It's been an article of conventional wisdom for a while now that smaller food retailers, together with the largest, have the best shot at being successful, while mid-level retailers were less likely to succeed.

Sure enough, a study of industry profitability issued lately shows that smaller and larger retailers tend to be significantly more profitable than those in the middle regions of retailing. Let's take a closer look at the profitability findings, then consider why profitability spreads have developed as they have.

The new study is the Food Marketing Institute's “Annual Financial Review 2006-2007.” It specifies that retailers with annual sales of less than $100 million had a median net profit of 1.83%. Those with sales of $1 billion or more had profits of 1.93%. Mid-level retailers had profits of 1.1%. Incidentally, the report shows that the industry as a whole did well in the study period by a number of other measures. Return on assets rose to 5.85%, up from 4.62% during 2005-2006. Return on equity was 16.79%, up from 14.55%; EBITDA rose to 4.8%, against 4.29%. Two measures that should drop did so: Inventory as a percentage of assets went to 18.32% as compared to 19.62%, and interest expense dropped to 0.66% of sales, against 0.87%. The strong industry performance came despite rising costs of distribution, operations and other activities driven upward by rising energy costs.

As has long been the case, smaller companies do well because they are closest to their customers, they have more involved management and they have a stake in managing costs more closely. Beyond that, though, there has been a stealth return in recent time to meal solutions as a means to increase profits. Retailers that have done well lately with meal solutions are not necessarily the smallest companies, but many are far from being the largest, which may be influencing the positive performance of smaller companies. As was reported by SN's Roseanne Harper in last week's issue, prepared food programs at supermarkets are expected to chalk up sales of $25 billion this year. Many retailers have increased the footage devoted to prepared meals and have increased item count so shoppers can take home several complete meals at a time. Most likely, prepared meal programs are receiving increased attention because of the example of Whole Foods. It may be that Wal-Mart plays a role too. Previously, many retailers feared that Wal-Mart would wipe out much of the industry, so it seemed prudent to hunker down to preserve resources. Now that Wal-Mart is nearing market saturation, conventional operators are finding the courage to plan for a brighter future.

Meanwhile, a news feature written by SN's Michael Garry, also in last week's issue, points out that two of the nation's largest retailers, Safeway and Kroger, are among the best practitioners of an information technology known as “molecular management,” used to examine in nearly real time what customers are buying. That makes it possible to quickly tailor product mixes and the shopping experience to fit what customers will reward. Tesco is thought to be a user of the method, too.

In sum, the largest companies and many smaller companies achieve success by converging on the same solution using different means. The solution is the simplest one of all: Give shoppers what they want.