SEMINAR: ACTIVITY-BASED COSTING FOR FRESH MEALS

JENNIFER QUAIL

NEW ORLEANS -- Retailers who operate delis and fresh-meals departments must develop a reliable method of analyzing the total cost of manufacturing the finished product.

During a seminar at Dairy-Deli-Bake '99 last month, consultant Rick Spaulding of The Hale Group, Danvers, Mass., addressed the benefits of implementing such a practice, called activity-based costing. He also provided an overview of the current food-service sourcing options that affect pricing, profit and margin expectations.

Spaulding based his remarks on the results of "Building a Meal Solution Delivery System," an industry study published in 1998 by the research firm in conjunction with the Coca-Cola Retailing Research Council. The purpose of the study was to determine the most cost-effective method for food-service product procurement, establish accepted best practices and define operating practices and systems.

The study found most operators are unaware of the potential pitfalls that lurk in supermarket food service and are struggling to capture the meal-solution opportunity. Spaulding attributed this situation to lack of a good example.

"You can't really name a retailer who has had both operational and financial success in this [food-service] category," he said. "A lot of times it's trial and error. You put a new program in, and if it's not successful within six months, you pull it out."

He cited recent talk in the industry of cutting back in the food-service area, once thought to hold enormous profit potential, in favor of focusing more on a whole-store approach to selling existing items under different merchandising strategies.

"We have seen many of the once leading [food-service] retailers taking a step back from the complexities of food service and getting back to a more retaillike system," he said.

"Much of the potential profitability is being reduced by poor performance in four main cost areas. They are food cost, labor cost, wrap cost and shrink cost," he added.

Specifically, The Hale Group found that food cost runs in excess of 40% of sales, labor cost is currently approaching 35% and rising, up to 10% for wrap cost is common and shrink cost is typically more than 10% before merchandising.

"There's not much room left for profitability," Spaulding said.

In a follow-up interview with SN, Spaulding said these numbers were probably lower than those found in the industry as a whole, because they were taken from the study group of 12 supermarket operators who were considered to be retail food-service leaders. According to Spaulding, all operators developing food-service concepts can control these numbers better if they address each of the four main trouble areas.

"Any one area can impact the others," said Spaulding. "A reduction in labor may have a dramatic impact on shrink; a recipe change may impact labor cost. Each one impacts the others, and so a total analysis is needed."

Food cost, he said, incorporates sourcing and shelf life, production requirements, storage, and cross-merchandising potential. Spaulding encouraged food-service operators to examine the cost of core ingredients for a given menu item, the store's ability to leverage its buying power when securing those ingredients, the potential for recovering food cost via pricing, and the sensitivity of a given recipe to consistency from batch to batch.

Labor costs are affected by the labor market, the skill level of staff members, local competition, and service and menu requirements. According to Spaulding, key points when examining labor are whether the store has the food-service expertise to create an item, whether the department can afford the required labor, whether sufficient supervision can be provided, and the potential to price the item at a level that will recover labor costs.

Multiple handling, labeling, shelf life, portability and convenience all play a role in wrap costs, Spaulding said. This area presents difficulties, because operators often misunderstand the multiple packaging required for many of their items and forget that labor and material costs must be incorporated here as well.

He also warned retailers that shrink can occur during each of the major production stages. Shrink, he said, incorporates consumer demand and inventory control, production requirements, shelf life, and the skill level of staff members.

"On-site production will inevitably lead to production shrink," Spaulding said. "This shrink needs to be controlled."

He stressed the need to monitor receiving, assembly, cooking and packaging shrink, in order to control and reduce production shrink.

An alternative to on-site production -- one of the most aspired-to options for food-service operators -- is outsourcing, where retailers turn to either a commissary or a manufacturer to produce foods that may be too costly to create in house.

Spaulding cited the commissary as having numerous advantages. It offers consistency in availability and lowered shrink, eliminates the need for in-store production labor, provides ordering flexibility and inventory management, and reduces the need for store-level production equipment and space, he said.

However, while some retailers already operate their own commissaries, The Hale Group warned that central kitchens are not a panacea.

"Food-service volume is so low with regard to overall sales that it doesn't warrant the expense of a new facility," said Spaulding. "The information found in our study is based on the use of an independent commissary."

The study found manufacturers can also eliminate scratch production, reduce equipment space, improve product consistency and minimize inventory shrink. However, according to Spaulding, manufactured products typically carry higher distribution costs and are hampered by a uniform appearance, with no room for customization.

And while national names might spark brand recognition among shoppers, they can endanger the very profits retailers are hoping to build, since consumers might consider the brand more of an "industrial product" (rather than in-store fresh), a perception that will force down the price and, therefore, profit margins.

"Quality perception may be lower [for manufactured products], resulting in lost sales and higher shrink for food-service products," Spaulding said. "Pricing strategies may also be impacted due to the lower perceived value."

Spaulding urged retailers to conduct a thorough cost analysis for each food-service item on their shelves. It is the only way, he said, to determine the appropriate solution for a department. Since the survey, he added, many chains have gotten away from scratch production in food service due to the high operational costs.

"Food-service items require an integrated cost approach to determine sourcing strategies," Spaulding concluded. "A total cost analysis will provide the retailer with the facts he needs to be successful."

While many retailers continue to alter their in-store food-service program, Spaulding foresees a change in the workings of the food-service industry as a whole.

"I think the supermarkets will move back to being more retailers than food-service operators," he told SN. "We'll see more operations like the EatZi's chain, and others designed specifically for this purpose."