THE CO-OP SOLUTION

MARK HAMSTRA

These are not your grandfather's co-ops.

Today's retailer-owned wholesaling cooperatives have more power and influence than ever before, and are leveraging them to expand operations and modernize infrastructures.

The disappearance of Fleming Cos. from the grocery-wholesale landscape last year drove an influx of new membership for many of the nation's cooperative wholesalers, bolstering a segment of the food distribution business that has periodically been written off as antiquated or unsustainable.

Nine of the 10 largest wholesaling co-ops, which are owned by the independent retailers they supply, saw an increase in revenues last year, according to data released this month from National Cooperative Bank, Washington (see The SN List on Page 21). Much of those gains could be attributed to Fleming's disappearance.

"You hated to see a great company like Fleming go out of business, but I think it was beneficial for the retailer-owned channel," said Richard Parkinson, president and chief executive officer, Associated Food Stores, Salt Lake City.

AFS was one of the prime beneficiaries of Fleming's implosion after Fleming shuttered its Salt Lake City warehouse. Other co-ops that realized substantial gains from Fleming's disappearance included Associated Wholesale Grocers, Kansas City, Kan.; Associated Grocers of Florida, Miami; Associated Grocers of Louisiana, Baton Rouge; and Affiliated Foods, Amarillo, Texas.

The infusion of new membership helped strengthen those companies' operations, but most of them had already been on a growth trend. Over the past several years, co-ops have become more powerful through consolidation and competition with well-financed national chains.

"About 15 years ago, there were about 50 co-ops in the grocery field, and now there are about 23," said Barry Silver, managing director, National Cooperative Bank. "The ones that are left today are much stronger than the ones that were around 15 years ago."

As evidence of their strength relative to decades past, Silver said NCB, which is itself a cooperative that is owned by its customers, now has lending relationships with almost all of the grocery wholesaling co-ops and many of their members, while 15 years ago there were several co-ops that the bank considered to be too high a risk for loans.

"We are very focused on making the co-ops succeed, and that means not lending to co-ops that we shouldn't be lending to," he said.

The co-ops have evolved from a disparate patchwork of territorial fiefdoms into stronger, regional operators serving large chunks of territory and often operating out of several warehouses. Industry observers said these companies are operating with relatively low debt levels and are providing services for their members that are helping make independent retailers more competitive.

"I think it's interesting that every decade or so, we hear about the demise and the elimination of the cooperative structure in the U.S., just as we've heard about the demise of the independent or the demise of the regional wholesale distributor. Yet these entities continue to flourish," said Tom Zaucha, president and CEO, National Grocers Association, Arlington, Va.

He said that over the years, retailer-owned wholesalers -- a term many in the industry prefer to "co-op" -- also have changed their ownership structures so that individual members have a greater stake in the performance of the wholesaler.

"They've changed their structure to one that allows more infusion of capital into the growth of the total entity, both retail and distribution," he said.

Recent large-scale investment initiatives in technology and new warehouses by many of the co-ops reflect these companies' more sophisticated approaches to the food distribution business.

"Everybody is getting better at delivering a lower cost of goods for our members," said Rob Winett, vice president, marketing, Associated Wholesalers, Robesonia, Pa., which recently upgraded its logistics systems (see SN, Oct. 18, 2004, Page 73). "We are all doing things to become more cost-efficient. If you can't deliver a low cost of goods for your members, they are going to go to another wholesaler."

Zaucha agreed that competition has forced retailer-owned wholesalers to modernize their business structures.

"Thirty years ago, I would describe many of their cultures as being entrenched," he said. "You had a lot of feudal lords. It was a period of protectionism. There was kind of an unspoken word that you had your regional turf, and there was not a lot of interregional competition between retailer-owned companies and other wholesale distributors."

Now, he said there is much more competition, not only among cooperative wholesalers themselves, but between co-ops and voluntary wholesalers, and between their members and nontraditional operators like Wal-Mart Stores, Bentonville, Ark., and dollar stores.

At the same time, however, he said the growth of institutions like NGA -- whose members include both independent food retailers and the wholesalers who serve them -- and other institutions like NCB and the Retailer Owned Food Distributors Association, Birmingham, Ala., have been instrumental in helping these organizations become more competitive. In addition, he said the ability of co-ops around the country to collectively manage joint private-label programs -- such as Topco Associates and Western Family Holding Co. -- has let co-ops offer better pricing to their members.

"In terms of their buying practices, this has made them very competitive," Zaucha said, adding that the pooling of resources to share technology also has been advantageous for the retailer-owned wholesalers (see related story).

Financial Commitment

According to Silver of NCB, co-ops have also adopted a financial structure that helps them retain retailers by requiring a deeper commitment on the part of members.

"Historically, the cooperatives have allowed retailers to pull their capital out very quickly and leave the co-op at any time," he said. "The theory was that if members knew they were allowed to take their money out, they would be more likely to stay with you."

The reality, however, was that if a couple of large members left a co-op -- as was the case with Twin County Grocers, an Edison, N.J.-based Foodtown cooperative that went out of business in 1999 -- the co-op can suddenly be left with a sprawling distribution infrastructure, but not enough revenue to support it.

During the past 10 to 15 years, many wholesaling cooperatives have adopted a strategy in which they require members to receive their patronage dividends -- their share of the warehouse's profits -- in the forms of both cash and warehouse stock.

"It may appear on the surface as though that's less beneficial for the independent because they are not getting as much cash back," said Silver. "But in return for continuing to invest in the cooperative, the retailers are getting better services and stronger management teams because they are working with warehouses that are much better capitalized."

He said the 2002 acquisition by Elizabeth, N.J.-based Wakefern of Big V, its largest member, illustrated this principle. Both Wakefern and Quincy, Mass.-based Stop & Shop -- the latter in partnership with Pathmark, Carteret, N.J. -- offered to acquire Big V out of bankruptcy, but the exit fee Big V would have had to pay to leave the Wakefern cooperative was prohibitive. Wakefern, parent of the Shop-Rite cooperative, said at the time that it believed the exit fee would be about $300 million, or nearly double the price of the Stop & Shop-Pathmark offer.

"What essentially happened was that the membership agreement between the cooperative and the member prevailed," said Silver. "That agreement effectively said that if you are going to be a member of this co-op, the financial institutions that are supporting the co-op want you to stay as a member so you can't just pick up and leave after we've invested millions of dollars in capital improvements."

Reaction to Fleming

Independents left without a source of supply by Fleming's disappearance sometimes turned to co-ops because they wanted to have more control over their supply chain, while for others, there were few other choices.

"Frankly, in our market there weren't a whole lot of alternatives available to them," said Parkinson of AFS. "Fleming and Associated represented their two alternatives for source of supply."

Calvin Miller, president and CEO, Associated Grocers of Florida, said his co-op also picked up several new members who had no other alternatives.

"We picked up a lot of customers in Miami, in northern Florida and in the Caribbean," he said. "Fleming was my main competitor down there, and when they walked away, a lot of people came to us."

He said many of the former Fleming customers started out with AG of Florida as contract customers to "test the waters," but most of those have become full-fledged members.

J. Ferrell Franklin, president and CEO, ROFDA, said that in the chaos that accompanied Fleming's free fall through bankruptcy, retailer-owned co-ops were basically able to take on as much business as they wanted.

"We had a couple of members who took a back seat to this, thinking that they would not be able to handle the new business effectively while serving their existing members," he said. "But a majority of them pretty aggressively pursued the business, and the majority of them have done extremely well."

In fact, he said, many co-ops became much more selective in the wake of Fleming's implosion and actually turned away potential members.

"There was a lot of business available, and there were probably some retailers that would not have made good members because of the logistics involved with serving them or because of their balance sheet," he said.

Silver of NCB agreed that as the co-ops have become stronger, they have been able to be more selective about whom to accept as members -- which has led to the creation of stronger organizations overall.

"It used to be that the co-ops would take anybody," he said. "Now it's the stronger independents that are going with the stronger co-ops. There's no way that an independent grocer, without having a strong supply chain, can compete."

Cleaning Up in Florida

Co-op executives said the disappearance of Fleming gave many independents reason to want to have a stake in their wholesaling company.

"Whoever thought Fleming was going to go down?" asked Miller of AG of Florida. "Those people have learned a lesson -- that it's better to be a part of something."

He said AG of Florida added about 60 new members because of Fleming's implosion, about half in the mainland United States and the other half in the 42 Caribbean islands where it does business. It acquired one of Fleming's former warehouses, near Miami, which it now uses to serve the new membership. The new facility, located about seven miles from the company's headquarters warehouse, provided for the expansion the company needed. It now has about 1.5 million square feet of warehouse space.

AG of Florida serves 245 members altogether, and it generated $420 million in sales in 2003, up 8.5% over the preceding year, according to data from NCB. According to Miller, volume this year is up 127% in the company's Ocala, Fla., warehouse, most of which is former Fleming business.

The company also became an IGA distributor because of Fleming's exit from the market, and Miller said some members are switching to that banner.

He said the company had been experiencing steady growth before Fleming went bankrupt, and it continues to add new customers. AG of Florida, he said, now stands as one of the better-capitalized co-ops in the country.

"We own a lot of real estate, and we have no mortgages on any of our properties," he said. "Our members' children and grandchildren will have an income, whether it is in real estate or the grocery business."

Windfalls in the West

The dispersal of Fleming's $20 billion in wholesaling volume among other wholesalers had an even bigger impact on Associated Wholesale Grocers. The nation's second-largest wholesaling co-op -- behind Wakefern, and not counting Topco -- acquired several of Fleming's former distribution centers, leading to an 18.5% increase in revenues in the last year, according to NCB data.

AWG remains in an acquisitive mode, negotiating on behalf of one of its customers for the purchase this month of 16 Winn-Dixie stores in Indiana and Kentucky. AWG also was reported to be negotiating for another 14 to 16 Winn-Dixie stores in the region for other independent customers. AWG declined to comment for this article.

Parkinson of AFS praised AWG's strategic moves in the wake of Fleming's failure.

"Look at [AWG CEO] Gary Phillips and the tremendous things he was able to accomplish," Parkinson said. "He acquired six warehouses and kept four -- he closed a couple -- expanded his nonfood presentation and got into a couple of different markets."

AFS itself was one of the first of the co-ops to reap the benefits of Fleming's implosion, as Fleming began shutting down its Salt Lake City warehouse shortly before it filed for bankruptcy in April 2003.

Associated added about 25 customers that had been customers of Fleming, which brought its member base to about 420 members at the end of its fiscal year in March. It also supplies more than 100 stores on a contract basis throughout its eight-state operating region.

One of the biggest challenges in absorbing the new members, Parkinson said, was the fact that longtime customers lost one of their key points of differentiation against competitors -- the Western Family private label. Western Family, based in Portland, Ore., and owned by five regional wholesalers, had provided AFS members with a key point of differentiation against customers of Fleming, Parkinson said.

Although AFS still competes as a wholesaler with Minneapolis-based Supervalu in Montana, where both companies have distribution facilities, the only other major competition the company faces is with other retailer-owned cooperatives along the edges of its operating areas. Supervalu pulled out of Colorado as a supermarket wholesaler last year.

AFS recently opened a new, 1 million-square-foot warehouse in Farr West, Utah, which has greatly increased the company's efficiency and reduced the number of mispicks and damaged cases, the company said. It processes more than 178,000 cases per year from the new facility.

Parkinson agreed that in today's competitive environment, efficiency is the cost of entry into the wholesaling arena.

"Really, it has become a cost-of-goods mentality [among potential independent customers]," said Parkinson. "We are working on a model or an economic system that will give us the lowest possible cost of goods. We try to drive that more so than a rebate mentality."

The company is also looking for ways to help its retailers differentiate themselves by focusing on individual market needs. AFS has spent most of this year analyzing each of the 140 markets where its customers operate in an effort to develop individualized marketing plans for the retailers in those areas.

"We're doing a detailed analysis of the demographics of those markets, looking at what the competitive influences are in those markets, and trying to find the seams of opportunity for our retailers."

Second-Hand Benefits

While many retailer-owned distributors benefited directly from the disappearance of Fleming, others were able to capitalize on the shake-up that followed.

Associated Grocers of New England, Manchester, N.H., one of the smallest co-ops in the country, lost one of its main competitors when Supervalu pulled out of the region as part of an asset exchange with C&S Wholesale Grocers, Keene, N.H., which acquired much of Fleming's business.

"It helped us in a back-door way, in the sense that it removed a wholesaler from the market," said Mike Bourgoine, CEO, AG of New England. "C&S was already here."

In addition to C&S, AG of New England continues to compete against Bozzuto's, another voluntary wholesaler, based in Cheshire, Conn.

"I think the co-op model is attractive today to the independent retailer because of the consolidations they've seen and the disruptions in the supply chain on the wholesale side," he said. "They want a secure source of supply, and what better way to get it than to be one of the owners of a distribution center?"

Bourgoine said AG of New England has had consistent growth of about 5% to 10% every year for the past 10 years, and now generates about $270 million per year in revenues and has about 170 members, up from an estimated 120 five years ago. The company has plans to relocate into a brand-new, 350,000-square-foot distribution center next year in Pembroke, N.H., about 20 miles north of its current headquarters and DC, which measures 240,000 square feet.

"We've grown to the point where we actually feel the need to invest in a new facility," he said. "We cannot expand our current facility -- we're bursting at the seams.

"It will have a lot of advantages over our current building, which was built in 1955," he said. "A lot of what we're working with is 1955 technology and efficiencies."

The new warehouse, scheduled to open in about a year, will have higher ceilings, wider aisles, larger docks and more doors, in addition to more advanced systems, he said.

"It will put us in position for substantial growth in the future."