Supermarket sweep: the transformation of the food retail sector.

Mexico is not alone among "emerging markets" in experiencing a rapid transformation of its food retail sector.

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Over the past decade, Latin America as well as East and Southeast Asia have witnessed the rapid spread of supermarkets. In turn, this is dramatically affecting how fruits and vegetables are grown and sold throughout Mexico and the rest of the world.

This phenomenon has had a major impact on local and national supply chains as farmers face an entirely new market driven by institutional changes in the supermarket sector's product procurement systems. Farmers and suppliers are faced with challenges that have significant development and trade implications.

Recognizing that the global expansion of supermarkets is primarily led by U.S. companies, USAID is spearheading a program aimed at documenting the experience in Mexico. In conjunction with the U.S. Department of Agriculture (USDA), Mexico's Agriculture Secretariat and private sector representatives, USAID is funding a study to identify the winners and losers associated with the increased dominance of supermarkets.

The research project will establish "how the supply chain can be improved and how programs can be developed to improve local production, especially in ways that keep smaller-scale producers competitive," according to a USAID document.

Mexico Conference

In addition to the study, USAID and the USDA will sponsor a two-day conference in Mexico City that will focus on global experiences associated with supermarkets. Guest speakers from around the world will take part in the June 9-10 event, discussing the supermarket experience in the United States, Europe, Asia and other Latin American countries.

The conference will examine the special requirements supermarkets place on the supply chain and how the rapidly increasing dominance of major retailers has modified the supply chain on other countries and regions.

"By raising the awareness of Mexico's government officials and private sector representatives, we hope to increase their commitment to addressing the changes this phenomenon will cause in Mexico," the USAID document explains.

Dr. Tom Reardon, an international expert who teaches in Michigan State University's Department of Agricultural Economics, is conducting the USAID-funded study in collaboration with U.S. and Mexican researchers. The study focuses on avocados and tomatoes and will assess the entire supply and marketing chain--from producers and producers' associations, to packers and shippers, wholesalers and retail outlets.

The completion of the study is scheduled for September, with a final report due shortly thereafter. Its release will coincide with a second conference that will focus specifically on Mexico. This conference--in the organizational phase--is tentatively set for October in Morelia and would attempt to develop recommendations to increase the competitiveness of small farms here in Mexico.

"Our goal is to use the information (in the Reardon study) to analyze what is happening in Mexico and to determine what actions are required to support small-scale producers in different sectors," the USAID document says.

The primary audience for the October conference will be Mexican government officials and representatives from supermarkets, producers' organizations and other elements of the supply chain. Technical and financial services organizations also will be invited to attend.

Speedy Change

One of the more fascinating aspects of the supermarket phenomenon in "emerging markets" is the accelerated pace at which they are becoming the dominant suppliers. It took over 50 years for the Piggly Wigglys and the Wal-Marts of the world to take over the food supply sector in the United States. The same process is happening in less than 10 years in Mexico.

The resulting transformation in the supply chain has been dramatic, particularly for smaller scale producers who struggle to compete with large, well-financed farms. The situation is exacerbated since supermarkets demand more uniform quality, reliable deliveries and large supplies.

USAID recognizes that large producers dominate Mexico's export market, so it is critical that small farmers remain competitive as internal market demands change and reflect more stringent international standards and marketing formats.

This is especially true because internal markets don't often receive the attention that the export sector does.

When California bans Mexican avocados or Florida fights to keep Mexican tomatoes out of its market, it's big news. And while such export market issues are important, Reardon told BUSINESS MEXICO internal market issues are just as important, yet the dynamics of the market get significantly less attention.

"Latin American markets buy 2.5 times more fruits and vegetables from domestic growers for their internal markets than is exported," he said. "That's why the phenomenon of "supermarketization" is so important."

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Reardon ticked off a variety of issues that he identifies as critical in understanding the rise of supermarkets: acceptance by consumers; diffusion into markets; diffusion over space and time; the interface with the food supply system; the establishment of sourcing centers; and the wholesale transformation of the procurement system.

"While it's true that we are just beginning to understand these changes in trade, it is apparent that as identifiable patterns develop, we will be able to predict patterns in growth and penetration," he said.

Supermarket Revolution

Reardon has been studying this supermarket revolution for many years now.

In a paper published in the Journal of Food Distribution Research, Reardon, Julio Berdegue and C. Peter Timmer characterize the phenomenon as a "new wave of profound transformation ... from the demand side, sparked by a relatively sudden and massive evolution of the retail sector."

In the article--entitled "Supermarketization of the 'Emerging Markets' of the Pacific Rim: Development and Trade Implications"--Reardon and his associates focus on the changes and their implications.

As late as the 1980s, domestic supermarket chains comprised only a tiny niche of the food retail sector (5-10 percent) and "served mainly upper income consumers in a few large cities."

About 10 years ago, supermarkets accelerated markedly, transforming food markets dramatically. In Mexico, supermarkets jumped from 5-10 percent of the food retail share in 1990 to 30-50 percent in the early 2000s.

The article identifies two "supply-side factors" that were of extreme importance in this trend. The first was the massive influx of retail foreign direct investment (FDI), matched by competitive investment by local chains.

The FDI was driven by "push factors" (saturation and intense competition at home) and "pull factors" (primarily much higher margins when investing in developing markets). Additionally, "initial competition in the receiving regions was weak."

The second factor is the adoption of procurement system organization and institutional changes that greatly reduced retailers' procurement costs.

This reduction in costs encouraged retail chains to move into secondary cities and even smaller towns as competition intensified.

Winners And Losers

A primary goal of Reardon's research and the USAID study is to understand the transformations in the procurement systems and how they impact farmers.

"The supermarketization process has produced big wins and big losses," Reardon said. "Inevitably, some farmers are forced out."

Technological, organizational and institutional change in the procurement systems of supermarkets are key determinants of change in the markets facing farmers, write Reardon et al.

Throughout the 90s, the "traditional procurement system" dominated:

1. each store procured its own products or one store was used as an entrepot for a few neighboring stores

2. products were procured from the traditional wholesale markets

3. retailers relied on spot markets rather than on contracts with suppliers

4. retailers relied on public quality and safety standards where they existed

Typically, the article explains, "supermarket chains found a gap between the objectives noted above and the capacities of the traditional food supply and market mechanisms ... to meet these objectives."

In response, adjustments to the procurement system were made, providing greater efficiency, higher quality and cost reduction.

The Pillars Of Change

The first adjustment is a trend toward centralization of procurement. As supermarket chains grow, they shift from a "per-store procurement system to a distribution center serving several stores" in a given region.

"Centralization increases efficiency of procurement by reducing coordination and other transaction costs, although it may increase transport costs by extra movement of the actual products. The net savings can be substantial," the article says.

In response, leading domestic retailers--such as Soriana, Gigante and Comercial Mexicana--have adopted the same practice of centralization.

Subsequently, a "regional system of distribution centers to allow coordinated procurement over a set of countries" was developed. For instance, Wal-Mart is sourcing avocados from Mexico to supply its stores in China and Korea, while H.E.B. is planning direct supply from its new distribution center in Mexico to stores in Texas.

The second pillar of change is the use of specialized/dedicated wholesalers. These specialized wholesalers supply a single product category specifically for the supermarket sector. This cuts transaction and search costs, as well as enforcing private standards.

This change is especially evident in Mexico where the top four retail chains have shifted away from the spot market into specialized relationships in the past five years. This has produced consistent year-round volumes and quality.

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Reardon et al report that the reduction in volumes of produce going through the wholesale markets in Mexico City (25 percent), Monterrey (30 percent) and Guadalajara (50 percent) has been dramatic.

The third pillar of change is that supermarket chains are signing contracts with their suppliers.

These contracts serve as "incentives to the suppliers to stay with the buyer and ... make investments in assets ... specific to the retailer specifications regarding the products." They also sometimes include direct or indirect assistance for farmers.

The fourth pillar of change involves the implementation of private standards for quality and safety of food products.

Basically this establishes a standardization of product requirements and, as an offshoot, this has driven the enforcement of public standards,

which often were never enforced before.

Resulting Implications

Reardon, Berdegue and Timmer argue that supermarketization and the ongoing changes to the procurement system effects an integration of national and regional markets.

"This integrating force is at least as powerful as policy determinants of trade and regional integration," they write.

The "knitting together" of these markets inevitably reduces transaction costs and "increases opportunities for exporters ... to gain access to the emerging markets of the region."

The research indicates that "this type of 'supermarketization-transformed trade' will gradually or perhaps quickly replace the traditional trade-wholesaler based trade that dominates at present. This change could well spell a change in the nature, composition, and volume of trade in the region in the next decade."

The good news is that suppliers adopting the new practices can grow from a local supplier to a national, regional or global supplier.

In addition, "private process standards can increase efficiency of operations and raise profitability."

But the catch is that these changes require costly investment. And since the supermarket sector is a high-competition, low-margin industry, only the most capable farmers will survive. Consumer prices won't be raised to help pay for the farm-level investments required.

Tom Buckley is the editor of BUSINESS MEXICO.