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Pundit Mailbag — Is Wal-Mart Adopting Other Retailers’ Buying Practices?

Jim Prevor’s Perishable Pundit, November 20, 2009

Our piece, As Manolo Reyes Takes Over Ron McCormick’s Role, Wal-Mart Squeezes Vendors To Generate Higher Profits, brought a number of interesting notes including this one from an industry veteran who says it is basic economics:

Wal-Mart putting more pressure on suppliers is nothing really new! All the chains stores do it! The mere fact that there are hundreds of suppliers selling (or trying to sell) produce to only a few buyers puts the big chain stores in control of the prices.

— Alan C. Fitzgerald
Chairman
Tri-Pak Machinery, Inc
Harlingen, Texas

The idea that big chain stores are “in control” of produce prices reminds us of an important quote related to the stock market:

“In the short run, the market is a voting machine, but in the long run it is a weighing machine.”

— Benjamin Graham, The Intelligent Investor

So with produce, yes, in the short run, big buyers can obviously dictate the price. The produce is grown and packed and producers have to take what they can get. In the long run, though, things are more complicated.

1) Buyers are constricted by their own formats

There was a big contretemps a couple years ago when Bonita Banana/Pacific Fruit tried to raise prices on Costco. It was a big miscalculation because Costco simply did without bananas for awhile as it did without spinach for a long time after the spinach crisis of 2006. Recently Costco just discontinued Coca-Cola products because of a pricing dispute.

Most supermarkets and supercenters, however, do not have the luxury of doing without important items, so they can only drive what they are willing to pay down so far without creating a supply response.

2) Big buyers need big suppliers.

Although there may be “hundreds of suppliers” trying to sell retailers, there are not hundreds of suppliers capable of supplying Wal-Mart with any appreciable proportion of its needs for any given produce item.

One reason Wal-Mart’s aggressive organic efforts largely failed in fresh produce is because you wound up having Wal-Mart buyers chasing tiny producers in order to stock stores. The efforts were time consuming and, ultimately, quixotic.

Few retailers are staffed to deal with more than a handful of suppliers at one time in one category.

3) All product and all vendors are not created equal.

We have known many retail produce directors and all had different philosophies but, none, not one, thought it didn’t matter who they bought from. Some were persuaded by the studies produced by particular brands of produce, others found through their own experience that certain varieties or brands turned more quickly with lower shrink, etc.

Even if the product was considered very similar, the service, reliability and consistency of different suppliers certainly made a difference.

******

The reality is that these factors and others significantly constrain the flexibility of large retailers.

In fact large suppliers and large buyers need each other. The philosophy changed but it was not all that long ago that Lee Scott, who served as Wal-Mart’s CEO before Mike Duke took over, was often heard saying that Wal-Mart needed its suppliers more than its suppliers needed Wal-Mart.

More fundamentally, although growers can lose money on a particular crop, if they lose too much, too consistently, they will be unable to raise capital to plant again and will go out of business. This will constrain supplies, alter the power mix between buyers and sellers and lead to higher prices.

So there is an inherent limitation on the degree to which retailers can, in fact, push prices down because, in the long run, suppliers who do not make money go out of business.

Oftentimes producers don’t experience the business this way, but that is typically because they are concentrated on one item.

Although vendors must be profitable over time, no individual item must be sold at prices that produce profits. So a vendor who only grows, say, cucumbers, will be vulnerable to a competitor who sells cucumbers and tomatoes and various types of pepper. This competitor may well adopt a policy of selling cucumbers at a loss as part of a strategy to secure orders for a broader array of items.

Note though that this is not a case of retailers beating up on producers; it is a case of two producers having different marketing strategies.

In general the trend of retailers asking vendors to submit a bid on a fixed price for a few months is increasing risk in the produce industry because many producers only sell one item — say onions or potatoes — and, in a particular season, only from one place. So , as a result, they are taking a big risk when they submit a bid to say, Safeway, because they have not diversified their risk. So a crop failure or reduction in yield can bankrupt them. If they were to supply a hundred items, grown in a hundred places, the risk would be far less.

Alan’s point that Wal-Mart is merely becoming more like other chain stores is true. Of course, Wal-Mart is by far the most successful retail story of the last two decades, so why it would think that adopting the practices of other retailers would be a big win is not clear.

We thank Alan C. Fitzgerald and Tri-Pak Machinery, Inc., for weighing in on this important matter.

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