In 2009 David Moore, then president of the Western Growers Associated, testified before Congress about how grocery stores were making it extremely difficult for small farmers to earn a living. Moore, who runs a farm in California, said it cost him as much as $1,000 every week to have his packaged almonds displayed in supermarkets. He then had to watch the stores sell the almonds for more than three times what it cost him to grow.
Yesterday, for those of us who aren't industry insiders, we were introduced to the hidden profit machine for many grocery chains: slotting fees. In essence, these are fees food companies (or small farmers) pay to grocery stores to get new products placed on grocery store shelves.
If a food company wanted to introduce new food products nationwide across several grocery chains, it's estimated that it would cost as much as $2.5 million per product. With costs that high, the question must be asked: Is this an ethical model for selecting what new products get shelf space?
The argument for slotting fees
A 2011 paper (pdf), written by professors from Penn State and NYU, reviews the key argument justifying the use of slotting fees. Proponents, the paper states, argue that "slotting fees are thought to promote efficiency by ... screening the risks and rewards associated with new products, thereby leading to more efficient shelf space allocation."
There's no way that all the new products that flood the market every year can be carried in every grocery store. Therefore, one way to narrow the playing field -- and turn a nice profit in doing so -- is to charge food producers to introduce new products into the market.
But slotting fees aren't only a way to kill two birds with one stone. There are real risks associated with introducing new products in a store, the grocery industry claims. If a new product fails, there are real costs associated for the individual stores.
Industry insiders point to the fact that "riskier" products usually have higher slotting fees as evidence that this is more than just a way to extract more money. For instance, products that have to be refrigerated, thereby incurring more overhead costs associated with extra energy needed to keep the products cooled, usually have significantly higher slotting fees than those that don't need refrigeration.
The argument against
But as David Moore's experience shows, the practice can also make it impossible for smaller players to enter the market. Lacking the deep pockets of the nation's largest players, these growers simply can't pony up thousands of dollars to get their products on shelves.
This, according to opponents of the practice, leads to an anti-competitive environment in which the best products don't necessarily rise to the top -- just the ones that come from well-funded companies.
As Sen. Conrad Burns of Montana put it during the 2009 hearings: "I may have a product that's worth nothing, but if I've got a big checkbook I can get shelf space." Surely, that's not a model we want to use to figure out what food makes it onto our plates.
The main problem, as I see it ...
I don't doubt that there are serious risks associated with stocking new products on a store's shelves. The grocery business can be brutal, with razor-thin margins that rely on a heavy volume of product sales. At times, there's a real economic argument that can be made for the use slotting fees.
But the problem is that there's virtually no transparency when it comes to these fees. Grocers usually don't want to talk about it because they don't want each supplier to know how much the other is being charged, and suppliers don't want to ruin a relationship with a grocer by revealing that sensitive information.
In fact, in 2009, when the Government Accountability Office asked the grocery industry to release any documents related to slotting fees, it got exactly zero replies. Without any transparency, it's almost impossible to tell where mitigating real economic risks ends, and simple profit grabbing begins.
... And why it might not matter
Here's the rub, though: Not every grocer charges slotting fees. Two of the country's largest grocers -- Safeway (NYSE:SWY) and Kroger (NYSE:KR) -- appear to partake in the practice, based on 10-K filings. But the new wave of grocers focused on fresh, local, and organic products have decided to forgo the practice. That includes Whole Foods Market (NASDAQ:WFM), Fairway (NASDAQ:FWM), and The Fresh Market (NASDAQ:TFM).
Though the latter group's imprint across the nation is much smaller than the former's, it's getting bigger by the day. And based on revenue growth over the past three years, chains that don't charge slotting fees have had no problem growing revenue.
Fool contributor Brian Stoffel owns shares of Whole Foods Market. The Motley Fool recommends The Fresh Market and Whole Foods Market and owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.