- In 2003, food companies such as General Mills Inc., Nestle
SA, International Multifoods Corp. and Kraft Inc. quietly funneled an estimated
$100 billion to the biggest U.S. retailers and food distributors.
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- Most shoppers are unaware of the practice, known as trade
promotion spending, but they benefit from it by way of coupons, special
promotions, or two-for-one deals on cereal or crackers.
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- But the dirty little secret in the food industry is that
more than half of that $100 billion does not go to consumer promotions.
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- Securities and Exchange Commission regulators are investigating
whether food companies are using the money instead to pay their customers
-- retailers and distributors -- to order more items than they need, a
possible violation of both federal law and accounting standards.
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- Executives at General Mills, Coca-Cola and a host of
other food companies under investigation say they have nothing to hide.
But food company executives admit that the industry and its salesmen are
hooked trade on promotional spending as a way to goose sales and compete
in a low-cost world.
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- And in confidential industry surveys they acknowledge
that they can't account for how all that money is used, even as they spend
an increasing amount of their budgets on such promotions.
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- Promotional spending now consumes 54 percent of food
company marketing budgets and represents an average of 17.3 percent of
gross sales, compared with 14.9 percent in 1999, according to a survey
of food company executives by Cannondale Associates, a Connecticut consulting
firm.
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- In 2002 alone, General Mills spent about $500 million
on advertising, but it gave retailers $2.25 billion, an amount equal to
26 percent of its total sales. In that same year, Hormel Foods Corp. in
Austin spent about $270 million on trade promotion.
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- Safeway Inc., one of the country's biggest supermarket
chains, got $2.2 billion in promotional payments in 2003, a year when it
lost $170 million.
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- How it works
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- The billions of dollars swapping hands each year that
are part of the complex web of relationships between manufacturers, distributors
and retailers are supposed to come with strings attached. When Target runs
a two-for-one special on Cheerios, it's not doing so out of kindness; General
Mills has paid for the promotion. A breadmaker might pay a supermarket
to run a promotion designed to sell a certain number of packages of hot-dog
rolls in a week.
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- The federal Robinson-Patman Act says retailers "should
expend the allowance solely for the purpose for which it was given."
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- If the store fails to sell as many rolls as promised
or expected, the breadmaker is supposed to suspend the payments and the
retailer is supposed to return unused money or roll it into another promotion.
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- Industry executives, few of whom are willing to speak
publicly, say that almost never happens, but it is difficult to track whether
every dollar spent on promotion is used properly. Companies are not required
to disclose how much they give to retailers, and trade promotion deals
can vary from week to week and retailer to retailer. One store can run
dozens of promotions a week. According to some estimates, 30 percent of
a grocer's products are "on deal" each week.
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- "We track as closely as we can, but this isn't an
exact science," said Craig Schnuck, chairman and CEO of Schnuck Markets
Inc., a regional grocery chain based in St. Louis. Often, he said, the
use of the money depends on trust between the vendor and the retailer.
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- At General Mills, SEC investigators are looking into
whether the company artifically inflated sales by shipping excess inventory
to retailers, a tactic known as "loading." In February, the SEC
informed General Mills that it and its two top executives, CEO Stephen
Sanger and Chief Financial Officer Jim Lawerence will probably face civil
charges.
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- In a recent interview, General Mills Vice Chairman Stephen
Demeritt declined to speak specifically about the SEC investigation but
said the company closely monitors its trade promotion programs.
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- The company sets annual budgets and tracks promotion
money by customer, region and brand, he said. Demeritt noted that the Cannondale
study consistently ranks General Mills as one of the industry leaders in
trade promotion in terms of strategy and execution.
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- "Trade promotion is one of a number of different
marketing tools that we use," Demeritt said. "We try to eliminate
the least efficient [programs] and invest on the ones that are efficient.
We have a constant desire to get better. But we got a pretty good handle
on the situation."
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- The Federal Trade Commission, which is charged with enforcing
Robinson-Patman, lacks the resources to monitor trade spending. "The
accounting is just so complicated," said Patricia Schultheiss, a lawyer
with FTC's bureau of competition.
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- For companies under pressure to meet sales and profit
promises made to Wall Street, the loose rules and lax oversight of trade
spending can prove a temptation too great to resist.
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- Executives at St. Louis-based Aurora Foods, maker of
Lenders bagels and Duncan Hines cake mix, pleaded guilty in 2000 to inflating
profits by hiding $43 million worth of trade promotion costs. Last year,
Dutch grocery giant Royal Ahold NV lowered previous reported profits by
about $3.1 billion after conceding that it had inflated the amount of trade
spending it received from foodmakers in its U.S. Foodservice unit. Sara
Lee Corp. and ConAgra Foods Inc. acknowledged last year that their salespeople
signed off on inaccurate documents that showed the foodmakers owed more
in promotional allowances to U.S. Foodservice than the companies actually
did.
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- "The SEC is battening down the hatches," said
Eric Larson, an industry analyst with Piper Jaffray in Minneapolis. The
agency is "making sure people know that they are watching."
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- Paying for shelf space
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- Any explanation for the spike in trade spending isn't
complete without a visit to the nearest Wal-Mart Supercenter.
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- Wal-Mart, the world's largest company, accounts for about
19 percent of all U.S. grocery sales. It has become the largest customer
for the world's biggest consumer brands. General Mills, for example, gets
13 percent of its sales through Wal-Mart.
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- Supermarket chains have scrambled to compete with Wal-Mart
by snapping up regional companies. In 2003, the six largest grocery store
operators gobbled up 50 percent of all U.S. food spending. Profit margins
on food are notoriously slim but, with an increasing amount of shelf space
in the hands of a few large companies, retailers have more power than ever
to demand promotion spending from food companies.
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- "The only time retailers can make money is from
trade promotion," said Mark Hostetler, an attorney who represents
food companies. "Their profit margins are just so narrow that they
need other sources of income."
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- Food companies will usually comply with retailers' demands.
They don't want to lose shelf space to a rival, they don't want Wal-Mart
to become too big, and they don't want to risk disappointing investors,
said Bob Hilarides, a Chicago-based consultant for Cannondale
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- Sometimes, the foodmaker's biggest competitor is its
retail customers, which rely increasingly on private label brands. Consumers
long ago abandoned their squeamishness about buying such products. Wal-Mart's
Old Roy dog food, for example, is the nation's top selling dog food.
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- To stay competitive, manufacturers of brand name products
say they must lower their prices through sales and other promotions. And
retailers aren't above playing one food company promotion off against another's,
creating a "price war situation," among company salespeople,
said Mike Campana, a former controller at a regional food company who is
now a partner with the accounting firm McGladrey & Pullen in Bloomington.
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- "We had to rein in a lot of salespeople," Campana
said. "They were always trying to one-up the competition."
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- According to Cannondale, trade spending has jumped 33
percent in the past five years. Hilarides, who likens it to a drug addiction,
isn't surprised. Companies "report earnings quarterly and need to
support sales volume," he said. "They are not sure shareholder
patience will be there. But by increasing trade spending, they only raise
the bar for next year. It becomes a never-ending cycle."
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- Like most food companies, General Mills doesn't disclose
quarterly or annual trade spending. But company documents contained in
a lawsuit by Jeffrey Millard, a former manager in Phoenix, show sizeable
spikes in shipments every three months, when the company had to report
earnings to investors.
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- In October 2002, General Mills shipped 46 million cases
to retailers. Shipments in November, the last month of its first quarter,
rose 28 percent, to 59.2 million cases. Shipments dropped the next two
months, but rose 19 percent, to 50.8 million cases, in February 2003, the
last month of its third quarter.
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- Executives have attributed the increase in shipments
to product introductions, such as Berry Burst Cheerios. But Greg Downey,
a General Mills employee on a disability leave, and Millard, who was fired
in February 2003, have told SEC investigators that the General Mills salespeople,
under pressure to meet quarterly volume targets, dangled large rebates
and payments before retailers to get them to take more merchandise than
they needed. The incentives were usually tied to shipments of cereal and
other nonperishables.
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- Why would retailers take inventory they don't need? "That's
an easy one," one analyst said. "They got it for dirt cheap."
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- Sanger, speaking before analysts in Arizona in February,
dismissed the allegations.
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- "We ship what our customers order," Sanger
said at the time.
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- Thomas Lee is at tlee@startribune.com.
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