If you're in the grocery business, you know how difficult the economics can be. You might buy something for $1 and sell it for $1.30, which isn't a terrible margin. But when you subtract out all of the overhead costs associated with running a 40,000-square foot facility, you're lucky to bank a penny or two for profit.
But there exists a little-known -- and even less talked about -- profit machine that helps grocery stores collect cash with almost no work required on their part: slotting fees.
A short history of slotting fees
According to researchers at the University of Northern Florida, there are more than 100,000 grocery products available for consumption in a given year, but the average store only has room to display 40,000. Of these, several are new products to the market. Somehow, grocery stores need to decide which products are worth carrying and which aren't.
Though its impossible to nail down a specific date, starting around the late 1970s, grocery stores came up with a novel, profitable way to deal with this product overload: charge fees for shelf space. These days, manufacturers (food companies) generally pay slotting fees to retailers (grocers) for placement of new food items on a store's shelves.
In essence, food companies have to "rent" shelf space from the grocer to offset the risks involved with displaying a new product. By paying a fee, the food company will get its product displayed for a "reasonable" amount of time before the grocer decides if the product is worth keeping on its shelves.
How common is this practice?
Because the exchange of slotting fee monies usually takes place off the books, it can be very difficult to get accurate numbers on how common the practice is or how much it costs.
In 2003, the Federal Trade Commission (FTC) conducted a study (pdf) on the use of slotting fees. There were several interesting findings:
- The food companies surveyed reported that they paid slotting fees for 80% to 90% of all new food product introductions.
- The slotting fee associated with one product in a chain of stores in one metropolitan area varied from $2,313 to $21,768.
- If a food company wanted to roll a new product out nationwide, it would need a slotting fee allowance of between $1 million and $2 million.
Keep in mind that these numbers are from a decade ago. If they increased at the rate of inflation, nationwide rollouts could now run as high as $2.5 million.
Though it's impossible to know for sure, it appears that slotting fees are the norm for nationwide grocers Kroger (NYSE: KR) and Safeway (NYSE: SWY), as well as regional grocers like Roundy's (NYSE: RNDY). That's certainly not an exhaustive list, but these three retailers alone have 4,400 locations in the United States and Canada.
Bucking the trend
It seems, however, that the more recent entrants to the market -- which represent a new wave of grocery stores that focus on fresh perishables and a more pleasant in-store experience -- are forgoing this practice.
Whole Foods (NASDAQ: WFM), The Fresh Market (NASDAQ: TFM), and New York-centered Fairway (NASDAQ: FWM) have all decided not to use slotting fees to supplement their income. Instead, these stores focus on selecting the products they think will best fit their customers' needs.
Oddly enough, there's a fourth member of this no-slotting-fees club, but it doesn't fit the "new wave" label like the other three: Wal-Mart (NYSE: WMT). The company has such clout that by virtue of its ubiquity in the market place, it is able to negotiate with food companies for the lowest possible prices to pass on to its customers.
Tomorrow, I'll dig a little deeper into slotting fees and the effects they can have on both consumers, and food companies. In the meantime, you can read up on the one grocer our analysts have identified as the runaway leader in the industry. The company is one of three revealed in our special free report: "3 Companies Ready to Rule Retail." Uncovering these top picks is free today -- just click here to read more.
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Fool contributor Brian Stoffel owns shares of Whole Foods Market. The Motley Fool recommends The Fresh Market and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.