Is Self-Manufacturing Right For You?

Retailers need to carefully consider the pros and cons before getting into the food and beverage processing game.

The goal of any retailer, of course, is to make a profit by selling goods to shoppers. Moreover, for most retailers, store brand goods typically are more profitable than other goods. And when a retailer also self-manufactures those store brand goods — specifically, foods and beverages — profitability has the potential to rise substantially.

Two food-retailing giants already self-manufacture a large number of their own food and beverage products. Cincinnati-based Kroger Co. currently boasts 39 manufacturing facilities. And Safeway, Pleasanton, Calif., is close behind with 32. What's more, a number of regional retailers such as Lakeland, Fla.-based Publix and Meijer, Grand Rapids, Mich., operate a handful of manufacturing facilities for selected products, with dairy and bakery items getting particular emphasis.

The pros

The road to self-manufacture is not easy — nor does traveling on it make sense for every food retailer. But for retailers willing to commit the appropriate time and resources, self-manufacturing in certain food and beverage categories potentially offers a number of advantages.

The primary incentive retailers have for operating any manufacturing facility is profit. If a retailer is able to capture the manufacturing margins and internalize them to increase its overall profitability, then self-manufacturing might makes sense, says Jim Wisner, founder of Wisner Marketing Group, Libertyville, Ill.

Jim Hertel, a managing partner with Willard Bishop, Barrington, Ill., agrees.

"The biggest benefit is incremental gross margin percentage, which could reach into double digits on a percentage-of-sales basis," he says. "The retailer essentially converts a private label supplier's gross profit margin to 'inside income' and pockets it."

Such facilities also could allow a retailer to customize a particular product for its own shoppers' needs, Wisner adds. And if the manufacturing facility sits in a location that's more optimized for the retailer's distribution networks to the stores — or the retailer's own distribution center — the company could reduce total product costs as well.

"Secondary benefits that may or may not accrue — depending on the retailer's unique situation — can be increased and more consistent product quality," Hertel says, as well as better control over stock levels.

The cons

Like any other venture, self-manufacturing also has its drawbacks — drawbacks that have prompted a number of retailers to cut back on — or get out of — operations here.

Most of the retailer-run plants that exist today center on dairy, bakery and other products that boast highly standardized operations, Wisner notes. And with dairy products, in particular, the decision to self-manufacture often factors in distribution costs.

"Essentially, you're moving what is relatively inexpensive high-weight product," he says. "So minimizing the amount of transport — and if you're operating your own plant, obviously you do that — does help to reduce the overall costs."

But outside these areas, the cons often outweigh the pros.

"The problem with some of the more traditional-type plants is that they are a more capital-intensive business, Wisner says. "It does tie up capital that could be redirected to new stores and other things."

Staying current on technology changes within a category is another challenge, Wisner says. Most retailers are not equipped to respond as efficiently and effectively as a processor that is serving a much broader base of customers.

And on the raw materials side, a small retailer might not be able to get pricing as attractive as a larger processor could, Hertel adds.

"They may lack the scale or the sophistication to lock in prices via commodity hedging," he says. "And if there are interruptions in supply — say, due to a freeze in the orange groves — they may not have the clout to be first in line like a major private label processor would be."

Food safety presents yet another hurdle.

"If you are manufacturing the product, you own the liability lock, stock and barrel" should a food safety snafu occur, Wisner stresses.

In weighing the pros and cons, Chip Averwater, a third-generation retailer and author of Retail Truths: The Unconventional Wisdom of Retailing, leans toward a no-go decision.

"It involves investment, time, risk and distraction," he says. "Unless the quantities are substantial or there are strong strategic reasons for owning the processor, I think it makes more sense to focus on retailing and let the processor do his job. There are too many processors bidding to do the work more efficiently and inexpensively than a retailer could."

Decision time

Those retailers undeterred by self-manufacturing's drawbacks might want to look to companies that have had success here for guidance. Both Wisner and Hertel point to Kroger as a standout here.

"They run it like an independent business," Wisner explains. "They operate very good plants. They've been careful to stay in areas that are 'safer' from a manufacturing standpoint, where there are standardized processes, where you know who the equipment manufacturers are and all those kinds of things."

Retailers also will want to ask themselves some critical questions before jumping into the self-manufacturing game.

The first question, Wisner maintains, should be "Do I have a source of supply immediately within my trading area that can meet both the standards and the types of products that I want, economically and efficiently?" The second question should be "Am I willing to make the leap of faith, invest in what I have to invest [in] in terms of management, facilities, food safety processes, etc.?"

Finally, retailers need to ask themselves if they are truly willing to take the risk, understanding that, like most new businesses, it probably will not be successful in the beginning, Wisner says.

And be truthful about the role of private label in your overall strategy, Hertel adds.

"Many retailers are in it to expand gross margins relative to national brands; you can do that nicely without becoming a manufacturer," he maintains. "If you are committed to private label as a way to building ongoing customer loyalty, however, bringing manufacturing in-house can help you ensure you're delivering new items, top quality and consistency of experience to your shoppers."

Consider fresh prep

Another opportunity — one that doesn't come with many of the headaches of full-blown manufacturing operations — can be found in fresh-prep facilities. Pittsburgh-based Giant Eagle and Fresh $ Easy Neighborhood Market, El Segundo, Calif., are just two of the U.S. retailers testing the waters here.

Wisner views this area as exciting and primed for growth.

"Now you get into one of the major areas of growth for the supermarket — fresh products, foodservice and ready-to-eat, ready-to-prepare meals," he says. "These are all more craft-driven products as opposed to what you typically think of as a manufactured product."

Fresh prep facilities also allow retailers more flexibility in terms of product design and variety, he says, and retailers have more control over ingredients and freshness.

"My belief is we're going to start seeing more of this — they do this very well in Europe," Wisner adds. "[It requires] kind of understanding the whole commissary model, where you're providing fresh-prep foods to a whole network of stores as opposed to them having to make all of that product individually on-site with fewer controls and less efficiency." PGSB

'It does tie up capital that could be redirected to new stores and other things."'

—Jim Wisner, founder of Wisner Marketing Group.