You’ve probably heard the term “frenemies,” a new word that combines “friends” and “enemies.” In the business world, frenemies are two competitors that cooperate with each other to increase business, but at the expense of sharing customer purchase data and other proprietary business information. The birth of the Internet spawned the term, as smaller companies with something to sell struck deals with large web portals like Google, Facebook and Amazon in order to get access to the millions of eyeballs visiting these massive sites every day.

Tradeoffs

But even before the Internet, doing business involved making tradeoffs; commitments you make to your vendors to perform in a certain way over a period of time in order to secure cooperation, support, deals and discounts. And there has always been a tension between business partners as power shifts, in this case, from manufacturers to retailers and back again depending on the size and strength of each.  

In the food business, this tension is most evident in the conventional supermarket channel. While food manufacturers such as Kraft Heinz, Coca Cola, Pepsi, General Mills, Nestle, Kellogg, Anheuser-Busch and others need to make wholesale truckload shipments to supermarket warehouses to efficiently reach consumers, these large companies also effectively control a portion of the retail merchandising area in these stores. The level of control is such that, in one analysis, conventional supermarkets are simply dealer showrooms: they make all or most of their profits from “leasing” space to large manufacturers in the form of “slotting fees”; “slotting fees” are the roughly two percentage points supermarkets have become accustomed to charging manufacturers in order to allow new SKUs into their warehouses and onto their shelves. Pre-tax net profits for supermarkets are often at or below two percent.

Private Label

In order to take back control of their shelves, many supermarket retailers have developed their own private label brands of products that mimic the national brands, today often matching quality while beating price. One extreme example is Trader Joe’s, the compact specialty foods retailer that gets an estimated 80 percent of its sales from private label. But here’s something that may surprise you: Kroger, the Cincinnati, Ohio-based conventional supermarket chain with over 2,600 stores under various brand banners in 34 states, gets 25 percent, or $25 billion of its $100 billion in sales from its private label brands.

That private label effort includes, by the way, the Simple Truth natural and Simple Truth Organics lines that hit $1.2 billion (yes, billion with a “B”) in sales this year. The Simple Truth line comprises nearly 2,700 SKUs, and has been experiencing “explosive growth” according to the company. This success in the grocery aisles has prompted Kroger to begin distributing some of these Simple Truth foods to its standalone convenience stores, and to make them available on Vitacost.com, the Internet vitamin and supplement retailer with 45,000 nutrition SKUs that Kroger acquired last year for $280 million. It appears Kroger bought Vitacost.com to accelerate its overall Internet capabilities, but the fact that Vitacost.com is a vitamin and supplement specialist at the center of the health and wellness movement is certainly not coincidental. Do you think Austin, TX-based Whole Foods Market—its sales tracking at $15–16 billion this year—is paying attention to Kroger?

A New Distribution Channel?

The Internet has created what looks like an entirely new distribution channel, one that appears to threaten the existence of brick-and-mortar retailing. But is the Internet really its own distribution channel? Not entirely. Two examples—music and books—help illustrate the point.

Music, an aural experience, can be delivered electronically, precisely matching the Internet’s digital mode of distribution. Even music videos do not require physical distribution. With 100 percent exposure to electronic distribution, the music retail store industry was the Internet’s first casualty. Apple, Inc.’s, 2001 launch of iTunes, its Internet music delivery service, along with the iPod, changed music distribution forever; from physical to electronic delivery, driving most new-music retail stores out of business in the process.

The second industry to fall prey to the Internet was books. While books can be transmitted electronically, only about one in three people in the U.S. owns an e-reader. And even though e-readers are gaining market share, people still read the majority of books in printed form. With only a third of its market share currently exposed to electronic distribution, the book retailing sector has been hit hard, but continues to survive.

While Borders Books, the second largest brick-and-mortar book retailer, declared Chapter 11 bankruptcy in 2011, Barnes and Noble, the number one retail book chain, plans to remain while reducing its store count by about 40 percent, to fewer than 500 by 2022 from a peak of more than 700 in 2008.
There is a link here: the more exposed to electronic distribution your industry, the greater the threat the Internet is to your business model.

The Hurdle of the Last Mile

Think about it this way. The average U.S. household buys about 28 pounds of food per week for consumption at home. Shipped via United Parcel Service ground, that’s about $18. Shipped second day via the U.S. Postal Service, it’s about $30. And that’s dry goods. Try double or triple for refrigerated and frozen foods.