declined to comment.)
“These trade practices are not new,” says
Mark Baum, who runs the consumer product goods division of Diamond
Consulting, a management consulting firm that provides services ranging
from merger and acquisition strategies to supply chain management.
“In the grocery channel they’ve certainly intensified through
consolidation and competitive pressures, and we’re seeing the same
thing in drug.
“We have a history of enabling these practices,
which go back to slotting fees, which initially were justified as
introducing new items into stores that had a lack of available shelf
space,” Baum continues. “However, these legitimate costs
gave way to whatever price the market could bear. Larger chains could
charge more than small chains, so the price varied depending on the
company. It became a ‘pay to play’ fee and has become embedded
in the cost of sales for manufacturers. The result is that those suppliers
who have a great demand for their products are not as burdened as small
companies. In that sense, it’s a somewhat insidious practice.”
Chasing the dollars
These kinds of fees — heaped upon slotting
allowances, deductions, reclamations, and other charges — have made
it harder and harder for mid-sized and small manufacturers to reach the
market through these distribution channels. Major candy manufacturers can
absorb these one-time hits, or sic their 10-person deduction-dedicated
legal teams on the retailers to negotiate away a good portion of the
charges. Small suppliers, on the other hand, lack the resources and/or the
bargaining power to push back — and many can’t afford to walk
away from the business.
“This kind of activity has always been in the
industry, but the new kinds of fees we’re seeing today were never
used,” says Jay Pearlman, president of Ludo LLC, a Cleveland-based
interactive novelty candy company. “Are they unethical? Yes. But the
retailer has the right to do whatever they want to do, and the manufacturer
has the right not to participate. It absolutely hurts small manufacturers
in a way that it doesn’t hurt the Mars, Nestlés, and Hersheys
of the world, who can pull these allowances out of marketing development
funds. And the little guy knows that if he refuses to pay these fees, there
are big companies lined up behind him who will.”
Small guys squeezed
In Pearlman’s opinion, the practice damages the
industry by squeezing out smaller companies. “Now when you go into an
account, you see the same products. Do you really need five different sizes
of Snickers on the shelf? The less choice for consumers makes all the
stores look the same — and one of the things that make our industry
so great is the variety.”
Because of the nature of his company, Pearlman
doesn’t have to chase the dollars the way that some other
confectioners do. “I made a decision a long time ago that when I got
my business to a certain size, I would choose who I want to do business
with,” he says. “I have some great customers that it’s a
pleasure to work with. One customer, for example, charges slotting but I
know exactly what I’m getting into, and they have a decent
justification for their fees. The distributor can go into the stores and
reset the planograms for us, and we’ll be charged for the reset
— but that’s reasonable.”
What seems so unreasonable to most suppliers is the
disconnect between the fee and the understandable expectation that it will
be used to merchandise their products. As one former candy executive said,
“Why is money changing hands between buyer and seller when no sales
are happening?”
Take slotting fees, for instance. Retailers need to
evaluate the sales and margin potential of any change in merchandise they
sell, so they charge suppliers a fee to offset the costs associated with
their efforts to determine which item will be cut back — or
eliminated — to make room for a new item. Suppliers
aren’t doing cartwheels because they’re charged slotting fees,
but at least they understand the business rationale behind them.
Negotiating a “fair share”
The requests for fees vary dramatically, making it
hard to provide a sound comparison. In some cases, retailers charge fees
based on total purchase commitment, while in others they charge based on
items per store or on the total amount of real estate a product occupies on
the shelf. Geography can also play a part in the equation. For instance,
the fee charged to a supplier servicing New York could be twice as high as
one charged to a supplier in Tulsa — and even higher to a supplier in
California.
“Just about all retailers charge slotting
allowances for new items; some retailers will send you a bill for a new
store set or a reset of an existing store, and some have a yearly fee for
resets,” says Eric Ostrow, vice president of sales and marketing for
Ce De Candy. “You’re expected to pay your ‘fair
share’ based on the number of items in the schematic.
“In most cases, these charges aren’t
prohibitive. But what you have to understand is that every time a retailer
imposes a cost on a manufacturer — whether it goes through a
distributor or not — the price goes up. Most retailers expect the
manufacturer, who is a fraction of their size, to absorb these
costs.”
Ostrow can negotiate the fees based on the power of
his brand: Smarties have been a familiar part of the confectionery
landscape for nearly 60 years, and in its novelty category continues to
rank in the top 10 in the United States in annual tonnage. “We try to
give our retailers a fair deal, and maintain our normal profit margins, and
all we ask is the same in return. Most retailers are willing to do that.
But during any negotiation you have to be aware of what kinds of fees could
come about. What’s even more frustrating is that sometimes you agree
on a price and a retailer will come back in three months with a new format
and try to renegotiate the price … after we’ve already planned
for it in our annual budget.”
One Midwestern manufacturer, who requested anonymity,
has had success negotiating down acquisition-based fees by pointing to the
fact that his seasonal confections are in high demand among consumers.
“We’re able to show the candy buyers how our products have sold
over the years. We’ve built up a track record that’s hard to
argue with. On newer items or line extensions, where the sales projections
are harder to make, we agree to sell-through allowances.”
Following the money
One of the biggest issues surrounding
acquisition-based fees is that it’s hard to trace the revenue
generated by them to improved promotion, better advertising, or innovative
store sets — anything that would make suppliers feel as if they were
getting something in return for the “special opportunity.”
“Most retailers have some fees for new store
openings even if they don’t have slotting fees,” says the chief
marketing officer for a Midwestern candy company, who asked that his name
be withheld. “The belief is that they carry more risk because the
sales level is uncertain, so they try to pass it on to the manufacturer to
defray the cost. In a lot of cases, that will involve special terms or
additional sell-through allowances.
“Our experience has been that these fees have
nothing to do with location or store size,” the marketing officer
continues. “The companies that are charging them are minimizing the
exposure to their working capital by asking their suppliers for terms.
They’re also using them to minimize their risk as a buyer. If a
retailer has an ‘ABC’ format, they generally know what’s
going to sell. But if they acquire a new store in a new geographical
location they may be less certain, so they shift the risk back to the
supplier. It’s the equivalent of buying yourself an insurance policy
at the expense of your suppliers.”
Calculate the return
“If I was a manufacturer,” Baum says,
“I would want to know how these fees were applied, where they were
applied, and what return I will get. If they’re to be allocated to
marketing, where were they used? Did the retailer produce an extra ad or
promotion? Was it a productive use of the dollars? Most of these fees seem
to be more like a toll. They don’t necessarily go to anything related
to an individual company.”
The best retailers will engage their suppliers to
maximize those dollars in the most creative way, Baum points out, thereby
exposing their products to more consumers through the additional stores
they’ve acquired, giving suppliers of all sizes a much more visible
return on their investment.
“The retailers who are only collecting these
fees as a way of using suppliers as profit centers will lessen their
competitive edge, while those who use the fees to reflect better products
on the shelf — and better serve their customers — will
ultimately win the battle,” says Baum.
“The interesting thing about confectionery is
that it does tend to be more fragmented once you get past the
Nestlés, Hersheys and Mars of the world,” Baum
continues. “The second thing that makes confectionery interesting is
that in addition to being a household item, it’s also a high-impulse
item, so point-of-sale placement and cross-merchandising activity are more
important than in other categories. There’s more demand and more
movement, so there needs to be more collaboration between retailers and
manufacturers.”
Diversifying through distribution
The size and extent of the fees have forced some
suppliers to investigate alternatives to traditional distribution channels.
“We’ve seen cases across the spectrum in which wholesalers have
become their own distributors, or found other outlets to distribute their
products,” says Al Ferrara, national director of Retail and Consumer
Products Services with BDO Seidman LLP, a leading accounting and trade
practices firm. “Rather than become solely dependent on one
distribution channel, they’ve turned to outlet stores, seconds,
boutiques, or opened their own retail operation.”
Confectionery is not unlike other categories,
according to Ferrara. “A select few suppliers have leverage over the
retailers or have carved out a unique place in the market,” he notes.
“But with continued consolidation, the strength of retailers will
only increase, and their hold on the distribution channel will get tighter.
Part of their strategy will be to add as much additional margin dollars as
they can out of their suppliers.”
Positive thinking
Some candy companies have tried their best to put a
positive spin on the situation. “You don’t have much of a
choice, but in a sense you don’t mind doing it because you solidify
your sales in the store,” says Eric Atkinson, president of Atkinson
Candy, now in its 75th year. “It’s a cost of doing business.
You can do the math and figure your paybacks pretty quick. If there’s
not a payback, we don’t do it. That’s the way we look at it,
and it doesn’t seem that oppressive.”
There’s no question that when a company like
Rite Aid or CVS purchases another retail entity, there are huge costs in
terms of harmonizing items and converting formats. “From their
perspective, they feel like a manufacturer who will enjoy increased
business should share in the cost,” says one consultant who has
worked with both retailers and manufacturers. “But the manufacturers
feel like they’ve already paid to have those items in retail, so
they’re just incurring a new cost against a product that’s
already selling.
“A lot of suppliers feel that the best business
practice should be to factor those costs into the price of the acquisition,
rather than push them onto manufacturers with new allowances to keep them
in the store,” the consultant continues. “What’s happened
is that manufacturers have acquiesced over time. Companies who
couldn’t afford not to be in distribution would crack and pay …
and as soon as one cracked, they all folded and the rest went along.
“From a retail perspective, this is just a
short-term cash grab,” the consultant says. “But the long-term
effect is that products don’t sell as well because suppliers reduce
their promotional and advertising expenses to offset the cost of these
fees. That hurts retailers, too … but if a company can add $350,000
to its bottom line, it’s probably worth the risk.”
Hail the channel commander
As much as they bemoan the situation, manufacturers
bear much of the responsibility for letting the balance of power shift to
retailers over the past several decades. One old-timer, who asked not to be
named, described it like this: “If you went to a candy company
headquarters in New York in the ’60s or ’70s, you were showed
into a massive waiting room where the buyers would come to talk to them and
‘sell’ them on their stores. Now it’s completely the
opposite. The manufacturers are coming to the retailers and offering to pay
such and such to put their products in — and the retailers know they
have the power.”
The shift has occurred so quickly that the latest
generation of confectionery executives now in their 30s and 40s
doesn’t feel the same moral outrage about supplier purchase
allowances that “elder statesmen” in their 50s and 60s do.
“Many of the fees injected into the business in the past 15 years
have gone through a generation cycle to the point where they’re
inherent and accepted rather than rejected,” says a senior executive
in the industry. “The longer they prevail, the more they become the
norm. And the more they become the norm, they harder they are to
change.”
“There have been tensions over fees between
suppliers and retailers for decades,” says Professor Eugene Fram of
the Rochester Institute of Technology, the author of hundreds of articles
and six books about retail marketing. “Every time there’s a new
wrinkle in the relationship, it is settled by the ‘channel
commander’ — the trading partner that has the most power in the
channel being used. If we go back in time, the channel commander was the
manufacturer who had the branded name. Customers would look to the
manufacturer to provide the latest styles and merchandising.
“In the last 10 years, the retailer has become
the channel commander because the retailer now speaks more for the
customer,” Fram continues. “In the past, manufacturers did
market research and took the initiative in merchandising. But now the
retailer has the stronger local presence, and vast buying power, a la
Wal-Mart. For example, if Wal-Mart demands that merchandise is to be
delivered at a specific time and specific location and packed in a specific
way, and the manufacturer’s trucks are late, they’ll levy a
fine, and most manufacturers are compelled to pay it.
“The channel commander will continue to call the
plays in the retail industry,” says Fram. “Whether or not
retailers are justified in seeking this type of financial assistance will
probably be determined by the Federal Trade Commission or the courts.
Manufacturers might consider legal action on some of these issues …
but it doesn’t pay to sue your customers.”
Confrontation or collaboration?
When asked about the future, the prevailing attitude
among many of the sources that we interviewed was one of cautious
pessimism. “As long as those retailers can continue to make
additional profit by charging these fees and as long as suppliers continue
to pay them, it’s only going to get worse,” one candy
manufacturer, who spoke on the condition of anonymity, said. “I
don’t see fees coming down as long as retailers continue to incur the
costs of acquisition, particularly in the drug and grocery
industries.”
Manufacturers, especially smaller candy companies,
will have to become more creative in finding ways to work around purchase
allowances and other fees. Some experts suggest that suppliers could seek
out retailers whose consumer orientation would be enhanced by their
products — a specialty or novelty retailer in a trendy shopping area,
for instance — and work hard to show the advantages of
differentiation.
“One of the things we’re seeing with
leading-edge retailers is a stronger desire to collaborate with their
suppliers,” says Lisa Feigen Dugal, partner and co-leader of the
PricewaterhouseCoopers Retail & Consumer Advisory practice.
“Companies on both sides are looking at their business more
holistically. For example, there’s been a tendency towards more open
sharing of data. Retailers have a certain portion of data and suppliers
have a certain portion of data, and when they leverage it together along
the value channel it leads to more win-wins for both companies.”
Dugal’s colleague at PricewaterhouseCoopers,
Michael Hartman, who has worked with the National Association of Chain Drug
Stores on the development of its Efficiency and Effectiveness Everyday (3E)
study, sees the collaboration extending to the point where the line blurs
between manufacturers and retailers. “We’ve seen many cases in
which manufacturers are setting up their own retail displays and even
opening their own stores,” says Hartman. “At the same time,
you’ve got retailers who are creating their own brands and marketing
them aggressively. The result is that they’re starting to see things
through each other’s eyes. A consumer products goods company wants to
leverage all available channels — including their own — to
build their business, and the best retailers want to do the same thing
… so both sides are after the same goal.”
The push toward more collaboration won’t be
easy, Hartman says. “There will definitely be winners and losers. But
those who latch on to customization, taking advantage of customer insights
and leveraging all available channels, will reach the full power of the
value chain.”
The challenge, one industry executive says, is that
manufacturers are prevented from taking a consolidated stance against the
fees because of federal legislation such as the Robinson-Patman Act that
outlaws price fixing. (See sidebar on page 53.) “The hard part for
suppliers is that each one is an island because of Robinson-Patman,”
the executive observes. “They can’t form a consortium to stand
up to retailers like Rite Aid and CVS and say ‘no,’ or else
they’d be in court tomorrow.
“One thing that gives me optimism, though, is
that sophisticated retailers have figured out ways to make money not only
on buying, but also on selling. For example, Safeway has revamped its
entire retailing philosophy by converting to a new ‘lifestyle’
format that features more prepared foods, more organic foods, more recipes.
They’ve made it easier to shop and offered their customers healthier
choices. It’s a matter of taking a new look at your customers and
listening to their concerns and utilizing the data you get to invest in new
marketing concepts. It’s a much different approach than making
short-term hits on manufacturers with fees or cost-cutting moves like
reducing overhead and people.”
Baum is also guardedly optimistic. “Over time, a
few companies will move along a continuum towards a model of collaboration,
cooperation, and convergence. These trading partners will be transparent
with one another to better serve their customers. The more success they
have, the more they’ll inspire others to follow that model. Other
companies will find themselves at various places along the continuum. Those
that charge fees that don’t make sense from a business perspective
will be the most at risk of losing sales to their competitors.”
What Would Mr. Robinson Think?
The practice of retailers charging suppliers fees to
defray the cost of mergers and acquisitions is not illegal, according to
the Robinson-Patman Act. But it’s illustrative of the complexity of
the issue to examine the impact of federal legislation on the trading
partners involved, and how it’s shaped their responses to the
situation.
Passed by Congress in 1936, the Robinson-Patman Act
forbade any company engaged in interstate commerce to discriminate in price
to different purchasers of the same product when the effect would be to
lessen competition or create a monopoly. Originally designed to supplement
the Clayton Anti-Trust Act, Robinson-Patman was intended to protect
independent retailers from chain-store competition, but it was also
strongly supported by wholesalers eager to prevent large chains from buying
directly from manufacturers at lower prices.
In the context of the times, Congress believed that
large retailing giants like A&P and Sears, Roebuck could dominate the
market by using their high-volume buying power to extract special deals,
including quantity discounts, free promotional materials, and purchase
allowances — all of which would be unavailable to their smaller
competitors. Sen. Joseph Robinson and Rep. Wright Patman argued that the
size of the chains gave them an unfair advantage by enabling them to
negotiate price concessions and rebates from their suppliers.
A product of the Great Depression, Robinson-Patman has
been criticized throughout its history for the faulty economic theory
behind it. Even the Supreme Court called it “complicated and vague in
itself and even more so in its context.” Almost from its inception,
critics pointed out that Congress passed the act with the protection of
small grocers and wholesalers in mind rather than in the interest of
competition.
The irony, of course, is that suppliers now find
themselves increasingly under the thumb of those same multi-location chain
stores, but are prevented from taking coordinated action by the very act
that was originally designed to keep them in check. “It’s a
Catch-22,” says one veteran confectionery executive, who declined to
speak on record. “Manufacturers can’t get together to discuss
these kinds of fees because that would be collusion,” he continues.
“So there’s very little they can do in opposition.
“Every few years someone in Congress will
express moral outrage, they’ll call for an investigation, and
they’ll take testimony … but nothing ever happens,” he
says. “The Federal Trade Commission (FTC) has said this is not a
priority even though it’s been going on for years. It’s why
trade relations in this industry stink.” n
The Retail Honor Roll
Not all retailers who have made acquisitions in recent
years were denigrated for their fee collection systems. Several sources
pointed to San Antonio-based grocery chain H-E-B for its clear, clean
financial practices and its willingness to partner with its suppliers.
Kroger and Publix were also singled out for their upfront, transparent
approach to business.
Wal-Mart was also cited by a number of candy and snack
manufacturers as one of the toughest negotiators, but also one of the
fairest. “If you refuse their deal, Wal-Mart won’t care because
there is someone else to take your spot,” says one executive.
“They’ll squeeze you to death on price, but they’ve never
resorted to these types of practices. They pass every allowance on to the
consumer. More importantly, a deal is a deal at Wal-Mart. When you get a
purchase order from them, you feel good about it.”
What Recourse Is There?
The galling thing for most suppliers is that they have
very little recourse — especially small companies — to manage
supplier purchase allowances. Even confectioners with the most compelling
products, who in some cases can avoid slotting and other fees because of
their product’s “must-have” factor, can’t sidestep
the acquisition fees imposed by retailers.
What can companies do that can’t pay to play?
Here are some ideas from Dr. Robert Robicheaux, executive director,
marketing and industrial distribution, at the University of
Alabama-Birmingham.
Many confectioners have turned to guerilla
marketing to connect with consumers. Ironically, those who are successful
often find themselves later courted by the same retailers who drove them
away with unbearable purchase allowances.
The Internet has opened global markets to many
entrepreneurs. Some companies have created Web sites and been deluged by
demand that exceeded their sales expectations and even their production
capacities.
Many start-ups have employed infomercials to
market their products directly to target customers.