February/March, 2003

From the Editor

Selling Souls

The shareholder lawsuits are bound to be filed, and we can leave the particulars and legalities to the Securities and Exchange Commission. For the deli industry, Ahold’s announcement that it has significantly overstated its earnings — due to the way its U.S. Foodservice division accounted for various types of slotting fees and promotional allowances — provides food for thought about the real impact of these fees on business.

The press reports giving details of what happened are positively dramatic. Big meetings were called in which announcements were made that the division wasn’t going to make its numbers for the quarter. This means no bonuses for executives and, in any case, that is unacceptable.

Then we see an almost surreal world, a business world positively warped by financial inducements. As the executive team struggles to make its numbers, there is scarcely a word said about trying to sell more product; nothing about giving customers better service; no notion at all that by selling products more appropriate to the customers’ operations, they can help the customers be more successful and that U.S. Foodservice can share in this success.

All the basic building blocks of business success were ignored, and instead the executives initiated a mad dash to gain promotional funds. Product was ordered for which there were no customers — so much of it that they had to lease warehouse space and trailers to store it all.

Divisions were told that if they didn’t order more product from vendors who were paying up, headquarters would place the orders for them.

Salespeople were directed not to sell the product that best suits the needs of the customer, even if that product was in the warehouse on the official product offering sheets, but only to sell those brands that were paying special fees.

It gets worse. Manufacturers have also reported being literally held up. There are detailed reports of manufacturers being told they had to give back tens of thousands of dollars because they were caught “overcharging”. If they refused, their product was discontinued, and U.S. Foodservice took deductions from whatever they owed the manufacturers.

U.S. Foodservice is the Number Two foodservice distributor in the United States. To not have your product in its system is a horrible blow to anyone producing for the foodservice market. It means the death of companies, jobs lost, good products made unavailable. But what is a manufacturer to do when such an important entity is being run like a shakedown operation?

The whole situation suggests many remedies. Certainly there was something wrong with the bonus system at U.S. Foodservice if it paid strictly on reported profits and ignored actions that caused profits to collapse the next quarter. Certainly one wants to know where the auditors were as they analyzed these promotional payments and signed off that they could be added to current income. The cost of earning those payments, which couldn’t be determined until the product was sold, was left to be determined some future quarter.

For the deli industry, the big red flag is how distorting to good business practices these payments can become. The whole culture of a company can change from one where the priority is on good product and service to one where the priority is on renting slots and shelves.

Although as far as we know, these gross abuses at Ahold are confined to its U.S. Foodservice unit, the truth is that retail grocery operations all across the country are long addicted to these payments, with decisions about which products to carry, where to display them and how aggressively to promote them made not based on judgments about consumer preference, but made based on financial calculations regarding up front fees.

Deli and the perishable departments have traditionally been havens from many of these fees. Pricing is often based on commodity markets, and orders may switch back and forth from primary to secondary suppliers because of availability limitations. In general, the environment is not as suitable for such fees, plus the perishable nature of the items means there is a tendency for suppliers to be more regional, with smaller marketers less able to ante up.

This has led many producers of mustards or a chips or other non-perishable products that could be sold in grocery to prefer to enter the chain through the deli department and thus avoid all these fees. But there are plenty of fees imposed in delis. Big checks have been written to become a primary meat and/or cheese line, and the salad category has been a focus of plenty of jousting for dollars.

In supermarkets, top executives are bound to increase the pressure for promotional dollars as they face sales and margin problems from both a troubled economy and the growth of supercenters and alternative food outlets.

Of course, it is all rather odd. So much of this is being motivated by Wal-Mart, but Wal-Mart doesn’t take most of these fees.

Isn’t it at least possible that Wal-Mart’s success is not due solely to competence with technology or with ready access to capital or with a hundred other claims that are made? Maybe, just maybe, Wal-Mart’s secret weapon that allows them to succeed from Bentonville to Beijing is building a culture that is focused on the consumer.

Perhaps the real lesson of the U.S. Foodservice debacle is that we need to structure our businesses to avoid being distracted by nonessential things. In the end, it is satisfying customers that is important, and we should remind ourselves of that the next time someone wants to make the numbers by selling the soul of the department for an upfront fee.  DB