Price Discount = Profit Erosion

Unlike some of the brands that are improving their profits with price increase, others are reporting losses from heavy discounts. The latest in that line up:

  1. Sears  reported 55% drop in profit and almost 10% drop in revenue from heavy discounting
  2. Limited Brands reported almost 90% drop in profits and 8.7% drop in revenues, once again due to gross margin erosion from huge markdowns.

It is probably time to start a list of those who are showing profit increase from price increase and those who are losing profit from discounting.

Retailer Going After CPG Price Increases

While the leading CPG brands (Heinz, Nestle, Unilever, Del Monte) are reporting increase in profits from price increases, the retailers are not happy with the price increase. Safeway is asking the brands to  rollback their prices and is using their private label leverage. Safeway executive Steve Burd, told analysts,

I say wait and see, because we’re going to chew  up on corporate brands

Mr. Burd makes his case based on falling input costs and hence the brands must pass on the savings to the customers. Again to repeat for the umpteenth time, costs are not relevant to pricing. These food brands were able to retain their price increase and grow their profits despite the drop in sales volume. This is because of the change in customer mix, the price sensitive segment has already moved on to private labels. The brands are doing the most rational thing, price products at what customers are willing to pay.

The retailers have a higher gross margin on the private labels and most private label products are produced by the same corporate brands Mr. Burd was talking about. The retailer margins are so thin that they need the large volume to make up for their high fixed costs. The retail operations are measured by dollars per cubic (or square) inch.  The fall in volume of name brands due to their  price increase is starting to affect retailers despite the increase in sales of private labels.

One questions we should ask is if a retailer can “chew the corporate brands” with their private labels, why not do just that? Why threaten to do this? I believe the loss to retailers with this move will be larger than it would be from a negotiated price agreement with the brands. Retailers depend on the same brands for supplying private labels, they need to spend more on promotion and stand to lose customer traffic if brands are pulled out of their stores.

What is the likely outcome? Brands are happy with their price increase and know that those who are buying now are their brand loyal customers. If a retailer pulls the brand off the shelves most customers will seek another store. But the risk exists that the brands will lose out in the long term. The most likely scenarios to happen are

  1. Brands will allow retailers to keep more of the price increase in the form of trade promotion
  2. Brands cut a better price deal with retailers on the wholesale price of private labels manufactured in their factories.

In any case it is time for retailers to start thinking about reducing their operational costs.

Did You Suggest Dasani Water Today?

Hudson  Group, a privately held retail corporation operates mainly Airport convenience stores under the brand Hudson News. You will find more than one in the same terminal, closer to most gates, and also one or more in the main terminal. Hudson News stores are  very neatly arranged and well lit  selling everything from books and magazines to snacks and bottled water. The stores have a open layout with things stacked along the walls. There is a center island with 2 clerks surrounded by every possible candy and gum.

When I stopped to purchase a pack of gum last week at a Hudson News store in an airport I noticed that the clerks were asking everyone, “Would you like some water with that?”. In the morning most travelers were stopping by for newspaper or a bag of snacks. All the same, even I was asked the same question for a pack of  gum. It was the equivalent of “Do you want fries with that?”. Over the few minutes I was there not a single customer that that offer. The clerks had several pallets of Dasani water, stacked u to their hips. As I peeked inside I saw the label posted on the cash register monitor, “Did you suggest Dasani Water Today”. I walked into every store in that terminal and found the same sticker and heard the same questions.

Clearly there was some incentive for them and the store to make the marginal sale. They sold 20Oz bottles for the price of $1.59, which is same price in any non-airport convenience store. The wholesale price goes for $0.5 to $0.75 per bottle but big volume discounts point to a much lower price. Hudson News sold only Dasani brand (Coca-Cola’s brand) and hence must get a much better price. Conservatively every sale is bound to make a profit of at least $0.75, accounting for any other marginal cost for transporting and storing.

Even if each store sold just 10 additional bottles per day, it is $7.5  in pure profit per day per store. This may not sound much but with low margins and obsessive focus on same store performance generating an additional sale of $15.9 and a profit of $7.5 is not bad. Cumulatively, that is $3000 in profit from 400 stores per day.

Now, $3000 for just planting the idea in travellers mind unobtrusively and for a reasonable price that is not much different from a non-airport store, Hudson stands to generate $1 million a year in additional profit.  A lucrative opportunity executed nicely. That said,  this is not a cure-all or a scalable solution. A clerk can afford to ask just one question without turning off customers and slowing down the transactions. Once fully exploited, there is no room for growth unless Hudson can switch to a higher margin product.

Kudos to the Hudson group management.

Who are your competitors?

The merger of Whole Foods and Wild Oats, completed long back, is still being challenged by FTC. The reason for the continued fight despite losing the law suit the first time is FTC’s belief that the merger created too large a player in the natural foods market.  It is clear that FTC defined he market and the competitive landscape very narrowly and not in the broadest scope any marketer worth his salt would.

In his seminal article, Marketing Myopia, Ted Levitt talks about the failure of companies that defined themselves too narrow and failed to anticipate competition from outside. The competition to Whole Foods is not just Trade Joe’s and Planet Organic but any distribution channel. Douglas, who writes the Healthy Habits blog, did a great job of researching the market size, organic food suppliers and channels. His data shows the market size of organic foods is less than 3% of total food sales (in 2006) and most importantly the Relative Market Share (market share  of follower compared to leader or vice versa) of  Supermarkets is approaching 1, showing an equal split.

By this definition, the competition is not what FTC defined to be but included supermarket chains. Among these, Wal-Mart with its competitive advantage in economies of scale and supply chain management can and will easily enter the natural foods market and dominate.

Instead of continuing to fight the merger battle, FTC should let the market competition decide the fate of Whole Foods. After all the merger in itself introduced other problems not the least of which is the continued lease payments for the erstwhile Wild Oats locations.

CO2 Share: Walmart Vs Small Store

I am still not convinced about the impact of CO2 emissions on global climate change. However I decided to do a comparison of CO2 footprint of Walmart vs small stores. Since there are so many discussions around supporting local mom and pop stores vs. big box retailers, I wanted to do a comparison of these two along just this one dimension (commemorating the Earth week). To make it an even comparison I used CO2 tonnes per dollar of sales and per employee.

I assumed that the retail stores are on the average 4000 square feet and owned one car driven for 20,000 miles for business purposes. Since no free calculator for small business is available, I used an estimate that mirrors an household of similar size and people. Hence I underestimated the electricity spent on large refrigerators, continuous lighting, store display signs and the CO2 impact of distribution of goods to the stores.

For Walmart, the published data says $19.2 million tonnes and it includes all their trucks, corporate jets, stores and corporate offices.

The total US retail sales is $4.2 trillion (retailindustry.about.com).
The single stores’ share of total retail sales is 50% (same source).
US Census data says, the number of retail stores with less than 10 employees as 796,000. These numbers give a very high annual per-store sales (about $2 million). This should be treated as an overestimate of actual numbers.

Here is the comparison. On a per dollar sales, Walmart looks about 50% as bad. On a per employee basis, Walmart is way better.

Caveats:

  1. For small stores, the CO2 footprint is underestimated and the annual sales numbers are overestimated.
  2. Walmart’s numbers include the entire corporation and non retail related activities.
  3. Walmart has large economies of scale and can ride their experience curve to make large positive impact on their CO2 footprint.

Getting your suppiers to pay you to play

Home furnishings retailer Linens N Things is on the brink of filing bankruptcy. The New York Times reports that some of their suppliers are tightening contract conditions and stopping shipments. The question to ask is would the suppliers be better off by helping LnT at this crucial time or by choking it further and hastening its bankruptcy.

Gilbert W. Harrison, Financo’s chairman, said that despite its financial problems, Linens ‘n Things has several attractive assets like its real estate.

But suppliers have an incentive to keep Linens ‘n Things afloat, Mr. Harrison said. Without the chain, they will have to deal with only one major customer, Bed, Bath and Beyond.

The questions the suppliers must be grappling with are

  1. What are the chances a LnT turnaround or a potential buyer rescuing LnT?
  2. What is underneath the problems?
  3. What is the expected cost of LnT going down, both from lost account receivables and from future pricing squeeze by Bed Bath and Beyond?
  4. What is the expected cost of reviving LnT and for how long they have to keep it up?
  5. Would they be the only vendor stuck with supporting LnT? Would everyone else go with it? What is the critical mass required that improves the changes for turnaround?
  6. If they are he first, would everyone else follow? Should they wait for someone else to move first? What if everyone waits for the other to move?

“Vendors want to keep this company alive,” Mr. Harrison said. “The last thing they want to see is for it to die.”