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Foodservice Distributors and CPG – COVID, concentration, and what it means for CPG companies
Foodservice is a different animal than traditional CPG retail. In traditional retail, CPG manufacturers sell goods to retailers, who then sell goods to consumers. CPG companies generate bargaining power through strong brands and horizontal acquisitions. The stronger your brand is, and the more strong brands you own, the more you can dictate pricing.
Foodservice is different. Since the products are inputs into a finished product (e.g., a meal), branding doesn’t matter. An end consumer does not care if the milk in their milkshake is from Deans or Organic Valley. It’s effectively a volume-based commodity business that is supplied by branded CPG companies. In this model, CPG manufacturers sell goods to foodservice distributors, who then sell goods to restaurants/hotels/schools, who use the goods to make products that consumers buy.
It’s all about pricing, which is why foodservice distributors are the major power player and gatekeepers in the industry.
Foodservice Distributors in the USA
Before I get into the upcoming platform wars, it’s important to take a step back and define foodservice distributors. From an overall market perspective, most analysts consider foodservice distribution in America a highly fragmented market. The latest estimates place the number of food distributors at 16,500 and value the market at $268 billion a year. Personally, I view that as slightly misleading. Based on 2019 data, the top 6 distributors capture around 50 percent of the market’s revenue.
Company, Region, Tractors, Distribution Centers
Distributors are typically drawn from three categories: broadline, system, and specialty.
Broadline: Offer a wide variety or “broadline” of products and services.
System: Provide goods for specific large chains.
Specialty: Concentrate on a niche segment (e.g., cheese, fresh fish).
The major players dominate the broadline and system categories, and as you can imagine, the major distributors are becoming bigger and bigger. Since the early 2010s, Sysco and US Foods have completed over 30 acquisitions—increasing their revenue by $12 and $4 billion.
How do foodservice distributors make money?
In simplest terms, foodservice distributors buy products from manufacturers, hold products in warehouses, sell products to restaurants/venues, and deliver the products once sold. The goal for a foodservice distributor is basically that of a Vegas sport’s book. Just as Westgate sets a betting line to get equal money on both sides, foodservice distributors are trying to balance inbound products and outbound orders. Buy too much product, and the distributors have to pay for unnecessary storage and transportation. Buy too little, and customers jump ship because they aren’t meeting their needs.
The key business assets are the physical distribution centers, trucking network and sales network. The distribution and trucking network are huge capital expenditures—reducing the threat of new entrants into the industry. Amazon is often praised for its 100+ distribution facilities across America. Sysco has 236 locations. US Foods has 168. Unlike Amazon warehouses, they are refrigerated. Allowing both to service effectively every single place in America that sells food. (Note. In 2020, Amazon made a huge investment in food wholesaler Spartan Nash. Food wholesalers aren’t exactly foodservice distributors, but it’s an adjacent market.)
The sales network is a little less concrete but just as important. Independent restaurants figured out that they can gain more pricing leverage against the industry if they join together in what is commonly called buying groups. Buying groups often sign short-term agreements with food distributors around negotiated prices. It’s not uncommon for a buying group to switch their distributor every year. That means that distributors routinely ask for massive price discounts from manufacturers. If manufacturers don’t agree, a food distributor can drop the entire SKU from the buying group and the larger catalog.
COVID – 10 years of foodservice evolution in 10 months
COVID crated the foodservice industry in America. McKinsey estimates that restaurant sales dropped by 40-50 percent.
A McKinsey analysis explains what happened next:
Immediately after coronavirus-related shutdowns, outbound orders suddenly stopped because of government-mandated closures of restaurants, even though inbound orders of food kept coming in from farmers, foodservice producers, and processors. That led to logistical bottlenecks and storage-space shortages as distributors worked to cancel incoming shipments of inventory from farmers.
Large companies could use their scale to absorb the shock—small and medium operators were left with unsold inventory—often perishable. Perhaps even more strategically important, larger operators used the downtime to focus on sales.
Kevin Hourican, Sysco CEO, explained:
Our sales teams are actively engaged with new customers and helping existing customers maximize their business during this recovery period. We continue to win business at the national and contract sales level. We have now posted over $1.8 billion of net new wins since the start of the pandemic with another strong quarter of new contracts signed. I’ve said on prior calls, the contracts we are writing are at historic profit margins.
Here’s Pietro Satriano, US Food’s CEO, saying the same thing:
For nationally managed customers, which, remember, includes national chains, healthcare, and hospitality, you will remember that in 2020 we added $800 million of new customer wins, which is driving some of the increases we are seeing. In the first quarter of 2021, we added $200 million of new customer wins, and our pipeline for the balance of the year is very healthy.
To restate: it’s estimated that restaurant sales dropped by 40-50 percent and the large players are adding billions of dollars of high profit margin business.
Translation: That margin isn’t coming from restaurants. CPG manufacturers are going to be squeezed.
With a handful of distributors controlling 50% of the market, distributors are going to increasingly demand price concessions–putting branded CPG firms in an uncomfortable position.