Foodservice Distribution 2.0: Algorithms Optimize the Value Chain

The $268 billion foodservice supply chain is competitive and efficient with the notable exception of how business is transacted between independent operators and their suppliers. Technomic research and observations reveal that foodservice distributor sales representatives (DSRs) spend most of their workday visiting accounts to collect orders, in large part because the prevailing business model and a lack of awareness of more efficient alternatives discourage customers from using contemporary e-commerce platforms for replenishment. Consequently, operators “go-with-the-flow,” and pay a premium – often a hefty one – for a sub-optimal approach, unaware of the value of alternatives.

That might not be problematic except that the industry’s “other half,” chains like McDonalds, Starbucks, Dominos, and Applebee’s earn a vast majority of the industry’s profits by out-selling and out-buying their independent counterparts.  In fact, the average independent’s buy-side disadvantage is more than twice the size of his/her bottom line.  Chains may tolerate less frequent or “inconvenient” midnight deliveries, but those trade-offs translate to financial advantages which in turn manifest themselves in market dominance.

The same distributor truck with four, say, Subway orders onboard delivers to schools, hospitals, daycare centers and multiple “mom & pop” restaurants the same day; but the price of butter varies widely from one to the other.  That’s in part because the same reps restaurateurs regard as business partners are paid to maximize profits by charging whatever the market will bear.  This isn’t to say operators never compare prices between distributors. They know the cost of critical items such as cheese for pizza or ground beef for burgers.  Yet because they know it’s risky to over-trust a distributor, they buy from many to “keep them honest,” a system that costs independents dearly.

To achieve a desired balance of selection, quality, and price, operators buy from 2-3 broadline and 6-7 (and often more) specialty distributors, meaning there are 15-25 orders to manage weekly.  It’s therefore not unusual to find an owner or manager spending 10-15 hours/week on purchasing. In turn, a distributor needs about $80 just to process an order, so an operator supports over $1,000 of supplier fixed costs on a weekly basis.

Distributors’ price/service models are designed to perpetuate and profit from these same inefficiencies.  DSRs earn a percentage commission of each invoice’s gross profit, and higher percentages as the profit increases.  It has long been the industry’s prevailing approach, at odds with the financial well-being of its weakest stakeholders.  The cost of fielding a distributor sales force (wages, benefits, management, office support, etc.) is enormous (>$1.50 per case), in contrast to the value delivered by more efficient alternatives.  As an example, the aforementioned chains pay less than $.05/case for sales representation.

This disparity creates a dilemma for broadline distributors because they earn the bulk of their profits from independents, a class of trade commonly referred to as “Street” business.  They perpetuate structural inefficiencies because transparent alternatives presumably risk lower gross margins.  In fact, convincing a major distributor to allow a “Street” customer to order online can take months or years.  Why hasn’t someone sized up this anachronistic yet highly-profitable channel and blown it sky high?  The answer – “it isn’t easy.”

Fortunately, a few disruptive models provide relief for the “disadvantaged.”  The clearest and most visible benefit comes from the Club/Cash & Carry channel, notably Restaurant Depot, Sam’s Club, and Costco.  Operators save 5-25% depending on the item, but sacrifice valuable time and energy to pick and haul their requirements.  But if $25 billion/10% market share and 500,000 users is any evidence, they’ve made a big difference to independent restaurants.

Another important factor is Group Purchasing Organizations (GPOs).  Chains naturally function as their own GPOs and leverage their scale upstream, but independents often feel compelled to do things for themselves.  The very concept of a “Group” implies togetherness, similarity, and commonality; characteristics not historically associated with culinary entrepreneurs.

Restaurant GPOs such as Boston-based Dining Alliance deliver significant savings, often double-digits, when an operator behaves like a chain by using specific brands and products for which the GPO has negotiated deep discounts.  If an operator prefers certain brands that don’t align with a GPO’s leveraged offering, the impact is somewhat diminished.  Still, it’s a rare operator that is not better off with, versus without one.  To date, less than 10% of the independent restaurant population participates in a GPO.

Newer among foodservice supply chain disruptors are technology firms offering software that replicates in nanoseconds what would otherwise take hundreds of man-hours to figure out.  Powerful algorithms scour price offers from competing distributors and calculate “optimum orders,” the best possible order allocation to an operator’s distributor network that accommodates his/her preference for product brand, quality, and performance.

New York-based TradingTable has developed a platform enabling distributors to offer price/service parameters of their own preference, incorporating safeguards to prevent “cherry-picking,” an inherent flaw of most digital bid/spreadsheet approaches.  Instead, their algorithm focuses on achieving the lowest overall spend, which takes into account each distributor’s “rules” in terms of order size and quality, rather than a line-by-line comparison.  TradingTable’s universal catalog makes it easy for the restaurateur to create an order which the system in turn “dynamically shops” between competing distributors’ customized offers.  Early adopters of the platform have saved 8-10% (>$50k annualized) without sacrificing product preference, quality or service; if anything, users can reap the benefit of better service as a result of larger order sizes.  At the same time, distributors realize incremental volume under their own conditions – in other words, they establish the “rules” under which they “bid” for the business.

Specifically, TradingTable’s platform allows participating distributors to capture more of their customers’ weekly orders (line items, cases, and spend) by rewarding operators for larger orders, made possible through the platform’s “make-your-own-rules” functionality and pricing algorithm.  In fact, distributors previously competing against 10-15 distributors offline for a given operator’s business are now capturing 3-5x larger orders from the same account.

While GPOs can offer savings when operators compromise on their product preferences, TradingTable’s algorithms provide a medium through which distributors can optimize prices, profitability, and selection with minimal effort, while enabling customer cost savings that rival the less flexible GPO model.  The ability to “get what I want” through the TradingTable platform introduces attractive value stream efficiencies missing from the GPO model.

The Club/Cash & Carry and GPO channels are maturing but still gaining share of the foodservice supply chain, indicative of pent-up demand for price/value and transparency.  Algorithm Optimizers like TradingTable represent enormous potential as they refine their offerings and communicate their value propositions.

The good news for operators is that they can choose whichever model best fits their style.  As the “early adopter” phase transitions into “early majority,” independents will need to come along or risk even greater financial disadvantage. 

Click here to download a pdf version of this article.

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Bob Goldin

Bob Goldin is Vice Chairman at Technomic Inc, with over 30 years of broad-based food industry experience, working as a consultant, researcher and industry executive. He leads Technomic's Consulting and Research Group, where he directs a wide range of projects for food manufacturers, distributors and related suppliers. Bob also has consulted extensively in nontraditional channels, including club stores and vending.

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Comments

  1. Great article Bob. This entrenched inefficiency is artificial, and as you point out, has a huge impact on the financial performance of independent operators.

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