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Wal-Mart’s Blind And Costly Focus On FOB’s

Our piece, Flaws In Wal-Mart’s Produce-Procurement Thinking, brought a number of interesting responses. For example, a prominent retail produce executive made this comment:

As per normal, great article and insight on Wal-Mart Procurement.

We experienced this same confused logic prior to our split with the Mother ship. When folks with little industry experience are making the grand plan decisions, the lower level folks generally make the numbers be whatever they need to be.

With all the moving parts that exist within produce logistics, saving the 10% based on some esoteric metric is like playing the game of shells. It’s probably still there somewhere but you just need to find it. It could be hiding in brokerage fees, freight cost, cooling and palletization fees, sizing, quality or any number of below-the-line costs.

Now the more interesting thing is that, in general, apple prices are down significantly from last year. We experienced a high market for the 2008 crop, and the 2009 crop gave us plenty of volume on the sizes we want… so the market actually fell when compared to last year. Not by 10%… but by an average of almost 19%. So… if I as a buyer have been given the charge to save 10% on apple costs, and the market drops 19%, can I deliver the targeted 10% savings and make my performance goals??

Oh Yeah, you betcha!

— Dan Sutton
Director of Produce
Albertsons LLC
Boise, Idaho

We appreciate Dan’s willingness to point out the enormous problem with these types of pronouncements. When The Financial Timesreported that Wal-Mart was claiming that its Washington apple procurement experiment, which we talked about here, was saving it 10%, it is hard to give very much credence to that.

First, as Dan Sutton points out, if you focus on getting low FOBs, you can get low FOBs — that doesn’t mean lower total cost. We’ve sat in offices and watched sellers say: This guy is focused on getting the FOB down, so let’s up the transportation and cut the FOB.

We are reminded of the slogan emblazoned behind the desk of Meshulam Riklis, the businessman more famous for manipulating financial structures (and for marrying and promoting the career of Pia Zadora) than for actual business. The motto he lived by: “You can name the price if I can name the terms.”

Second, Wal-Mart could compare its costs against its last year’s contract, but it can’t know what it would have paid on a fictitious contract that never was actually negotiated. So, as Dan points out, if the apple market is weak, maybe it could have saved more under its old program.

Third, the impact on consumers can be significant and deleterious to Wal-Mart. The Pundit used to ship a lot of Fancy Goldens to Europe. Did it for years with satisfied customers. Then one year, all the customers in Europe started complaining: These were not Fancy apples.

We did an investigation and it turned out that that particular year happened to be a bad one for quality. In prior years, the typical fruit shipped as Fancy well exceeded the minimum requirements. The market had become conditioned to thinking Fancy meant product that well exceeded minimum requirements for the grade.

When Wal-Mart was under contract, its vendors had an obligation to meet volume requirements week in and week out at the agreed price. Sometimes, although the contract may have been based on a particular grade, say US Extra Fancy, the shippers wound up delivering better grades, say Washington Extra Fancy, to meet their obligations.

Now the shippers can pick and choose when to bid for the Wal-Mart business; that won’t happen very much.

So the consequence of Wal-Mart’s switch is that its shoppers will have lower quality produce than they did before. What is the long-term cost to Wal-Mart of handling a lower quality package — even if it meets minimum Wal-Mart specs.

Fourth, Wal-Mart didn’t just buy apples and transport… it bought a range of services that fall under a category of business analysis. Just a tiny shift here can result in thousands of incidents of being out of stock. Under the old system, if Wal-Mart was out of stock, that counted against the vendor and would affect its being awarded future business.

Who does it count against now? Nobody. Which means out-of-stocks will zoom. This means that even if they are successful in reducing procurement costs — the whole procedure will still cost Wal-Mart a fortune.

This is what happens when people who don’t know the business seize on something they can quantify — cost of goods sold — and work to reduce it without really understanding the consequences of their actions.

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