Special Report: Slotting Fees

Do slotting allowances enhance efficiency or hinder competition?That's both the title of a May 2006 paper in the Journal of Marketing Research and a concise summary of the debate that continues to simmer regarding slotting fees, which retailers (most often supermarkets) levy on CPGs to stock new and unproven products on their shelves.Professors Vithala R. Rao of Cornell University and K. Sudhir of Yale University, who co-wrote the aforementioned 2006 paper, concluded that on balance, slotting fees are more positive than negative: "The analysis indicates that, in general, there is more support for the efficiency theories than the anti-competitive theories."However, the paper contains the caveat that the conclusions are based on data roughly two decades old because obtaining accurate information on present-day contractual arrangements between retailers and CPG companies is difficult at best."This is not something you can easily collect information on because of the nature of it," Rao says. But based on his research, he says, "It doesn't bar new companies [from entering the market]. That's not our conclusion, at least."Other observers are less sanguine. Steve Hannaford, business editor of the online publication www.oligopolywatch.com and author of the book "Market Domination," believes the expenses involved raise the bar for smaller companies to enter the market and to maintain their shelf presence over the long term when they wish to expand. "You come out with a new brand of yogurt, or something like that, and the upfront cost of getting it into a representative sample of stores, per SKU, is enormous," says Hannaford. "While it's possible for a brand like Dannon or Breyer to test out 20 new products to see which ones stick, a small company can't do that. That makes it harder and harder for small, innovative companies to bring [new products] to market."Hannaford adds that smaller brands like Odwalla or Power Bar often end up selling out to larger companies even when they do make it, and he believes the cost of slotting fees hinders "the ability to expand the product line, which is the way companies build profitability. What is just an overhead expense for one of the major food manufacturers is a gigantic investment for small business. That explains why frequently these companies sell out to the eight or 10 large food manufacturers."How much are the fees?Gregory Gundlach, professor of marketing at the University of North Florida, told a California state Senate committee in 2005 that slotting fees estimates vary greatly. He testified that:"On a regional or store basis, ranges for the fees reported in the literature include $10,000 to $30,000 and $3,000 to $40,000. Estimates for obtaining national distribution are reported to also vary. These estimates range from $1.4 million to $2 million per SKU to as much as $16.8 million to introduce a small product line of four items in all supermarkets nationwide. However, according to a recent A.C. Nielsen survey, more than one-third of respondents indicated they paid less than $500,000 in slotting payments for their latest national product introduction."A Los Angeles Times article on the subject that appeared on Jan. 29, 2000, said that CPGs spend $9 billion per year in the aggregate on slotting fees, representing more than half of the supermarket industry's total profits, with estimates of $25,000 per SKU. "In Southern California, the fees start at $25,000 per item at Ralphs, $20,000 to $30,000 at Albertsons and $10,000 to $15,000 at Vons, Los Angeles-area food makers said," says the article.Gundlach believes the impact of slotting fees varies greatly. His answer to the question posed in the title of Rao and Sudhir's paper would be: "It depends on the circumstances." He agrees that retailers' concentration has given them greater leverage."Over the last 10 or 15 years, there's been fairly profound shifts in many industries, from circumstances where manufacturers held sway -- they were the channel captains -- to circumstances where retailers have a considerable amount of clout," he says, and slotting fees are one manifestation of that trend. But that's not necessarily a negative."When a dominant manufacturer makes huge payments to a downstream retailer contingent on getting rid of their competition, it has a negative result," Gundlach says. "On the other hand, if it helps the retailer and doesn't exclude competition, it's OK. For many years, people were trying to condemn these things in totality, or they were trying to argue they were positive. It's all about knowing the actual effects in the marketplace."He cites one case in which a Mexican tortilla manufacturer, Gruma Corp., allegedly engaged in anti-competitive practices to gain U.S. market dominance. "Some of the public data that came out indicated there were huge payments," he says. "It was their modus operandi as they moved from being a dominant company in Mexico to here in the United States -- huge payments contingent on severe limitations on competitors. They literally marched across the United States and were very successful."But Kenneth Harris, managing director at Cannondale Associates in Evanston, IL, doesn't believe the anti-competitive scenario is the norm. "Smaller companies that have proven themselves to be fast on their feet in introducing products that are truly unique have figured out ways to work with retailers," he says. "It may not be quite as cost-prohibitive" as other observers estimate.Harris has heard estimates of as much as $1.5 to $2 million for national distribution of a given SKU at all retailers. He believes the amounts paid have not changed radically in recent years but says brands are demanding more measurement of sell-through in exchange for the fees. "They'll say they don't give slotting, period, or if they do, there are requirements that go along with it," he says. "They've been relatively effective [in gaining such consideration]. The key in any of this is getting from the manufacturer to the shelf as quickly as possible, and then creating a track record."Harris does not believe smaller companies necessarily pay more -- the more significant factor is the uniqueness of the product. "If you have a product that's new to the world, the amount you're going to pay is less," he says. "That's viewed more favorably by the retailer than if it's a line extension -- the retailers are emboldened to take that [extra] money because they say, 'Fine, if you want to pay for distribution of an item that we don't think is particularly value-added, you should expect to pay [more] for it.'"But Hannaford believes slotting fees mostly serve to insulate retailers from risk. "The whole point about slotting fees is shifting risk -- 'I'll rent you a shelf,' rather than, 'I'll push your product. You push your product, and if you don't get results, we'll find something else.' It's about shifting risk. Retailers have found this great way of doing it. They don't have to worry about whether Aunt Mae's chocolate chip cookies sell or not. They have no investment in them. They're making money on the failures."He adds that he's heard estimates that grocers like Safeway or Kroger make most or all of their profit based on slotting fees. "That's the difference between profit and loss -- whereas they might break even from the actual sales."When the Federal Trade Commission investigated the issue earlier this decade -- and came up with sunnier conclusions similar to those of Rao and Harris -- few companies revealed any degree of detail, Hannaford says. "It was very difficult to get any source to admit what the practice was," he says. "The vendors aren't too eager to admit it. Some of the best information came from failed vendors because they had nothing to lose. It's just kind of a dirty secret."CPG SilenceFew manufacturers or retailers contacted returned phone calls, and most that did declined to comment on the record. The two CPGs who did said they did not face slotting fees terribly often but had heard stories.Carl E. Lee Jr., CEO of Snyders of Hanover, says his company rarely faces them because it provides direct-to-store delivery rather than via retailers' warehouses. "We do face it, but it's minor; it's insignificant," he says. "For the guys going through the warehouse, it's every day, and it's the first question posed when they have a new item."Lee has the impression that retailers treat larger and smaller companies reasonably equally. "The retailers have certain expectations, and everybody has to live up to them," he says. "If anything, they probably give the smaller guys a break."Chelle Blaszczyk, marketing director for Natural Ovens Bakery, says her company's parent, Alpha Baking Co., faces slotting fees when distributing through Jewel stores in the Chicago area. But her brand, distributed mainly in Roundy's and Supervalu stores in Minnesota and Wisconsin, has not. "They've never said anything about it."Few expect the FTC to delve into the issue of slotting fees again anytime soon, certainly not while the Bush administration is still in power."They're applying a lens of theory that makes it very difficult to see some of the challenges that are there, including how it disrupts choice processes on the part of retailers and excludes competition," Gundlach says. "That could change, and I think probably rightfully so. The pendulum swings on these things in either direction. We would be remiss to think there weren't issues of concern in distribution relationships, including this area. That's been the signal coming out of this administration, that there's nothing wrong with these. That doesn't stand against the empirical literature out there."As a self-described "staunch Republican," Harris doesn't see the FTC becoming involved again, even if a Democrat wins the presidency, unless motivated by strong evidence of anti-competitive practices. "If there's something where, somebody has a smoking gun and they come up with unfair trade practices, I suppose they would. But I don't anticipate that," he says."This is not such a big issue for them," Rao says. "The question is, what is the payoff? They have limited resources. They have limited time. Should they [instead] go after some merger between XM Radio and Sirius? It's hard to say if this issue is such a predominant practice that they have to worry about it."

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