Thursday, August 16, 2007

Thursday Talking Points Memo

Wal-Mart and Organic Groceries: Analysis & Opinion

In march of last year (2006) Wal-Mart Stores, Inc. made an amazing announcement that it would more than double it's organic grocery offerings in its stores beginning immediately--and that it would price it's organic grocery items at only about 10% above conventionally produced products. At the time of the announcement Wal-Mart CEO Lee Scott said of the organics initiative, "We don't think you should have to have a lot of money to feed your family organic foods."

These two articles from the New York Times provide a good background on the announcement and the initiative. The first is a piece in the June 4, 2006 Times Magazine by Michael Pollan, titled "Mass Natural."

The second is a Times' editorial titled "When Wal-Mart Goes Organic," from the paper's May 14, 2006 Editorial page.

Additionally this piece from the May 15, 2006 edition of the New Yorker provides some good perspective on organic foods vis-a-vis the Wal-Mart initiative. The piece is by writer Steven Shapin in the magazine's "Critic at Large" section.

Implementing the organic initiative
Following it's announcement Wal-Mart began implementing their organic grocery products initiative. They met with vendors, distributors and brokers bringing them on-board. They added numerous skus of organic groceries in their store sections. They also promoted the initiative and the organic products via advertising and public relations. Things moved slow and steady throughout the next few months. As one Wal-Mart store manager told me about six months after the initiative began, "We are seeing some strong interest in the new organic items but I wouldn't say they are 'barn burners' just yet."

Then in mid-September of 2006 The Cornucopia Institute, a U.S.-based organic farming watchdog group, sent a letter to Wal-Mart CEO Scott informing him the group had found numerous non-organic food items being sold in Wal-Mart stores which they said were not organic. They asked Scott to investigate and fix the situation. The group also asked the USDA to investigate what they said was the illegal representation of non-organic products as organic in many Wal-Mart stores. This December 12, 2006 story in the industry publication Food provides more details on the issue as well as further charges that were made by the group.

This situation was reported all over the mainstream and industry press and took the luster off of Wal-Mart's organic initiative a bit. Wal-Mart has not been formally charged by the federal government for anything involving this issue to date.
Wal-Mart goes forward
Wal-Mart, however, continued to go forward with their organic initiative albeit at a slower pace. Currently most of their stores--especially the combo food/general merchandise mega Super Centers--have considerable more organic grocery products than prior to the initiative kick-off over a year ago. Most Wal-Mart observers peg it at close to double the number of organic grocery skus the chain merchandised before beginning the initiative.
Thus far organic sales at Wal-Mart stores have been fairly lackluster. To paraphrase the earlier store manager "They aren't exactly barn burners." Additionally Wal-Mart has slowed the growth or addition of more organic grocery items into their stores considerably. They are evaluating the mix and determining strategies to increase sales--but continue to move forward. CEO Scott says he is happy with the initiative thus far. Organic grocery retail prices in Wal-Mart currently range from about 13-15% higher than convention grocery items on average. May of the organic items in the very basic grocery categories are only 10% or so higher than their conventional cousins.
The way forward
In terms of the success and pace of Wal-Mart's organic grocery initiative moving forward I believe it's a mixed bag. First, Wal-Mart's core shopper--middle, lower middle, and low income shoppers--aren't the historic demographic which buys organic foods. They also tend to have completed high school and perhaps some college but aren't college graduates in the main. And few have graduate or professional degrees. Consumers' educational level is important vis-a-vis organic foods purchasing. Whole Foods Markets, Inc., for example, says education level--college degrees and graduate/professional degrees--are the best predictor of if a store will do well in a community. And the use education level demographic data--even before income data--is the key variable Whole Foods uses when they research potential new store locations.

Wal-Mart CEO Scott also just issued a report this week saying his core shoppers--those I detailed above--are having a tough time making ends meet. The report said they are having serious economic problems do to the current combination of flat wages, higher energy costs, housing failures, and mortgage failures in the U.S. Even if organic grocery products are only priced at 10% above conventional (they are closer to an average of 15% at Wal-Mart Currently) that amounts to a substantial premium on a total grocery bill for consumers having problems making ends meet. For example, on a $300 dollar total grocery bill--half of which lets say contains organic grocery items--it amounts to a $15.00 premium at minimum.

Another difficulty with the initiative is the organic market and distribution system as it currently exists. For Wal-Mart to merchandise organic groceries at only 10% above conventional groceries at retail the chain needs to be able to buy organics in the same manner they buy their conventional groceries. They need to be able to hammer out the lowest cost of goods from their organic grocery suppliers--like they do with conventional grocery suppliers--and then use the efficiencies of their logistics and distribution system to get them to their stores super efficiently--like they currently do with conventional grocery products. In other words conventional and organic grocery procurement and distribution needs to be part of the same seamless system in order for Wal-Mart to offer the organics at such a low retail price point and still make a decent margin.

The current organic grocery supplier industry is not like that however. Many of the supplier companies remain small to medium size, and do not operate at the technological level as the huge conventional companies that make up the bulk of Wal-Mart's suppliers. Many of these organic grocery companies also use third-party distributors rather than selling direct to supermarket or mass merchandise chains. They are reluctant to sell direct to a Wal-Mart or other large chains because doing so could hurt their relationships--and business--with distributors. In fact many natural and specialty foods distributors and retailers have told these organic suppliers that selling to Wal-Mart directly will hurt the companies' business with them--and some of these distributors and retailers have even given the organic suppliers guidelines that include not selling direct to Wal-Mart.

These small to medium size organic grocery suppliers also do not have the market development funds like the large conventional companies. Wal-Mart uses market development funds from these grocery firms to reduce everyday retail prices in their stores in addition to advertising. Wal-Mart also asks for and gets volume discounts from these conventional companies since Wal-Mart has so many stores world-wide and sells such a huge volume of grocery products. These organic suppliers neither have such funds available nor can they or do they want to give substantial volume discounts to Wal-Mart. In fact it's difficult enough for many of these organic suppliers to meet Wal-Marts current volume with them let alone increase it.
In conclusion
All of these current factors make it difficult that Wal-Mart's organic initiative is going to be a raging success anytime soon. However, that does not mean it isn't a smart move for the giant retailer. It also doesn't mean that over time Wal-Mart can't make it work. However, the organics initiative was a part of Wal-Mart's strategy to go after higher income and more upscale shoppers--in addition to their core shopper--and this "more upscale" strategy seems to be diminishing at Wal-Mart headquarters. There is much industry talk that Wal-Mart executives, including CEO Scott, are thinking that targeting the more upscale shopper might not be where the chain should be currently. If this is the case it likely would result in a reduction in emphasis on the organic grocery initiative as it is clearly part of the overall more upscale consumer campaign.

Don't be mistaken however. My analysis far from rules-out Wal-Mart being successful--and becoming a major retail player in--organic grocery merchandising and retail sales. Even though Wal-Mart doesn't get near the number of upper middle class shoppers as say Target Stores, by virtue of the mega-retailers sheer store count, they still get millions of upper-income consumers through their store doors. Many of these shoppers regularly purchase organics at natural foods stores or supermarkets and are buying them when at Wal-Mart.

Further, many middle-income shoppers--a large segment of Wal-Mart's core customer base--are increasingly buying some organic grocery products. And if they see these organic items in Wal-Mart regularly--and at considerably lower retails than in the supermarket and natural foods stores-- hey may increase their organic purchases considerably at Wal-Mart stores.
Additionally, as Wal-Mart grows it's organic grocery presence it will serve as motivation for many large conventional grocery suppliers to ass organic skus to their brand portfolios. It will also motivate them to purchase smaller and medium size organic suppliers to get deeper in the game with Wal-Mart.

The jury is still out on the success of Wal-Mart's organic grocery initiative. And much of that success will depend on all the variables and circumstances I have described. However, it would be foolish for anybody to rule Wal-Mart out of the organic retailing derby at this point. To do so is at ones own economic peril.

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