An Exchange on Price and the Mainstreaming of Natural/Organic
To the Editor and George Southworth,
We are the leading natural food distributor in Ontario. Our main problem has been how to restrain and shape our growth, which is proceeding at a torrid pace. In fiscal 1997, we achieved Canadian $4.4 million in sales; in 2001, we'll do about $15 million. Ontario's natural food market is considerably less mature than most U.S. regions, though consolidation is underway here too, and the major supermarket chains are making aggressive natural food initiatives.
"We must reduce the competitive price gap. But our survival depends on being able to define and enhance the organic food knowledge and service we provide." In that light, I found your article in Cooperative Grocer ("We all have to compete with more efficient channels of distribution and retailing now") very troubling. You describe a rapidly consolidating mature industry where the major conventional food distributors have huge advantages in economies-of-scale over the much smaller natural food distributors. Nothing prevents them from undercutting us on price in a market where competition becomes increasingly reducible to price, and consumers (presumably) don't care about much else and shop comparatively for the best deals. Consequently, we are extremely vulnerable to encroachment from ruthlessly efficient giants. You seem to argue that our only defense is to fight on their terrain by competing on price, becoming, very rapidly, just as low-cost/low-margin as they are. It's either that or extinction, apparently.
This prescription seems self-defeating to me. We'll never win in head-to-head price competition with the major conventional food distribution firms, or even hold onto our own market share if price is the decisive factor. We can, and must, operate more efficiently, reduce the competitive price gap. But I believe that, ultimately, our survival depends much more on being able to define and enhance the organic-food knowledge and service we provide to our co-op members and other customers who share our values (in their environmental, fair trade and local-produce concerns) while distrusting our cost-minimizing competitors on precisely these grounds.
Can you cite sound market research that would show that our service/value advantage is declining in importance in the buying decisions of organic-food shoppers,that price now trumps every other factor in the competitive equation? Your analysis seems to be based on that assumption. (I grant that this is a brief article, and you do say, at the end, that we ought to "retain and enhance customer service." Perhaps you could elaborate on that point.)
In my view, if the organic food market is reduced to uniform name-brand commodities on sale everywhere, and if shoppers for organic food become just like conventional food shoppers, then we are destined to be driven out of business no matter what we do, and probably sooner rather than later. Yet what defines organic shoppers is that they resist the full-scale commodification of food, the way it has been cheapened. The natural food alternative has arisen in capitalist economies as a countercurrent to commodification because more and more people distrust the end-result of industrial agriculture (mass-production, high-chemical inputs, large-farm monocultures). Organic shoppers connect their families' health concerns with a broader concern with the health of the soil and freshwater systems that sustain agriculture. They demand more accurate information about what's in the food they buy and the conditions under which it has been grown and processed.
Realizing that they are not themselves in a position to 'track-back' products to source, urban shoppers place a high value on those who can earn their trust as the guardians of that supply chain -- dedicated organic food distributors and retailers. Our survival depends upon people's willingness to 'pay the difference' for that trust, and upon our ability to be worthy of it, and to a broader public around it . We may well ask: how much difference are organic shoppers willing to pay for integrity in the food-chain in each product category? Good question. Price will always be an important consideration. But if we cannot convince people to pay a substantial difference, we're toast (as it were). Surely, as well as striving to be more efficient, we have to clarify what makes us different, nurture and enhance that difference, and educate people as to why they ought to pay higher prices to secure the benefits, for themselves and the environment, of healthier food.
Cheap food is actually costly to our health, the health of our kids and theirs, and to the health of the ecosystem. The growth of the natural food industry is due to the dawning public recognition of this fact. It's a counter-trend pitted against the cheapening of food and the degradation of the agricultural environment -- the gradual expulsion of more and more labor-time from food production and domestic meal preparation. Of course, the dominant trend exerts tremendous (price) pressure upon us. That's a reality we must face. But our survival depends upon the strength of the counter-trend and on the degree that we are able to appeal to it and play an active role in extending and educating it. That's our enduring market advantage, isn't it?
All the best,
Treasurer, Ontario Natural Foods
George Southworth responds:
We are in total agreement on many points in your heartfelt letter. I covered a lot of ground in my article. The present exchange is an expanded discussion of one of the major conclusions: namely, that price and service expectations depend on format and that within this context, the co-ops to compete on price if one agrees with the assumptions as to how the industry is maturing. This does not mean they have to compete on price on every single item. Price is a function of the interplay of format, consumer expectations and local marketplace dynamics (demographics and competition).
Regarding sourcing, there is not much research published on the issue of price vs. service as you characterize it. Most companies jealously guard that information. The information and perspective in the article comes from widespread reporting re natural products marketshare (a $32 billion U.S. industry in annual sales), who owns it, what store format they have; closely following the much better documented supermarket industry ($450 billion) of which natural products is but a niche; and also closely following the mass merchandiser market, of which the supermarket business is a niche, combined with the trends in all of the above. I and others at Northeast Cooperatives have checked the assumptions via extensive discussions with many industry leaders. Another source of data is available through comparative market penetration studies available from Pete Davis of CDS, which measure the existing dynamics of a store and competing formats extrapolated against consumer preferences in a given market.
Your overall question must be divided into two parts, distriubution and retail. I am sending you a discussion of distribution while responding here on retail issues.
Retail is more complex than distribution, as befits a much less consolidated part of the industry. But the trends are similar. Consumers at the supermarket level make their decisions on issues well tracked by Food Marketing Institute. There are no comparable data assembled for natural products shoppers, though the Hartman group is working on portions of the problem. The FMI data shows that consumers basically expect their store to be close to home or work, clean, well merchandised, priced appropriately, and have good selection. The order varies slightly each year, and I have grouped certain attributes together for purposes of discussion.
There are three basic formats that appeal to the consumer on these issues but in different rankings. They are:
• price impact/essential selection: Trader Joe's, Wal-Mart
• convenience/expanded selection: natural food stores, supermarkets. (Expanded selection means wider selection than most of the competition; this is situationally dependent and could mean a 5,000 item store fulfills this niche if supermarkets are nearby with less than 2,500 such items.)
• largest selection/highest service: Whole Foods, upscale supermarkets (service refers to service counters such as bakery, deli, cafe, sushi bar, floral dept., etc.)
All of these formats have overlapping elements of each other. Let's take them one at a time as they interact.
The average supermarket shopper travels 2.8 miles to the store. It used to be that natural foods stores could pull customers from a 30 mile radius, except in dense urban areas with more competition. This is decreasing as many more stores offer natural foods. Natural products have gone from primarily a destination shopping experience to one of convenience, though supermarkets use natural products as a destination shopping point in the store.
The exception to distance traveled is at opposite ends of the spectrum. Trader Joe's as a price impact store still pulls customers from a 30 mile or greater radius. Whole Foods as the extensive selection and service provider does the same, though WF stores tend to be clustered in metropolitan area for market penetration, produce/commissary kitchen distribution, staffing, advertising synergies, and the ROI needed for that large a store.
The Hartman Group has probably done the most natural foods consumer oriented research. One intriguing finding is that 75% of current natural foods shoppers prefer to shop for natural foods at their local supermarket. We know from Natural Foods Merchandiser annual marketshare studies that 19% of natural products are sold through supermarkets. But many manufacturers report that their core items are becoming essentially branded commodities and have more sales in supermarkets, when including the supernaturals (Whole Foods, Wild Oats), than all other outlets combined. One could reasonably conclude that the core natural product items are now widely available to the consumer in a large number of formats, thus creating price competition on these items (branded commidities). These become the price-image, price-sensitive items of the industry. Information on products' benefits and attributes is widely available through a variety of media. They must be priced on a competitive basis, since this is the only point of store differentiation on these products.
Consumers simply expect a clean, well-merchandised store, similar to a well-run supermarket, from any place they shop these days. This is no longer a point of differentiation; the consumer simply will not shop at a store that does not meet these standards unless it is a price-impact store. Even then, Trader Joe's and Wal-Mart are clean though not fancy in store appointments and ambiance.
U.S. consumers have had over 60 years of training on what to expect in a food shopping experience. That is how long supermarkets have been the dominant format. And most supermarkets are laid out in one basic pattern. Many of the natural food stores are laid out in eclectic shopping patterens and benefit from having a new shopper orientation process.
In the consumers' mind, selection is based on expectations of the store format. They expect that Trader Joe's will have what they need (not necessarily the brand they are look for) at the best price. For example, there may be only two soy milks, in three basic flavors, a regular and a low fat, in a national brand and the Trader Joe's brand. They will not expect 37 different varieties of the above as in many expanded selection stores. But they expect that it will be the best price. Each category of product will be represented on the shelves in a similar manner, all categories but very narrow selection within categories, and no customer service to speak of.
At the opposite end of the spectrum are the 40,000+ sq. ft. Whole Foods and Wild Oats. Here the consumer expects to find a high array of products in each category and a large number of perimeter departments. And the best customer service is a given. That is the value add, and consumers are willing to pay for it, as evidenced by the over all high prices of a Whole Foods. But to compete and maintain a competitive price image, Whole Foods sets prices accordingly for price-sensitive and price-image items: items in each category that are the category leader, the 365 private label program, and flyer ad items.
The consumer expects stores with these formates to be competitively priced on all items with stores in the same type of format. All store formats are beginning to price branded commodities in a similar fashion. Look at supermarkets, which essentially price all boxed and canned product very close to one another but differentiate themselves and make their profits on the perimeter departments. This is a large portion of Whole Foods' strategy. So unless co-ops evoke a unique format, eventually they will be forced to compete with the other formats in their marketplaces on prices on core items with some variant of service/selection.
It has been my experience, corroborated by discussions industry-wide, that a perceived 5% differential in price at retail is enough to get most consumers to switch. Obviously this is different by type and category of product. A low priced product like a pound of flour at 45 cents will not cause someone to shop elsewhere if it retails at 48 cents, but extra virgin olive oil at $6.39 that costs $5.99 elsewhere may. Further, a few pennies difference for price image items like milk, eggs, butter and soymilk can cause a consumer to consider other retail choices if they are available.
The data that really settles this question are price elasticity studies that are performed across formats using marketshare data. Only the larger supermarket chains and manufacturers can afford this, though there are new companies arising in the supermarket industry that claim to be using this approach. Independent supermarkets can contract out their management of pricing and promotions to these companies. Whole Foods, as the 63rd largest supermarket chain in the U.S., has the ability to create this. You can bet that Kroger has added natural products to their category management program. But you can also bet that neither will share that information with the co-ops.
The last point made by Wally is differentiating co-op retails based on knowledge or customer service. I will speak to the problems we face; possible solutions are the next article.
Product knowledge is increasingly conveyed by publications, newspapers and the internet. There is a rapidly expanding body of science/knowledge that is supporting natural products claims in a narrow technical fashion, and most store buyers cannot keep up with this issue. They have limited time for managing shelves and new items, merchandising, pricing, promotions and profitability. Combine this with the huge number of items in the natural products industry, and add the liability of misrepresenting structure/function claims. The task is impossible; a different approach is called for.
Additionally, services have arisen that provide natural products informaton, exemplified by HealthNotes(TM). Large supermarket chains and price impact stores have contracted with HealthNotes for this service. Combining that with a loyalty shopping program -- customized discounts based on the individual consumer's preference -- makes a potentially strong program that the co-ops have yet to match in total, though elements are in place. Additionally, given the turnover of staff at retail, what training programs are in place to ensure a knowledge differential is maintained by the co-ops? Two organizations that do this well are PCC and Hanover Co-op. But these are large co-ops, each with over $40 million in sales.
Lastly, an anecdotal point: Many manufacturers have said to me that they depend primarily on their packaging to differentiate them and to sell the product. Next are direct to consumer advertising/promotions and the media. Few expect that staff at retail will actively hand sell their product, for all the reasons listed above. They expect the retail to sell product via promotions, retail newsletters and good merchandising.
In essence, the industry has grown and broadened so that one size or approach does not appeal to the majority of consumers any more. Each of the three formats appeals to specific consumer attributes and focuses resources and store layout accordingly. The co-ops are so varied in their individual needs, organizational maturity and desire to coordinate spending on these issues that execution becomes problematic. All that said, much good is happening on these very issues both regionally and nationally.
As promised, a future article will be on potential strategies to meet the coming (or already arrived) competition.