Markets’ Shelf Fees Put Squeeze on Small Firms

The letter from Ralphs Grocery Co. to its fruit and vegetable suppliers began cordially enough. Addressed “Dear Valued Supplier,” it laid out Ralphs’ plans to add 44 stores in Northern California and build a warehouse to service them.

Then came the hard sell: To help pay for Ralphs’ growth, suppliers would have to pony up thousands of dollars in shelf fees, either in cash or by surrendering dozens of cases of free products. The implication was that if they didn’t, there would be no space on the chains’ shelves for their goods.

Ralphs’ letter is one demonstration of a dramatic escalation in the grocery industry’s demands for so-called slotting fees, which food companies pay to get supermarket shelf space for new products. Manufacturers shell out $9 billion a year in shelf fees, representing more than half of the supermarket industry’s total profits, analysts estimate.

Mergers have sharply consolidated supermarket ownership in recent years. Five giant companies account for 40% of U.S. grocery sales, and the mega-chain share of the Southland market is even higher.

With grocers using their newfound clout to expand the “pay for space” system to the produce aisle, and to charge $25,000 or more to place new products, small suppliers say they can’t compete.

Regulators are watching with concern. Three federal investigations into slotting practices are underway, but fear prevents many food makers from coming forward. Retailers have so intimidated suppliers that witnesses at a recent Senate hearing on slotting wore hoods to conceal their identities.

Like Hollywood accounting, the economics of slotting and grocery pricing are shrouded in mystery, fueling the debate on the system’s ultimate effect on consumers.

Slotting’s critics say that shoppers end up eating most of the $9 billion manufacturers pay for space, as slotting fees are built into the price of products. Bagels jumped 159% in price after grocery stores in the Midwest booted out local bakeries in favor of a big corporate supplier that agreed to pay slotting fees, manufacturers say.

Critics also say slotting results in less variety on store shelves. What’s more, many supposedly competing brands are actually controlled by the same companies.

“Because of slotting, small companies have limited access to mainstream supermarkets, which means consumers have limited choices,” said Christine Bruhn, director of the Center for Consumer Research at UC Davis. A success story such as Nancy’s Quiches, started in the founder’s Bay Area kitchen, would never happen today, she said.

Retailers say that slotting simply makes manufacturers shoulder part of the risk in introducing new products, most of which fail. If the product is a hit, the supplier can boost wholesale prices to offset slotting costs, they say. If not, the fees cushion the retailer from losing money.

“If we didn’t get the deals, our prices would be higher,” said Jack Brown, chief executive of the 155-store Stater Bros. chain.

Fee System Has Become Widespread

Slotting, which started decades ago as a one-time fee for changing labels and making warehouse space for new products, has become pervasive in the last decade.

In ACNielsen’s annual trade promotion survey, 91% of food manufacturers reported paying fees to introduce products in 1998 and 90% of retailers said they charged them.

As grocery chains have become larger and categories more crowded, retailers have upped their rates. In Southern California, the fees start at $25,000 per item at Ralphs, $20,000 to $30,000 at Albertsons and $10,000 to $15,000 at Vons, Los Angeles-area food makers said. Each ice cream flavor, each different-size jar of mayonnaise, constitutes a separate item.

Often, upfront cash is only the beginning. When Monrovia meatpacker Don Burnett approached a major California chain about stocking his microwaveable meals, the company’s buyers demanded $5,000 per item for warehouse costs, another $5,000 for quarterly newspaper ads and $86,000 in free samples.

“There’s no way I could afford that, so I don’t do business with them,” Burnett said. Absorbing the fees would have kept him from turning a profit for six months, he said.

How do supermarkets command such premiums? Market power. Three companies hold two-thirds of the Los Angeles market: Kroger Co., which owns Food 4 Less Warehouse Stores and recently bought Ralphs Grocery Co. (Ralphs swallowed Hughes in 1997); Safeway Inc., which owns Vons; and Albertsons, which recently acquired Lucky.

In the recent Senate hearings, Sen. John Kerry (D-Mass.) compared slotting fees to payola, the illegal bribes that music companies have paid to disc jockeys to get records airplay.

But slotting is legal, except on alcoholic beverages. Although suppliers are prohibited from trading cash for exclusivity, manufacturers can offer upfront payments--ostensibly to cover introduction costs--as long as they offer them equally to all retailers in a market.

The practice remains a touchy subject at the chains. None would answer The Times’ questions about how much they receive annually in slotting or how much the fees add to profits.

Big discounters such as Wal-Mart and Costco do not collect slotting fees, instead demanding rock-bottom wholesale prices and stocking only the fastest-moving items.

Traditional supermarkets, however, maintain that they need slotting as insurance for gambling on the 15,000 to 20,000 products introduced each year, more than 80% of which fail, said John Motley, a director of the Food Marketing Institute.

Industrywide, supermarket profits hover at just over 1% of sales. Although figures vary widely by product, food manufacturers earn an average of 5% of sales, according to the Grocery Manufacturers of America trade group.

Sales Stagnate for Nonparticipants

Critics counter that grocers’ push for upfront fees is making mainstream supermarkets almost impenetrable to small manufacturers.

Food 4 Less offered a Santa Fe Springs ethnic foods manufacturer 20% of its tortilla shelf space for $230,000, the company’s chief executive said, adding that Vons wanted $5,000 per item to put products into stores in Latino areas and $12,000 per item for space in the chain’s other Southern California stores. K.V. Mart wanted $50,000 in free product, he said.

He couldn’t afford to make any of the deals, but without them, sales have stagnated, said the chief executive, who requested anonymity. “It really prohibits us from getting in,” he said. “We don’t have deep pockets.”

Different rules apply to large manufacturers, which can count on consumers to demand their brands regardless of whether they pay to place them.

Cincinnati-based Procter & Gamble Co. refuses to pay cash for shelf space, spokeswoman Gretchen Briscoe said. Instead, the maker of Tide, Pampers and dozens of other household standards contributes “brand development funds,” paying directly for in-store promotions or special price cuts, expenses that otherwise fall to retailers.

But some big manufacturers use slotting fees to up the ante, muscling out smaller rivals who can’t pay the going rate, industry sources said. Bakeries nationwide cried foul in 1997 when their products were dropped in favor of a bagel line from baked-goods behemoth Sara Lee.

Competitors, who filed suit in Los Angeles against Sara Lee and one of its subsidiaries, charge that Sara Lee paid millions to West Coast retailers in exchange for the majority of bagel space. At many Southland chain stores, Sara Lee bagels now occupy all but the top and bottom shelves.

Sara Lee declined to talk about the lawsuit or its slotting policies.

Drew Skully, vice president of Old World Bakery in Cincinnati, said his company lost $1.5 million a year when it lost its space to Sara Lee in Indianapolis and Columbus, Ohio. Consumers lost out too, he said. Skully said his six-bagel package sold for 69 cents to $1.29; Sara Lee’s cost $1.79 to $2.79.

“It made us mad and it was a bad deal for customers,” he said. “But Sara Lee’s got a big name and a lot of money to throw around.”

Until recently, only packaged food makers had to pay to acquire and keep turf. But as the Ralphs letter shows, retailers are stretching the slotting system to encompass fresh produce.

The turning point came with the introduction of bagged salads and carrots, products that resembled traditional branded goods. Ready Pac of Irwindale said it pays slotting for each variety of bagged greens.

“It’s no secret that someone has to pay for all of the costs of these [supermarket] acquisitions,” said Dennis Gertmenian, Ready Pac’s president. Slotting “is just part of the cost of doing business.”

Bulk produce shippers, however, have balked at slotting demands.

Valley Fruit & Produce Co. of Los Angeles fired back a letter to Ralphs, aghast that the chain expected merchandising fees, plus a separate payment--either a 10% stocking fee, 50 cases of product or the cash equivalent of 50 cases--to help build a warehouse in Stockton.

The fees would have added about 6% to costs, said Valley Vice President Art La Londe.

“It would have meant not being able to offer customers the best possible price because, one way or another, you have to get your costs back,” said La Londe. It is too soon to tell if Valley’s stance will cost it business with Ralphs and Food 4 Less, he said.

Ralphs declined to comment on the letter or growers’ reaction to it. Western Growers Assn. President David Moore has called for the fees to be refunded.

Growers also are pleading their case with government regulators. At their request, the U.S. Department of Agriculture’s Economic Research Service is studying how supermarkets buy produce and whether they are forcing suppliers to absorb their marketing costs.

As skirmishes over slotting intensify between manufacturers and retailers, regulatory pressure seems to be building, too. Sen. Christopher Bond (R-Mo.), chairman of the Senate Small Business Committee, plans a second round of hearings focused on fruit and vegetable suppliers.

The Federal Trade Commission is preparing its first slotting-related enforcement action in more than a decade, a lawsuit alleging that Sparks, Md.-based spice maker McCormick & Co. paid some retailers disproportionately more in slotting fees than others. McCormick has denied wrongdoing, but has made settlement overtures to avoid a prolonged fight.

For consumers, slotting’s impact lies in what is--and isn’t--on supermarket shelves. Southland stores, jampacked with a jumble of brands, would seem to disprove the notion that the “pay for space” system limits consumer choice. Or do they?

Each chain stocks at least 10 brands of instant coffee, but three conglomerates own most of them: General Foods (Maxwell House, Sanka, Yuban, General Foods International Coffees), Nestle (Taster’s Choice, Nescafe, Sunrise, MJB and Chase & Sanborn) and Procter & Gamble (Folger’s).

Similarly, two labels--Mission and Guerrero--divide almost all the shelf space for flour tortillas. Both are owned by Gruma Corp. of Mexico, which pays “in the low millions” in slotting fees each year, acknowledged Asima Yed, the company’s marketing vice president.

Small manufacturers say they lack the capital and the volume to keep up. Frustrated and angry, meatpacker Burnett initially consulted an attorney about taking on the slotting system via a class-action lawsuit. But open rebellion could cost him another chance with the chain in question and might scuttle his relationships with other retailers, he concluded.

“I don’t want to cut off my nose to spite my face,” he said.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Speaking Supermarketese

Slotting fee: Upfront cash, discount or merchandise given by a manufacturer to a retailer to stock a new product. Also known as a slotting allowance.

Pay-to-stay fee: A manufacturer’s payment to a retailer to continue stocking and displaying a product.

Hello money: Fee paid by manufacturer for making a sales presentation to a supermarket buyer. Also known as a presentation fee.

End cap: A massive merchandise display at the end of an aisle, often for high margin, impulse items. These prime selling locations, also known as ends or end displays, command among the highest fees.

Failure fee: A manufacturer’s payment to retailers for merchandise that does not sell as expected and is being dropped from the retailer’s inventory.

Street money: Cash offered to retailers by suppliers or middlemen for reaching specific performance goals, meeting conditions or making purchases.

Table allowance: A manufacturer’s payment to a retailer to display or highlight a product on supplemental tables. Also called a Table Display Allowance (TDA).

Push money: A manufacturer’s incentive to wholesalers to actively market their products. Usually payments are based on the number of cases sold. Also called promotion money or a spiff.

Listing allowance: Money that a manufacturer or wholesaler gives a retailer to advertise a product.

Promotion allowance: A discount offered by manufacturers to wholesalers and retailers to advertise a product, reduce its price or provide a special display for it during a salespromotion period.

Source: Food Marketing Institute.