To the CEO of a major retailer, it must look like a no-brainer – hard times call for tough measures. With consumers demanding what one retail consultant calls “extreme value”, analysts focusing on the numbers more than ever, and investors unusually willing to seek the dismissal of business leaders they believe are not performing, one easy way to satisfy all stakeholders is to cut costs. And the fast, painless way to do that is surely to pay suppliers less for more or discount their products in store.
Except it isn’t quite that simple. In May 2012, worried by the fact that 25.6% of grocery products in Europe are sold using some kind of discount or deal, Unilever’s chief executive Paul Polman said: “We will undoubtedly have to stay competitive, but these big promotions and deep cuts are not building brands and consumer loyalty. In many cases, these promotions are turning out to be zero-sum games – down if you do and down if you don’t.”
The relationship between retailers and manufacturers is incredibly complex. Retailers are customers, collaborators and, in some cases, competitors of their suppliers. Although the immediate financial benefits gained from squeezing suppliers are obvious, is this a sound long-term strategy for retailers, manufacturers or the retail industry’s consumers?
It’s probably worth recapping how we got here. The world’s first supermarket, the Upham’s Corner Market Co. was founded in 1915 in Dorchester, Massachusetts, yet for decades brands called the shots, insisting retailers stock all sizes of a particular product, limiting supply of certain high-end products when they wanted to and having the edge when negotiating at what price items would be supplied and sold.
At the root of this dominance was one crude fact: the companies making the brands were usually much bigger than the retailers they were supplying. That is no longer the case. Twenty years ago, Nestlé, the world’s largest food and beverage company, achieved sales of US$33.7bn and the biggest retailer made US$32.6bn. Yet in 2011, while Nestlé’s sales had grown to US$87.5bn, the leading retailer’s had ballooned to US$418.9bn.
The major retailers haven’t just got bigger, their reach and market share has changed exponentially as the industry has consolidated. Almost 65% of US food sales now come from the largest supermarkets, while the major supermarkets in France, Germany and the UK have a combined market share of 85%. Ambitious retail giants can transform markets.
The emergence of such global retail giants as Carrefour, Tesco and Metro Group has transformed their relationship with manufacturers. “The retailers are setting the agenda,” says Mark Larson, KPMG’s Global Head of Retail. “They have squeezed manufacturers to lower costs and tried to maximize the profitability of their shelf space through various marketing pressures, such as asking for more marketing support for shelf placement and promotions. Forward-thinking retailers want to maximize their profits but they know if the balance of power is too heavily weighted in their favor, it’s a short-term strategy.”
Manufacturers are certainly feeling the pain. “It is very difficult to make a profit as a supplier,” says the CEO of one leading apparel manufacturer. “It’s so different to 20 years ago. Our biggest competitors now are retail customers. Margins are difficult.” Difficult may be an understatement: industry analysts say that in some sectors they have shrunk by 20%.
The boom in retailers’ own private labels has piled on the pressure. In the US, one in four products purchased is a store brand – they generated around US$92.7bn in revenue in 2011. The UK’s bestselling skincare range is No7, a brand developed by pharmacy chain Boots (now 45% owned by American retailer Walgreens). The focus in the US is polishing up these brands so stores can charge more and diversifying into such sectors as healthcare and alcohol.
Mark Larson, KPMG’s Global Head of Retail
Retailers argue that by playing hardball on costs, seeking marketing support and developing their own brands they are merely doing what their customers want them to do – and protecting their business in an industry which has reached an inflection point, as the digital revolution gets underway.
There is some truth in that. Compared to five years ago, retailers have an enormous amount of data about their customers, but this resource has not always made the consumer any easier to predict. As Larson says: “It is harder than ever to label consumers by any one category. This is an era where consumers trade up to high-value premium brands and down to low-cost commodity goods. The mass consumer has become a hybrid consumer and retailers are having to work harder to expand their market share in a given category and their share of a customer’s wallet.”
The internet has proved a gamechanger, with online shopping making life harder for bricks and mortar stores. When shoppers do visit a store they are significantly better informed than at any time in the history of the retail industry. Retailers and manufacturers have responded by investing billions to acquire deeper insight into customers. Larson says: “The companies that will emerge as winners will do so, in part, because they can identify and satisfy the unmet – and occasionally unarticulated – needs of consumers”.
This is no small challenge, one Larson suggests might be more easily achieved if retailers and manufacturers work together. “We’re coming out of very tough times and the retailer and the manufacturer do their own significant consumer planning and strategies. They could benefit from the ability to have input into each other’s strategies. With collaboration and trust, they can focus on the big issue: how can they establish a more enduring appeal to their customers?”
There are already signs that collaboration is catching on – even in the unlikely area of private labels. ConAgra, home of such brands as Marie Callender’s and Healthy Choice, acquired four store brands in the fiscal year 2011/12 and is now making products for such retailers as Costco, Kroger and Trader Joe’s. This move has confounded some analysts but others believe there is room on the shelves for both store brands and traditional manufacturer brands. Nirmalya Kumar, professor of marketing at the London Business School (and author of Private Label Strategy), says: “Manufacturers can compete with private label if they have something better to offer. They can never be cheaper than private label but if they can convince the customer they are superior, there’s space for them.”
If the retail industry is to develop the kind of innovations it needs to open up new markets and product categories it cannot afford to exclusively rely on either retailers or manufacturers. “It’s push versus pull,” says Larson. “Suppliers will invest in R&D, developing such new products as Coke Zero or Innocent Smoothies, but equally retailers are on the front line and will demand things that meet their customers’ immediate needs.”
So when UK retailers identified consumer concerns about fish being difficult to cook or prepare, or that people just don’t like handling it, Seachill came up with the concept of Saucy Fish to directly answer those issues. Meanwhile, when Tesco were looking for a premium ice cream to rival the likes of Ben & Jerry’s but at a budget price, they got together with R&R who came up with Chokablok for them.
In consumer goods, product development is seldom cheap or easy. So it’s often best to let the manufacturer push ahead. It took eight years, 450 product sketches, 6,000 consumer tests and hundreds of millions of dollars in investment for Procter & Gamble to launch its Tide Pod laundry tablet – and it still had to collaborate with an external partner, MonoSol, to develop the film that can stand up to wet hands but dissolves quickly in the wash.
Sometimes, retailers have found it profitable to behave like manufacturers and at other times it has suited manufacturers to behave like retailers. With the iconic George Clooney as its global champion, Nestlé’s Nespresso, the coffee capsule brand, achieved global sales of US$3.82bn in 2011, 20% more than in 2010. Kumar says: “Nespresso is particularly intriguing because Nestlé can avoid retailers entirely – consumers can purchase capsules, machines and accessories online straight from the manufacturer.”
Yet to keep improving its performance, the retail industry needs to be more ambitious in the way it collaborates. Intriguing win-win collaborations include Campbell’s Soup and American supermarket Kroger working together to develop the Simple Meals concept, adapted to make the most of the retailer’s end-of-aisle merchandising so shoppers can buy ‘grab and go’ meals.
Through collaboration, retailers and manufacturers could, Larson says, master two great strategic challenges: the supply chain and customer data. A two million square foot automated warehouse in York, Pennyslvania, symbolizes one potential future for the industry’s supply chains. A collaboration between such manufacturers as Del Monte, logistics firm ES3 and retailer Ahold, this direct-to-store program has cut costs and carbon usage, reduced the time products take to reach the shelf and shortened the supply chain.
Mark Larson, KPMG’s Global Head of Retail
Online shopping will, Larson says, require such flexible thinking on a grand scale: “If we continue down the path of one-hour shipping and same-day dispatch, suppliers will have to straddle some real-time inventory issues and ensure they’ve got the supply chain and logistics to meet retailers’ needs.”
Working out how manufacturers and retailers can most usefully share their insight into customers could be even more complicated. “Retailers have more information than ever before but in our experience they can struggle to take advantage of their oceans of data in a systematic way,” says Larson.
Manufacturers have long mined data to hone their consumer insights. Home appliances giant Whirlpool has standardized its data to make it more customer focused and help retailers as the brand seeks to reach out to consumers, not just as purchasers but as collaborators who can help shape the products and services the company develops.
Coke is an acknowledged master at this, harvesting data from its Freestyle vending machines, which contain more than 100 brands. Christopher Roberts, former vice-president of retailing at Coca-Cola, has eloquently summed up the goal: “You want to completely understand the science of your shoppers. You want to establish those insights you can turn into tangible actions. The aim is to walk up to your retail partner with a unique, effective, shopper-based solution for their stores.”
There’s not much at stake here, only the entire future of the retail industry. Yet ultimately, retailers and manufacturers need each other. They just have to adapt to a world where they can be in competition, partnership or bargaining over the terms under which products are sold. “There will always be conflict,” says Larson. “Yet they can still collaborate. Even now it’s not always about price. Consumers are price sensitive but they will pay more for a brand they trust, like and know what it stands for.”