Are You Experienced?
Want some good news? Co-op store productivity increased in the third quarter of 1998, when compared to the third quarter of 1997. (See Graph 1.)
Want some bad news? As a group these same co-ops show a decrease in net income when compared to the same quarter of the previous year. (See Graph 2.)
Conclusion: It's the experience curve. Although we are making operational gains, we are not improving fast enough, and our profits are dropping.
The experience curve
The experience curve suggests that most co-ops may go out of business in the next ten years. Based on research in hundreds of industries, the experience curve shows that per unit costs fall predictably with increases in market share. This is an observable phenomenon.
In the natural foods industry, investor-owned stores are gaining in overall market share. Graph 3 (next page), an experience curve example, compares payroll costs as a percent of sales, using data from the last two Natural Foods Merchandiser annual reports with those from Cooperative Grocer. As you can see, payroll costs in investor-owned stores have started dropping while co-op store payroll costs have increased.
Graph 3 also shows margins increasing in recent years. However, the experience curve, reflecting the strategy usually associated with it, predicts that gross margin will also drop as chains and mass market stores increase their natural food market share. Whole Foods lends credence to this, with low pricing in their most competitive markets.
Our natural food and mass market chain competitors will be able to drop prices and still be profitable because of the experience curve phenomenon -- their per unit costs will drop at a rate as fast as or faster than the gross margin drop. Co-ops that don't realize similar efficiencies won't be able to compete on price. Graph 4, using speculative data, illustrates this point. Many co-ops don't want to compete just on price -- but if we are not in the ballpark on price, we won't be able to capitalize on our unique community ownership differences and benefits.
Thesis of this article
The upside: If co-ops smartly pick the issues to attack and effectively take action at the appropriate local, regional and national levels, we can realize experience curve benefits. Co-ops will remain viable and keep valuable community benefits flowing back into neighborhoods.
The downside: If co-op stores only manage locally, we will not gain the same experience curve benefits that our competition realizes. New wave co-ops will follow the path of the old wave co-ops (formed in earlier decades). Extrapolating from the 1983 "Report of the National Planning Task Force for Food Cooperatives," I calculate 1981 sales volume of the old wave co-op stores at approximately $700 million. Most of those stores closed; the volume of those still in business is perhaps $100 million. We don't want to follow the same strategy!
Cooperatives helped build the natural foods industry. But while our "same store sales" compare favorably with those of private stores, cooperatives have lost market share over the last 20 years because we haven't figured out a way to open new stores as rapidly as our investor-owned competitors. The experience curve predicts that our competitive position will deteriorate as our market share decreases (Graph 4).
Consumer co-ops are quite significant in the market. There are over 300 cooperative grocery stores in the U.S., ranging from sales of under $100,000 to single store sales of over $20 million. Co-op annual retail volume is approximately $500 million. If viewed as a natural food chain, this would make us the largest in number of stores and second in sales volume. However, we are not realizing all of the experience curve benefits that these numbers imply, because we are structured primarily to operate locally.
For example, co-ops have many different ways of recording accounting information. This makes it more difficult to compare information and is an example of reinventing the wheel. This redundancy, which often creates cost and not value, is prevalent throughout most of our operating departments.
Another example: cost of goods. Co-ops, with the same volume as their nearby competitors, often pay 3-5% more for the same products because we aren't effectively using our $500 million in volume to leverage a lower cost of goods.
Our financial base is solid. According to the most recent Cooperative Grocer survey, the average retail cooperative is financially sound and liquid. Average debt to equity ratios are less than 1:1, and liquidity is high. And same store sales increases are strong, comparable to those of investor-owned stores.
Our industry is changing, growing rapidly and consolidating quickly, as exemplified by Whole Foods, Tree of Life, and United Naturals. And the mass market cometh. Based on an informal survey of suppliers, natural food growth is now primarily generated from the mass market. More and more conventional supermarket chains, such as Star Market and Kroger's, are offering sophisticated natural foods sections and stand-alone stores. Mass marketers have or will become our most significant competitors, at least in terms of product availability and price. Scarcity in volume may sometimes result. Some large firms are buying up entire runs of high visibility products, and co-ops end up out of stock on critical items.
What are our needs?
Given this situation, what are our needs? Looks like a "pair o' dimes" shift. Retail co-ops can ultimately compete if we discover additional ways to work together to realize the same experience curve benefits that accrue to our competitors. If we don't, we've got slow death ahead of us. If we do, we will remain key players in the natural foods industry.
Ultimately, we're in this for the positive social changes that cooperatives can help achieve. Financially sound co-ops can have a substantial and beneficial community impact. We could deprive our neighborhoods of these potential benefits by not making correct strategic decisions and by not taking decisive action.
We need to know what actions to take to remain competitive and the best ways to take those actions. Sounds simple, but is hard. At this time, natural food co-ops have not been able to gain the purchasing, marketing, operating, and financial benefits of our chain competitors. In places where natural food or mass market chains are not now competitors, they soon will be. Serious competition will show up everywhere.
The current structure of our movement does not facilitate quick decision making or allocation of adequate resources to deal with issues at the regional and national levels. In my non-co-op investment banking work, one of the most important lessons I have learned is the importance and power of "cycle time." For example, by manifesting the experience curve and working together, it's not unrealistic to assume that we could save 2% on much of our $500 million in annual volume -- several groups of cooperatives have already demonstrated just that. That translates to thousands of dollars in savings that we could be realizing. Making correct decisions could help us achieve the benefits our combined volume indicates. The opportunity cost is staggering and should create a sense of urgency among us.
How to proceed? The exciting aspect is that we are in the midst of just doing it! The CGA (Cooperative Grocer Association) Midwest and Blooming Prairie took leadership, and were soon joined by CGANE and Northeast Cooperatives in initiating what has become CoCoFiSt (Common Cooperative Financial Statements, source of data in Graphs 1 and 2). The Twin Cities Natural Food Cooperatives have started joint advertising programs. The Southeast CGA negotiated a major savings joint buying program, and Puget Consumers Co-op and Cooperative Development Services have sponsored two powerful store development forums. The National Cooperative Bank and MSI Foundation have also been very supportive of these endeavors.
Mandated at the joint CGA meeting last year, representatives of six CGAs recently met to discuss what structure would support and nurture these regional initiatives and what programs should also be addressed at the national level. After receiving comments from regional CGA member co-ops, these representatives will present a proposal for a national strategy, structure, and projects. Watch for this important development in upcoming issues of Cooperative Grocer.
Here is what is going to happen: We're going to build on the momentum and examples we have already created and use our combined numbers and volume to get the benefits of a chain, without being a chain, while competing with chains. We have the experience!