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State of the Industry for Wholesale-Distribution
Margins are down. Profits are down. So what’s up?
By Traci Carneal
Sales growth is on the rise for the wholesale-distribution industry, despite a struggling economy and slew of changes impacting the bottom line. Problem is, industry profits are going down.
It just doesn’t make sense, says industry advisor Al Bates, president of The Profit Planning Group, a research firm in Boulder, CO. "Based on sales growth, the industry should be in wonderful shape," he says. "But we’re not making any money. I feel like we are squandering an opportunity."
Bates says he talks to the guys in industrial distribution, an industry in which sales are down 20 percent. "They have an excuse!" he notes. "There’s something going on in our industry that’s not right."
Based on an on-line survey of AWMA members by Distribution Channels, the industry agrees with Bates. In fact, 95 percent of survey respondents indicate that the whole distribution business should be more profitable than it is. Only five percent aren’t sure.
This leads Bates to feel less than enthusiastic about the state of the industry right now. Twenty-eight percent of the respondents feel the same way as Bates. However, an optimistic 41 percent describe their feelings as "somewhat positive," while 25 percent indicated "it’s status quo" right now. Four percent feel "very positive" about the state of the industry.
The reasons for the lower profits can be attributed to several factors, including gross margin squeezes and changes to tobacco manufacturer incentive programs, extremely high payroll expenses, and excess costs.
"We’re just not getting the expenses in line quick enough as the margins are going down. We’re sitting there with new lower margins and the same old expenses," Bates asserts.
Bates believes that when the industry is in a situation in which it is growing, "we should be able to make these changes with more finesse than we have done."
On the bright side, sales for many companies continue to grow. Forty-two percent of survey respondents report that sales for 2003 are "a bit higher" than last year, with 14 percent claiming sales are much stronger than usual. For 17 percent, sales are the same, and 23 percent report lower sales than in 2002. The trend does point to increased sales for the majority of wholesalers.
So why the shrinking profits? Bates attributes it partly to complacency, and a lot to the dilemma many face as tobacco continues to receive bad press and companies must search for alternative products and services to get into a "true convenience" mode.
Distributors are spending a lot of money on those activities, and these "other convenience products" are much more expensive than cigarettes to handle, says Bates. "They may a bit hesitant to price those products the way they should. So distributors end up with cigarette gross margins, but convenience product expenses. These two just don’t go together."
Another red flag Bates sees is insurmountable payroll costs that "have us by the throat." He says payroll expenses are primarily to blame for excessive costs, not the typical operational costs that come to mind. The simple formula is decreased costs will result in a fatter bottom line.
"We are so productive in the cigarette category, it’s not even funny," Bates notes. "We need to cut back and reach higher levels of productivity in the other convenience categories as well." He also recommends companies cut out any services that they think are "nifty," but customers don’t really care about.
According to results of the Distribution Channels survey, many companies are already working toward these goals.
When asked to identify concepts that assisted them in enhancing their companies’ operations this year, 64 percent of respondents said they cut expenses and overhead in 2003, 39 percent said they streamlined warehouse logistics, 50 percent added new product lines, 41 percent depended on more personal communication with customers, 27 percent relied on tips picked up at trade shows and conferences, 9 percent hired more staff, 52 percent improved their technology, and 23 percent relied on less staff.
Others benefited from less turnover in staff, their customers buying stores from retailers, higher sales volume, a move to a new warehouse and increased sales.
Based on the DC survey, says Bates, it sounds like at least some in the industry are right on target with expense reduction and streamlining efforts. He does note, however, that the encouraging response could be due in part to the fact that the most dynamic, involved and aggressive companies tend to respond to surveys more often. The others, which don’t respond, are the "ones we are worried about!" he says.
Bates’ research indicates that the potential is there for companies that want to achieve a better return on assets. "Despite the ongoing profitability challenges in distribution, virtually every segment has its winners and losers. AWMA is no different in that regard," Bates notes. "There are high profit companies and then the typical companies. Which one are you going to be?"
High-Growth Categories
When asked which c-store product categories they see the most growth, 54 percent of respondents indicated that foodservice products (breakfast, lunch and dinner options) and snacks fit the bill, followed by beverages (36 percent), frozen and refrigerated products (26 percent), tobacco (25 percent), candy and general merchandise (20 percent), baked goods (13 percent), gums and mints (11 percent) and health and beauty care (10 percent).
Some wholesalers indicated low/no carb drinks and bars, novelties, healthy snack foods and frozen beverages as categories of future growth.
Threats to Profitability
Seventy-two percent, the majority of respondents, feel that changes to tobacco manufacturer programs are the biggest threat to convenience industry profitability. Other areas of concern include the onslaught of discount marketers (53 percent), tobacco taxes and laws (53 percent), increased convenience provided by grocery stores (42 percent), poor trading partner relationships (30 percent), lack of creativity in marketing (21 percent), theft (15 percent), and outdated distribution technology (only 2 percent).
Other threats include insult pricing, too many c-stores, grocery chains and mass merchandisers selling gasoline, and insurance challenges.
Predictions for the Industry
Wholesale distributors were asked to make one prediction for the wholesale distribution industry, as well as for the c-store industry. Here’s what they said:
Wholesale Distribution
- More consolidation (many responses)
- Fewer distributors unless manufacturers treat them as partners
- Stiff competition from traditional vending suppliers
- Fewer suppliers, especially in cigarette and tobacco, pressing for fewer distributors and less service
- More co-op arrangements
- The days of "standard industry cigarette prices" are gone
- Fewer wholesalers with heavy emphasis on cigarettes – they need to diversify to stick around
- Cigarette manufacturers will continue to reduce their programs, and low priced products will gain wider acceptance, but not much more than actual market share
- If cigarette laws get any worse, it will be the end of many c-stores
- Wholesalers better increase their profit or there will be a large cleansing in the industry
- Value-added will have to be paid for by the recipient
- Number of wholesalers will decrease
- Need to diversify to grow
- Fewer distributors offering non-service deliveries at competitive prices
- Cut-throat competition, lack of supplier support and changes in cigarette programs will forever change the industry as we know it
- More regulatory changes in tobacco
- In three years or less, there will be another strong national distributor to compete in all markets
- Survival of the strongest and most profitable
- A need for distributors to find new product lines with decent margins
- There will be half of us left in three years!
Convenience Store Industry
- Healthier and fresh will become more important
- Regulation of tobacco and "trans-fat" foods will have a huge impact
- Fewer c-stores in the next two years; more chain accounts
- A need for c-stores to become more consumer friendly
- More small store operators due to high cost and low profit of chains
- Stronger getting stronger; weaker getting weaker
- Elimination of rack payments
- More competition from discount merchandisers
- Consolidation
- Product mix will be redefined
- Stronger relationships with distributor partners
- Merchandise sales and profits will lead the way
- Stores will be forced to become more competitive
- Will make many changes, but continue to have strong sales
- More loyalty
- Continued pressure to maintain gross profit margins
- It will improve
- In three years, there will be 20 percent fewer store open
- Need to be more high-tech
- More new-age American operators
- Need to learn to operate profitably without gas margins
Keeping a Pulse on Public Policy Issues
AWMA is tracking several regulatory and legislative issues in the states and at the federal level that impact wholesale distributors. Top issues of concern include potential legislation that would give FDA regulatory authority over tobacco, legislation that addresses the growing concern of obesity in America, and upcoming regulations that hinder acts of bioterrorism against the U.S. food supply.
Sen. Mike DeWine (R-OH) was preparing to introduce a bill before the end of 2003 that would give regulatory authority for tobacco to the Food and Drug Administration (FDA). AWMA is opposed to such legislation because it is viewed as a "back-door" ban on tobacco products. It would give FDA broad authority over advertising, sales distribution, promotion of products, among other areas of tobacco marketing.
Introduction of the bill has been delayed for at least the remainder of this year, and it’s unlikely any action will be taken in 2004. Most politicians would rather avoid a controversial issue such as tobacco during an election year. But out-of-sight does not mean out-of-mind – this issue will likely be brought up again once the elections are over, according to Anne Holloway, AWMA’s director of government affairs.
Referred to as the next tobacco issue, the topic of obesity in America is gaining weight on both federal and state levels. AWMA is trying to take a proactive approach to the laws and regulations brewing to curb the growing obesity dilemma by supporting legislation that will help consumers, but not harm the food industry.
One common sense bill, introduced by Sen. Bill Frist (R-TN) and labeled the Improved Nutrition Physical Activity Act, focuses on better education and more school grants to encourage physical activity for school-age children. This approach addresses the waistline issue in a common sense, strategic manner, rather than burdening the industry with more regulations or taxes. Several major food trade associations join AWMA in support of this approach.
Lastly, FDA recently released the first phase of regulations designed to protect the U.S. food supply from acts of bioterrorism. AWMA sent a memo to all members to help them deal with a requirement that every food facility for human or animal consumption must register with FDA by December 12.
This is just the first in a series of regulations that should be coming out by the end of the year. The record-keeping requirements, which are next on the list, will likely be more troublesome. AWMA will assist members in any way they can to ease the compliance process.
Other issues to keep on the radar screen for 2004 are ergonomics, the Estate Tax, snack taxes, remote sales of tobacco, and hours of service legislation.
Traditionals Get More Convenient
Keep Your Eyes on These Trends
Supermarket operators are expanding one-stop shopping opportunities for customers by including specialty services in more stores, according to a new Food Marketing Institute (FMI) study, Facts About Store Development, 2003, posing a challenge for the typical convenience store. Nearly 99 percent of all new stores now offer fresh seafood, greeting card and fresh bakery departments, and nearly as many contain floral service, deli, prepared foods for takeout and natural foods departments/aisles.
In developing new stores, food retail operators are exploring concepts that will attract the fast-growing Hispanic market. In 2002, just over two in 10 companies surveyed operated Hispanic-oriented formats, which typically emphasize pricing and focus on strategic ways of merchandising products offered in a traditional store as well as ethnic products that appeal to Hispanic consumers. Although Hispanic-oriented formats represented a small percentage of all supermarkets in operation in 2002, they represented 11 percent of the stores for companies that operate this type of format.
Food retail/wholesale companies continue to offer consumers more convenience-oriented services in one place, including pharmacies, ATM services and meal solutions.
Most popular services and the percentage of new stores containing them:
Fresh seafood = 99%
Greeting cards = 99%
Scratch/bake-off bakery = 99%
Deli (e.g., sliced meats, cheeses, side salads) = 97.9%
Floral/plant shop = 97.9%
Fresh, prepared foods for takeout = 97.9%
ATM = 95.9%
Separate natural food aisle/section = 93.8%
Wine = 88.7%
Space for cooking demonstrations 79.4%
Pharmacy = 72.2%
Self-scanning area = 17.5%
Pick-Up Area for Online Orders= 6.2%
Survey respondents are also adding more specialty services during store remodeling, with self-scanning checkout lanes the most significant addition.
Just over one-third of remodeled stores are rolling out these systems. The most popular additions during store remodels:
Self-scanning area = 34.1%
Separate natural food aisle/section = 17.9%
Fresh, prepared foods for takeout = 8.9%
Pharmacy = 7.3%
Floral/plant shop = 6.5%
Convenience/Consumer Trends
American shoppers are taking more responsibility for their health and that of their family, but they want to do more, according to a new white paper from the Food Marketing Institute (FMI), Healthy Lifestyles: From Parents to Kids.
The white paper, which highlights one section of the 2003 Shopping for Health report released by FMI and PREVENTION magazine in October, also finds that convenience is the major driver behind food purchases made by families with children, and that most consumers would like more information about eating a balanced diet.
"Parents with children in the household are aware of the importance of nutrition, and they recognize that high standards of nutrition are often not met," says Janice Jones, FMI director of research. "However, with time often in short supply, busy families are challenged to provide ideal meals in terms of nutrition."
In an age of super-sized fast-food meals and recreation dominated by computer games and music videos, American waistlines continue to expand. Nearly 65 percent of adults and 15 percent of children, aged 6 to 19, are overweight, and nearly a third (31 percent) of the adults are classified as obese, according to the National Center for Health Statistics of the Centers for Disease Control and Prevention.
Even more concerning, the U. S. Surgeon General estimates that the number of overweight children and adolescents has nearly tripled in the past two decades.
- Shopping for Health found that 74 percent of households with children and 63 percent of households with no children admit that their diets could be somewhat or a lot healthier. Survey participants offered several reasons they are challenged to maintain a healthy diet, including too busy to eat healthily, and that healthy fast-foods are hard to find and they cost too much.
- People are also confused about health claims. Shoppers with children are especially interested in convenience, and the industry is responding with individualized product packaging in nearly every supermarket aisle. The single-serve products are ideal for school lunches brought from home or mobile moments in the car, for example, because they provide a quick, quality alternative to traditional sugar- and sodium-filled snacks. Complete meals in single-size portions are also becoming sought-after products — 40 percent of families with children regularly purchase these items.
- When asked about the importance of nutrition and health-related services and products at their grocery store, the majority of all shoppers indicate that having information available or having staff available to answer questions about nutrition is very or somewhat important to them.
Despite their good intentions, however, few shoppers indicate they have sought out information from store personnel. This could provide an opportunity for stores to be more proactive by offering relevant demonstrations or short programs in the store, according to the report.
"Healthy meal options are already there for those who are committed to a high standard of nutrition for their families," adds Jones. "And now more than ever, food retailers [suppliers and distributors] are an important link in meeting this challenge for the health of individuals and the nation."
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