It’s not every day that you see a video about supply chain contracting, so I cannot resist posting about it:
The video comes from Vox and they have an article that goes with it (The hidden war over grocery shelf space, Nov 22). That article, in turn, was at least partially inspired by a report written for the Center for Science in the Public Interest (Rigged: Supermarket Shelves for Sale, Sep 28, 2016).
The contract in question is a slotting allowance. Slotting allowances are paid by food manufacturers to retailers in order to get items onto shelves. The money is paid upfront and often varies with the number of stock keeping units (SKUs) introduced and the number of stores in which the products will be stocked. The term comes from the act of creating a space — i.e., a slot — for an item in a warehouse or on a store shelf. The origin story is that retailers at some point started demanding that vendors compensate them for the costs they incur in helping launch new products (which often fail). The reality is that the money involved is now significantly higher than the cost of rearranging products. In effect, retailers are selling off their real estate.
So are slotting allowances good or bad for markets and customers?
It turns out that there has been a fair amount of research on slotting allowances, and I should acknowledge that I have a dog in this fight. My very first publication was on slotting allowances. A case against slotting allowance is laid out in the Center for Science in the Public Interest article which essentially argues that slotting allowances stifle innovation. If one believes that smaller firms are more likely to develop truly novel offerings, then one has to wonder whether paying to gain distribution keeps those new products off of shelves. Paying upfront money to the retailer doesn’t create value for the customer but does create a barrier to entry. This would be particularly true if overall demand for a category is not really growing. A new product then is largely just going to shift sales from Product 1 to Product 2. If Product 1 is made by a deep-pocketed multinational, then it can easily afford to launch a new product (say, 1A), outbid the maker of Product 2 for shelf space and protect its sales. The retailer may happily go along with this since it gets to book essentially riskless revenue by taking the slotting allowance for 1A even if Product 2 would have been a top seller had it been given a chance.
In the eyes of the Center for Science in the Public Interest, this is bad since it means that the offerings at the store are driven by marketing budgets over what consumers want. From a policy perspective, it also creates issues by complicating the launch of more healthful products. They argue that the Big Boys of the supermarket world have gotten big by selling highly processed food loaded with sodium, fat, and all sorts of other things that don’t promote healthy eating. The Big Boys have every incentive to keep doing more of the same. Hence, slotting allowances limit consumer choice in a way that harms public health.
I should acknowledge that this is not the only argument against slotting allowances. Some have argued that they can lead to higher retail prices. These fees increase costs and the vendors have to recoup that cost somehow. Wholesale prices go up and that in turn is passed on to customers. (This is intuitively clear but it actually takes a bit of work to model this since one needs a reason why the retailer would benefit from a higher wholesale price. In principle, the firm should like a lower wholesale price since it can then increase the volume it sells. However, if demand is relatively inelastic, a price cut may not bring a significant increase in volume.)
So what are slotting allowances good for? Go back to my Product 2 above. I said Product 2 would have been a top seller. However, odds are it won’t be. Most new products introduced into supermarkets fail. On top of that, there is a huge number of new products launched every year. So if you are a buyer for a supermarket chain, how do you separate the wheat from the chaff? Slotting allowances are one approach. Assume that vendor is better informed about the likely success of the product — that is, a firm that makes mayonnaise for a living knows more about the latest trends in condiments and aiolis. Every vendor has incentive to tout the wonders of their product. Talk is cheap, and no one is ever going to claim that their offering is just so-so. Slotting allowances change that. Talk is not cheap if you have to pony up a couple hundred bucks per store to launch your product. Slotting fees then create value for the retailer by providing guidance on which of the many products being offered have a chance of being successful in the market place. This then benefits customer since “good” products make it on to shelves while those with limited potential don’t.
There is, of course, a caveat to this argument. This evaluates a product on its lonesome. It doesn’t consider interactions between products in a supplier’s portfolio. To go back to my earlier example, a supplier with multiple products may be willing to pay up for a weak product if it protects their overall market share even if the product it is launching is weak brand extension.