June, 2002

Fruits of Thought

Recipe For Disaster

Centralized procurement is the latest trend sweeping produce retailing. The question is: What does it really mean?

In and of itself, centralized procurement isn’t a particularly big change. The fact that the old “Salinas Buyer” may now work in an office in Arizona or Ohio may be bad or good – bad because the buyer won’t see the product firsthand and won’t have built the depth of relationships with the growing community that comes from living in Salinas, and good because a more distant buyer is less likely to accept various gratuities or have his judgment clouded by personal relationships that come with living amidst one’s suppliers. But bad or good, it is a difference of degree, not of kind.

Equally, if a chain has acquired very different divisions over time – say one predominantly in white-collar neighborhoods and one in blue-collar neighborhoods – and centralized buying means that two separate buyers will work in one building buying product destined for and appropriate to each separate division, then centralizing procurement is likely to offer a distinction without a difference.

Of course it is highly likely that chains centralizing procurement intend to do so much more than to simply gain minor efficiencies that come from reducing the buying staff and closing a few regional offices. The goal of the centralization is to realize substantial savings via improved transportation and logistics and by getting better terms from suppliers.

Retailers have noted that Wal-Mart maintains a centralized procurement system and figure they should reap the benefits as well. But there is not much evidence that Wal-Mart is purchasing much cheaper than major supermarket chains. With the latest PRODUCE BUSINESS study showing competitive chains selling at around 30 percent higher than Wal-Mart, it is inconceivable that good buying accounts for the difference. In fact it is a cultural and philosophical difference and, unless that issue is addressed, merely putting all the buyers under one roof won’t make a difference.

Besides all this, Wal-Mart does have a big advantage. Because it has built its Supercenter chain from scratch, it has had the luxury of only building stores that fit its concept. So there are no Wal-Mart supercenters in, say, Beverly Hills with separate buying requirements. Sure there are always regional preferences and different ethnic mixes in different neighborhoods, but, almost by definition, Wal-Mart’s approach of only offering a more limited assortment means that, for the most part, these minor differences don’t affect its offer.

This is very different from chains like Safeway, Kroger, or Ahold. When Safeway buys an upscale marketer like Genuardi’s, it faces an issue of what it wants Genuardi’s to be in the Safeway family. Did Safeway just buy real estate in a densely developed area, and ultimately the stores will be indistinguishable from the other Safeway stores? Did Safeway simply buy a regional upscale chain and will operate it forever almost unconnected to what Safeway is and does elsewhere? Or did Safeway buy a retailing concept that it might roll out elsewhere – in other words, that in the same market there might be Safeway stores and Genuardi’s because they serve different clientele?

The problem here is simple and obvious. If a big chain acquired a regional chain for anything other than just the real estate, it becomes difficult to use the leverage of centralized procurement. Because now we are talking about non-uniform product, different sizes, grades, even varieties. We are talking about preferences for smaller shipper brands and regionally known brands.

Now a centralized procurement system can do all this – it can buy Champagne grapes for 50 upscale stores and a well known Virginia apple for stores in the South, for example – but from the retailer’s perspective, it is not clear what the point would be.

What the retailer wants to do is shrink its number of suppliers and order uniform products to be handled more efficiently in its warehouses. The chain wants to leverage its volume into price concessions by offering vendors larger orders. It doesn’t want to buy two different brands of broccoli regardless of what consumers think.

And perhaps ultimately that is why these centralizing efforts are bound to fail. To be effective at achieving its economic goals, centralized procurement almost inevitably puts procurement and logistic efficiency over consumer preference. And this is a recipe for disaster.

Wal-Mart knows this. Remember its watchword: “Always low prices. Always.” But note that this speaks of what the store will do for consumers. In fact, Wal-Mart knows full well that efforts neglecting the consumer in the name of efficiency are almost certainly bound to fail.

Why? Simple, there are few sins that cannot be covered up by a rising sales per square foot number. Nothing one can do in procurement is likely to reduce costs per dollar of sales if the sales per square foot number falls.

If you want a simple explanation for why Kmart is in bankruptcy court, you could do worse than this: Because Wal-Mart had higher sales per square foot, its costs per dollar sold were lower, which allowed Wal-Mart to lower its prices, which caused sales per square foot to rise, thus further reducing costs per dollar sold, thus allowing a further reduction in price. It is called a virtuous circle.

If centralized procurement becomes a tool for saving pennies on purchases while ignoring customer needs, Kmart will not be the last company to fall victim to Wal-Mart’s virtuous circle.  pb