North America Council, 1980: There have been shortages of vital commodities which threatened national or even world economics. Rational minds know that the threats do eventually come to an end. Whatever it was that was in short supply, is plentiful again. But tens of millions of years of forest growth are gone forever. Eventually, different forms of fuel will fulfill our needs, but, in 1980, the Coca-Cola Retailing Research Council (CCRRC) set out to help address what would happen until then. Actually, looking back at the 1970s and the two-time jump in gas prices is scarier now than when it first happened.
The events of the fifties and sixties created a retail economy that was unconsciously dependent on cheap fuel. It was clear that major shifts were underway in the American family, due to the war and the children’s purchasing power increasing. The changes brought about by shifting cultural standards and new lifestyles were drastic but, in a sense, anticipated. What was not anticipated was how the economy would be affected by the rise in the price of oil. It has been seven years since that first impact, and the question now is, “Are the next seven years going to be the lean years or the fat?” For the purpose of this paper, the only thing assumed is the aspect of the energy picture, particularly because of its aspect in the marketplace. Also, the predictions need to be particularly different for each different case that comes up.
Energy in the Eighties
In the 1960s, the rate of discovery of new reserves began to decline toward the end of the decade. At the same time, a general growth in affluence drove some people to increase their usage of energy. Once demand began to exceed supply, the owners of supplies were in the driver’s seat. The first jump in crude oil prices one year was actually larger on a percent increase basis than the total increase since. Because the CPI has a healthy component of energy prices, inflation in other sectors must, by comparison, have been much less than the rate of rise in energy.
The 20th century has been a century of cheap energy. Being relatively cheap, energy was used perhaps more intensively than it would have been otherwise. As a consequence, the energy equivalent for each rise in GNP began to rise toward the end of the sixties, which brought our crisis on a bit sooner. In the 1970s, the impact of higher prices has resulted in a remarkable reduction in the amount of energy equivalent per unit of GNP both in the U.S. and in the rest of the world, even though the U.S. governmental policies until recently encouraged consumption by maintaining an artificially low price for fuel. Conservation efforts that have taken hold more promptly in European Nations are what will save us. The impact of high prices on conservation has been remarkable. Had it not been for the enormous energy savings in energy demand, the level of production would be quite higher. These savings have been brought about through changes which have affected the American and the world economy.
The shortages which create higher prices not only spur conservation but also the development of new supplies. There has been a rise of over 50% in the number of seismic crews at work in the United States in the year following some decontrol of prices. Even greater is the fact that, between 1978 and 1979, the number of seismic crews dipped because of the drop in the real oil price combined with the pessimistic outlook for decontrol of prices and the stifling atmosphere of over-regulation. Considering all the activities which have had to go on in the short time, this recent increase is the leading edge of interest in oil exploration, and seismic activity is expected to rise. While proven oil reserves have not increased during the past few years, at least the rate of decrease has declined. Most forecasts now call for a gradual building of reserves in terms of total years of supply at least in the short term.
Since the first and most important impact on the food industry distribution system will come from the success or failure of the energy industry, it should be noted that overall price and supply forces are being influenced by and influencing the natural forces of the marketplace. What we have seen is that, when prices are permitted to rise, conservation and substitutes take hold. Yet, as adjustments are made and economies recover, demand will rise again. For the 1980s, we can forecast that the world can count on at least one more decade of relatively slight shortfalls between supply and demand, and that the increase in the prices of energy relative to those of food and other commodities should be no worse and probably lower than they have been in the 1970s.
The Changing Nature of Food Distribution
One prediction that is easy to make is that this industry will be a rapidly moving target. Change is the rule in food distribution, and variety is its foundation. While the range and scope of the manufacturing and processing sector is staggering, its complexity and variety pale when compared with the wholesale and distribution segment. And retailing is full of still more surprises. For all the high expectations of the age of one-stop shopping, the largest sales increases in 1979 were in the specialty store segment, the meat markets, produce stands and bake shops, which the energy shortage was supposed to have put out of business. The bewildering variety of manufacturers, processors, distributors and retailers is a response exactly tailored to consumers’ needs. Since no two consumers tradeoff price, convenience, service, quality and even ambience in quite the same way, there are myriad opportunities to serve consumer preferences in a profitable way.
The food manufacturing and distribution industry in the United States has responded quickly to the 1970s change in energy economics. The initial emphasis was to adopt new technologies, holding tightly to traditional margins and geography. Regardless of how diverse the food industry is or how wide its scope, the incentives to find more economic means of distribution grow as does the price of fuel. The ways in which this can be done can be characterized as:
- Making more efficient use of current plants and transport;
- Shifting to more efficient systems;
- Eliminating or consolidating the least efficient systems, and
- Restructuring markets along geographic lines.
Manufacturing and Processing
There are many ways for manufacturers to reduce their energy needs. Plant location and product line determination decisions basically set transport costs and inventory-service level tradeoffs. Higher energy costs tend to favor multi-product plants, which allow for direct shipments to distributors in smaller quantities. Another alternative is adding distribution centers, because of a contraction in the breakeven distance at which the firm can profitably operate by truck. Smaller firms will find their distribution enhanced most readily by combining with others in joint tenancy in distribution centers. Eliminating “double-back” miles on high bulk products will also create significant energy savings. Double mileage is caused by lack of information as to where and when what product is needed. Its cure will be in the many online information processing systems that have become common in our offices and plants.
The third alternative is to shift to a more fuel efficient means of transport. Railroads are potentially far more efficient users of fuel than trucks. Major gains in efficiency could come through the increased use of rail for inter-city transport. Although the American rail system has been plagued by heavy regulation resulting in overcapacity and low ROI, the success of air deregulation, both freight and passenger, the initial success of truck deregulation, and the gains in rail traffic as a result of the few steps towards rail deregulation suggest that economic forces are already indicating that rail could be – and should be – the energy surprise for food distribution in the 1980s.
The largest impact of energy prices in the 1980s could be the erosion of uniform regional and national pricing. Currently, many manufacturers maintain a uniform price throughout the United States, regardless of the marginal cost of bringing the product to any specific location. Such a policy can exist only until the difference between the true cost of the product and the price that it is being sold at becomes large enough to attract competition. The recent jump in generic market share at retail level may be, in part, a consequence of increased transportation costs which have been passed into the competing brands price structure as part of the uniform price.
The increasing price of energy and transportation will require that these costs be spread over greater volumes and more items in order to obtain economies of scale. The balance between the virtues of direct sales representatives and a broker’s diversified force will be shifted further towards the use of brokers and away from individual sales reps. The former are well positioned to expand as a result of the need for lower cost per call in direct sales.
Items delivered outside the normal mainstream of grocery products, such as snacks, bread, milk, soft drinks and some dairy products, are normally delivered by smaller, less fuel-efficient delivery vehicles. This system will be under more than usual cost pressure because of the price rises in energy for transportation, although those with large national market shares and huge delivery systems may be less affected. The development of local agents or brokers who stock local outlets from a distribution center shipment has proved efficient in some product lines, such as general merchandise.
Distributors
The distribution function from warehouse to retail stores is the most energy-dependent of any of the sectors in the farm-to-consumer chain. An indicator of how distributors have coped with shortages in the 1970s is in the impact on transportation costs. Higher fuel prices have spurred innovation with such technological advances as the fan clutch, air shield reflectors and fuel squeezer engines. However, energy costs growing in the same magnitude in the next ten years will put a severe strain on wholesale distribution profits. It should be noted, as well, that the distribution industry is far from an efficient use of energy. Several practices could help the distribution industry to enhance its efficiency in fuel consumption:
- Backhaul: The simplest, most direct response to higher energy costs will be a more efficient use of current transportation. Most recent studies of common carriers and private trucking indicate low rates of utilization of the freight capacity of a truck when a complete round trip is considered. The economic incentive to fill the truck both ways adds to the significant energy savings that would result from such practice. New legislation favoring backhaul has passed in Congress, allowing well-functioning trucking networks to match overall transport availability to the freight movement required, minimizing empty truck movement.
- Common Carriage: A rewarding potential lies in the ability to haul whatever is available in whatever direction it is needed – i.e., for distributors to become common carriers. A grocery distributor with experience in trucking operations should haul furniture, paper products, chemicals or whatever available freight will fit in his truck, and for which he has the appropriate equipment. The efficient functioning of a network of this kind, however, will require a higher degree of operating flexibility and greater internal discipline. By the end of the decade, food distribution companies in their backhaul routes could be hauling as much non-food as food.
- Combining Deliveries Across Market Segments: The biggest gains in better utilization of capacity may come from combining different market segments in one overall system. For example, consider the possibilities of combining a food-service delivery truck route with a convenience store delivery route from a different city. When a wholesale grocery truck is delivering groceries in a city 100 miles away from the nearest distribution center, there is a bonus available if he can figure out a way to get 40 extra cases of specialty items to the little restaurant down the street or the convenience store at the end of town. For an industry such as grocery wholesaling, where local profits are below 2% of sales, the high delivery cost of convenience stores, restaurants and general merchandise jobs is a highly attractive target.
Higher transportation costs will force new store development to focus on market areas near the distribution center. Many retail chains and some wholesalers do not know their true cost of delivery to distant stores, but increasing energy prices will soon get their attention. At the same, both unit operating costs and unit inventory investment for a distribution center are reduced through higher volume. These conflicting pressures suggest that there will be more intense development of “home” markets, while wholesalers will be used to supply stores in promising but distant locations. In addition, volume will be increased by serving other marketplaces (convenience stores, restaurants, institutional clients).
The Retailers’ View
The ultimate test of adjustments to the use of energy is the retail store. No amount of efficiency can compensate for failure to meet consumers’ desires. Retail food stores have accommodated the increases in energy supply costs that have occurred during the past decade, but their impact on profitability has been growing rapidly. While energy costs today account for only 1% to 2% of the sales dollar and 5% to 10% of the gross margin total, they are a new external factor that has been added in the past ten years as an expense of doing business.
The 1974 data compared to the 1980 data tend to indicate that much of the increase in energy costs has been absorbed through efficiencies during this period. Technology and store design have contributed much to energy savings through the use of the latest refrigerated equipment and heat-reclaim devices, as well as window elimination, better insulation, non-automatic doors and more energy efficient lighting.
The savings for full truck loads gives larger stores a cost advantage that should grow with time. Other energy cost related effects benefiting large stores and increasing cost pressures on small stores will add to the development of larger stores. While the recent trend towards specialty stores is perhaps contradictory to this expectation (specialty stores have shown a dramatic increase in number), it would be a good guess that these stores are primarily located in urban settings, where the distance between stops is shorter. It should be possible to provide the management attention that gave specialty shops their drawing power within larger stores, adding further to their attractiveness.
These same factors operating in a suburban or rural environment should result in continued consolidation of food stores in smaller communities. Two smaller stores simply cannot provide the variety and cost of savings of one larger store in most of these towns. It is significant that almost the entire reduction in the total number of stores in the United States over the past five years came from the smaller stores sector. The continued pressures on small stores suggest that store operators may become more innovative in the near future. If there is not enough business volume to earn economies of scale in the food industry, there may be opportunities to combine the grocery store base with broader lines of general merchandise and carry-out foods.
Higher energy costs may also favor the emergence of cash-and-carry type operations as well, particularly in urban areas. The cash-and-carry store essentially permits buyers to establish their own optimum deliveries using lower-priced equipment without regard to a distributor’s lack of flexibility in establishing equipment or delivery schedules. In addition, higher energy costs will force closer examination of losing items. Since costs are caused by bulk, and revenues created by value per unit, high-bulk, low-value items are often money losers. Many of the items that fit this description are, unfortunately, high-volume sales items. They are excellent candidates for pre-booked sale, direct delivery to retail stores or for sale outside the store from sheds, racks or storage bins to minimize in-store handling.
Many of the alternatives that allow distributors and manufacturers to minimize transportation expenses result in higher inventories at retail. Inventory level control is certain to receive additional emphasis in coming years. U.S. data on retail chains indicates that there have been no improvements in turns in the past ten years, in spite of the availability of greatly improved computer technology. The incentives for improvement in the next decade will be greater than they have ever been.
Conclusions
The last ten years have established energy costs firmly as a strategic variable that is in the process of inducing far-reaching changes in the U.S. food distribution system. The initial reaction to higher fuel and energy prices in the system has been to attack the elements of energy usage directly – more efficient lighting, better diesel engines, elimination of in-store heat losses. Customers have also reacted, both by reducing the amount of energy they consume in traveling to stores and by being very supportive of innovations to save energy at stores.
However, we are not likely to be able to accommodate higher energy costs by further increases in the efficiency of machines and structures. While progress will continue, it will not be possible to totally insulate operating costs from energy price rises in the future. This means that there will be a gradual erosion of margins for energy intensive parts of the food distribution industry, with survival options available through the development of new distribution channels. Retail food stores which find a way to serve the institutional food needs of local schools, hospitals, offices and factories will save more fuel than the most energy-efficient device ever. A manufacturing company that redistributes its plants and production assignments can reduce its transportation requirements by half, saving more energy than it would have saved through new production processes – though both savings should be welcome.
The decade ahead, then, as have all the decades behind us, will be full of unforeseen events – most of which can be counted on to make our jobs more complex or, as some might say, more interesting. The one thing that will not change is that the customer will continue to dominate the scene. What we have learned from failed predictions in the past is that the customer will be served, and the merchant who learns how to meet customers’ desire, while accommodating the impacts of economic changes through other mechanisms, will be successful.
Every change in the economic environment represents an opportunity for someone to increase his/her share of the market. The growth of the warehouse market and the box store is clearly a response to high wage rates. For similar reasons, some innovative manufacturers will soon start the process which will erode the practice of uniform national pricing of products. The biggest impact of rising energy costs then will be the emergence of distribution costs as a variable capable of providing a real competitive edge in the retail food marketplace.