One of the most notable characteristics of the US grocery industry is its enduring commitment to manufacturing. While many developed grocery markets have moved away from production in the last 30-40 years, many retailers have recently begun to ‘vertically integrate’ by setting up production facilities and managing the manufacture of their own products.

The US sets the benchmark

Some of the largest consumer goods retailers undertake private label manufacturing on a significant scale in the US.  Kroger, Safeway and Publix are among the largest proponents of vertical integration and they operate over 70 different facilities between them, producing a range of dairy, grocery, meat and bakery products. The majority of these sites produce private label goods for the retailers’ own operations, although a small proportion of products are sometimes made for other retailers. Manufacturing facilities are typically located in close proximity to the retailers’ existing distribution centres or stores to minimise costs, producing up to around 40% of their private label volumes.

Growing interest among global retailers

There has also been increased interest in production among grocery retailers outside of the US.  In the UK, for example, Morrisons has reiterated its commitment to manufacturing by expanding capacity for existing ranges, such as its recent investment in seafood processing, and broadening its category coverage to flowers. In Belgium, Colruyt has continued to advance its own facilities in recent years by investing in coffee roasting, wine bottling and rice packing.  Beyond direct manufacturing, Walmart has invested significantly through its Direct Farm programmes in China and India to establish direct trading relationships with growers in these countries and improve yields through sharing best practice.

Different models emerging, but most start with ‘made in-store’

There are a range of models of vertical integration where retailers manage all or parts of the manufacturing process of their goods, but the most common focus is in-store production.  This is probably one the easiest areas for retailers to start to move to a production-based model, as many already have some element of in-store preparation they can build upon.

‘Made in-store today’ or ‘made in our kitchen’ is becoming a much more frequently used marketing message, as retailers appeal to shoppers’ demands for more locally produced and locally sourced products.  In-store production guarantees freshness, but the key trend over the last couple of years has been open and visible preparation areas giving a sense of ‘retail theatre’ to a shopping trip.

Some retailers have opted for more advanced integration, going as far as growing their own fruits, vegetables and grains. Others are going one-step beyond the store by opening central kitchens to support their foodservice or convenience meal solutions.

Meeting shopper needs through flexibility and responsiveness

As well as the advantages to marketing, the popularity of vertical integration among retailers is also driven by a need to reassure shoppers about food safety and product traceability. Owning more of the process also helps retailers to ensure the security of food supplies and support private label growth plans.  Through direct ownership of production facilities, retailers can have a direct influence on product quality, ingredients and recipes, and they can develop expertise in key product categories.  Vertical integration also provides an element of flexibility, as retailers can test and trial new product developments at relatively low cost and risk.

Supply chain complexity

Extending the scope of operations beyond the store environment is not without its challenges.  Production management requires a broader set of skills and can add a level of complexity to existing supply chains; production needs to be planned in line with shopper demand. It is an added complication for retailers seeking to simplify their supply chains.

Production facilities also need to evolve as the retail business develops and grows; this often leads to new facilities running below optimum capacity for several years, therefore impacting the balance sheet. 

Retailers must also be mindful of the fact that it can also be costly to comply with food safety regulations and that they are shifting the food safety risk back in-house.

Retail trends could challenge existing models

In the future, private label production could become of even more interest to retailers as food security becomes a more prominent issue globally and shoppers show increasing interest in product traceability.

However, for the majority of retailers, the focus remains on developing the range of products which can be produced either in-store or within a central kitchen facility. With each step that retailers take beyond their traditional model comes an increasing level of complexity and an additional need for specialist skills.  The challenge for retailers will be to differentiate their propositions as ‘made in-store’ becomes more familiar to shoppers and, more fundamentally, to compete when a greater proportion of sales come from online and convenience channels, two environments where it is difficult to replicate this model.

Stewart Samuel,

North American analyst

IGD

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