May, 1997

Fruits of Thought

Industry Growing Pains

Joseph Schumpeter was an economist whose theory of “creative destruction” defines and identifies, more accurately than almost any other, the state of conditions necessary for economic growth. For what Schumpeter recognized is that progress is not painless. It is, in fact, the process by which existing organizations are destroyed so as to free up resources — capital, labor, management, etc. — for redeployment in new and more productive ways.

For the produce industry, as we approach the millennium, the ghost of Schumpeter hovers high over the trade. For perhaps not since the collapse of the auction system and the blossoming of direct retail buying have we been so close to a dramatic change in the way in which produce is bought and sold.

Less than a decade ago this magazine was featuring articles about the development of the “fax auction” — a short-hand term for the fact that an industry, whose buying and selling had long focused on calling around to get the best price, was becoming even more price-oriented, as it seemed that virtually every supplier had taken to faxing virtually every buyer with current prices and availability. Some buyers stopped taking phone calls — “just fax over the prices.”

Yet now, the industry stands on a precipice, and it needs to make a great leap forward. Why? In part, it is because the logic of the standard telephone and fax buying/selling process is not persuasive. One very important retailer who is looking at new ways of organizing his supply chain made the point clearly: “Every day there are fifteen buyers who engage in intensive negotiations with a given supplier, all to make sure they are getting the best price — yet all fifteen are paying different prices.” In other words, each company individually, and the industry collectively, is expending enormous resources for little purpose.

Even more than this, bargaining on price has self-evident limits. Buyers don’t want to guarantee growers a profit; they want to keep the pressure on for both growers and shippers to find more efficient ways of doing business. Yet, despite day-to-day pressure for buyers to get the best price, enlightened buyers recognize the limit to this tactic. After all, ultimately, growers must make a profit if they are to stay in business.

So, long-term, the only sustainable way for buyers to get better prices is to drive costs out of the system. Then, buyers can get better prices even while growers get better returns. In general, it goes under the rubric of supply-chain management, and it encompasses things like just-in-time inventory systems, electronic data interface, continual replenishment, etc.

Though some of these terms first became commonplace when they were identified as advantages that Japanese auto manufacturers possessed over the U.S. auto industry, all of them have been commonplace in general merchandise for years, and supermarkets have been adapting these types of practices in their non-perishable areas for some time.

Conventional wisdom in the produce industry has been that such practices are impossible to adapt to produce because of its unique qualities — perishability, rapid fluctuations in price, weakness of brands, etc. Still, the proliferation of UPC and PLU codes has made what once seemed impossible to be merely a challenge.

In any case, suppliers are rapidly learning they are not likely to have a choice in the matter. Today, estimates are that the top 22 chains are accounting for 50 percent of the supermarket trade; within a decade projections are that only six chains will account for that same 50 percent of the business. This centralization of buying power will allow large retailers to insist on new ways of doing business. Particularly, keep your eye on Wal-Mart. Having entered the produce business from the general merchandise side, Wal-Mart sees things through a different conceptual lens than do traditional grocers.

One thing we can be certain of is that if Wal-Mart does implement more effective ways of procuring produce, the practices it evolves won’t stop with Wal-Mart. A constant of current management theory is benchmarking against “best practices” — in short identifying which organization does something “best” and then setting a goal to equal or exceed the best of what anyone else is doing. So a more effective means of supplying produce will rapidly become standard procedure as big buyers refuse to do business with companies unwilling or unable to keep up with the technology and practices required to sell in the most efficient manner.

So where does this leave the produce industry? On both the buying and supply side we will see a rapid trifurcation of the industry. One sector will be the well capitalized, technologically adept and progressively oriented firms. These may be major chain supermarkets and large suppliers. A second sector will be undercapitalized, not as technologically sophisticated and, culturally, not as well adapted to the new world. This group would consist of many medium-sized produce shippers and a large number of independent retailers.

The produce shippers have challenges ahead. Without resources to handle the new buying demands internally, they need either access to new capital or to form co-ops or to ally with larger shippers. On the retail side, already, big wholesale grocers have felt the need to get substantially into retailing themselves (a big motivation behind Fleming’s purchase of Scrivner with its coveted Rainbow stores, for example) as they, correctly, noted that the number of independents capable of making the investments required to thrive in the competitive situation of tomorrow was very few indeed.

Finally, the entrepreneur gets his shot in the niche market category. From retail to growers, there has been an explosion of companies focusing on organics, ethnic markets or on income-extreme communities.

The bottom-line is that we do live in interesting times. The business model today is rapidly moving away from the business model that has sustained us in the past. Once upon a time, one just had to have terrific produce. Today, an ability to handle information and integrate it with logistics may be every bit as essential.  pb