FLEMING: SYNERGY AND SYMBOLISM

DAVID MERREFIELD

LEWISVILLE, Texas -- There's symbolism in location.

DaimlerChrysler hopes to grab global attention and prestige by re-establishing an office in the Chrysler Building, the stylish Art Deco tower in Midtown Manhattan.

Conversely, Fleming Cos. hopes to drive home the message of customer service and thrift by means of its relocation from high-rent headquarters in Oklahoma City to austere offices here.

But there's a great deal more than symbolism going on at Fleming right now. Mark S. Hansen, Fleming's chairman, president and chief executive officer for the past 18 months, told SN in an interview here that:

Fleming's distribution sales volume is growing at a fast clip, with two distribution centers each achieving sales volumes of more than $1 billion and two more expected to do so soon.

Fleming, in a dramatic move, intends to spin off its considerable supermarket assets and redirect its retail approach to price-impact stores.

And, Fleming's low-cost-pursuit initiative has so far stripped some $50 million in unnecessary operating costs from the system, with the expectation that the figure will double by year's end.

But there can be no doubt that Fleming needs something more than symbolism, no matter how important it might be. The wholesaler's top line has slumped from $16.5 billion in 1996 to $14.6 billion for its most recent full fiscal year, ended in December. In 1998, Fleming's loss was $510.6 million. That loss narrowed to $44.7 million in 1999. The loss continued through Fleming's first quarter of this year, amounting to $26 million, on sales of $4.4 billion, although without costs associated with its strategic plan, net income of $12 million would have been obtained. During Fleming's second quarter, results of which were issued last week, the loss amounted to $13.3 million, again the effect of strategic-plan charges. Sales were $3.4 billion. Excluding plan charges, net income was $14 million. For more on Fleming's second quarter results, see Page 8. Moreover, Fleming still faces a class-action suit from a group of independent stores in Salt Lake City. The suit claims Fleming overcharged for goods. Fleming has long been plagued by a string of such suits. Hansen said of the lawsuit that "we will aggressively defend ourselves."

On a brighter note, the equity markets seem to be giving Fleming some credit for solving such problems. During the first calendar half of this year, Fleming's stock rose more than 27%, according to a study of industry equity values published in SN July 17.

Edward F. Comeau, a securities analyst at Donaldson, Lufkin & Jenrette, New York, told SN that "Fleming has a lot on its plate and a lot to fix up. Anything Fleming can do to help with the fixup is good -- and that includes leaving retail for another day. The real work is to stabilize the wholesale side of the business.

"The issue facing all wholesaling -- not just Fleming -- is that business is driven by the retail-customer base. The larger and more successful retail customers tend to become self-distributing, or are bought up by chains. We see it all the time; wholesalers have real issues."

But there is undeniable and much needed symbolic upside in Fleming's new offices in this quickly developing Dallas exurb not far from the Dallas-Fort Worth Airport. Indeed, the space here couldn't be much more different from the Oklahoma City headquarters it left a month ago. That office building was an opulent, multifloor arrangement dominated by a dynamic staircase driving into a soaring atrium. It was said to be among the highest-rent spaces in all of Oklahoma.

Fleming's new headquarters -- the term of choice is "customer-support center," not headquarters -- is little more than a white, one-deck slab set into a vast parking lot. Inside, much of the building is an unrelieved open-cubical area teeming with clerks. There's a spacious cafeteria that provides demarcation between the open-seating area and the executive wing. The latter is characterized by unusually modest offices adorned by maybe a meeting table and not much else.

"Anyone looking at this complex will see it's serviceable and pleasant, but also as projecting a spirit of thrift," Hansen told SN during the interview at the new office. "We promise that the air conditioner will work and the roof won't leak. And, it's a fine place to work and very much in character with the margin structure of the industry.

"But the most important thing about this office is it represents the end of a top-down leadership style for the business. This is called a customer-support center. It shows that we really have made substantial progress within the business of converting the management environment to a servant-leadership style."

Servant leadership? "We think of that management style as an inverted triangle; the consumer is at the top, next are the stores serving the consumer, then come the front-line Fleming people serving the store, then the backstage Fleming people serving the front-line people, then, eventually, comes the customer-support center, which is foundational support for the entire system.

"The primary responsibility at the customer-support center here, aside from executive leadership, is those activities that drive success for our retailers. They include procurement, marketing, logistics and those kinds of activities."

Hansen said, though, that an administrative-support center will remain in Oklahoma City, which will operate functions such as accounting, systems and systems development. The group won't be in the old headquarters building there, but located elsewhere.

The plan behind the administrative centers here and in Oklahoma City is to relieve Fleming's distribution divisions of the energy they previously spent making backstage business functions run, functions such as accounting, human resources, systems, real estate and construction. In place of that, energy can be poured into being merchants, supporting stores and building the business, Hansen said.

But what's the real plan to restore the financial vitality of the long-stumbling Fleming? "We're moving through the process," Hansen said. "Last year at about this time we were knee-deep in an asset-rationalization process aimed at getting productivity straightened out. We've achieved dramatic metrics in that time. On average, the volume per distribution center, or as our lingo is, 'product-supply center,' has gone from $390 million to $589 million. At $390 million we were about industry average, so that's a dramatic leap in productivity.

"And, a year ago we had no PSC achieving $1 billion run rates; we now have four, or will have soon," he said. The two distribution centers now at the $1 billion rate are Northeast, Md., and Massillon, Ohio. By year's end, Phoenix and Fresno-Sacramento are expected to hit the mark. (Distribution centers in Fresno and Sacramento are operated under a common headquarters.)

"At about this time last year, as we walked into the business, it was a post-merger integration that never happened. It was a holding company that had some level of corporate activity, but the reality of it was that we had a collection of $390 million or $400 million divisions that didn't synergize on behalf of our stores, our shareholders or our people.

"So by now we've made substantial progress in improving the asset productivity of the business, and not just on the volume side; the average productivity of our hourly work force in the PSC has risen in the same time period by 8%. We have real throughput productivity gains," Hansen concluded.

Much of the sales and productivity gains have come about because of an asset-integration process undertaken after Hansen's advent at Fleming. That has involved the reduction of the net number of full-line distribution centers from 33 to 22 and the addition of one convenience-store center, from two to three. The number of general-merchandise and specialty-food centers has remained stable at six. So, there has been a net reduction of 10 distribution points.

Hansen maintained that the sales and productivity gains are far more than just a reduction in distribution points, though: "Increased productivity is a function of two things: It's a consolidation process and it's a sales-development process. We've had some exciting revenue growth over the past number of months. Last year, on a net-net basis, we layered on $1.4 billion in new distribution business. This year, to date, we've layered on $680 million in new distribution business, also on a net-net basis." (Fleming's top line continues to slump because this volume growth is in distribution. Corporately owned retailing continues to pull down the overall top line.)

But, said Hansen, "No matter how you cut it, in about 18 months, we added a good-sized company to what we do because of our aggressive approach of saying, 'we must make the supply chain more competitive to support our retailers.' The rewards are the ability to grow distribution in an environment that many didn't think could support growth. In terms of the throughput volumes, the metrics in this business revolve around super-regional distribution, which really lend themselves to very efficient operations. And if you layer that much new volume on, the ability to gain productivity is magic."

The top-line drag represented by Fleming's corporately owned retailing explains one of the most dramatic moves undertaken by Hansen during his brief tenure, namely the decision to sell most of Fleming's conventional supermarket assets, and to roll out hundreds of Food 4 Less price-impact warehouse stores.

The plan to dispose of retail assets flies in the face of conventional wisdom in wholesaling, which is that wholesalers should gradually build the proportion of revenue generated by corporately owned wholesaling. That tack is being taken by Fleming's two chief competitors, Nash Finch Co. and Supervalu. The latter, though, has stated intentions to focus added energy on price-impact retailing, but has signaled no intention to attenuate corporately owned conventional retailing.

Fleming's supermarket assets are considerable, representing in excess of 160 stores under banners such as Rainbow Foods (42 stores, Minnesota); Baker's Supermarkets (Nebraska, 16 stores); Sentry Foods (Wisconsin, 34 stores); Abco Desert Market (Arizona, 56 stores); and Thompson's Food Basket (Illinois, 13 stores).

Why jettison such stores? To Hansen, they represent mid-market assets that are fated to experience declining sales unless they are propped up by costly additions, such as fuel sales, pharmacy and nonfood. Indeed, Hansen predicts that such stores will see sales declines from center store of up to 12% in the next five years as consumers drain dollars toward alternate formats. He acknowledged that the hand of supercenter rollouts is involved in the decision to exit conventional stores since the entrance of a supercenter into a local market often results in a 10% reduction in conventional-supermarket sales. "We are in the process of pursuing strategic alternatives for our conventional supermarkets," Hansen said. "And one of those may lead to the disposition of those stores. That process started in 1999 with a very careful study. The conclusion that leadership and the board came to, and one we really believe, is that in a market like food retailing, there's basically no growth available."

So how can growth be achieved?

"There are two winning strategies," he said. "One is to aggregate volume and become a consolidator. Kroger, Ahold, Albertson's, Safeway and others are able to drive earnings growth for their businesses by buying other business, shedding duplicate costs and driving earnings. That's fine.

"On the total other side of the spectrum are in-market high-quality [independent] operators who run with their hands on the throttle, right there with their customer. They do well.

"The 'tweener,' or in-between, position [conventional supermarkets] are vulnerable because they have the cost and complexity of the big guys, but without the scale."

And, Hansen acknowledged, the "tweener" position is where Fleming's conventional-store assets sit, so a sales process expected to culminate in upcoming weeks was initiated. Perhaps signaling the seriousness with which Fleming views this asset disposal, Hansen acknowledged that stores may be sold without regard for whether Fleming retains the new owners' distribution business or not: "At the end of the day we have a fiduciary responsibility to maximize the position for our shareholders, whatever that means."

Then, energy will be plowed into building the Food 4 Less business.

"Food 4 Less is a price-impact, food-warehouse shopping experience. It's not a grocery store, not a supermarket. It's a highly differentiated format. We like Food 4 Less for a lot of reasons: It's a high-volume store; it can be franchised extremely well; in fact, half the [26] Food 4 Less stores in our system are franchised. It's a highly differentiated store, which draws from a large trade area by focusing on consumers who look at price as being the most important aspect of shopping."

The executive in charge of Food 4 Less development is Dennis C. Lucas, the newly hired executive vice president of the Fleming retail group. Lucas was also interviewed by SN here.

Lucas asserted that Food 4 Less "is a very exciting proposition, which represents a exciting future."

"We're literally restructuring our past focus on conventional retail. We think the future is in price-impact retail. So we're moving to that. We're going to take our small group of 26 stores we have currently and will build that to a chain of in excess of 500 stores in about 10 years.

"We've put the business model together and we're in process of starting the rollout. "We're concentrating on leveraging the core competency we have of good case pick, good piece pick and delivering the goods. This gets back to our strength with the center of the store."

Lucas joined Fleming less than a year ago after a 27-year career at Albertson's.

Another major aspect of Hansen's change agenda for Fleming has been to launch an unrelenting cost-abatement initiative dubbed "low-cost pursuit."

"Low-cost pursuit is the internal label on what is an enterprise-wide attack on what we call 'non-value-added costs,' and we've made a very specific distinction between value-added and non-value-added costs.

"Last year we stripped out about $50 million in system costs. This year, by the fourth quarter, we will achieve $100 million in cost reductions. The benefit of the asset-productivity improvements and the drivedown of costs is to make the supply chain we represent much more competitive."

So what are these non-value-added costs that are melting away?

Hansen offered these examples: "Office supplies. We bought office supplies from everybody and now we have a national contract. The same with telephone contracts and what we pay for diesel fuel. And, of course the Waterford complex in Oklahoma City [the former headquarters].

"We've put an evergreen process into the business to just aggressively and tenaciously attack these costs on an ongoing basis. I'm really pleased at the quality of the work of the group. What happens when you start a process like that is that it ingrains itself and people start finding other things, and people on the front line, who really know what's going on, start to say, 'here's something we can do because the company is really serious about thrift and wants to operate in an environment that takes out costs that add no value."'

Another aspect of Fleming's new customer-support center is that it represents a substantial move to centralized buying, Hansen said.

"We are, rough and tumble, about halfway done with centralized buying," Hansen said. "Basically, we're done with perishables and about 40% done on nonperishables. The process should complete itself by early fall, and we're on the timetable.

"That will allow us to buy about 60% of the merchandise we sell out of Lewisville, and about 40% will still be bought in market. In food, it's our philosophy there are some brands and products that transcend all geography, but some just don't. Bratwurst is relevant to Wisconsin, not Louisiana. Beans and rice aren't really relevant in Wisconsin, but you had better have that program understood in Louisiana. So we've looked and carefully dissected those parts of the business that make sense to leverage."

Finally, there's a new emphasis at Fleming on making it a good place to work. Spearheading that effort is Scott M. Northcutt, Fleming's executive vice president of human resources, and the company's head cheerleader. Northcutt joined Fleming about 18 months ago from Sam's Club, the subsidiary of Wal-Mart Stores of which Hansen also was an executive. Northcutt was interviewed here by SN.

"Our goal is to over-communicate with our people," he said. "Fleming, in the past, as I understand it, didn't spend a lot of time communicating.

"We've started a new theme for communication we call 'GP3.' That means that Fleming is a great place to work, a great place to trade, and great place to invest. That moves us toward our mission, which is simply to buy and sell merchandise. That means we're more than food wholesaling. Any product that will go through a distribution center we'll buy and sell. That opens up the whole world to us.

"Our values include that we want to share these goals with people and put them on the performance reviews for how they achieve them. We also want people to have fun, and we'll measure people according to how much fun they have, and how much fun their team has.

"That makes this a great place to work, but the overall topside view is we want to create guardrails to lead people toward our vision, mission and values. There must be a few policies and a few rules, but the emphasis is on a few. We want guardrails instead that will let people figure out how to get to the destination by whatever means that are legal, ethical and moral.

"It's amazing what will happen when you give people that kind of freedom. Look at what this company has gone through in the last year financially, operationally and culturally. But we started from deep within our own end zone last year, so there was a lot of opportunity."