Industry Voices

Unlocking Value Through Virtual Integration

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This article is co-authored by Randy Burt, a principal with A.T. Kearney based in Chicago (randy.burt@atkearney.com); Kumar Venkataraman, a partner with A.T. Kearney focused on the retail sector and based in Chicago (kumar.venkataraman@atkearney.com); and Nilam Ganenthiran, a consultant with A.T. Kearney based in Toronto.

Over the last several years, many U.S.-centric food retailers capitalized on the “value first” momentum generated during the Great Recession. Indeed, private label products are projected to account for 19% of grocery purchases by 2016 and resonate with consumers across the socio-economic spectrum. With continued cost uncertainty and the value-conscious shopper here to stay, many observers believe it is only a matter of time until North American private label penetration rates close the gap with the much higher rates seen in Western Europe.Randy Burt of A.T. Kearney

Given this, managing the private label portfolio will become increasingly strategic for food retailers in the coming years; understanding how to innovate new value chain strategies will be critical to enabling increased capture of attractive private label margins. Select traditional grocers and pharmacy retailers create advantage from vertical integration — while other players reap many of the benefits of vertical integration with innovative supply relationships that do not require significant capital investments.

Nilam GanenthiranSafeway and Kroger, for example, control much of their own private label supply by owning manufacturing assets in key categories such as dairy, frozen foods, carbonated soft drinks, and fruits/vegetables. Beyond capturing manufacturing margins, they maintain visibility and relative control over key input costs. Moreover, two of Canada’s largest drug retailers, Shoppers Drug Mart and Jean Coutu, have followed a similar vertical integration strategy, acquiring generic drug manufacturing capabilities ahead of the large run-up in generics share (from 50% to 61% over the last five years), allowing these retailers to capture a higher proportion of the profit pool. Some argue that the scale required to own manufacturing assets will not pay off for any but the largest of players.

Kumar VenkataramanHowever, moving from a category- to manufacturing platform-centric view, similar to how a CPG manufacturer tends to view its asset base, may uncover opportunities to gain fixed asset, capability and variable cost advantages from assets able to manufacture multiple categories. Moreover, if capital outlays required for in-house capabilities remain unattractive, food retailers can gain advantage from moving from tactical to strategic contract manufacturer, grower and processor relationships. The right contracting and relationship management strategies, or “virtual” integration, yield many of the benefits of actual vertical integration.


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For example, long-term commitments (think five years-plus) allow manufacturer partners to invest in innovation, while joint sales and demand planning reduces overall value chain risk and hence lowers cost. Pooled purchasing and joint commodity risk management strategies offer opportunities to further control costs and raise margins. Success in pursuing such strategies requires an ability to segment strategic categories to target, sophisticated supplier relationship management capabilities, and a willingness to make long-term commitments. Success in private label will increasingly drive overall success for food retailers in the U.S. — winning players will apply innovative value-chain approaches to create competitive advantage.

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Sean McBride

Sean McBride, founder of DSM Strategic Communications, LLC, is former EVP of communications and member services at the Grocery Manufacturers Association.
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