RATIONALIZING THE VOLUME 2004-06-28 (1)

ELLIOT ZWIEBACH

The fallout from Fleming's collapse a year ago is still unsettled and in play, though most of the volume has been dispersed for the time being among an array of other wholesalers, industry sources told SN.

Some of that volume is still up for grabs, several wholesalers pointed out, though it may be years before it finds a permanent slot in someone's warehouse. For now, some wholesalers are still assessing their capacity, and as short-term contracts come up for renewal, retailers will evaluate their distribution service levels and costs.

The amount of volume available is uncertain, however. By the time Fleming got out of wholesaling last summer, its volume had fallen from close to $16 billion at the outset of 2003 to something closer to $6 billion as service levels dipped, distribution centers closed, and retail customers scrambled to find other sources of supplies (see Page 20).

For just a moment last year, C&S Wholesale Grocers, based in Keene, N.H., thought it might be able to acquire most of what was left and become a national player. Yet with so many Fleming distribution centers shuttered and their volume spread out in several different directions, C&S decided to sell off most of Fleming's assets after it acquired the company in August and wait for another day to expand its base.

As a result, when the debris from Fleming's implosion cleared, nearly $4 billion of its remaining volume ended up with three leading wholesalers -- C&S, Supervalu and Associated Wholesale Grocers -- while the rest went to a number of medium- and smaller-sized players.

"It's been a big boon for smaller wholesalers around the country because a lot of retailers are finding they like being serviced by these smaller wholesalers, and service levels have increased, so it's a win-win for everybody," David Livingston, managing partner at DJL Research, Pewaukee, Wis., said.

However, some of that volume that's been won remains in flux, industry observers indicated.

"The perception is that the Fleming 'sweepstakes' ended when contracts were signed, but that's not the case," Ron Marshall, chief executive officer of Nash Finch, Minneapolis, said. "Opportunities to pick up business still exist.

"Although many of those contracts were for five, six or seven years, the average length is three years, and as they come up for renegotiation, that will provide an opportunity for us, as well as other wholesalers, [to add new business] over the next few years."

According to Gary Phillips, president and CEO of AWG, Kansas City, Kan., "Several Fleming customers left to go with other suppliers before C&S purchased Fleming, and some of those might like to come back to the warehouse that was serving them or else they might want to be part of a cooperative distribution system and own a piece of their own warehouse, and we're picking up some of those customers every week."

Chuck Cerankosky, an analyst with McDonald Investments, Cleveland, also said he believes the former Fleming volume is still in play. "Fleming went down rather quickly, and a lot of retailers were looking for backup suppliers. However, because their negotiating strength was limited at that point, many of them signed supply agreements with those backups, but some of them are now willing to explore other options and possibly looking for a better deal if there's one out there."

Yolanda Scharton, vice president, corporate communications and investor relations for Supervalu, Minneapolis, said the issue of market rationalization may provide additional opportunities, noting the problems which brought Fleming down are still in play and could threaten some of the volume that went to other wholesalers.

"There's a lot of capacity floating around out there from Fleming that still has to be addressed," she told SN. "Some of the Fleming volume just evaporated or moved to self-supply, but there's going to be a delayed reaction in resolving some of the irrational approaches in place when Fleming was around, and that's part of the microcosm that's playing out in the marketplace for the excess capacity that hasn't been rationalized."

C&S has been a clear beneficiary from Fleming's shutdown of its wholesale business even after cutting deals with Supervalu; AWG; Grocers Supply, Houston; Associated Grocers of Florida, Miami; and Associated Grocers, Baton Rouge, La. (see "Repackaging Fleming's Assets," Page 18).

C&S added about $1.7 billion of volume -- $1 billion from the 1,000 former Fleming retailers it added on the West Coast and $700 million in New England after its swap with Supervalu, according to Mark Gross, executive vice president for C&S.

Gross acknowledged there was some initial apprehension among some West Coast independents that C&S had limited experience with independent operators, "but I believe most of them feel good about the transition today," he said.

"I think they've found in us a group that's very willing to listen to their advice and suggestions. We realize we don't have all the answers to every question, but we are willing to listen and work with the independent retailers to understand what they need, and as a result, they're willing to work with us."

Before the Fleming acquisition, C&S was doing $10 billion in sales with chains and less than $1 billion with independents, Gross said. Its independent business is now approaching $2.5 billion -- about 20% of the $13.5 billion sales volume it will do this year, he said.

Bicoastal for Now

According to Gross, C&S is content for the moment to be a bicoastal wholesaler, though it hasn't given up its hopes of becoming more national in scope.

"If you had asked us what role we would like to play in the national supply chain, the next market we would have picked after the Northeast is California," Gross said. "When you look at the major population areas in the country, the largest population is in the Northeast and the second-most-populous area is California.

"California is a very exciting market for us. The customer base there is very vibrant and very food-focused, with both retailers and consumers willing to experiment and try new things."

Gross said C&S would still like to be the nation's leading wholesaler, "with a broader distribution base supplying customers throughout the U.S. At this point, however, we are making improvements in our operations in the Northeast and California, though we continue to be interested in looking at opportunities across the country."

As it seeks to expand, however, "our preference is not to take any business from the [five] companies with whom we did transactions," Gross said.

To determine how much business those companies and others picked up following Fleming's collapse, SN talked with several of them, including the following:

AWG, which picked up 480 new customers that boosted volume by $1.25 billion, according to Phillips. The deal also included six Fleming distribution centers, of which AWG kept three, closed two, and sold one.

In the process, the cooperative picked up members in nine new states: Alabama, Louisiana, Mississippi, Tennessee, Georgia, Kentucky, Virginia, Ohio and Indiana.

"Our board consists of independent retail operators who felt strongly there were some great independent operators in those states who could be very successful if given the opportunity to work with a viable co-op," Phillips explained. "Those retailers had dealt with an onslaught of heavy competition for 15 years and poor service levels and inadequate quantities for several months, and they were real survivors."

Of the three distribution centers AWG kept, the facilities in South Haven, Miss., (a suburb of Memphis, Tenn.,) and Nashville, Tenn., remained open as full-line grocery operations, while it converted a nonfood facility in Memphis into a warehouse for specialty foods (a new category for the company, Phillips said), dollar merchandise and general merchandise.

The warehouse transitions were "remarkably smooth," Phillips said. "Both grocery warehouses were good, well-maintained facilities that required a minimal amount of new software and equipment, and we tripled the inventory in the first week."

AWG transferred the volume from Fleming's Tulsa, Okla., warehouse to its own facilities in Oklahoma City and Springfield, Mo., and the lease on that facility and another one AWG acquired in Topeka, Kan., were rejected by the bankruptcy court. Phillips said the facility in Lincoln, Neb., had a favorable lease, "and we were able to sell it."

Supervalu, which boosted volume by "at least $1 billion" by adding approximately 325 stores in the Southwest, the Midwest and the Southeast, including 47 SuperTarget stores in addition to the 73 it was already supplying, Scharton told SN.

When Supervalu swapped its New England business with C&S for the former Fleming operations in the Midwest, "we actually gave away more volume than we picked up -- we came out of it with a negative $200 million in revenues," Scharton said.

"But this business is not about sales anymore. It's about having a successful business model and an investment in the best supply chain solutions.

"Our goal is to provide a variety of services for our customers. It's not just a matter of shipping product to the back of the store, and it's more than the commodity business that some might think it is."

According to Scharton, other wholesalers picked up distribution centers -- what she called bricks-and-mortar -- along with volume, "but we did not choose to do that. We looked at other [geographic] areas when C&S was parceling off Fleming properties, but we chose not to do those deals because we felt some of that volume was not secure or strong enough with the bricks and mortar attached. We preferred pulling volume into our facilities.

"We knew some of the Fleming volume was at risk, and some of that volume that's been acquired by others is still at risk in some markets.

"Picking up the Fleming business is not just a matter of chasing sales or opening more warehouses -- it's about leveraging your infrastructure, driving costs down and investing cash flow in technology and business-to-business tools. So while we took three warehouses we didn't want [in the swap with C&S], we closed them down, and moved the inventory to our existing facilities. It's about profitable new business, not just assets and revenues -- that's what brought Fleming down."

Nash Finch, Minneapolis, which picked up approximately $200 million in former Fleming volume, including a large portion of Fleming's Kmart business.

Associated Grocers of Florida, which added approximately $200 million from 181 new accounts, Calvin J. Miller, president and CEO, told SN.

AG had to turn down some Fleming retailers looking for a new supplier last summer "because it was difficult to serve our regular members without running into out-of-stock situations, so we took on what we could while some potential customers went to other wholesalers," Miller explained.

"But we've been adding more Fleming business every week, including a 10-store operator just this week who went from Fleming to Supervalu and now to us."

Besides adding customers, AG also picked up Fleming's 170,000-square-foot perishables distribution center in Miami, which enabled it to move perishables out of its own 340,000-square-foot facility there and thus free up enough space to stock $8 million worth of additional dry grocery inventory, Miller said. The acquired warehouse also enabled AG to stock frozen foods for the first time, rather than buying them from a third party, he added.

To accommodate the influx of new business, AG transferred some of its Miami-area accounts to its Ocala, Fla., division, where it operates a 700,000-square-foot DC, "which gave us more room here in Miami," Miller said. The company also had to lease more trucks and hire additional employees to handle the new business, he added.

Unified Western Grocers, Los Angeles, which added about $140 million from 100 former Fleming customers in California and Arizona, Al Plamann, president and CEO, told SN.

"Some of that business came to us before Fleming went out of business, however, and we haven't carefully separated the customers who came to us when Fleming's service levels were dropping and those that came to us after it shut down," he pointed out.

Because Unified added the business over a period of nine to 10 months, there was no strain on Unified's distribution facilities, Plamann said.

He said he believes Unified could still pick up additional customers who were once with Fleming, including some C&S customers in Northern California and some IGA stores in Arizona being serviced by Bashas'. "Those retailers are on our list of potential customers, and we're continuing to try to earn their business," Plamann said.

What's delaying the process in Northern California, he explained, is the question of store leases, some of which had been guaranteed by Fleming. "That situation won't be resolved until C&S rationalizes its business in California or until certain clauses in the lease agreements are exercised or when the leases run out." Plamann said.

"But we're not interested in getting into any legal tussles over leases, so we're not going to pursue it to that length. Right now, the situation is too confusing and too distracting, and that's not the way we do things."

Laurel Grocery, London, Ky., which picked up approximately 100 stores doing approximately $100 million, Jim Buchanan, president and chief operating officer, said.

Laurel Grocery customers were located in Kentucky, Georgia, Indiana and West Virginia. The wholesaler expanded into Ohio and Tennessee to accommodate retailers formerly 0served by Fleming supply centers in Massillon, Ohio, and Nashville.

The company was adding so much new business last summer that it had to put a halt to adding new accounts in September, he added.

"We knew many of the customers coming to us, but we ended up having to put a moratorium on new development because we had reached our distribution capacity and it was beginning to have a negative impact on service to other customers. So we stopped taking new business until we were sure we could take care of each customer," Buchanan said.

At the time it began adding former Fleming accounts, Laurel was operating a 285,000-square-foot distribution center for groceries and perishables; it had already opened a 100,000-square-foot nonfood facility two blocks away, and was in the process of adding 50,000 square feet of additional perishables space, Buchanan said.

Once the perishables addition was completed, Laurel lifted the moratorium and went after additional business, adding eight more Fleming retailers since last fall, he said.

Associated Food Stores, Salt Lake City, which added $75 million to $80 million from 25 former Fleming customers, Rich Parkinson, president and CEO, told SN. He said the company also added Harmon's, a 10-store Salt Lake City-based retailer, early in 2003, before Fleming's collapse was imminent.

The cooperative had no trouble accommodating the new business, Parkinson said, "because our three-year-old distribution center in Far West [Utah] was not capacitized. In fact, the added business made that warehouse more efficient."

Parkinson said Associated's new customers "were grateful to have a place to go, and our top priority has been to help them through this conversion. They were our competitors before, but once they came under our umbrella, we wanted to accommodate them as quickly as possible, and it's worked out extremely well, with very few bumps."

Associated Grocers, Baton Rouge, La., which took on 25 former Fleming retailers in Louisiana, Arkansas, Mississippi and Alabama (a new distribution area for the cooperative), adding about $50 million in volume, J.H. Campbell Jr., president and CEO, told SN. AG also acquired Fleming's Lafayette, La., distribution center, he added.

"But we never go after volume -- we go after independent retailers," Campbell pointed out. "We know who the retailers are in the marketplaces we serve, and we continue to call on them and let them know that if a need ever arises, we are ready to serve them."

AG started prospecting for new business when Fleming's position as a wholesaler became precarious in early 2003, Campbell said, "and we completed the process last June."

However, he said the company has stayed in touch with other retailers in its distribution area, "and we've picked up five or so more Fleming retailers since mid-2003."

Affiliated Foods Southwest, Little Rock, Ark., which added 40 customers in Louisiana, Texas and Oklahoma for an annual volume boost of $35 million, Jerry W. Davis, chairman, president and CEO, told SN.

"We were able to handle the influx of new business by leasing some warehouse space for about six months till we could complete a 40,000-square-foot perishables addition to our warehouse," he said.

Davis said he still sees opportunities to add more former Fleming business, noting his company has picked up three to five additional stores in the last few weeks.

Grocers Supply, which acquired approximately 100 retail stores in Texas and Louisiana and Fleming's former distribution center in Garland, Texas.

Dave Hoffman, senior vice president, sales and marketing, declined to pinpoint the volume the stores added to the company's base. He acknowledged that Grocers Supply had to take the warehouse as part of the retail package, but said the company operated it for only six or seven weeks -- "until we were able to liquidate the inventory out of it," he said -- before shutting it down and servicing the new accounts out of its Houston facility.

Half of the stores it picked up were IGA stores, Hoffman added.

Roundy's, Milwaukee, which picked up 50 customers representing an unspecified number of stores, encompassing multiple-store operators that included Rainbow Foods, Minneapolis-St. Paul, and smaller independents, Robert A. Mariano, chairman, president and CEO, said. He declined to pinpoint the volume Roundy's added in the deal.

Affiliated Foods Midwest Cooperative, Norfolk, Neb., which picked up approximately 25 new accounts.

Martin Arter, president and CEO, declined to discuss how much volume his company added. "What happened to Fleming was not good for the industry nor for the independent grocer," he said. "Our approach was, if a retailer needed someone to service him, we would go ahead, and that's it. We wanted to treat them as we would have wanted our members to be treated if we couldn't service them."

Some retailers who were using Affiliated as a secondary supplier became permanent customers, while others left, Arter said. "Once we became one of IGA's licensed wholesalers, that attracted some retailers to us who wanted to remain IGA operators."

Bashas', Chandler, Ariz., a retailer that used Fleming's wholesale collapse to experiment with food distribution to stores other than its own when 21 IGA operators in Arizona found themselves with no source of supply. Bashas' declined to pinpoint the volume it picked up.

The chain supplies the IGA stores with a full line of groceries, perishables and nonfoods, plus a limited assortment of IGA private label "because we don't have a lot of room in our warehouse for that merchandise," a spokeswoman told SN.

The chain uses a third-party distributor to deliver merchandise from its warehouse to the stores, "and while there are still some kinks and bumps in the process, we have all the necessary processes in place," she said. "It's been difficult for us to supply stores outside our own chain, but the system is working reasonably well."

Of the 21 IGA's Bashas' was originally supplying, five have closed, but six new ones have opened, giving the chain 22 stores to supply.

Where Some of Fleming's Volume Went

At the time Fleming was sold to C&S Wholesale Grocers last August, its volume had fallen from about $16 billion eight months earlier to about $6 billion. SN attempted to determine where that volume ended up, with the following results:

Wholesaler: Volume Added; No. of stores/warehouses added

C&S Wholesale Grocers, Keene, N.H.: $1.7 billion; 1,000 stores

Associated Wholesale Grocers, Kansas City, Kan.: $1.25 billion; 480 stores, 6 warehouses (kept 3, closed 3)

Supervalu, Minneapolis: $1 billion; 325 stores, 3 warehouses (all closed)

Nash Finch, Minneapolis: $200 million; unspecified

Associated Grocers of Florida, Miami: $200 million; 181 accounts, 1 warehouse

Unified Western Grocers, Los Angeles: $140 million; 100 stores

Laurel Grocery, London, Ky.: $100 million; 100 stores

Associated Food Stores, Salt Lake City: $75-$80 million; 25 accounts

Associated Grocers, Baton Rouge, La.: $50 million; 25 stores, 1 warehouse

Affiliated Foods Southwest, Little Rock, Ark.: $35 million; 40 stores

Grocers Supply, Garland, Texas: Not available; 100 accounts 1 warehouse (later liquidated)

Roundy's, Milwaukee: Not available; 50 accounts

Affiliated Foods Midwest Cooperative, Norfolk, Neb.: Not available; 25 accounts

Bashas', Chandler, Ariz.: Not available; 21 stores