April/May, 2003

From the Editor

Focus On Fleming

Fleming Companies Inc. has filed for protection under Chapter 11 of the U.S. Bankruptcy code. It claims that its troubles are due to the bankruptcy of what was, until recently, Fleming’s largest customer, K-Mart, which had accounted for about 20% of Fleming’s business.

It would be more accurate to say that Fleming got involved with K-Mart as a last ditch effort to evade its problems, which are rooted in the changing nature of the industry.

Fleming had for years been a leading service wholesaler supplying food to those supermarkets with too few stores to justify their own warehouse. This was a market strategy in trouble. Those independents that were well financed and well merchandised would grow sufficiently to justify their own warehouse, or a larger chain would acquire the top performers, or some independents would join a co-op.

In any case these top-performing independents would no longer be prospective customers for Fleming.

In the meantime, large chains were growing, new formats, such as warehouse clubs and supercenters, were winning market share and leaving weakened the surviving independents.

With a weaker and weaker customer base, the future looked grim. There were two solutions to help Fleming get out of trouble. One solution required Fleming to help its retailers more extensively. Instead of simply selling food, Fleming would scout locations, design and finance new stores and renovations, in some cases even acquire chains to sell stores off individually to successful operators.

This strategy has fundamental limitations. In the first place, really successful operators are bound to be highly profitable and likely to be able to raise capital from other sources. Secondly, the dynamic of entrepreneurism changes when one winds up being dependent on a Fleming for money and supplies.

I remember an executive of an upscale store group both serviced and financed by Fleming bitterly complaining to me that he wanted to buy a range of upscale deli products that Fleming didn’t carry in the local warehouse, but the owner said he was counting on Fleming’s continued financial support and didn’t want to rock the boat by bringing in product sourced independently. As a result, the stores never reached their potential and were eventually closed at a big loss to Fleming.

The other alternative was for Fleming to actually become a supermarket chain. And this was pursued, also with some success. Fleming bought and built stores and some, such as the Rainbow chain, got good notices.

The problem with this strategy was two-fold: first, the growth of its own retail operations would limit its success as a wholesaler. Many retailers who might have chosen to work with Fleming would decline if Fleming was also going to compete against these retail customers and prospects.

More generally, as the big mergers started in retail, it became clear that Fleming was not likely to obtain the critical mass in retailing that Kroger, Safeway or Albertson’s were likely to obtain.

And, of course, Fleming was at heart a distributor, and saving the company by becoming a retailer was like saving a steel mill by becoming an auto manufacturer. You may save the corporate entity but the business is gone. Why not just milk the distributor business as long as you can, pay out heavily in dividends and let the shareholders buy stock in supermarket chains if that is what they want?

K-Mart walked in at this moment in Fleming’s history. Prodded by a mutual investor, an opportunity presented itself. Although K-Mart was relatively new to the large scale food business, it was expected to compete against Wal-Mart with a massive roll-out of supercenters. As such an unusual opportunity presented itself: Here was a large and growing food retailer, but one that did not have the capacity for self-distribution. So Fleming signed up.

What is interesting is that in the pivotal negotiations, Fleming was not the only one at the table. Supervalu walked away from the business, a stroke of management brilliance that reminds us all that not all customers are worth having.

We don’t know the details of why Supervalu walked away, but three obvious ideas present themselves:

  1. Credit: K-Mart’s dilemma is incomprehensible without understanding its financial weakness. K-Mart couldn’t raise the capital to both roll out supercenter stores and to build a distribution system.
    This financial weakness really made K-Mart unsuitable for any credit. Although Fleming limited the credit, they did extend it. Perhaps Supervalu wanted cash in advance.
  2. Facilities: It would have been one thing for Fleming to sell to K-Mart through those already existing warehouses in which Fleming had surplus capacity. But to handle all the K-Mart business, Fleming actually built additional facilities. Perhaps Supervalu had refused to do this? Perhaps they said if we need new distribution facilities, K-Mart can build them with its own capital and Supervalu will manage the facilities?
  3. Perpetuity: Finally it seems like a bit of a heads-you-win, tails-I-lose scenario. After all, if K-Mart had really succeeded in building these supercenters, K-Mart would have prospered and been able to raise money on its own. It would have eventually either bought out Fleming or built its own distribution system, leaving Fleming holding the bag.

Bottom line: Though Fleming had expertise, that expertise could have been purchased from other sources. What Fleming really offered K-Mart was the opportunity to grow without more capital investment. In effect, Fleming became a financier for K-Mart. That is why as soon as it filed for chapter 11, K-Mart felt free to break the supply contract with Fleming.

One can learn a lot just by watching: all customers are not created equal, changing industry conditions require different responses, and be wary of staking your future on one giant customer are three good places to start.  DB