August, 2016

Fruits of Thought

Smoke-And-Mirror Retailing

When an external enemy attacks, it tends to create a response. Look at how Wal-Mart, most recently with its acquisition of Jet.com, is consciously trying to respond to the threat posed by Amazon.com and the growing onslaught of online shopping.

Obviously some adversity can’t be overcome, but the clarity of the threat and the instinct of organizations to be self-defensive often leads them to find a way to survive and thrive. They defeat the competition or get out of the way of the competitor, or they find a way to co-exist.

When the undoing of an organization is internal, it is harder to battle. When the problem is one’s boss, the challenge is substantial.

And such is the dilemma faced by many, perhaps most, supermarkets today as supermarket CEOs insist on policies that hurt the whole produce department.

What is the issue we speak of? What surreptitious force is undermining produce departments? And why would CEOs act in a way that weakens one of their most important departments?

The answer is that retail produce departments suffer because they are compelled by supermarket CEOs to match competitive banana prices. Sometimes it is with another supermarket, sometimes directly with Wal-Mart… in many cases, it amounts to the same thing: One supermarket in a region decides it must price compete with Wal-Mart on bananas, and the whole market is pricing with Wal-Mart on bananas.

The driver behind this disruption is rarely the produce executives at retail. It is top corporate executives who have decided that bananas are the marquee produce item, that consumers will flee a chain in search of better banana prices, that consumers will remember competitive offers on bananas and that being high on bananas will powerfully impact consumer price perception of the entire chain.

Yet CEOs’ perceptions may be out of date. You can hear them focus on bananas and iceberg lettuce, as memories bubble up of their younger days spent in the stores. Yet iceberg lettuce has become a minor item and, though bananas have long been the best-selling produce item — and that remains true today — bananas are rarely the best-selling category these days.

Thirty years ago, it was not uncommon for bananas to account for 15 percent of produce department sales in less affluent stores. All this was destined to change. An explosion of counter-seasonal fruit meant that bananas would have more winter competition. An explosion of fresh-cuts meant that many convenient snacking options would appear. More flavorful grapes, tree fruit, apples and berries were more competitive. Easy-peeling citrus made a whole new category develop. Innovations in packaging would allow many produce items to be handled conveniently — think of Naturipe’s blueberry packaging used in McDonald’s superseding a world where bananas, almost uniquely, had this advantage naturally.

Yet while there are good reasons why bananas would not dominate produce as they once did, this natural trend has been accelerated because prices have been set so low that profitability has been drained from the category, and that means retailers are loathe to advertise, market or give prime display space and more copious room to bananas. Imagine you had a brilliant merchandising idea that would result in sales dropping for berries or grapes by $1 million but would see banana sales climb $2 million. For most stores that would be a loser because the gross profit on bananas is typically so low.

If this all resulted in the department’s Number One item being drained of profitability, we could probably lament that and go on living with it. But it is much worse. When top corporate executives order low banana prices, they do it as a form of advertising for the overall store. They want to impact the price perception not just of the produce department but of the whole store and of the banner name.  Yet, rare indeed is the CEO who both says to produce executives that A) I want you to lower banana prices and B) I am going to treat the lost margin as a corporate advertising expense and reimburse the department for lost margin.

Instead, most top corporate executives at retail expect the department to meet the same margin goals as before, but without the profits from its highest volume item. Translation: Produce departments have to raise prices on every other produce item to maintain overall margin when they are getting little or no margin from bananas.

This depresses consumption, consumer trial, and everything the industry hopes to achieve. And for what? We actually don’t have good data indicating that consumers won’t pay a fair price for bananas. And there is a lot of anecdotal evidence that the elasticity of demand on bananas is not high.

Retailers have seen this story before. In the “wet salad” department in the deli, vendors came to offer the big three salads on the cheap — that is potato, macaroni and coleslaw. But the price shift of moving all the profitability to small volume salads — cucumber, beet, carrot raisin, etc. — made these items excessively expensive and suppressed consumer demand.

The idea of price matching is a relic of days when retailers were comparable. Now the specialized retailers, such as Trader Joe’s, Aldi and Whole Foods, have different cost structures, different merchandising approaches, different clienteles. It will be impossible to match price and assortment with these radically different concepts.

Building a reputation for good prices shouldn’t be done through shifting margins from one item to another — that kind of smoke-and-mirror retailing won’t be the way forward. Reputations need to be built on sustainable profitability. We can start by urging CEOs to set banana prices free.                                                                                  pb