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Natural Foods Merchandiser

The future of distribution

The natural products industry is a business whose fundamentals haven’t changed, while the world around it won’t stand still. Nowhere is this more apparent than in the symbiotic relationship between natural products distributors and retailers.

The natural products industry is a business whose fundamentals haven’t changed, while the world around it won’t stand still. Nowhere is this more apparent than in the symbiotic relationship between natural products distributors and retailers.

“Distributors by their nature are tied to the success of their retail customers,” says Greg Leonard, senior vice president of natural food sales for St. Augustine, Fla.-based distributor Tree of Life. “Ideally, all of our marketing programs and business-process improvements should help our retail customers become more successful. We can only be successful if our customers grow and prosper.”

Current circumstances have both strengthened and taxed that relationship, as the turbulent economy, rapidly changing technology and a big industry merger are leading distributors to find new, streamlined ways to get products on store shelves and forge stronger ties with retailers. And retailers, facing challenges of their own, are looking for the best price, reliably stocked inventories, on-time deliveries and attentive service.

As 2010 draws to a close, here’s a look at how changes in the distribution industry are affecting retailers and manufacturers, as well as industry predictions for what’s likely to happen next year and beyond.

UNFI dominates
The world of natural and organic products distribution is dominated by United Natural Foods Inc. Providence, R.I.-based UNFI is expected to post earnings of $1.54 per share on revenue of $3.64 billion for fiscal year 2010. The company carries more than 60,000 natural, organic and specialty products, including personal care and dietary supplements, and serves more than 17,000 customers nationwide from 13 distribution centers–its newest a facility that opened last summer in Texas. UNFI also has a handful of other natural and organic divisions, including a chain of 13 natural products stores in the East.

As Mike Gilliland, head of the Boulder, Colo.-based natural foods—store chain Sunflower Farmers Market and a customer of UNFI, puts it: “They own the business.”

UNFI completed a deal earlier this year to buy SunOpta’s Canadian food distribution group for $68 million. The deal makes UNFI the largest distributor of natural and organic products in North America. And in June, UNFI and natural foods giant Whole Foods Market of Austin, Texas, extended their distribution agreement for an additional seven years.

But despite its apparent lock on the market, UNFI Chairman and Cofounder Michael Funk says the company has no intention of taking it easy. “You work like you’re number two,” he says. Along those lines, UNFI will invest in technological advancements aimed at improving warehouse management, transportation, timely deliveries and inventory levels. That will not only lower costs but also “significantly reduce our mis-picks,” Funk says. “The investment in technology will really take us to the next level.”

He believes that investment, in turn, will help retailers, who want “the lowest-cost, on-time deliveries and the highest product selection. One thing we’re focused on is to ensure the independents stay healthy. They’re still 40 percent of our business. The independents need us to be price-competitive.”

Funk says UNFI’s relationship with its manufacturers is going through “a major shift. We need to help them improve their out-of-stocks, and work together to stabilize our inventories.” UNFI’s out-of-stocks are about 2 percent, but manufacturers average about 5 percent, “higher than it should be,” Funk says. “Everyone loses money when a product is not on the shelves.”

Tree of Life spreads its branches
For the immediate future at least, Funk says UNFI will set its sights on gaining market share. Other distributors are being more aggressive on the merger and acquisitions front, particularly Romeoville, Ill.-based Kehe Distributors, which bought Tree of Life for $190 million early this year.

The deal left some observers scratching their heads over why employee-owned Kehe, which distributes to 15,000 retail outlets in the United States, Mexico and the Caribbean, would buy the larger Tree of Life, which never seemed able to gain a big foothold during the industry’s growth years after some earlier missteps. Analysts say Tree of Life was a drag on its previous owner, the Dutch conglomerate Royal Wessanen, which seemed to ignore the distributor as it tried to divest itself of its North American assets.

Few details of the Tree-Kehe sale have emerged, and Kehe and Tree of Life executives declined to comment for this story.

Consultant Jay Jacobowitz, president and founder of Brattleboro, Vt.-based Retail Insights, says Tree of Life lost market share in the 1990s after switching its focus from natural foods to supermarkets before trying to make a comeback to naturals more recently. Kehe, which is “most at home in supermarket and gourmet,” is a “dark horse,” Jacobowitz says. How well the pairing will succeed depends on how much investment Kehe can put into distribution centers and truck capacity and routes for the naturals business, he says. “By [next spring], we’ll know whether they’ve made a serious effort.” Meanwhile, Tree of Life management, sales staff and services remain in place, which is “a good thing,” Jacobowitz believes.

Summer Auerbach, chief operating officer at Rainbow Blossom Natural Food Markets in Louisville, Ky., says her chain of five stores works with Tree of Life and “nothing has changed. It’s still Tree of Life. It’s a division of Kehe. We have the same sales reps, the same relationship.” Auerbach applauds the deal with Kehe because “it has opened us up to be able to work with another distributor.”

Smaller suit, same material
UNFI, Tree of Life and Kehe aren’t the only games in town. The natural products distribution landscape is dotted with smaller natural and organic and specialty distributors. And they face many of the same challenges as their bigger brothers.

Brea, Calif.-based Nature’s Best serves about 2,000 independent retail customers in the western U.S., Alaska and Hawaii. After “challenging times” the last couple of years, the privately held company is posting double-digit growth, says Russell Parker, senior vice president of procurement and marketing.

“Before Tree of Life left the West, we had to compete with UNFI and Tree of Life every minute. It kept us sharp. Now there’s only one evil empire we have to keep our eye on,” Parker says with a laugh before adding, “We are very sober about UNFI. But because we are so small, we can change instantly.”

That nimbleness has been a big factor for Phoenix-based Sprouts Farmers Market, which has been opening stores at a fast clip. By the end of 2010, Sprouts will have opened 54 stores in four states in slightly more than eight years, says President Doug Sanders. “We’ve had delivery schedules that needed to be changed, resources needed to help set up new stores, and [Nature’s Best] has been so accommodating,” he says. “When we made the leap to Texas, they weren’t in Texas at the time. They worked with us to resolve the problem.”

Parker says Nature’s Best focuses on staying at the cutting edge of new products—the company is seeing a lot of growth in dietary supplements—by making use of sophisticated software to track trends in inventories, which keeps out-of-stocks low and service levels high.

“What we hear from our customers is not necessarily that they want better pricing, but more accurate delivery windows,” he says. “If a truck is scheduled to arrive at 7 o’clock, you have employees there waiting to unload. But if the truck doesn’t arrive until 8, the employees are just standing around, and you still have to pay them.”

Parker says retailers also “expect us to have a very strong in-stock position. They have fewer cups of yogurt or cans of tomatoes on the shelves because they know we will deliver when they need it. They can have lower minimum quantities. We’re supposed to be the one that ties up cash in inventory.”

Nature’s Best is “open to the possibility” of acquiring another distributor, though “there aren’t that many opportunities out there,” Parker says. On the other side of the coin, would the company be open to an offer from a potential buyer? “Absolutely not,” he says.

One way to stave off the competition is to not compete. Neshaminy Valley Natural Foods Distributor of Ivyland, Pa., has been ensconced in its niche as a secondary organic food and natural products distributor from Massachusetts to Virginia since 1977. The company, which has about 1,200 customers, does not handle products that contain sugar or fructose. Neshaminy Valley also carries about 325 bulk items, 85 percent of which are organic. “Fifty percent of our products are not readily available from other venues,” says Founder and CEO Phil Margolis. “It’s a reason to order from us.”

That philosophy seems to be working. Margolis says the company routinely posts 5 percent to 10 percent annual growth, but the recession has caused a change in orders from retailers. “The frequency of purchasing is down, but average order size has remained the same for the last several years,” he says. “You’d expect to see a decrease in both, but only frequency is down. I don’t know why.”

More partner than customer
Natural products retailers view their relationships with their distributors as just that: relationships. Price is primary, but it’s not just about price. “It’s service, in-stock position, how open they are to collaborating with us on buying,” says Sprouts’ Sanders. Auerbach calls it “flexibility, the sales staff working with you and responding to you.”

“Out-of-stocks are huge,” adds Sunflower’s Gilliland. “We’re seeing tighter inventories because of cash flow. And the end user—the retailer—pays the price.” Gilliland views the distribution game from both sides: Although about 25 percent of Sunflower’s product is provided by UNFI, the chain also uses its own distribution facility for about half of its business. Basically, “everything has gotten more competitive,” he says.

Rainbow Blossom’s two primary distributors are UNFI and Tree of Life. “We want to have strong relationships with both parties,” Auerbach says. “And having a little competition is good for the industry.” The retailer orders from both distributors every week in addition to smaller specialty and local distributors. “Large distributors can get us the products we are expected to carry. And you get a volume discount,” Auerbach says. “On the other hand, your competition also carries what the large distributors are offering.” However, small distributors usually charge a shipping fee that the big ones don’t. “So there are definite advantages to buying from both large and small distributors,” she says.

Auerbach says Rainbow Blossom has been trying to figure out how to recoup a fuel surcharge distributors initiated when gas prices rose. “You never used to pay for deliveries,” she says. “Distributors pass the cost on to us, but we can’t always pass the cost on to our customers.”

Promotional and marketing support, the ability to order one item only rather than a full case, longer dates on perishables and new products (sometimes given away free as introductory offers) all play into the distributor-retailer relationship as well. “We have to do a good job of forecasting,” says Sanders of Sprouts Farmers Market. “A lot of it comes down to the retailer telling the distributor what they want six, eight weeks out.”

Jane Hoback is a writer and editor in Denver.

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