Industry Trends and Issues
The food and beverage industry is not without significant pressures. Margins are slim, the demand for products unpredictable, and the demand for customers service significant. These challenges become life-or-death business issues when compounded with rapid turnaround time; extremely short shelf life; a constant influx of new, improved, and differently flavored prepared and packaged products; climate- and weather-related threats; and the high variability of ingredients. Throughout the product life cycle, dynamic environment factors must be carefully managed if a product is to continue to meet customer requirements for quality and cost.
Part Two of the series Food and Beverage "Delights."
There are also many product categories, and to compete, firms must constantly innovate. They not only have to meet production demands, but they also have to provide true research and development (R&D), additional product quality and safety testing, and the ability to bi-directionally expand the supply chain around the world. Hence, many rightfully think it is one of the most competitive industries. Further on, we will examine the major issues and resulting pressures on food and beverage manufacturers and distributors today, and analyze what these pressures mean to them (and for some cases look at what actions could alleviate the conundrum).
For background and a definition of the industry see Food and Beverage "Delights".
Erratic Consumer Behavior
As consumers, we are fickle, and our behavior is ever-changing. We have new preferences and fads dominating our buying decisions. For example, refrigerated meats and poultry products increased their revenue by about 22 percent from 2003 to 2004, while frozen juice fell 15.4 percent, and seafood and dry-packaged dinners declined about 7 percent during the same time. Looking at the consumer demands for the next five years shows us that the rate of change will not slow down, and may even quicken. Furthermore, modern lifestyles and increased disposable incomes in many nations now dictate that food products not only come to us fresh, but also processed and packaged in different ways (as in fully cooked buffalo wings, marinated ribs, or grilled chicken breasts). This is because we want to spend less time in the kitchen preparing food (chopping and dicing) and more time in the active enjoyment of eating and drinking.
Moreover, cultural differences play a big part in how we prepare and cook our foods (according to kosher or vegan requirements, for instance), and distributors should know about the demographic details. Whether demanded by regulations or not, accompanying documentation has to provide ingredient statements, nutrition information, approved claims information, religious certification, details of allergens, and many other customer-specific requirements. As said earlier, we also tend to eat out more, choosing from a variety of restaurants and eating establishments. These trends require food products that are readily available fresh or at different levels of preparation to suit consumer convenience. The industry has to be ever more creative in providing choices that cater to consumer preferences, in order to increase turnover and gain market share.
The consolidation of retailers is a fact, and is a global trend that affects not just groceries but all retail categories (see Challenging the Competition: Mega-mergers and Supply Chain Technology). A $400 million (USD) food processor recently commented that the percentage of business it derives from its four largest accounts continues to rise each year. One of its executives summed up this trend by saying, "The small customers are getting both fewer and smaller, while the large ones are getting fewer and bigger." The company has organized its business around these four major accounts plus "other accounts," reflecting the concentration of its business. Customer consolidation means fewer decision makers with more power, where each controls greater volume and market coverage. More importantly, a loss of business from a major retailer eliminates the manufacturer from a large segment of the business, with decreasing options to make up the lost opportunity and volume.
Thus, the food and beverage and fast-moving consumer goods (FMCG) manufacturers and distributors that supply the major supermarket retailers share many common business challenges, along with a tough competitive environment. This holds true whether the product is food, drink, personal care, cleaning products, or any other product stocked and sold by supermarkets. The customers—huge, powerful, and demanding supermarkets and retail chains—want products manufactured "to order," with lead times often measured in hours rather than days or weeks. In fact, in the sector it is routine to deal with delivery lead times shorter than the time actually needed to make the product. To top it all off, this circumstance is often bundled with highly variable forecasts, which shatters any remaining hint of predictability.
As indicated above, most consumer packaged goods (CPG) manufacturers have a few very important customers that account for much of their output, and these customers will usually provide some form of demand projection or forecast. Such customers are so-called channel masters, which control a significant portion of demand. The term channel master describes the role of the major retailers (Wal-Mart, Kroger, Tesco, Kmart, etc.), food service companies (MacDonald's, Wendy's, etc.) and food service distributors (Sysco). When asked to describe channel masters, a vice president (VP) of marketing at a food manufacturer explained, "when they demand something, the manufacturer just has to say thank you'." These channel masters control access to the market. The channel master has the power to determine prices, promotions, placement, etc. Such customers want guaranteed supplies at guaranteed prices, though some specialty products do have seasonal variations. Their preference is to enter into price or supply contracts for periods of up to one year. The food services industry has organized buying groups to negotiate better prices, whereas major retail chains are large enough to negotiate their own pricing.
Furthermore, these exacting customers often demand that their suppliers come up with new product ideas and to run test production, without any guarantee that the new line will be approved. As if that were not enough, the costs of the finished goods are constantly being driven downwards—but consistent high quality is mandatory. Variability is the major enemy of food and beverage manufacturers, whether in terms of the attributes, shelf life, or potency of raw materials, intermediate products, and finished-goods inventory. These dynamics all create significant challenges for process specifications, and can add delays and costs to the process, and impact customer satisfaction if the quality for the products is not maintained within strict tolerances.
To thrive and grow in the sector, food manufacturers will have to increase their value, and differentiate through tighter relationships and with exemplary service for their mighty customers. They will have to address many demands of these customers in a variety of areas, including product quality, sales commitments and product availability, make-to-order (MTO) capabilities, vendor-managed inventory (VMI), on-time delivery, and customer service. For instance, product bundling is a common practice for retailers, as one retailer might want a three-pack kit simply because its competitor sells a two-pack. These requests are most efficiently executed in distribution when they support a final assembly postponement strategy. CPG manufacturers have to measure the most important metric of all: orders delivered on time, in full (see The Perfect Order—Inside-out or Outside-in?).
The Technology Demands of Channel Masters
Channel masters also determine the business methods and technologies necessary to do business with them. To that end, radio frequency identification (RFID) technology has pervaded the consumer and industry news, since channel masters are increasingly setting technical and business process requirements and deadlines for their suppliers. Despite the emerging technology's growing pains and hype, no one doubts that RFID will be an absolute requirement in the future. In fact, the issue is not if, but when (see As Hype Becomes Reality, a Radio Frequency Identification Ecosystem Emerges, When will RFID Hit Main Street?, and The Three Rs of RFID: Rewards, Risk, and ROI).
RFID is just one element of a continuing process on the part of retailers to drive costs out of the supply chain. The food industry was in fact an early innovator in the exchange of electronic communication based on the Wal-Mart electronic data interchange (EDI) model. EDI communication with several business partners has never been easy (see The Pain and Gain of Integrated EDI). For that reason, it is not terribly surprising that other data interchange protocols—such as extensible markup language (XML) messaging and more recently, global data synchronization (GDS) and product information management (PIM)— have emerged (see $40 Billion Is Being Wasted by Companies without Product Information Management Strategies—How Is Yours Coming Along?).
One fact is certain: the development of Internet-based communications with global supply chain partners will continue to expand as food distributors look for simpler but faster ways to exchange information. It is essential that trading partners and technology providers provide open systems that make it far easier for business applications to exchange information. These technology-driven requirements represent an ever-higher technology hurdle that manufacturers must clear to participate in the retailer's sales success.
For many, these technology demands should benefit both the retailer and the manufacturer. For example, AMR Research has reported that GDS reduces invoice and purchase order errors by more than 40 percent, while decreasing the time to introduce new items by as much as three weeks. Wal-Mart's drive toward "everyday low prices" is not new, but has clearly helped the retailer become the largest retailer in the world. Wal-Mart continues this quest by leveraging both its size and technology to drive costs out of its supply chain. If a manufacturer wants to do business with Wal-Mart, it has to provide more than just product. It must also meet Wal-Mart's technology requirements.
Wal-Mart is not an isolated example, but it is the one we hear about most often. Technology mandates also exist from Marks & Spencer, Tesco, Albertsons, and other major names. Often, a mandate is for the same technology but with individual twists. Meeting Wal-Mart's RFID requirements is not the same as meeting those of Tesco or Marks & Spencer. The manufacturer needs the ability both to meet the technology requirement and to tailor its response to the demands of the individual retailer. In fact, since every major customer may have its own way of managing sales order entries, the supplier's back-office or enterprise resource planning (ERP) system must be sufficiently flexible and workflow-enabled to support the user's particular method of managing customer orders. A midsized food company recently had an introductory meeting with buyers from a major retailer. A key part of the meeting consisted of the retailer probing into the food company's ability to meet the retailer's technical needs. It was clear that if the food company could not jump over the retailer's technology hurdle, no second meeting would be necessary.
Retailers continue to push other business practices that cut costs and increase product availability, such as point of sale (POS) information to help manage restocking by examining sales and stocking levels for generating sales orders and delivery schedules, for both short- and long-term delivery plans (see Point of Sale: To Stand Alone or Not?). This, in turn, should help food distributors with the call-offs against the customer's supply contracts, predicting where there might be shortfalls and overruns; food distributors should use this information to notify suppliers of any changes in their delivery schedules. With those objectives in mind, the channel masters insist on tighter shipping schedules. This yields fewer inventories across the supply chain, which reduces cost and also results in less stock handled, which in turn reduces labor and damage. Product availability or the elimination of out-of-stocks has a major financial impact on both retailer and manufacturer. A supply chain executive at Procter and Gamble (P&G) says of the impact of retail out-of-stocks, "retailers on average lose the sale 41 percent of the time, while P&G loses 29 percent of the time."
Indeed, with a reported average retail out-of-stock rate of about 7 percent, availability is a huge issue affecting manufacturers, distributors, and retailers. The major retail chains dictate highly demanding service levels and delivery requirements, and expect zero errors. Their turnover volumes are so large that they often source the same products from several different food distributors. If a supplier's performance dwindles, the retail chain might suspend the order call-offs and switch to another supplier for a month or two. There are no guarantees: the major food retailers have all the power, so it is essential to establish a supply operation to support the "right the first time, every time" guiding principle. Most food and beverage manufacturers operate on relatively thin margins, and with the added overhead of retailer and regulatory compliance, the need to minimize rework becomes critical. For most companies, small percentages of rework translate into significant cuts into profits, and executing processes right the first time is vital to survival and growth.
Because of the tight time scales involved, manufacturers have to interpret forecasts astutely in order to set the production processes in motion, and order entry has to be very closely coupled with forecasting, demand management, and manufacturing planning. The fast-moving food and consumer goods industries were the primary innovators of efficient consumer response (ECR). This practice enables retailers to use vast databases of sales information to analyze customer buying patterns and predict future product and packaging requirements. Collaborative planning, forecasting, and replenishment (CPFR) is another industry initiative that enables companies along the supply chain to work together via the Internet to develop a single, more accurate demand forecast, and to create a plan for delivering product to meet that demand. This information is useful for food producers and growers to plan product strategies.
The APICS Dictionary (eleventh edition) defines CPFR as
a collaboration process whereby supply chain trading partners can jointly plan key supply chain activities from production and delivery of raw materials to production and delivery of final products to end customers. Collaboration encompasses business planning, sales forecasting, and all operations required to replenish raw materials and finished goods. CPFR is considered a standard, endorsed by the Voluntary Inter-industry Commerce Standards.
In any case, dealing with a channel master means increased volume and revenue, but it means increased complexity and cost of customer service. With tight margins throughout the industry, what does doing business with a channel master mean to the manufacturer's bottom line? For more information, see Living and Thriving with Channel Master Customers and Yes, We Have No Bananas: Consumer Goods Manufacturers Serve Demanding Customers.
A form of consolidation comes from food distributors. Many food distributors act as commodity brokers, negotiating annual supply contracts for major retail chains for a range of food products. Often, these are "own label" or "private label" products that are sourced from several different growers or food processors around the world to guarantee a year-round supply. Brands play a major role in the food industry. Stores count on brands to help promote their stores, and feel comfortably certain that consumers prefer branded products to "unknown products." Grocery stores will typically carry two or three brands in a category, with one of the brands often being the grocery store's own brand, a known store brand, or a private label. If a manufacturer is not able to gain shelf space due to the limited number of brands being carried, it cannot sell their products at all through that retailer. The existence of private label or store brands yields a business opportunity for manufacturers (see The Fragile Consumer Packaged Goods Market and Private Label Products). Most of the private label products are produced by manufacturers who package these products with the retailer's label. For some retailers, a large portion of their sales come from private label products. For example, half of Wal-Mart's grocery sales are from store brands. At Kroger, that number is 24 percent, while Safeway reports that 23 percent of its sales are store brands.
These products are processed and packaged to precise specifications, and containerized for shipment. A resulting common occurrence is that canned products will be stored as "bright stock," meaning they are simply cans without labels. Then, as demand is established, the cans are run through a labeling operation to give them a name brand or store brand label, depending on the order. Some containers might be shipped directly to a customer's own distribution center (DC), whereas others are shipped to a distributor's warehouse or to public warehousing. The logistics planning, documentation, and quality of the product must be precise if costs are to be kept under control. If the quality is not up to standard and the consignment is rejected, the food distributor has the problem of replacement, re-labeling, and disposal on the secondary market, almost surely at a loss.
About the Authors
Predrag Jakovljevic is a principal analyst with Technology Evaluation Centers (TEC), with a focus on the enterprise applications market. He has nearly twenty years of manufacturing industry experience, including several years as a power user of IT/ERP and related applications, as well as being a consultant/implementer and market analyst. He holds a bachelor's degree in mechanical engineering from the University of Belgrade (Serbia [the former Yugoslavia]), and has also been certified in production and inventory management (CPIM) and integrated resources management (CIRM) by APICS.
Olin Thompson is Lawson's vice-president of industry strategy. He has over twenty-five years of experience as an executive in the software industry, and has been called the "father of process ERP." Thompson is a frequent author and award-winning speaker on such topics as gaining value from ERP, supply chain planning (SCP), e-commerce, and the impact of technology on industry. He can be reached at firstname.lastname@example.org.