COOPERATIVES' GAME PLAN

David Merrefield / Staff Reports

There's a locus of change in the food-distribution industry that's as significant as it is virtually ignored: The vast changes sweeping cooperative wholesalers.

Co-op wholesaling is a form of business founded at the dawn of supermarkets in a bid to ensure the survival of independent retailers. The underlying premise is that independent retailers -- often competing retailers -- would be better off pooling their product-buying power instead of each facing alone the might of integrated retail-distribution chains. Co-ops generally distribute profits back to their retail ownership.

Thomas K. Zaucha, president of the National Grocers Association, Reston, Va., pointed out that many co-ops have changed over time into entities that would be better described as retail-owned distributors. Under that description, a portion of the business might remain a traditional co-op, and another a profit-making branch. Such a company is Spartan Stores, Grand Rapids, Mich.

But whether a pure co-op or a retail-owned distributor, many such companies are adapting to new challenges in ways that would have been anathema just a couple of years ago.

The degree to which wholesaling in general is under pressure is a tale told by the numbers. According to a recent study issued by Food Distributors International, Falls Church, Va., the total number of full-line wholesalers of all types declined from 366 to 97 in just a dozen years.

And, of that number of survivors, about 25 are retail-owned food co-ops, according to the National Cooperative Bank, Washington.

The pressure is on wholesaling in general and co-ops in particular because they are pummeled by forces such as increasingly fierce and concentrated retail competition, and they are being squeezed by the need to move their technology offers into the modern era.

In response to the unpleasant convergence of these forces and others, co-ops are for the first time merging one with the other, are moving toward corporately owned retailing and are forming other alliances of various sorts.

"Retail-owned distributors are no different than any other wholesaler," said Zaucha. "They must create whatever alliances are necessary to be efficient. They don't need to be the biggest companies around, but there is some need for size to be efficient. Many of these companies are forming other types of alliances short of merging, such as buying alliances and technology alliances."

Many co-op executives agree that a new day is dawning for their style of business. "There are fewer and fewer co-ops. The ones that are staying are getting larger and larger. And if you're not getting bigger yourself, it's time to look at someone who is," said Virgil Froelich, president of Affiliated Foods, Norfolk, Neb. Indeed, that co-op is slated to acquire the assets of Affiliated Foods, Elwood, Kan. The deal is to close later this week, with the Norfolk concern to assume operations June 1.

The two Affiliated co-ops are far from alone in their endeavors to combine. Currently under negotiation is a merger proposal between Certified Grocers of California, Los Angeles, and United Grocers of Portland, Ore. The boards of each co-op are to meet next month to take a formal vote on whether to merge. Assuming the result endorses merger, and all goes well thereafter, the deal could close in the summer.

Also pending is a proposed deal between Associated Wholesaler Grocers, Kansas City, Kan., and Affiliated Food Stores, Tulsa, Okla. No proposed closing date could be ascertained for that deal.

"It's important to have co-ops participate in consolidation, and clearly that's happening," said Al Plamann, president and chief executive officer of Certified Grocers of California.

A similar theme was sounded by other co-op executives, such as Bob Rippley, president and chief executive officer of Affiliated Foods (Tulsa), who said that "the bigger these [corporate] entities get, the more we have to find ways to be viable, and that might be through mergers."

The upshot of the forces arrayed before co-ops is that "we're likely to see more consolidation in the near future involving co-ops," said securities analyst Meredith Adler, Lehman Bros., New York.

Aside from mergers, some co-ops are trying to secure their future by acquiring certain of the retail stores they supply, a strategy that seemingly flies in the face of the whole notion of cooperative wholesaling. The driving force may be technology considerations.

"The significant thing that really must be achieved is a virtual-chain situation featuring a conduit for information to flow more evenly and openly between the wholesaler and the retailer. When stores are owned by [independent] retailers, some information doesn't pass as seamlessly as it should," said Rich Parkinson, president and CEO of Associated Food Stores, Salt Lake City.

Earlier this year, the co-op closed a deal to acquire one of its independent operators, the four-unit Lin's MarketPlace, St. George, Utah. It is now in the process of adding the eight-store Macey chain, Salt Lake City.

Associated's store-ownership strategy "gives us a much better understanding of what retailers want," Parkinson said. "It's like having an in-house laboratory where you can work these details out."

Will there be more stores to be acquired in Associated's future? "That's something you'll definitely see more of with Associated Food," Parkinson vowed.

Again, Associated isn't alone in the store-acquisition game. Last year, Certified agreed to acquire Sav-Max foods, a seven-store operation in Modesto, Calif.

The NGA's Zaucha said some of the impetus leading wholesalers to buy independents is the lack of a new generation of entrepreneurs and risk-takers willing to perpetuate ongoing retail businesses. Should there be a reawakening of the entrepreneurial spirit in the future, wholesalers might spin off their retail holdings to independent retailers. Historically, wholesalers bought independent retailers with just that idea in mind.

Efforts now under way by many wholesalers -- whether co-op or voluntary -- to ensure an efficient information flow from store to wholesaler, and the reverse, underscore the major role of capital. It takes capital to acquire stores, or to upgrade technology.

Capital retention has always been a nettlesome issue for co-ops since wholesale-generated earnings are generally rebated by the wholesalers to their retail-store owners in the form of patronage dividends. In effect, board members must pluck money from their own pockets to finance cooperatives' improvements.

Indeed, strategies such as acquiring retailers or running parallel profit-making businesses are one way co-ops have jumped the capital hurdle.

Additionally, said Zaucha, the National Co-op bank and conventional lending institutions currently have a better understanding of the retail-owned distribution and independent-store model, which increases access to capital.

But not all difficulties have been swept away.

"The paradox is that the source of capital for co-ops is the retail customers [and owners] who have a greater calling on their capital to maintain their own store," said Chuck Cerankosky, a securities analyst at McDonald & Co., Cleveland. "Historically, co-ops have not kept physical plants up to standards as well as some publicly owned wholesalers have done. Additionally, technology is getting more and more advanced, and it's much needed to capture supply-chain efficiency."

Said Lehman Bros.' Adler, "An issue for the viability of co-ops is how sophisticated they are in terms of technology. Those that do a good job of that can be in a good position to combat deep-pocketed rivals."

Regardless of the difficulties surrounding capital retention, some co-ops -- perhaps the more highly evolved ones in particular -- seem to get the difficult work of capital improvements done, and are moving forward.

Dean Janeway, president and chief operating officer of Wakefern Food Corp., Elizabeth, N.J., the nation's largest co-op, said Wakefern has been able to improve efficiency through the use of computer-generated routing systems and other electronic distribution-center aides. The co-op is also able to assist its members in taking advantage of data culled from frequent-shopper cards.

"We've done a lot of work with direct marketing. To do that, you have to know who the consumer is and what their needs are. These are key areas of technology where we're taking complete advantage," Janeway said.

Affiliated's Froelich said that successful competition with other wholesalers means investing in "anything we can do to save labor and make things more convenient for our stores.

"We use Internet and satellite communication that lets us contact all our stores in less than a minute," Froelich said. "We use batch-picking and cross docking."

Certified's Plamann noted that "there is a need for independents to remain technologically competent and, in a co-op environment where independents can share the costs among themselves, it becomes economically feasible to maintain a high degree of readiness.

"Our warehouse runs as efficiently as any in the country. We've implemented significant warehouse systems in the last three to five years. Our retail-systems support activity, for which we utilize interactive ordering, makes inquiries about inventory levels, prepares sample orders to see what can be filled and what substitutes there may be. This all means we're working in partnership with retailers."

Certified of California is the nation's second-largest co-op.

Associated's Parkinson said that "one big technology area of importance to us is point-of-sale information and getting into a category-management mentality.

"We're dedicating our efforts to what consumers really want. To do that we need that point-of-sale data and we need it analyzed if we want to put the right product on the shelf at the right price.

"Retail front-end information helps our promotional activity because it gives us background, an understanding of what was happening in previous periods. This gives us the biggest bang for the marketing buck."

Increased use of technology lends itself to another innovation available to co-ops that can give them the benefits of synergy without actually completing a merger.

An example: United Grocers, Portland, Ore., is exploring a series of joint-venture initiatives with another co-op, Associated Grocers, Seattle.

Myron Fleck, United's chief financial consultant, told SN the two co-ops are "exploring the possibility of unified financial and warehouse systems, and we're working with the in-house attorney to develop joint bylaws that will deal with member equity and the capital structure of the two companies to see if we can blend them now or, if we wait, to be sure we have fewer complications later."

Terry Olsen, United's president and CEO, added that the co-ops are looking at sharing an information-technology specialist to oversee retail systems for both operations, as well as centralizing general merchandise and health and beauty care for both using United's Portland warehouse.

Meanwhile, the idea is, specialty foods and slow-moving food items could be centralized and distributed through Associated's center in Seattle.

In addition, the co-ops are looking at joint procurement, scheduling, trucking and warehousing.

Another co-op seeking an alliance partner is Associated of Salt Lake City.

"We've discussed developing more ways of sharing costs, particularly with information technology," Parkinson said. "But that's all on hold while we deal with Y2K issues. It is something we're thinking about all the time."

Y2K or not, Associated has already forged an alliance with Earthgrains Manna, a baked-goods company.

"They have a bakery in northern California and bake and market for us in that area. We have a bakery in southern California and do the same for them there," Parkinson said.

In addition to strategies such as these, co-ops are reacting to consumer trends, chief among them the much-bruited meal initiatives of various sorts, judging by the frequency of mention by co-op executives polled by SN.

"We're looking at solution selling," Parkinson said. "Rather than going with the plastic container, microwave meal, we're looking at a packaging approach where the meal is put together but still requires some preparation by the consumer."

He said that, for example, an Italian dinner could be merchandised with all needed elements, but the consumer would need to boil water, cook pasta and heat the sauce.

"We feel consumers still want to be engaged in some fashion in the preparation of the meal. It helps [working parents] get away from guilt they may have over not cooking complete meals for their children," Parkinson said.

Froelich said "people want to fix and eat in 15 minutes, and there's a lot more people who eat in the car. We're trying to understand their need to 'heat and run.' And, since we're seeing more and more items come in, we opened a new, 30,000-square-foot frozen-food facility.

"The name of the game is speed. Besides thaw and serve, we have a pasta program, soups, sandwiches, and we're trying to get the stores to get more of these departments up front. We have to get the message out that it's easier to stop at a grocery store than a fast-food restaurant."

Given the challenges co-ops face, and the fight-back strategies many are developing, what does the future hold for co-ops?

Here's a snapshot of opinion from several executives queried by SN:

Wakefern's Tom Infusino, chairman and CEO, said, "Well, there's no question at all that we have a bright future. We've had more growth the last five years than at any other time."

Wakefern's Janeway said a co-op "is only as strong as its weakest member. We do whatever it takes to help our members with issues concerning financing, operations and finding labor. There isn't anything we wouldn't do, and I think that's a key for co-ops around the country."

Affiliated of Norfolk's Froelich said, "We're strong as ever and we'll continue to grow. I see things as being very positive, and there are still a lot of operators out there who want to remain as independent."

Certified's Plamann said, "I think what will happen is owners of co-ops will become more operationally involved in both retail and wholesale, and ultimately we'll have what I would call a virtual chain. There will be a seamless interface between retail and wholesale. We'll reduce redundancy, support each other in business activities and become a lot more competitive with other channels."

Affiliated of Tulsa's Rippley said, "Co-ops do an outstanding job serving independent customers. You just can't buy better service than that. The one nice thing about cooperatives is your shareholders are your customers. It's not like it is with a public company, which must please Wall Street."