When Costs Go Up

McLane's packaged beverage increase underscores distribution challenges

Published in CSP Daily News

TEMPLE, Texas -- A change to the pricing structure followed by the convenience channel's largest distributor could force two of the industry's largest beverage suppliers to alter their distribution methods, according to a stock analyst note issued yesterday.

Temple, Texas-based McLane Co. recently notified packaged-beverage suppliers of its plans to shift from a cost-based to a weight-based fee where suppliers must pay 9.5 cents per pound shipped, with a minimum of $2.50 per case.

"The companies with the largest exposure to [image-nocss] a change in distributor fees for packaged beverages are PepsiCo's Gatorade and Nestle's U.S. water business," William Pecoriello of Morgan Stanley & Co., wrote yesterday. "We see an incremental $100 million as a worst-case impact on PepsiCo, ... [but] we see a relatively low probability of the worst-case scenario playing out."

McLane Co. said it decided to make the change, scheduled to take effect April 1, when it determined it could no longer absorb the ever-increasing costs of hauling packaged beverages.

We're addressing an issue that has become so unbalanced that the weight of a 32-pound case of packaged beverages is being delivered well under a dollar, Tony Frankenberger, McLane's vice president of merchandising of grocery distribution, told CSP Daily News. Our research shows that no other distribution provider outside of this channel provided even close to that cost.

The action comes on the heels of a report by industry expert Kit Dietz that raises serious profit concerns on behalf of distributors. The average distributor generated a pre-tax margin of just 0.5% in 2005, Dietz noted in his report, citing the American Wholesale Marketers Association Hershey Industry Profitability Analysis.

Packaged beverages, generally representing high cube, heavy and cumbersome products, generate thin distributor margins that don't cover direct handling costs, the Dietz report continues, and therefore provide a negative contribution to fixed overhead costs.

A note about the McLane change by Merrill Lynch analysts Christine Farkas and Mitch O'Brien quotes the Dietz report and raises some obvious questions: How will the decision affect the warehouse-delivered vs. direct-store delivered competition? Suppliers like Gatorade and Nestle Waters have seized a price advantage over the DSDs by driving volume through warehouse.

In his analysis, Pecoriello said, "We believe that the worst case impact for Gatorade would be an increased cost of $1.25 per case." He added that numerous implications could arise as a result:

1) PepsiCo could eat the increase.

2) PepsiCo could seek out other distributors who don't ask for an increase.

3) PepsiCo could negotiate the fee down with McLane.

4) PepsiCo could pass on the higher cost to retailers.

5) PepsiCo could move distribution to its bottling system.