Retailers drive some exceptionally hard bargains; questionable fees have vendors crying foul.

Not long after Rite Aid confirmed its $3.4 billion deal to buy more than 1,800 Brooks and Eckerd drugstores, it summoned all the confectionery suppliers that had provided products to the Brooks chain to offer them a “special opportunity.” Rite Aid told the suppliers they would need to pay $9,000 for every SKU they had in Brooks Drugs if they wanted to maintain their placement in the new combined chain. They also asked them for a purchase allowance (based on a percentage of annual volume) and extra dating for payments — 90 days above regular terms. In addition, suppliers were required to pay Rite Aid a sum equivalent to 1.5 percent of the last year’s sales of products to Brooks. This “conversion” fee was intended to defray the costs of revamping old Brooks’ stores to their new Rite Aid banner, including signage, racking and store remodeling.

“Our first reaction was, ‘This is going to be very expensive,’” says one of the vendors involved, who requested anonymity.  He estimated it would cost him 50 percent of the total of last year’s sales to Brooks to “participate” in the offer. Moreover, he was fearful that if he didn’t participate, the products that he currently had on the shelves at Rite Aid were in jeopardy of being pulled.

“We were paranoid,” he admitted. “If Rite Aid could do this in the drug arena and get away with it, then what’s to stop other retailers in grocery and mass from doing it in their channels? They might be thinking, ‘All we have to do is ask.’ And then we’ll be strapped by all our retailers.”

Another manufacturer, who also requested anonymity, was able to whittle down the fee through negotiation, but only after the sobering recognition that if it lost its presence in Rite Aid, another supplier with deeper pockets would take its place. “There are only three major drug chains, and as a supplier we’d better be in all three,” he said. “We didn’t want to lose our presence in their stores and have some other supplier take that business.”

The end result was that some candy makers paid a larger percentage of the fee than others, further calling into question the equitability of the fee. But when pressed for details, nearly all of the suppliers contacted were reluctant to speak on record about acquisition-based fees. They all agreed they were unjustified — if not discriminatory—but refused to publicly criticize them for fear of reprisal.

Rite Aid isn’t the only retailer that has asked its suppliers to help it shoulder the financial burden that accompanies a major acquisition. When CVS bought 1,200 Eckerd stores in 2004, it approached its suppliers with a request for purchase-based allowances. In the grocery industry, “pay to stay” fees are prevalent in many categories, and have been so for more than a decade. (Both Rite Aid and CVS declined our request for an interview. We contacted eight other retailers in various channels, but all declined to comment.)

“These trade practices are not new,” says Mark Baum, who runs the consumer product goods division of Diamond Consulting, a management consulting firm that provides services ranging from merger and acquisition strategies to supply chain management. “In the grocery channel they’ve certainly intensified through consolidation and competitive pressures, and we’re seeing the same thing in drug.

“We have a history of enabling these practices, which go back to slotting fees, which initially were justified as introducing new items into stores that had a lack of available shelf space,” Baum continues.  “However, these legitimate costs gave way to whatever price the market could bear. Larger chains could charge more than small chains, so the price varied depending on the company. It became a ‘pay to play’ fee and has become embedded in the cost of sales for manufacturers. The result is that those suppliers who have a great demand for their products are not as burdened as small companies. In that sense, it’s a somewhat insidious practice.”

These kinds of fees — heaped upon slotting allowances, deductions, reclamations, and other charges — have made it harder and harder for mid-sized and small manufacturers to reach the market through these distribution channels. Major candy manufacturers can absorb these one-time hits, or sic their 10-person deduction-dedicated legal teams on the retailers to negotiate away a good portion of the charges. Small suppliers, on the other hand, lack the resources and/or the bargaining power to push back — and many can’t afford to walk away from the business.

“This kind of activity has always been in the industry, but the new kinds of fees we’re seeing today were never used,” says Jay Pearlman, president of Ludo LLC, a Cleveland-based interactive novelty candy company. “Are they unethical? Yes. But the retailer has the right to do whatever they want to do, and the manufacturer has the right not to participate. It absolutely hurts small manufacturers in a way that it doesn’t hurt the Mars, Nestlés, and Hersheys of the world, who can pull these allowances out of marketing development funds. And the little guy knows that if he refuses to pay these fees, there are big companies lined up behind him who will.”

In Pearlman’s opinion, the practice damages the industry by squeezing out smaller companies. “Now when you go into an account, you see the same products. Do you really need five different sizes of Snickers on the shelf? The less choice for consumers makes all the stores look the same — and one of the things that make our industry so great is the variety.”

Because of the nature of his company, Pearlman doesn’t have to chase the dollars the way that some other confectioners do. “I made a decision a long time ago that when I got my business to a certain size, I would choose who I want to do business with,” he says. “I have some great customers that it’s a pleasure to work with. One customer, for example, charges slotting but I know exactly what I’m getting into, and they have a decent justification for their fees. The distributor can go into the stores and reset the planograms for us, and we’ll be charged for the reset — but that’s reasonable.”

What seems so unreasonable to most suppliers is the disconnect between the fee and the understandable expectation that it will be used to merchandise their products. As one former candy executive said, “Why is money changing hands between buyer and seller when no sales are happening?”  

Take slotting fees, for instance. Retailers need to evaluate the sales and margin potential of any change in merchandise they sell, so they charge suppliers a fee to offset the costs associated with their efforts to determine which item will be cut back — or eliminated —  to make room for a new item. Suppliers aren’t doing cartwheels because they’re charged slotting fees, but at least they understand the business rationale behind them.

The requests for fees vary dramatically, making it hard to provide a sound comparison. In some cases, retailers charge fees based on total purchase commitment, while in others they charge based on items per store or on the total amount of real estate a product occupies on the shelf. Geography can also play a part in the equation. For instance, the fee charged to a supplier servicing New York could be twice as high as one charged to a supplier in Tulsa — and even higher to a supplier in California.

“Just about all retailers charge slotting allowances for new items; some retailers will send you a bill for a new store set or a reset of an existing store, and some have a yearly fee for resets,” says Eric Ostrow, vice president of sales and marketing for Ce De Candy. “You’re expected to pay your ‘fair share’ based on the number of items in the schematic.

“In most cases, these charges aren’t prohibitive. But what you have to understand is that every time a retailer imposes a cost on a manufacturer — whether it goes through a distributor or not — the price goes up. Most retailers expect the manufacturer, who is a fraction of their size, to absorb these costs.”

Ostrow can negotiate the fees based on the power of his brand: Smarties have been a familiar part of the confectionery landscape for nearly 60 years, and in its novelty category continues to rank in the top 10 in the United States in annual tonnage. “We try to give our retailers a fair deal, and maintain our normal profit margins, and all we ask is the same in return. Most retailers are willing to do that. But during any negotiation you have to be aware of what kinds of fees could come about. What’s even more frustrating is that sometimes you agree on a price and a retailer will come back in three months with a new format and try to renegotiate the price … after we’ve already planned for it in our annual budget.”

One Midwestern manufacturer, who requested anonymity, has had success negotiating down acquisition-based fees by pointing to the fact that his seasonal confections are in high demand among consumers. “We’re able to show the candy buyers how our products have sold over the years. We’ve built up a track record that’s hard to argue with. On newer items or line extensions, where the sales projections are harder to make, we agree to sell-through allowances.”

One of the biggest issues surrounding acquisition-based fees is that it’s hard to trace the revenue generated by them to improved promotion, better advertising, or innovative store sets — anything that would make suppliers feel as if they were getting something in return for the “special opportunity.”

“Most retailers have some fees for new store openings even if they don’t have slotting fees,” says the chief marketing officer for a Midwestern candy company, who asked that his name be withheld. “The belief is that they carry more risk because the sales level is uncertain, so they try to pass it on to the manufacturer to defray the cost. In a lot of cases, that will involve special terms or additional sell-through allowances.

“Our experience has been that these fees have nothing to do with location or store size,” the marketing officer continues. “The companies that are charging them are minimizing the exposure to their working capital by asking their suppliers for terms. They’re also using them to minimize their risk as a buyer. If a retailer has an ‘ABC’ format, they generally know what’s going to sell. But if they acquire a new store in a new geographical location they may be less certain, so they shift the risk back to the supplier. It’s the equivalent of buying yourself an insurance policy at the expense of your suppliers.”

“If I was a manufacturer,” Baum says, “I would want to know how these fees were applied, where they were applied, and what return I will get. If they’re to be allocated to marketing, where were they used? Did the retailer produce an extra ad or promotion? Was it a productive use of the dollars? Most of these fees seem to be more like a toll. They don’t necessarily go to anything related to an individual company.”

The best retailers will engage their suppliers to maximize those dollars in the most creative way, Baum points out, thereby exposing their products to more consumers through the additional stores they’ve acquired, giving suppliers of all sizes a much more visible return on their investment.

“The retailers who are only collecting these fees as a way of using suppliers as profit centers will lessen their competitive edge, while those who use the fees to reflect better products on the shelf — and better serve their customers — will ultimately win the battle,” says Baum.

“The interesting thing about confectionery is that it does tend to be more fragmented once you get past the Nestlés,  Hersheys and Mars of the world,” Baum continues. “The second thing that makes confectionery interesting is that in addition to being a household item, it’s also a high-impulse item, so point-of-sale placement and cross-merchandising activity are more important than in other categories. There’s more demand and more movement, so there needs to be more collaboration between retailers and manufacturers.”

The size and extent of the fees have forced some suppliers to investigate alternatives to traditional distribution channels. “We’ve seen cases across the spectrum in which wholesalers have become their own distributors, or found other outlets to distribute their products,” says Al Ferrara, national director of Retail and Consumer Products Services with BDO Seidman LLP, a leading accounting and trade practices firm. “Rather than become solely dependent on one distribution channel, they’ve turned to outlet stores, seconds, boutiques, or opened their own retail operation.”

Confectionery is not unlike other categories, according to Ferrara. “A select few suppliers have leverage over the retailers or have carved out a unique place in the market,” he notes. “But with continued consolidation, the strength of retailers will only increase, and their hold on the distribution channel will get tighter. Part of their strategy will be to add as much additional margin dollars as they can out of their suppliers.”

Some candy companies have tried their best to put a positive spin on the situation. “You don’t have much of a choice, but in a sense you don’t mind doing it because you solidify your sales in the store,” says Eric Atkinson, president of Atkinson Candy, now in its 75th year. “It’s a cost of doing business. You can do the math and figure your paybacks pretty quick. If there’s not a payback, we don’t do it. That’s the way we look at it, and it doesn’t seem that oppressive.”

There’s no question that when a company like Rite Aid or CVS purchases another retail entity, there are huge costs in terms of harmonizing items and converting formats. “From their perspective, they feel like a manufacturer who will enjoy increased business should share in the cost,” says one consultant who has worked with both retailers and manufacturers. “But the manufacturers feel like they’ve already paid to have those items in retail, so they’re just incurring a new cost against a product that’s already selling.

“A lot of suppliers feel that the best business practice should be to factor those costs into the price of the acquisition, rather than push them onto manufacturers with new allowances to keep them in the store,” the consultant continues. “What’s happened is that manufacturers have acquiesced over time. Companies who couldn’t afford not to be in distribution would crack and pay … and as soon as one cracked, they all folded and the rest went along.  

“From a retail perspective, this is just a short-term cash grab,” the consultant says. “But the long-term effect is that products don’t sell as well because suppliers reduce their promotional and advertising expenses to offset the cost of these fees. That hurts retailers, too … but if a company can add $350,000 to its bottom line, it’s probably worth the risk.”

As much as they bemoan the situation, manufacturers bear much of the responsibility for letting the balance of power shift to retailers over the past several decades. One old-timer, who asked not to be named, described it like this: “If you went to a candy company headquarters in New York in the ’60s or ’70s, you were showed into a massive waiting room where the buyers would come to talk to them and ‘sell’ them on their stores. Now it’s completely the opposite. The manufacturers are coming to the retailers and offering to pay such and such to put their products in — and the retailers know they have the power.”

The shift has occurred so quickly that the latest generation of confectionery executives now in their 30s and 40s doesn’t feel the same moral outrage about supplier purchase allowances that “elder statesmen” in their 50s and 60s do. “Many of the fees injected into the business in the past 15 years have gone through a generation cycle to the point where they’re inherent and accepted rather than rejected,” says a senior executive in the industry. “The longer they prevail, the more they become the norm. And the more they become the norm, they harder they are to change.”

“There have been tensions over fees between suppliers and retailers for decades,” says Professor Eugene Fram of the Rochester Institute of Technology, the author of hundreds of articles and six books about retail marketing. “Every time there’s a new wrinkle in the relationship, it is settled by the ‘channel commander’ — the trading partner that has the most power in the channel being used. If we go back in time, the channel commander was the manufacturer who had the branded name. Customers would look to the manufacturer to provide the latest styles and merchandising.

“In the last 10 years, the retailer has become the channel commander because the retailer now speaks more for the customer,” Fram continues. “In the past, manufacturers did market research and took the initiative in merchandising. But now the retailer has the stronger local presence, and vast buying power, a la Wal-Mart. For example, if Wal-Mart demands that merchandise is to be delivered at a specific time and specific location and packed in a specific way, and the manufacturer’s trucks are late, they’ll levy a fine, and most manufacturers are compelled to pay it.

“The channel commander will continue to call the plays in the retail industry,” says Fram. “Whether or not retailers are justified in seeking this type of financial assistance will probably be determined by the Federal Trade Commission or the courts. Manufacturers might consider legal action on some of these issues … but it doesn’t pay to sue your customers.”

When asked about the future, the prevailing attitude among many of the sources that we interviewed was one of cautious pessimism. “As long as those retailers can continue to make additional profit by charging these fees and as long as suppliers continue to pay them, it’s only going to get worse,” one candy manufacturer, who spoke on the condition of anonymity, said. “I don’t see fees coming down as long as retailers continue to incur the costs of acquisition, particularly in the drug and grocery industries.”

Manufacturers, especially smaller candy companies, will have to become more creative in finding ways to work around purchase allowances and other fees. Some experts suggest that suppliers could seek out retailers whose consumer orientation would be enhanced by their products — a specialty or novelty retailer in a trendy shopping area, for instance — and work hard to show the advantages of differentiation.  

“One of the things we’re seeing with leading-edge retailers is a stronger desire to collaborate with their suppliers,” says Lisa Feigen Dugal, partner and co-leader of the PricewaterhouseCoopers Retail & Consumer Advisory practice. “Companies on both sides are looking at their business more holistically. For example, there’s been a tendency towards more open sharing of data. Retailers have a certain portion of data and suppliers have a certain portion of data, and when they leverage it together along the value channel it leads to more win-wins for both companies.”  

Dugal’s colleague at PricewaterhouseCoopers, Michael Hartman, who has worked with the National Association of Chain Drug Stores on the development of its Efficiency and Effectiveness Everyday (3E) study, sees the collaboration extending to the point where the line blurs between manufacturers and retailers. “We’ve seen many cases in which manufacturers are setting up their own retail displays and even opening their own stores,” says Hartman. “At the same time, you’ve got retailers who are creating their own brands and marketing them aggressively. The result is that they’re starting to see things through each other’s eyes. A consumer products goods company wants to leverage all available channels — including their own — to build their business, and the best retailers want to do the same thing … so both sides are after the same goal.”

The push toward more collaboration won’t be easy, Hartman says. “There will definitely be winners and losers. But those who latch on to customization, taking advantage of customer insights and leveraging all available channels, will reach the full power of the value chain.”

The challenge, one industry executive says, is that manufacturers are prevented from taking a consolidated stance against the fees because of federal legislation such as the Robinson-Patman Act that outlaws price fixing. (See sidebar on page 53.) “The hard part for suppliers is that each one is an island because of Robinson-Patman,” the executive observes. “They can’t form a consortium to stand up to retailers like Rite Aid and CVS and say ‘no,’ or else they’d be in court tomorrow.

“One thing that gives me optimism, though, is that sophisticated retailers have figured out ways to make money not only on buying, but also on selling. For example, Safeway has revamped its entire retailing philosophy by converting to a new ‘lifestyle’ format that features more prepared foods, more organic foods, more recipes. They’ve made it easier to shop and offered their customers healthier choices. It’s a matter of taking a new look at your customers and listening to their concerns and utilizing the data you get to invest in new marketing concepts. It’s a much different approach than making short-term hits on manufacturers with fees or cost-cutting moves like reducing overhead and people.”

Baum is also guardedly optimistic. “Over time, a few companies will move along a continuum towards a model of collaboration, cooperation, and convergence. These trading partners will be transparent with one another to better serve their customers. The more success they have, the more they’ll inspire others to follow that model. Other companies will find themselves at various places along the continuum. Those that charge fees that don’t make sense from a business perspective will be the most at risk of losing sales to their competitors.”

The practice of retailers charging suppliers fees to defray the cost of mergers and acquisitions is not illegal, according to the Robinson-Patman Act. But it’s illustrative of the complexity of the issue to examine the impact of federal legislation on the trading partners involved, and how it’s shaped their responses to the situation.

Passed by Congress in 1936, the Robinson-Patman Act forbade any company engaged in interstate commerce to discriminate in price to different purchasers of the same product when the effect would be to lessen competition or create a monopoly. Originally designed to supplement the Clayton Anti-Trust Act, Robinson-Patman was intended to protect independent retailers from chain-store competition, but it was also strongly supported by wholesalers eager to prevent large chains from buying directly from manufacturers at lower prices.

In the context of the times, Congress believed that large retailing giants like A&P and Sears, Roebuck could dominate the market by using their high-volume buying power to extract special deals, including quantity discounts, free promotional materials, and purchase allowances — all of which would be unavailable to their smaller competitors. Sen. Joseph Robinson and Rep. Wright Patman argued that the size of the chains gave them an unfair advantage by enabling them to negotiate price concessions and rebates from their suppliers.

A product of the Great Depression, Robinson-Patman has been criticized throughout its history for the faulty economic theory behind it. Even the Supreme Court called it “complicated and vague in itself and even more so in its context.” Almost from its inception, critics pointed out that Congress passed the act with the protection of small grocers and wholesalers in mind rather than in the interest of competition.

The irony, of course, is that suppliers now find themselves increasingly under the thumb of those same multi-location chain stores, but are prevented from taking coordinated action by the very act that was originally designed to keep them in check. “It’s a Catch-22,” says one veteran confectionery executive, who declined to speak on record. “Manufacturers can’t get together to discuss these kinds of fees because that would be collusion,” he continues. “So there’s very little they can do in opposition.

“Every few years someone in Congress will express moral outrage, they’ll call for an investigation, and they’ll take testimony … but nothing ever happens,” he says. “The Federal Trade Commission (FTC) has said this is not a priority even though it’s been going on for years. It’s why trade relations in this industry stink.” n

Not all retailers who have made acquisitions in recent years were denigrated for their fee collection systems. Several sources pointed to San Antonio-based grocery chain H-E-B for its clear, clean financial practices and its willingness to partner with its suppliers. Kroger and Publix were also singled out for their upfront, transparent approach to business.

Wal-Mart was also cited by a number of candy and snack manufacturers as one of the toughest negotiators, but also one of the fairest. “If you refuse their deal, Wal-Mart won’t care because there is someone else to take your spot,” says one executive. “They’ll squeeze you to death on price, but they’ve never resorted to these types of practices. They pass every allowance on to the consumer. More importantly, a deal is a deal at Wal-Mart. When you get a purchase order from them, you feel good about it.”

The galling thing for most suppliers is that they have very little recourse — especially small companies — to manage supplier purchase allowances. Even confectioners with the most compelling products, who in some cases can avoid slotting and other fees because of their product’s “must-have” factor, can’t sidestep the acquisition fees imposed by retailers.

What can companies do that can’t pay to play? Here are some ideas from Dr. Robert Robicheaux, executive director, marketing and industrial distribution, at the University of Alabama-Birmingham.

• Many confectioners have turned to guerilla marketing to connect with consumers. Ironically, those who are successful often find themselves later courted by the same retailers who drove them away with unbearable purchase allowances.

• The Internet has opened global markets to many entrepreneurs. Some companies have created Web sites and been deluged by demand that exceeded their sales expectations and even their production capacities.

• Many start-ups have employed infomercials to market their products directly to target customers.