Hidden payments may shape grocery strike outcome

Analysis: Hidden payments may shape grocery strike outcome






By: EDMOND JACOBY - Staff Writer

NORTH COUNTY ---- The outcome of the Southern California grocery clerks strike may depend less on a meeting of the minds between employers and employees than on an obscure grocery business practice that has become so pervasive it has sapped the competitive strength of three of the largest grocery chains in America.

But the same obscure practice ---- demanding and receiving from grocery products manufacturers' payments called slotting fees ---- has made it possible for the three chains to absorb losses that could add up to $1.5 billion without caving in to union demands that might cost far less.

To listen to one side tell the story is to hear that the three supermarket chains ---- Ralphs, a division of Kroger Co., Vons, a division of Safeway Inc., and Albertson's ---- are highly profitable and want to gorge themselves on even fatter profits by taking away hard-earned health and welfare benefits from their employees.

For their part, the grocers paint a picture of highly paid employees who are too greedy to be willing to pay five bucks a week for their own health insurance.

The truth, surprisingly, is not to be found somewhere between those two images, for they are not really what the strike is about. It is really about a source of cash that has become as addictive to the supermarkets as a drug. When the dust settles, the economic landscape of Southern California could be quite different than it was just 3 1/2 months ago when the strike began.

Slotting fees are payments demanded by large supermarket chains to guarantee space on store shelves. Big manufacturers pay surprisingly high fees to guarantee prime space, eye-level and so-called end-cap display, to ensure that their products will be the most visible and most available to consumers.

According to the Federal Trade Commission, food product manufacturers can pay as much as $22,000 per item for prime positioning of their ice cream, salad dressing, hot dogs, bread or pasta in the stores of a single supermarket chain in a single large metropolitan area such as San Diego County. Two flavors of ice cream or salad dressing, two kinds of bread or pasta, or two lengths of hot dog mean two fees, so the revenue for the supermarkets adds up quickly.

In fact, the FTC concluded, slotting fees represent as much as $9 billion annually for the supermarket industry as a whole. Only the big chains have the clout to successfully demand such fees, but the three chains involved in the strike are three of the nation's four largest ---- they control about half the retail grocery business in America ---- and they are likely to account for more than half the slotting fees manufacturers pay out every year: $4.5 billion-plus.

Practice shrouded in secrecy

That's just an estimate, of course; the total could be higher. There's no way to know, really, because nobody who either gives or gets slotting fees wants to talk about them, and calls by the North County Times to Vons, Ralphs and Albertson's seeking more information about them were not returned. When a congressional committee tried to unravel the secrecy surrounding slotting fees in 1999, some of the witnesses called to testify insisted on doing so only if their identities could be kept secret and their voices altered.

The trouble is, that $9 billion or more comes from somewhere. Consumers pay it as part of the price of the products they buy, because the manufacturers just add it in to the price they charge the grocers. Why go to all that trouble? Because the grocers get the fees upfront, and pay it back in elevated wholesale prices over time ---- it's an interest free loan, and in the end it's the consumer who makes the payments.

Slotting fees were virtually unheard of three decades ago, but investigations by the FTC and the U.S. General Accounting Office, an investigative arm of Congress, found that the practice is widespread today. Widespread, but not universal.

Small grocery chains and independent stores cannot compete with the likes of Kroger, Safeway and Albertson's for the attention of the manufacturers, primarily because they don't represent enough potential sales.

And Wal-Mart, which has become the nation's largest grocer and is poised to launch grocery superstores in California this year, rejects the fees, telling its suppliers that they earn shelf space with rock-bottom wholesale prices.

The difference with Wal-Mart

The principal cost-of-doing-business difference between the two large-scale retail models ---- Wal-Mart and traditional supermarkets ---- is that one accepts slotting fees and higher wholesale prices while the other does not.

The traditional retail model skews its wholesale purchasing decisions because those purchases are driven by the slotting fees, not by consumer demand for the products. The Wal-Mart retail model allows consumer demand to drive wholesale purchasing.

It's an important difference, because it determines the price point at which the public will buy the greatest quantity of goods, and the price point at which the grocer must sell the goods to maintain profitability. Those two price points must coincide in a free market if a business is to succeed.

With Wal-Mart expanding its grocery operations into California, the distinction ---- slotting fees versus lowest wholesale price ---- poses an inescapable threat to the three big chains: change your business model or go under. But it's never easy to give up cash advances once you've gotten used to living on them. In a note to clients, Credit Suisse First Boston estimated that promotional fees in the grocery industry are "roughly comparable to earnings before interest and tax." Slotting fees account for 20 percent of all promotional fees.

In the strike negotiations, both sides seem to be talking past each other instead of to each other. That phenomenon makes sense if the real issue is not the health benefits everyone squawks about, but is instead the looming threat that the efficacy and perhaps even the availability of slotting fees are at risk.

The demise of local stores

If the three chains are unwilling to wean themselves from slotting fees when confronted by an intruding competitor with a comparative advantage ---- lower wholesale costs ---- that applies to the most aggressively advertised market-leading products on their shelves, then they must find another formula for deriving a profit from the operation of their stores.

The formula they appear to have chosen is to reduce employee costs ---- not just by shifting some of the cost of health insurance to the current employees, but by replacing them over time with employees who earn much less and who receive far more meager benefits. Their contract proposal contains a two-tier employee strategy that would treat employees hired after Oct. 5 exactly that way.

It is a short-term strategy, one that can only postpone the inevitable. But with $4.5 billion or more in revenue from the slotting fees at stake, watching $1.5 billion in lost business go down the drain may make some perverse kind of sense.

As time goes by, consumers most likely will trend toward lower-priced products, which will give them additional purchasing or saving options, and, one by one, less efficient neighborhood groceries operated by one or another of the major chains will close. Adopting the so-called big-box, regional supermarket business model exemplified by Wal-Mart ultimately may be the only route to salvation for the chains.

What does this mean for you? Growing inconvenience during the next decade, and probably growing irritation, offset by more efficient use of grocery dollars ---- unless you're an investor in commercial real estate.

Impact on local centers

"There will be a lot of chaos in the commercial real estate market," said Jack Kyser, chief economist for the Los Angeles County Economic Development Corp., who expects the evolution of the grocery industry and the Southern California consequences of that evolution to play out in a lot of unexpected ways.

"If I were an institutional investor, I wouldn't touch a small shopping center anchored by a grocery store," he said.

Those shopping centers already are feeling the effects of the strike, Kyser said, because centers anchored by any of the three chains involved in the strike have lost business right along with the supermarkets.

As events unfold, it is likely that some of those stores, beginning with the inefficient ones, will close. The closing of grocery stores will leave the shopping centers without their biggest draw, and the other stores in those centers will likely be hit hard. The phenomenon, usually seen as a dying town center while big newcomer businesses thrive outside town, often is blamed on the newcomers. It is probably better understood, at least in some cases, as the result of the inflexibility of existing businesses in adapting to a new set of economic realities. And that's precisely what's afoot in the strike.

Contact staff writer and economist Edmond Jacoby at (760) 739-6675 or ejacoby [at] nctimes.com.