Strong Results, Debatable Future: 2001 Retail Operations Survey
Strong Results, Debatable Future
By Peg Nolan, Walden Swanson,
Kate Sumberg, and Dave Gutknecht
Synopsis: Several years of data from the Retail Operations Survey, the Natural Food Merchandiser (NFM) "Market Overview," and annual reports of Whole Foods Market, Inc. and Wild Oats Inc. indicate that the natural products market has changed in a predictable way. Based on a well-researched business paradigm called the "Experience Curve" we predict total natural food sales will continue to increase while industry gross and net margins will take a downward turn in the coming years; we'll feel intense pressure to drive costs out of the system, and many natural food players will go out of business.
In our opinion, given the current competitive environment, co-ops are doing quite well. Better buying and pricing have enabled us to maintain higher gross margins compared to many of our competitors. Our same store growth rates are the highest in the natural products industry. We have taken gigantic steps in practicing cooperation among cooperatives for both economic and social ends.
Even with these positive results, we face daunting challenges -- many stemming from our cooperative nature and long-held values. Yet differentiating ourselves as providers of unique cooperative values and benefits is perhaps our greatest challenge. These are two sides of the same coin. Our conclusion is that we can do both: be one of the most efficient and innovative industry players, and take advantage of our customer ownership nature to provide cooperative benefits that encourage loyalty, trust, and community. This is the imperative and essence of our double bottom line.
Using the Data
|SMALL:||Sales under $1 Million|
|MEDIUM SMALL:||Sales $1-2 Million|
|MEDIUM:||Sales $2-4 Million|
|MEDIUM LARGE:||Sales $4-7 Million|
|LARGE:||Sales over $7 Million|
Surveys were sent to about 300 food co-ops. Our survey group included 71 co-ops representing 83 stores in 28 states. Respondents were well distributed among store sizes.
We used information from the CoCoFiSt database, NFM "Market Overview," Whole Foods and Wild Oats annual reports and SEC filings (10Ks), and the Progressive Grocer "Annual Report of the Grocery Industry."
In the centerfold statistical chart we:
- provide results for all stores and in five size categories;
- present composite financial statements and ratios;
- use the unweighted averages for the Income Statement and Balance Sheet -- for these averaged percentiles, large co-ops have the same weight as small stores;
- for the Ratios section, we provide median and quartile results, which frequently are more balanced than is the mean or average. (If a set of responses is arranged sequentially, the median is in the middle and the upper and lower quartiles are 25% from the top and bottom, respectively.)
- Quartiles are calculated on each variable; for example, the sales trend upper quartile contains the 25% of stores with the highest growth rates.
No one statistic can paint definitive conclusions, but your collected "yellow pad" notes can be used to establish a direction towards improved performance for your co-op.
We are pleased to present the Retail Operations Survey. Please get out your yellow pad and be ready to take notes (see p. 13 sidebar, "Using the Data"). This year's survey respondents, representing 24% percent of the co-ops in the country and $400 million in sales, reflect wide diversity:
- Annual sales ranged from $207,000 to $67,000,000;
- Profits and losses ranged from +5.0% to -12.4%;
- 10% of co-ops reported expansions in 2001;
- 25% of co-ops reporting expect to expand in 2002;
- 73% of cooperatives reporting were profitable this year.
Summary: Perhaps the most important point to make is that the maturing of the natural foods industry can now be seen more clearly in our operational performance numbers. Though the Margin Minus Labor (MML) of co-ops rose 0.3% in 2001, it has not recovered to its 1997-1999 levels, and at the same time payroll costs have risen. Gross margin is trending downward in the industry, and net income continues to decline. Key points: lower gross margins, declining net income, slower growth and, new this year, a focus on EBITDA.
Lower Gross Margins: In 2001, average Gross Margin for co-op rose slightly to 35.9% but was still below the 1999 peak. For SM co-op stores, the average gross margin in 2001 fell by 0.04% to 33.8%. For all other size categories it rose. Personnel expense increases erased most of the gain for all but the Medium sized co-ops. (See Income Statement, p. 14.)
Wild Oats, Inc. (WOI) experienced a decrease in their gross margin in 2001. Whole Foods Markets, Inc. (WFI) projects a decrease in gross margin for 2002. NFM reported that storewide gross profit margins went up 2% in 2001 after decreasing last year but that those gains were not reflected in net profit because of an increase in"‘rent/mortgage" expense.
Margin Minus Labor: MML is a very valuable tool when comparing your store's data to aggregate data. When compared to other cooperatives, MML indicates how well you are managing gross margin and labor, two of the most controllable expenses. And it allows a better comparison between stores with different product mixes than does taking either variable alone.
As evidenced last year when margins went down and again this year when WOI showed decreasing margins, our industry has entered a different stage in its life cycle. (See the chart on p. 13.) A narrow increase in Margin Minus Labor to 12.8% was the result of increased personnel expenses being slightly less than the increase in gross margin. Average co-op labor costs increased from 22.6% last year to 23.1% this year. But comparing with the NFM report, we find that co-ops' MML is 2-4 percentage points lower than NFM stores (after adjustments to include an owner salary).
Declining Net Income: Net Income declined for co-ops for the third year in a row to 1.3%. NFM reported that net profit dropped by 1% to an adjusted NFM average of 1.4%. As co-ops expand or add new stores, average net income decreases because of the losses associated with these projects in the first year or more.
Our net income is lower than that of our competition and is trending downward. Reversing this trend implies cutting expenses, since industry gross margin is also trending downward. Collaboration on cooperative purchasing can assist us in reducing operational costs. In personnel expenses, we can break out administrative costs, employee benefits, and payroll by department.
Slower Growth: The natural foods industry growth rate is slowing down. The first sentence of the June 2002 NFM report says, "Retailers may be disappointed to see a second year of single digit growth." The 6.7 % industry sales growth figure reported by NFM refers to all channels of natural food distribution, including supermarkets, mail order, natural product retailers, and multi-level marketers -- and is down from 7% the previous year. For natural products retailers, including natural foods stores, health food stores, and vitamin shops, the sales growth was 8.3%. (Co-op numbers are again not included in the natural products section of NFM.)
Co-op Sales Growth looks better (see cover chart). Median co-op sales growth was 9.95% last year, while the average co-op sales growth was 13%. Average same store sales growth for the 62 stores from 52 responding co-ops was 10.1% -- also higher than either WOI at 4% or 9.2% for WFI.
Bigger Baskets: NFM reported, "Nearly all store formats showed decreases in average sales per customer and average number of customers per day in 2001, reversing increases in these categories in 2000. WFM also noted a smaller ‘basket size' in 2001, showing that decreasing sales per customer are not limited only to independents." Co-op performance ran counter to these trends (see chart above). Co-op customer count, however, shrunk slightly (see chart below). Total median customer count shows an increase, but this is because we had a higher proportion of large stores reporting.
NFM reported that an average of 68% of natural product stores showed positive growth (down from last year's 71%), while the proportion of co-ops with positive sales growth was 95%, up from last year's 84%. While this is partly the function of the 10% of co-ops that reported expansion projects, our co-op consumers are loyal and growing in number.
EBITDA: An operations performance measure
Last year we added a new measure that we thought might help stores focus on what to improve, especially from an income statement perspective. This year we are providing an in depth explanation of EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization.
Because EBITDA does not include depreciation/amortization, tax or interest expenses, it lets us focus on actual operational earnings. The effects of recent expansions and moves on operational performance are minimized in EBITDA, and cash flow from operations is accentuated. We ranked all co-ops based on these earnings (EBITDA) as a percent of total sales and examined the characteristics of the upper quartile EBITDA group by holding it constant. We found several factors correlated closely with the UQ EBITDA cooperatives.
The biggest surprise came from looking at gross margins, while the major factor distinguishing this UQ group was found in personnel expenses. Margin did not correlate significantly. On the other hand, comparing UQ and LQ for personnel expenses yielded a 2.56 percentage point difference.
After personnel costs, Occupancy Costs (rent, utilities, maintenance, insurance, and building taxes) contributed the most to the variance between the upper and lower quartile medians, accounting for a 1.34 percentage point difference. Occupancy costs relate to critical lease or purchase decisions that have a lasting impact. Unlike most other decisions that can be more easily changed, property decisions can affect profitability for 10 or 20 years. Experienced professionals can help make real estate decisions, some of the most critical choices that your co-op will make.
As noted earlier, expansions initially reduce earnings. Seven out of the ten co-ops with the lowest EBITDA ranking expanded or moved within the last two years. It often seems to take a year or two before labor expenses are brought under control after a major expansion. Yet there are co-op stores that entered the UQ EBITDA within two years of an expansion.
Our chart gives industry comparisons for EBITDA:
Our major conclusion concerning the Balance Sheet: We are less leveraged than our major competitors. While we do very well on a comparable store basis we are not opening or acquiring as many new stores as WFI. This slower co-op expansion is a consistent theme from year to year.
Ratios link disparate elements of financial statements to one another and inform us about their relationship. Ratios can tell us about root strengths and fundamental weaknesses, and they allow us to compare current co-op operations with prior periods and with others in the industry. As we do every year, we caution readers that the ratios presented here are not exhaustive, nor are the results necessarily good or bad. When comparing your store to these ratios, remember that many factors affect these figures. Setting ratio benchmarks based on your own store may be more useful.
Current Ratio: Median current ratio for all co-ops is about 2:1, and for LG stores is 1.5:1. The current ratio for both WFI and WOI is less than 1:1, leaving them with negative working capital. The current ratio and working capital are measures of a co-op's ability to meet obligations due within a year. Higher is stronger in terms of the ability to meet obligations, and co-ops clearly show a stronger position here.
Debt: Equity: Co-ops continue to be less leveraged, with more liquidity, than our competition. Debt:equity indicates how much total liability a company has compared to the owners' equity. But is a stronger current ratio and a stronger debt:equity ratio better? Probably ‘yes' in the short run and ‘no' in the long run. When compared to WFI and WOI, our low debt:equity ratio indicates that we are under-leveraged (borrowing too little money to maximize services to members). Average interest expense is about 0.6% for all co-ops. Our competition has a higher interest expense but also has higher net income. Investing in improving fixed assets may increase interest expense but can also increase future net income.
As shown by the composite data, cooperatives are not undercapitalized. What we lack is an efficient and effective mechanism for sharing balance sheets. This is no simple task and would involve significant management and organizational changes. However, well-leveraged balance sheets can create more successful cooperative opportunities for consumers, employees and their communities through opening new stores and maintaining well run cooperatives.
Inventory Turns: This ratio is a measure of effectiveness in category management and can reflect how well you pick products, discontinue products, price products, and manage your inventory. LG co-op Inventory Turns (17.0) in 2001 were greater than both WFI (16.1) and WOI (12.1). This is another ratio that is significantly affected by product mix. A large HABA department might have inventory turns of 6 per year, while a large produce department might have turns of 100 per year. Using the departmental inventory turns numbers from CoCoFiSt (www.cocofist.com) may be helpful in planning for improvement and cash flow.
Conclusions: Our Yellow Pad
Significance: The cooperative sector is significant. The 71 co-ops that responded to our survey had over $400 million in sales. In all there are about 300 retail food cooperatives in the U.S., representing approximately $750 million in sales. We estimate that to be about 3% of the market share and 10% of the natural foods retail channel. Viewed as a chain, co-ops are fourth in volume behind Whole Foods ($2.27 billion), Trader Joe's at ($1.9 billion), and Wild Oats (at nearly $900 million), while co-ops are first in number of natural food retail outlets (WFI 126 stores, Trader Joe's 130 stores, WOI 102 stores, co-ops 300 stores).
Market Share: In the long run, if we are to expand our market share effectively it is important that we shorten the cycle from expansion to profitability. In addition, we strategically need to figure out how we can leverage our balance sheets together and access other sources of capital to fund our expansions and new store projects. This would allow us to spread development costs over a wider range of co-ops.
Improve your own co-op: Use the data available to compare your store with the upper quartile store in your size category. Remember that efficient use of labor is the factor that correlates most highly with profitability, so that is probably a good place to start. Use the data here and elsewhere to create a plan for rapid improvement in your co-op. Find counterparts to learn from and/or hire a consultant who can speed your improvement efforts.
The industry trends, our significant strengths, and our considerable challenges demand strategic thought as well as tactical execution at the local, regional, and national levels. We have to deal with marketing, products, financing, efficiencies, and our cooperative nature at all of these levels and to find the optimum location for leadership, investment, and activity.
At the national level, we have created and supported structures to provide a nexus for leadership. At the regional level, Coperative Grocers Associations have taken a tremendous leap in determining and effectively acting upon strategies and issues. Several of the CGAs are providing millions of dollars of difference to their co-op members, including bargaining co-ops to deal with products, joint CoCoGAP sessions to deal with efficiency, and joint marketing and group benefits for cooperative members. At the local level, we are becoming better and better store operators and have also introduced customer innovations that have had significant and unique impacts in building loyalty to our co-ops.
Let's keep at it -- we have to! Otherwise, like the previous generation or "old wave" of cooperatives, our eventual experience will simply be to wave goodbye.