February 2019 – Perhaps the single most common complaint we receive here at Produce Business is shippers complaining that retailers maintain high prices on produce even when the FOB has dropped substantially. They see these high prices as a significant disincentive to demand, and by not dropping prices, the market-clearing function necessary to move volume is dampened.
There is certainly something to this. In general, if you raise the price of things, you sell less of them, and if you decrease prices, you sell more. But that broad statement doesn’t tell us very much about individual produce items at any given moment in time.
To start with, producers sometimes forget that dramatic declines in the FOB of an item do not typically translate into equally dramatic declines in the costs associated with retailing an item. Transportation is the obvious big fixed cost. It is not uncommon for a truck from California to New York to cost as much as the produce. Indeed, many times produce is cheap because it is plentiful, and that can put pressure on a relatively fixed number of drivers and trucks and thus drive up trucking costs.
Sometimes it is not just a truck. If it is an imported item, transport will involve trucks in the producing country, a boat or plane to the U.S., and then another truck domestically. In any case, the math is simple. If transportation is 50 percent of the delivered cost and that stays fixed while the FOB drops 50 percent, the total landed cost only drops 25 percent. And even this overstates the importance of the price of the produce. After all, the FOB is not the price on the tree or in the ground. The cost of picking, packing, pre-cooling, etc., all remain roughly the same.
And retailers have many other costs. They have to deliver the produce from their distribution centers to the stores; they have to put it on the shelves; they have insurance, do marketing, on and on. It is not uncommon for the produce in the field to account for less than 10 percent of the retail price, so even a collapse in the produce price in the field, a catastrophe for the grower, won’t necessarily have a big impact on retail costs.
Sometimes we need to thank God for unanswered prayers. Those producers who yearn for retailers to make less margin on their item should carefully consider whether it is rational to expect retailers to promote their least profitable products. Let me explain: Pricing is not solely determined by cost. Retailers all over America set banana prices, for example — the biggest single item in the department — based on what Walmart is pricing them! Retail CEOs see this as a marquee item where consumers establish value propositions about the entire store, so they give orders to their produce team to keep banana prices in line.
This is problematic. It might be OK if the retailer paid the produce department to maintain low prices on bananas as a kind of overall store marketing — but this almost never happens. Instead CEOs demand low prices on the biggest item in the department — often the biggest item in the whole store — but maintain the same margin expectation for the overall department. This means the CEOs are, de facto, ordering the department to raise prices on everything else!
To the surprise of some, these very low banana prices typically do not lead to massive increases in demand. This is the subject of this month’s cover story on the elasticity of demand. Some items have close to fixed usage. So even giving away, say, garlic, though it may lead to some stocking up by consumers, will not dramatically increase consumption that year. Bananas are much like that. I may eat a banana every morning with my cereal — that is seven bananas a week. Maybe multiplied by four people in my family, so that is 28 bananas a week. We leave them out with other snack fruit, such as easy peelers, apples, grapes, berries, etc. — that might mean a normal consumption of an extra banana a day per person. But even if banana prices fall 90 percent, we are unlikely to start eating a lot more bananas.
In fact, the low prices may actually reduce sales of bananas. How? Well the low prices, which translate into low margins, offer incentives for retailers to promote other items. Why bother giving bananas prime space or set up secondary displays in the cereal aisle and by the checkout stands if, in the end, the retailer can make a lot more profit giving these prime spaces to other higher margin items?
This points to another point … that price is a variable in moving the needle on consumer demand, but price is not the only variable.
When I worked in a retail operation my family owned, I would do the restocking. What I always found interesting was that when I came out with my cart, I quickly sold several baskets of mushrooms. When all the customers around me at the time I was restocking were finished putting the mushrooms in their carts, I would put the remaining baskets nice and full on the shelves. But movement was slow — until I came out again and sold a bunch in a few minutes. In other words, the excitement of fresh product moved the needle on sales far more than a cheaper price would have.
The produce department relies heavily on passively merchandising the beauty of our products. Sales … and profits … throughout the supply chain probably would increase if we worried less about price and more about actively engaging shoppers with freshness and flavor. Pb