Many of my friends and colleagues know I am a huge proponent of Wal-Mart’s and their Every Day Low Prices.  I frequently have lively discussions about my love for Wal-Mart and their low prices.  In mid December, I came across an article that discussed Chicagoland’s grocery chains and their battle for shoppers.  The article got me thinking about how powerful Wal-Mart’s “Every Day Low Price” strategy is.  Two lessons can be learned from the Every Day Low Price strategy: consumers don’t shop where they are unhappy, and innovative companies are profitable.

Pricing Strategies

Grocery stores primarily use one of two different pricing strategies: High-Low, or Every Day Low Prices (EDLPs).

Stores with “high-low” pricing strategies price some products at low prices, while having other products at higher prices.   These stores use promotional sales to lure shoppers into the store in order to persuade them to buy other high priced high margin items by utilizing other marketing techniques.

The competing grocery pricing strategy is “Every Day Low Prices”, or what I like to call, EDLPs.  Wal-Mart popularized this strategy and uses it to this day.  Prices are set low, and stay low.  The only time a price changes is when supply or demand changes, or when the retailer forces the supplier to innovate.  Furthermore, if prices do change, they usually go down.  Remember Wal-Mart’s “falling prices” marketing campaign? EDLPs have helped Wal-Mart become the world’s largest retailer.

The Grocery Store Game

Lesson one: Consumers don’t like to shop where they feel unhappy.

I don’t know about other shoppers, but I don’t like to play games when I shop. I like to know I am getting a fair price for everything I buy.  If I wanted to play games with my money, I would gamble.

Every time I shop at stores like Jewel and Dominick’s, stores that use the “high-low” pricing model, I feel like I am loosing a game of pricing. With the “high-low” pricing model, prices don’t change because of supply or demand; they change to trick the customer.  I always leave the store feeling like I lost the game, which makes me very unhappy.

The “high-low” pricing model is about as close as it can get to a “bait and switch” technique without actually being it.  Actually, when an item is out of stock, it does become a “bait and switch” technique.  Does anyone actually go through the hassle of getting a rain check on a bag of peas?

Let’s look at the shopping game in the eyes of an offensive or defensive player.

Defensive shoppers, like my self, usually go to the store when they need something.  And when they buy a product, they are at the store’s pricing mercy.

As stated in the fore mentioned article, stores who use the “high-low” pricing strategy have higher total transaction values; on average, 13% higher.

My defensive shopping habits cause me much frustration when I see the price I am paying.  As a price conscious consumer, I tend to remember what prices are good, and what prices are bad.  To this day, I know when I shop at Wal-Mart I can buy a cake mix for roughly $0.87 , no matter which store I am at or what day of the year it is.  At Jewel or Dominick’s, that price can range from a rare $1.00, to the usual $3.00.  Prices of many items at Jewel or Dominick’s fluctuate to this extreme, and it really makes me unhappy.

On the other hand, shoppers that buy offensively at these “high-low” stores, only buying products when they are on sale, usually do pay a decent price.  But that comes at a cost, shopping offensively is not only inconvenient; it requires a tremendous amount of planning and researching.  As explained in the story She’s crazy for coupons by the Star Tribune:

If you want to learn to save as much as the pros, check out their websites or attend one of the classes. Before long you’ll be buying 10 or more Sunday papers a week just for the coupons, going online for additional coupons and tips, devoting an entire room to food storage, and slashing grocery costs by 75 percent.

The Star Tribune is not alone, local and national news segments frequently feature customers that play the game so well, they can save nearly 85%.

I have tried this offensive technique, but living in downtown Chicago without a car, it is very difficult.  I am lacking both storage and transportation capacity.  It would cost me tens of thousands of dollars to devote a whole room to this strategy; eliminating any possibility to save money.

Efficiency

Lesson two: Companies that innovate are profitable.

As Jim Hertel points out in Food fight: Grocery chains, discounters in battle for shoppers, operating “high-low” pricing strategies actually creates inefficiencies, which translates into higher inventory costs.   I could not agree more with Jim.  Stocking and tracking inventory for temporary specials is extremely expensive. I recently discussed this along with many other inefficient practices associated with “high-low” pricing strategies in my recent post The Costs of Promotional Sales.

Jim also discussed the high amount of variety at stores like Jewel and Dominick’s.  Jewel and Dominick’s defend their vast variety, almost twice that of discounters such as SuperTarget, as adding to their level of service.  Stating,

Price comparison between conventional retailers like Dominick’s and low-cost discounters like Wal-Mart, SuperTarget and Food 4 Less is fundamentally unfair.

They continued,

We have different business models, and our format, offerings and overall selection and pricing strategy are not the same.

The last time I went to Jewel, there was half an isle of Jelly, Jam, and Peanut Butter.  How many varieties does the consumer need? I see the benefit of different brands and flavors, but there are countless sizes and varieties of each! Imagine the cost associated with stocking and tracking five different sizes/containers of each brand and type of jelly! This practice is not service, it is gross inefficiency that brings higher prices across the board.

One store has this “few varieties” concept down so well, I believe it has lead to their prices being lower than Wal-Mart’s prices.  Yes you heard me right; there is a retailer with lower prices than Wal-Mart. Aldi, well known in Europe for decades, has been expanding the number of their United States locations rapidly in recent years.  Aldi sells one size and one brand of grape Jelly. They only stock two peanut butter types: creamy and chunky, with one size fits all containers. Prices at Aldi are unbelievably low.

I can go on and on about Aldi, but I will save that for another day.  I will say, however, their business model is not only admirable, it’s brilliant and innovative.

Innovation is not unique to Aldi.  In order for Wal-Mart to have Every Day Low Prices, prices that are consistently lower than the competition, they need to lower costs.  Lowering costs is a religion at Wal-Mart.  The company is constantly innovating their supply chain and retail operations.

The most profitable companies are the ones that innovate: Wal-Mart, Apple, Google.  These companies are companies that I, along with most of the business community, admire to a great extent.

Innovation is, if anything, my religion.  Innovation should be never-ending.

In order for Wal-Mart to continue their goal of having EDLPs, they require their suppliers innovate and increase productivity. Many people see Wal-Mart as the goliath who forces suppliers to reduce wholesale prices, which, on occasion, puts the supplier out of business.

One of the most predominant examples of a supplier that Wal-Mart ruined was Rubbermaid.  Rubbermaid insisted on raising prices due to higher material costs.  Wal-Mart stopped selling Rubbermaid’s products.  A different supplier, Sterilite, quickly took advantage of the situation by innovating and became a significant supplier to Wal-Mart.  If Sterilite was able to supply Wal-Mart profitably, Rubbermaid should have been able to do so as well.  It was Rubbermaid’s failure to innovate which led to their failure, not Wal-Mart’s strength.

In fact, as mentioned in Wal-Mart’s Influence Grows, published in USA Today, Wal-Mart accounted for 25% of the late 1990s’ productivity gains. In the article, McKinsey & Co also explained that profit gains in the late 90s were primarily due to Wal-Mart.

The costliest thing a company can do is “do it like is has always been done” and languish in gross inefficiencies.

The Power of Every Day Low Prices

Looking at national, public grocer chains, and their financial data**, it is easy to see how powerful EDLPs can be. Stores that use the EDLP pricing model tend to be more profitable than those that do not.  Both Target and Wal-Mart have a healthy 4% average Net Margin for the last four fiscal years.  Kmart also utilized the EDLP strategy, but they stand out from the crowd.  Kmart’s refusal to innovate was, in large part, the reason for their demise.  As mentioned before, innovation is essential to the EDLP strategy.  Without innovation, the strategy will fail.

Now, let’s look at the stores that use the High-Low pricing model. SUPERVALU lost $2.9 Billion last fiscal year, a -6% Net Margin.  Over the three prior years, SUPERVALU had a 1% average Net Margin. Safeway and Kroger did slightly better, both having an average of 2% Net Margin the last four fiscal years. None of these stores had a fiscal year better than that of an EDLP store.

Every Day Low Prices make customers happy.  People like to shop where they feel happy. Shoppers know prices are consistently low at stores with Every Day Low Prices. And because shoppers know prices will be consistently low, they will continue to shop at those stores.  It is literally a free marketing campaign. Furthermore, both efficiency and innovation are functions of Every Day Low Prices.  In order to keep prices low, retailers must constantly monitor and reduce costs.  Cost reduction is a never-ending process requiring companies to be lean and innovate every day.

**National Grocer Chains Fiscal Data.  In Millions of USD.

* Fiscal years are estimates; company fiscal years deviate slightly from normal Gregorian calendar years.
* Fiscal data gathered from Google Finance on February 23^rd 2010.

Grocery retailers frequently use promotional sales to lure customers into stores.  Retailers hope customers will purchase higher margin products while they shop for the promoted items.  Chicago grocers Jewel-Osco, subsidiary of SUPERVALU, and Dominick’s, subsidiary of Safeway, both follow use this marketing strategy, changing promotions twice a week.  The promotional sales may increase customer traffic, but they may also lead to the demise of the store.  I suspect, retailers that use promotional sales, on every day products sold year round, increase the cost of doing business and decrease supply chain efficiency.

Used by many grocers, promotional sales are the activities, materials, devices, and techniques used in the advertising and marketing of products.  I separated their cost into two different categories; direct costs and indirect costs.  I see the money spent on the processes and material to implement the promotional sale as direct costs, and the money lost due of the effects of the promotional sales are considered indirect costs.  From my point of view, both of these costs are significantly high, high enough to possibly outweigh any benefit of the promotional sales.  If I were managing a retail grocery operation, these are the items I would consider when deciding whether or not to continue utilizing promotional sales.

Direct Costs

Promotional sales have many components, each having a cost associated with it. Planning, marketing, inventory builds, and store preparations all take time to complete and consume valuable company resources.

Planning

Planning a promotional sale must be time consuming and costly.  Stores need to decide what products to put on sale, when to put them on sale, and at which price to sell them during the sale.  They must also decide how they will market the promotion, design the promotion, and distribute the promotion. It takes time for the retailer to manage, and it takes time for suppliers to manage.  That being said, it is possible that retailers who promote frequently can manage this process relatively efficiently.  However, managing a promotional sales still requires resources; resources that do nothing other than manage and execute promotions. The planning process is only the beginning.

Marketing

Promotions need to be communicated to the public, using any number of methods, all of which cost money.  From my experience, grocers seem to prefer some form of print media, like news papers or local ad circulars. Designing, printing, and delivering these advertisements must add significantly to a retailers cost. Some grocers even compliment the print media with radio and TV commercials, all of which take additional resources to produce and distribute.

Inventory Builds

Before the promotional sale starts, retailers must increase inventory of the items being promoted. Vendors, transporters, distribution centers, and storefronts all need to take special measures to guarantee extra inventory is delivered, on time.  Not only on time, but just in time; fresh produce spoils quickly and it’s vital the delivery process be planned and executed without error.  Early or late delivery can lead to costly spoiled inventory. In addition to any spoiled inventory losses; inventory builds take significant amounts of working capital.

Store Preparations

At the start of the promotional sale, costly store preparations must occur.  I have witnessed employees rearranging store shelving to accommodate shifts in inventory in anticipation of an increase in demand for some products, and decrease in demand for others.  Price tags throughout the store need to be updated, reprinted, and reapplied.  Finally, if displays are being used, they must be built and placed.

Each activity and consumable is temporary.  As promotions end and new ones begin, I expect these four processes repeat endlessly, adding cost during each cycle.

Indirect Costs

Along with any direct costs mentioned above, I predict promotional sales also have indirect costs aswell. Indirect costs caused by poor forecast accuracy, inadequate supply chain communication, and large inventory swings.

Forecast Accuracy

As part the planning and execution phases, I suspect most vendors and retailers use Enterprise Resource Planning systems, or ERP systems, to manage the supply chain.  ERP systems use a multitude of variables, including, but not limited to forecasts, past orders, current orders, and current inventory levels, to track, plan, and manage inventory.  Recommendations to create purchase orders or manufacturing requirements are created on a regular basis. Recommendations may be edited manually and released by planners, or  they may be released automatically as purchase orders to suppliers.

Because forecasts are the foundation of ERP system demand calculations, I know the data must be clean and accurate for the systems to operate efficiently.  But, from my point of view, promotional sales cause forecast data to be dirty or inaccurate for two reasons: lack of predictability, and manual data entry.

I assume it is nearly impossible to precisely predict how inventory will move during and after a promotional sale.  The incredibly high quantity of variables makes it close to impossible to accurately forecast purchasing. Even the most nimble and elaborate forecasting software will likely have difficulty analyzing uneven sales data, not knowing what impact each dip or spike had, or if the dip or spike will happen again. During a promotion, inventory could be wiped out completely or may not be sold at all.  After the promotion, purchasing may likely decrease but it may, instead, increase.  The dip or spike in demand will last an unknown period of time.  I suspect competitors may possibly have a promotion on the same or competing products.  The promotion price may or may not impact purchasing.  Finally, it is also likely a naturally occurring or unpredicted event may also affect demand.

Even if all the variables are correct and accounted for, and the company has perfect knowledge of consumers’ thoughts and competitors’ marketing, forecasts may still be entered or edited incorrectly.  The manual data entry processes is far from six-sigma levels of accuracy and, from my experience in analyzing forecast data, will most likely have errors.  Incorrectly entered or edited data points could flow automatically from the retailer’s ERP system to the vendor’s ERP system without notice.  It is likely systems would be in place to detect erroneous data, but because the data nature of highly volatile forecasts, I would expect the detection systems would miss many errors.

Supply Chain Communications

The ramifications of incorrectly generated and/or entered forecasts could be huge and expensive.  Data often trickles down from retailers to distributors and from distributors to suppliers; Most likely traveling automatically by way of automatic releases of ERP generated purchase order recommendations.  An invalid forecast could be transfered from the retailer to distributor to vendor without anyone knowing its inaccuracy.

Correct, but changed forecasts, could also cause problems.  I expect promotion plans change all the time.  They may get canceled, dates may move, or anticipated purchasing may change.   Regardless of the change, corrections or non-standard changes could get lost, miss communicated, or miss translated when being sent from retailers to vendors.  In some cases, they may not be communicated at all.

The farther away in the supply chain a company is from the retailer, the more difficult planning and communication becomes.  At the front of the chain, retailers have direct knowledge of a promotion, and have the ability to add or edit the details in their ERP system.  As promotions are developed, retailers communicate information to suppliers.  But, as mentioned before, if a promotion changes, it may not be fully communicated to all suppliers.  To add to the confusion, suppliers have suppliers, and those suppliers also have suppliers.  The farther down the chain, the less promotion visibility is seen.

The entire chain is only as good as the weakest link.  If not handled quickly and efficiently, at all levels of the supply chain, one invalid or missed forecast entry, or forecast change, has the ability to trigger massive product spoilage.

Inventory Swings

From my experience at a manufacturing company, huge swings in inventory are nightmares for suppliers.  Inventory builds require increased production, which may require overtime pay and/or auxiliary temporary warehouse space; both impacting the supplier’s profitability.  On the other hand, purchasing reductions that occur after a promotion ends may lead to vast amounts of unused warehouse space, non-moving inventory, or unutilized resources or personnel.  These swings are not only problems for suppliers, they are disruptive to transporters as well.

Trucking is the predominant type of food transportation in the United States.  Trucking is a tough business; just like empty planes, empty or unused trucks are not profitable. To be profitable, trucking companies need to haul loads to and from sources and destinations.  And inventory swings spurred by promotion sales create irregular shipments and increase the possibility of empty trailers for flatbed trucks.  Fortunately, third party logistics companies have become a popular way to mitigate the cost of empty trucks, but I still don’t believe they are still not a perfect solution, nor do they provide free services.

The least tangible costs of inventory swings are their affect on data mining and forecast generation.  As previously discussed, forecast accuracy is crucial.  From my experience as a Supply Planner, large swings in inventory make it very difficult to produce an accurate forecast. Standard deviations for products that regularly go on sale are extremely high, and systematically generated forecasts can be incredibly inaccurate.

Any losses or costs incurred at any point in the supply chain will be passed on to the retailer by way of higher wholesale prices, regardless who is at fault.  The retailer will then pass that cost increase to the consumer via higher retail prices throughout the store, not necessarily on the product being promoted.   Keep in mind, all of these additional costs are being incurred to sell an item at a reduced price, likely a price below wholesale cost.

I believe retailers that use promotional sales as part of their marketing strategy are pregnant with cost saving opportunities.  It only requires retailers to realize how many costs are likely associated with their promotional sales in order for them to analyze their promotional sales strategy.  In a retail world ruled by everyday low prices, the analysis will hopefully come soon.  If not, retailers selling everyday products will likely fail because their promotional sales have a high probability of increasing their cost of doing business and decreasing their supply chain efficiency.

Individual Change… An individual may be confronted with a new user interface, a new “best practice”, a different way to make decisions, or any number of new requirements. When this is the case, individuals will tend to experience one or more of the following five key factors: fear, anxiety, confusion, loss of control, or erosion of power or influence in the organization. The more an individual feels any of these emotions, the less likely they are to accept the new way of doing things. Lack of acceptance will diminish or delay the benefits of the ERP effort…

Individual Change was something I dealt with on a daily basis during the implementation at each of the plants I was involved with.  To overcome the fears, anxiety, confusion, and loss of control or power, one of the things I stressed during my training sessions was how much impact the employee had during the process.  I made them aware of the many things that occurred in the background when they processed a transaction; including raw material consumption and inventory movement.  I also explained how that transaction impacted the rest of the business processes such as costing and planning.

This additional, non essential, information, made the employee realize not only how powerful the system was, the but the importance of completing the transaction accurately and in timely manner.  A side benefit of knowing what happened as the transaction processed and what impact a transaction had on other business processes,  was the ability to think, on the fly, of how to correct a problem that occurred outside of the typical business process.

Message:
Food safety is incredibly important to me and my family.

I am writing you to request your support of “Kevin’s Law” (Meat and Poultry Pathogen Reduction and Enforcement Act: H.R. 3160 [109th]).

I am also writing you to introduce/support legislation on increasing the quality and quantity on food labeling and safety.  I would like to see the following required labels on food, drink, and other ingestible products:

• City/State of
  • Origin
  • Processor
  • Packager
  • Distributor
• GMO Identification  (Genetically Modified Organism)
• Cloning Identification
• Livestock Feed Type (what did the cow/swine/chicken eat?)
  • Corn
  • ⁃Soy
  • Free range grass
• All involved companies in the supply chain
  • Seed manufacturer
  • Farmer
  • Processor
  • Slaughterer
  • Transporter
  • Contractor
  • Packager
  • Distributor
  • Retailer
  • Etc.
• All involved chemicals
  • Pesticides
  • Fertilizers
  • Antibiotics
  • Hormones

Most of these labels would not be inherently incriminating, but all are involved in a products safety, quality, and environmental impact.

If a manufacturer knows consumers will hesitate to buy something based on the labeling, that is all the more reason to require it.  Drug companies are required to list “bad” side effects of drugs.  And tobacco companies are required to print surgeon general warnings on their products.  People have not stopped buying those products.

Food manufacturers should not get a free pass just because of political connections.

Many corporations will say “we don’t want these labels on our products because consumers are not educated enough to know what they mean.”  I have three responses to that:

1. All of these labels would ADD to the consumer education.  I want to be educated on how my food is created, processed, stored, and transported.
2. As a consumer, if I do not understand something I educate my self about it.  If I  saw a label that said this food is from GMO crops, I would look up what GMO meant and read information on the pros and cons of GMOs.
3. If companies don’t think consumers are educated, nor will educate themselves, then it is the companies responsibility to educate the consumer.  That is what marketing budgets are for.  If they think Cloned animals are safe, they should tell us why.  A good example: the corn industry had a huge marketing campaign to increase the positive attitude towards corn syrup.

Please pass legislation to increase food safety and quality. Support H.R. 3160 [109th].  And introduce/support new legislation requiring better food labeling.  My safety and the environment is important to me, I hope they are important to you as well.

Thank you
Edward Hayes

I was sent a message on LinkedIn from a gentleman requesting my input on their planning methods. As I was writing my response, I thought that it would be of benefit to other people, so I am posting the question and response here. Click “read more” below to read the entire question and response.

Question:

We both share the Supply Chain group on linkedin.I understand you have experience in Demand Planning & Forecasting. We at the IBF – Institute of Business Forecasting & Planning are currently researching what companies are doing to manage their inventory, reduce operating costs, improve customer retention & fulfillment in this volatile market? Especially, when history can no longer be an indication of future outcome. It would be great if you could share some thoughts on what your company is doing to remain competitive and preserve cash. Furthermore, do you feel executives are recognizing the important of demand planning & forecasting, more so now than ever before? And if so, are they only looking for technology as the quick fix, or improving processes from your viewpoint? Of course, we see pursuing technology without having proper processes in place to be dangerous.

So far, we’re seeing companies paying more attention to forecasting for items with higher value only, and doing it at shorter interval. We’re also seeing companies truly leveraging their S&OP processes, as well as their POS and Syndicated data to make better planning decisions from having a clearer picture of consumer behavior at any given time.

Response:

Thanks for the message. I was unfortunately laid off in December. However, I can tell you that we had a similar problem, and when I left we were working on reducing working capital. The problem we had was that the production planners at the plants were all trying to fill their production schedule so that the production line was utilized when there were crews there to staff it. As a result, inventory was extremely high and all of our plants.

We did a few things to try to solve this. First, I created a tool to analyze safety stocks using data from our order history and item level fixed days supply. Second, we would discuss the new safety stock recommendations, by item, with the plants before adding the new data to our Oracle Item setups. Finally, there was a push to drive production solely off of our manufacturing plan recommendations. Recommendations were driven off of daily customer orders, forecast, and safety stock demand.

Oracle adoption was pushed from very high up in the company. The one pending item that we were working on when I left was our legacy way of thinking of inventory targets. Prior to our Oracle implementation, we had inventory targets as a metric. These targets were Monday Morning levels of inventory. We assuming production seven days a week and shipping five days a week. So these levels were historically the highest point of our inventory and were the metric at which plants were gauged.

Post oracle, this economy, and staffing changes all impacted changes to actual inventories at plants, and it was apparent that a heuristic or best judgment way of creating these targets would not work. It was also apparent, in my mind, that it was a poor metric to use. Plants should not be graded on their levels of inventory as compared to one target: temporary order surges or lulls could make a plant look poor, when in fact it was producing perfectly against the manufacturing plan.

As I was leaving, I was in the process of creating a method of calculating inventory targets using the fore mentioned safety stocks, fixed days supply, and average daily shipments. Where the total volume of safety stock would be a “minimum” inventory, and a calculation based on fixed days supply and average daily shipments added to the safety stock would be the peak of inventory. Of coarse the peak may or may not land on a Monday like our prior metrics assumed; that was a change management issue that had yet to be discussed or resolved.

When it comes to forecasting, we were in the process of upgrading to Oracle Demantra when I left. Oracle Demantra would greatly improve our forecasting methods, and accuracy. And yes, It was apparent that accurate forecasts were an important part of our planning process. But, an accurate forecast is meaningless if you do not produce exactly what you are recommended to based off all of the data inputs including, but limited to, forecasts, safety stocks, and orders.

Hope that helps.