November , 1998

From the Editor

Financing Distributor Fees

Exporting foods around the world used to be my occupation, and I had the advantage of learning from a master – my father. One of the most important lessons I learned was that every customer has different needs, and the successful supplier is the one who both identifies and meets these needs.

Everyone recognizes the importance of knowing your customer when offering product. That is why fine caviar importers don’t bother the 7-Eleven buyer and the manufacturers of mass-market snack food leave Balducci’s alone.

Somehow what is so often recognized when it comes to product selection is mysteriously forgotten when it comes to financial terms. This is brought to mind by the current hullabaloo over the imposition of various kinds of slotting fees, contract negotiation fees and whatnot by distributors. Thinking about the necessity of serving the customer may also provide a workable solution to the problem at hand.

Although slotting fees at retail are usually portrayed as a great injustice for manufacturers, the truth is that they hurt the whole industry, retailers especially. The problem with all kinds of up-front fees by retailers is that these fees change the dynamic of retail decision-making. Instead of focusing on what products consumers want, the focus becomes who can pay the most up-front. Inevitably, this means that stores have less appealing products than they would if decisions of what to stock were made solely on the basis of what would sell.

Consequently, retailers sell less than they would have and, thus, so do distributors and so do manufacturers. So a world without slotting fees is devoutly to be wished.

But enterprises also have a right to organize their businesses as makes sense for them, and, if a retailer wants to stop merchandising and, instead, basically become a renter of shelf space, that is its right too. Of course, the problem is that someone else is likely to remember the customer and win all the business.

The notion of a distributor paying a fee to distribute to a supermarket chain is rather bizarre. Obviously, whatever fee is paid will be allocated as an expense of selling that chain and will be recovered either by raising the distributor’s markup or by charging the manufacturers who will raise their own prices.

Despite the way it may look, it is almost certainly true that big distributors like to compete by paying these fees to retailers. After all, the practical effect of large “contract negotiation fees” are that relatively few competitors can compete for the business. It really creates a powerful barrier to entry for the small entrepreneurial or specialized distributors that are springing up all over in the wake of distributor consolidation.

Of course that doesn’t mean that coming up with all the money needed to pay chains is easy for the distributors. To adapt a famous Senator’s dictum to the specialty food industry: A few million here, a few million there, and pretty soon you are talking about real money.

So, of course, distributors who benefit from having exclusive access to a retailer will look to the manufacturers to come up with some cash to help pay these various fees to the retailer.

Once again, it is a mistake to think that all manufacturers find these charges onerous. Just as a big distributor may find competing on the basis of checkbook size a useful tool in limiting competition, so too may a manufacturer find that if the price of entry into a distributor’s program is high, it protects that manufacturer from pesky little competitors – perhaps even more innovative competitors – who can’t ante up.

In another industry this all might not really matter. Whether P&G pays a slotting fee of a million dollars to get Pampers in the chain or doesn’t pay any fee probably doesn’t make any difference. It is a financial matter and, in one case, the per case price will be set lower to compensate and, in the others, it is set higher to recapture the up-front investment.

This, of course, will end the specialty food industry as we know it. The cornucopia we see at each Fancy Food show will, for all practical purposes, be relegated to individual stores that buy via UPS. The supermarkets and other sectors served by distributors would gradually offer just a limited array of specialty foods sold by large companies.

The problem, of course, is that in the end, these mass products funded by big companies won’t actually be specialty foods at all. They will just be the worst selling foods in the supermarket.

To actually have a true specialty foods category, one needs to have regional items, innovative products of small kitchens, rarified imports from markets far way – none of which can pay the charges upfront.

So is there a solution? If we think about the customer there is.

When I sold food overseas, I was taught to understand each customer’s needs not only for product type and quality but also for financial terms. One client was cash-rich, and what he wanted was the best discount I could offer on pre-payment for his invoices. Another customer was growing so fast he was continuously short of working capital. He wanted the longest terms we could offer.

Now, of course, both of these customers got what they wanted from us and thus were loyal customers. The cash-rich company could deploy its cash profitably to get discounts and thus increase earnings. The working-capital-starved company could profitably deploy our increased credit and increase its earnings too. Sure we had to charge the extended-credit guy a little more or, looked at from the other direction, we could afford to give the prepayer a great discount for funding our operations. Still and all, it worked out great for everyone. We got the business, and our customers both made money.

The same needs to happen in specialty foods when it comes to charging manufacturers for the fees distributors pay to retailers.

Some manufacturers are cash-rich and would be happy to pay these fees up front – provided they get the lowest possible fee. Other companies will have to pay their share, but distributors should be able to offer a per box deduction off invoice to fund these fees. Obviously the per box fee will work out to be a bit more than if the full sum were paid in cash up front. This is only fair since the distributor is, in effect, using his credit or working capital to finance the fees paid to the supermarket.

Still, this is the only way. If we demand of specialty food manufacturers and importers that they be able to lay out enormous amounts of cash before they get slotted by a distributor, we guarantee that the specialty foods aisle will become, well, boring.

And the phrase “boring specialty foods” is an oxymoron the industry simply can’t allow into existence.  FDM