Food retail price wars threaten supply chains

It is ironic that smart logistics can be both a business game changer for the better and for the worse. This is particularly so in Britain's food retail sector, where looming price wars threaten to unleash hell on every part of the global supply chain, from farmers to third party logistics providers (3PLs), as if they were not abused enough already by the dominant buying power of big retailers. The catalyst is the cash-strapped consumer joining forces with the deep discounters like Aldi, Lidl and Poundland, whose remorseless rise in a few short years is rattling the leaders like Tesco, Sainsbury, Asda and Morrison, who jointly control 76% of Britain's food retail market. The chief enabler is the discounters' harnessing of smart logistics with an effective business model that has inventory control at its core. The result is that these deep discounters are seizing market share from the big four, prompting a price war reaction initiated by Tesco and Morrison. This may sound good news for consumers initially but the way in which the market leaders will pressure their suppliers to cut their costs and take on even more risks will have undeniably adverse, long-term effects for consumers.

For many years the abuse of buyer power has been widely and routinely practised against suppliers, and competition authorities have largely failed to deal with this problem in Britain. Big retailer abuse of suppliers takes many forms, including:

• Listing fees to be on a list of suppliers, thus raising suppliers' costs
• Delisting/threat of delisting. This occurs when suppliers refuse to cut prices or make other payments concessions.
• Slotting fees to gain access to shelf space
• Demanding retrospective payments like extra discounts and after-sales rebates
• Return of unsold goods to supplier, which means at the suppliers' expense because fresh food cannot be readily resold, and so the retailers' forecasting errors are passed back to the supplier
• Late payments, pushing up supplier finance costs. 
• Retrospective change to agreed terms putting limitations on suppliers' ability to supply competing retailers.

All of these odious forms of payment, and more, are reported to reduce suppliers' revenues by up to 50-70%. The adverse effects of all these downward pressures on supply prices mean that there is 1) a threat to supplier viability and supply, 2) it may raise prices and reduce choice, 3) downgrading of quality by cheapening of ingredients, leading to events like the recent horse meat scandal, 4) squeezed working conditions that could amount to gross abuse of human rights and people trafficking. Invariably, throughout the food supply chain it is the large retailers who take the lion's share of the retail price of any product they sell. With pineapples, for example, it has been shown to be 41% and with bananas 29%. The farm labourers take only 4%.

Best practice inventory control is key

Mr Zen Yaworsky, director of Britain's Supply Chain Academy, says: "We are not very good at inventory control." There is plenty of evidence to support that claim as poor inventory control has seen off many British household-name retailers, while embarrassing many more through empty shop shelves. Good inventory control, therefore, is at the heart of a successful supply chain, and a lesson the foreign-owned deep discounters have taken on board. Their business model relies heavily on stocking a much smaller range of items than the retail leaders, but which are commonly and frequently in demand. Lidl, for example, would typically stock only 1,600 SKUs while Tesco stocks 40,000. But almost all of Lidl's SKUs are fast movers, and when fast items become slow they are quickly dropped. What this means for the leaders is that a large percentage of their stock is relatively slow-moving and that in turn pushes up stock-holding costs, which can dwarf all other warehouse costs combined. In short, the large retailers are disadvantaged in this respect compared with the discounters because their higher stock holding costs are reflected in their higher item costs.

Over 20 years ago this writer went to Denmark to see the food retailer Netto's national distribution centre (NDC) in action and how the company was able to offer cheaper prices. The company subsequently became the first of the foreign-owned, deep discounters to set up in Britain, shortly to be followed by Lidl and Aldi with similar business models. Netto fully exploited the latest IT systems and automated materials handling equipment, particularly very fast sortation conveyors, to fulfil its key objective of fast stock replenishment to shops. All 125 shops were EPOS-equipped so that at the end of each day all information on items sold was transmitted electronically to the NDC, to initiate the replenishment process. Overnight all the replenishment items were picked and delivered to the shops before opening times the next day, thus ensuring no stock-outs. In effect, it was the consumer that did the stock forecasting for Netto whenever they bought an item, and stock forecasting is a potent weapon the the war to control inventory costs, but a weapon that is often dulled through complexity based on assumptions.

Squeezing suppliers is wrong-headed

The result of all this smart logistics was that 90% of all the inventory in the NDC passed through it every 24 hours, thus avoiding huge costs of financing slow-moving stocks. Britain's big food retailers cannot hope to compete with the discounters' business model centred around fast stock movement unless they adopt similar business models. Pressuring their suppliers to cut prices is not the way and would only ultimately harm consumer interests. One area, however, where the leading retailers could improve their supply chain costs without resort to abusive measures is to do more than lip service to supply chain collaboration, a hot topic for many years. Those companies that have initiated supply chain collaboration agreements have seen dramatic cuts in inventories and, therefore, costs. Why, then, have many more interested parties not followed suit? Many retailers still see collaboration with the supply chain as a threat rather than an opportunity and are reluctant to reveal the kind of business critical information to their logistics partners. Perhaps the threat from the discounters will concentrate their purblind minds.

Britain's rise of the supermarkets over the last 50 years has done much to improve the shopping experience and keep prices from rising too fast. Shoppers liked the idea and convenience of being able to fulfil all their weekly shopping needs under one roof, but technology moves on, and so do shoppers' habits. Today, one need not step outside one's home to buy anything, thanks to the Internet. The old habits are breaking down and buyers in a cost-conscious age want value for money in their food, every-day consumables and clothing more than ever. One estimate suggest that within five years 40% of all Britain's bricks and mortar shops will close permanently under the merciless hammering from on-line shopping. The big food and consumable retailers need to remember and implement the first law of marketing -- give the consumer what the consumer wants and not what retailers think is best for them.
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