The math on fresh

Fresh may not be your most profitable department after all. Go ahead and crunch the numbers

I have been in this grocery business of ours for 38 years now, and for all that time grocers have been telling me the most profitable departments in the store are the fresh departments–particularly produce.

That made sense to me until about two years ago, when I began to think about the amount of labour fresh departments require, and the fact that there’s quite a lot of shrink in fresh.

Over the last five years, grocers have put more emphasis on fresh food. The centre store has been downplayed as has, to some extent, frozen and dairy, in favour of more and better produce. Greater attention has also been paid to meat, the deli, bakery and home meal replacements.

There clearly is still a strong belief among grocers that fresh is a differentiator and is more profitable.

Perry Caicco, chief analyst with CIBC World Markets in Toronto, took a look at the performance of fresh departments and published his findings under the title “Quantifying the Fresh Myth.”

Caicco’s conclusions are well worth a look. As he wrote in the report, “There are many myths surrounding the fresh revolution, not the least of which is that fresh categories are more profitable than the traditional grocery sections.

Certainly, the going-in “invoice” margins are higher, and fresh goods are subject to fewer promotions. But the true profitability of fresh departments is, in most cases, lower than grocery departments.”

This is because fresh departments suffer much greater shrink than other grocery departments. Perhaps more importantly, the other core grocery departments (the centre store) are where most of the supplier funds are generated, whereas the fresh departments generate almost none. And as we know, supplier funds amount to substantial amounts of money for everything from listing allowances to penalties to special promotions.

Still, most grocers see fresh products as a way to upgrade their offerings. That’s particularly true since consumers have shifted their purchases to healthier and fresher foods.

To prove his point, Caicco drew a comparison of the profitability (defined as “contribution to fixed costs”) of $100 worth of fresh products compared to $100 worth of grocery products. The higher going-in gross margin is in fresh. But the grocery section generates another 9% in supplier money (assuming that 30% of the sales are in-store brands, which theoretically generate no supplier money).

Shrink is much higher on the fresh side, mostly due to spoilage. Labour is also higher, especially in stores with numerous service counters with their own staff. And fresh departments bear higher costs of packaging, waste removal and cleaning.

As a result, fresh departments generate only about half the profitability of core grocery departments (11.5% of fixed cost, compared to 21% for grocery, according to Caicco).

On top of that there is the matter of the capital cost of building fresh departments, which is substantially greater than the shelving for traditional grocery. The payback period will be much longer.

Caicco’s report showed the payback period was 3.9 years for fresh versus 1.1 years for grocery. Adds Caicco, “If the sales numbers don’t materialize in the fresh area, or if the gross margins are not up to par, then the grocer must decide to either: a) generate little to no return; or b) slash labour.”

The answer is always that labour gets slashed, and store conditions fall apart. How many times have you seen a newly renovated store begin to deteriorate after just a few months as the grocer rethinks his investment?

I should thank Caicco for giving me the answer I was searching for and confirming my suspicions. Grocers should take note that it’s not axiomatic that arbitrarily improving your fresh departments will guarantee greater profits. Take my advice and crunch the numbers carefully for yourself.