Slotting: Facilitation, Costs, or Bribery?82

Finding “Bearwiches” on the cookie shelf in your grocery store will be a daunting task. Locating some “Frookies,” a new line of fat-free, sugarless cookies, will take you on a journey through various aisles in the store, and you may find them at knee level in the health foods section. You can find packaged Lee’s Ice Cream from Baltimore in Saudi Arabia and South Korea, but it will not be found on the grocery store shelves in Baltimore. The difficulty with finding these items is not that they are not good products. The manufacturers of these products cannot afford to buy shelf space. The shelf space in grocery stores is not awarded on the basis of consumer demand for Bearwiches or Frookies. Shelf space in grocery stores is awarded on the basis of the manufacturer’s willingness to pay “slotting” fees. If manufacturers pay, they are given a space on the grocer’s shelf. If the slotting fees are not paid, the product is not sold by the grocer. Slotting fees are fees manufacturers pay to retailers in order to obtain retail shelf space.83 The practice has been common in the retail grocery industry since 1987. The origins of slotting fees are unclear with different parties in the food chain offering various explanations. Retailers claim slotting was started by manufacturers with the fees paid to retailers as an inducement to secure shelf space. Another theory of origin offered by retailers is that manufacturers use slotting fees to curtail market entrants. If a manufacturer buys more space with additional fees, the market can be controlled by existing manufacturers. Manufacturers claim slotting was started by retail grocers as a means of covering the bookkeeping and warehousing costs of the introduction of a new product. However, two things are clear. First, the practice of affiliated fees for sale has expanded to other industries. The retail book industry, particularly the large chains, now demands fees from publishers for shelf slots and displays for their books. In malls, developers and landlords now demand sums as large as $50,000 from tenants or prospective tenants before a lease can be negotiated or renegotiated. These fees for a position in the mall are referred to as key money or negative allowances. In certain areas, home builders are demanding “access fees” or “marketing premiums” from appliance makers and other residential construction suppliers for use of their products in the builders’ developments. In the computer software industry, the packaging of software programs with computers ensures sales and requires a fee. Even the display of programs in electronic stores is subject to a fee. The second clearly evolving trend in affiliated fees is that the practice is inconsistent and the purposes of the fees are unknown. Fees differ from manufacturer to manufacturer, from product to product, and from retailer to retailer. How Slotting Works Food manufacturers produce more than 10,000 new products each year. However, store shelf space remains fixed. Because profit margins at grocery stores hover at very narrow levels of only 1 to 2 percent of sales,84 additional shelf space would not increase profits or produce guaranteed returns from the new products displayed there. In addition, grocers must assume the risk of allocating shelf space to a new product that would not sell at a level sufficient to provide even the narrow margins. Retail grocers must absorb the cost of warehousing the product, accounting for it in inventory, bar coding it, and eventually stocking the shelves with it.85 In many cases, particularly where the manufacturer is a small company, there has been little or no advertising of the product and the retail grocer must also incur the cost of advertising the product in some way or offer in-store coupons to entice customer purchases. To the retail grocer, the introduction of a new product and the allocation of precious shelf space is a high-cost risk. There are no guarantees that a new product will garner sales, and there is the downside of the loss of revenue from whatever product is displaced by the new product. To retail grocers, a slotting fee is a means of insulation from the risk of new product introduction and a means of advance recoupment of costs. Within some retail grocery chains, slotting fees represent the net profits for the organization. Similar to the rental car industry in which earnings come from renters’ fees for insurance, car seats, and additional driver coverage, some retail grocers’ profits come not from the sales of food but from the fees manufacturers pay for access. The level and nature of slotting fees vary significantly. Some retailers have a flat fee of $5,000 per product for introduction. Other retailers have a graduated fee schedule tied to the shelf space location. Eye-level slots cost more than the knee- or ground-level slots. The prime spaces at the ends of grocery aisles bring premium slotting fees because those spaces virtually ensure customer attention.86 Other stores require that a “kill fee” be paid when a product does not sell. One supermarket chain requires $500 just for a manufacturer to make an appointment to present a new product. Some retailers will not accept a new product even with a slotting fee. Small businesses often incur the cost of product development only to be unable to place the product with grocery stores. Some stores charge a slotting fee, an additional fee if the product is new, and a “failure fee” on new products to cover the losses if the product fails to sell. A new fee, called the staying fee, has also developed. A staying fee is an annual rent fee that prevents the retailer from giving a manufacturer’s product slot to someone else. Some manufacturers offer to buy out the product in existing space in order to make room for their product. A 1988 survey found that 70 percent of all grocery retailers charge slotting fees, with one retail store disclosing that its $15-per-store per-product slotting fees bring in an additional $50 million in revenue each year.87 Examples of various slotting fees paid and documented are found in Table 8.1. The most typical slotting fee for a new product to be placed with a grocery retailer was $10,000. Slotting fees do not typically come down over time, even if the product sells well. At the retail level for CD-ROM sales, the producers pay a 20 percent fee per shipment, regardless of whether their product is in demand. The Legal Issues Surrounding Slotting The chairman of the board of a small food manufacturer in Ohio wrote to his congressman and described slotting fees in this way: “This is nothing but a device to extort money from packers and squeeze all the independent and smaller processors off the shelves and out of business. We believe this is the most flagrant restraint of trade device yet

conceived.” 89 The Senate Small Business Committee’s investigation included a report on an interview with one small manufacturer who said, “I know for a fact that my competition is paying the lease on the buyer’s BMW.” 90 When the Senate hearings were held, many of the manufacturers appeared behind a screen at the hearing and used voice-altering technology because of their expressed fear of retaliation from distributors and stores for speaking out on the extent of the fees and the problems of under-the-table payments that have sprung from the practice. One manufacturer testified with a grocery bag on his head. The Federal Trade Commission is investigating both slotting and rebate fees for possible antitrust implications. The American Antitrust Institute notes that there is an “absence of reliable industry-wide information” on slotting fees and a “pervasive secrecy surrounding what actually occurs among the major players.” 91 It is possible that a slotting fee might fall under the legally prohibited conduct of commercial bribery. However, for a successful prosecution for payment of a bribe, the conduct required must be that in which funds are paid by a seller to a buyer solely for the purpose of acquiring a contract or business opportunity (in the case of slotting, a space on the shelf). As noted earlier, however, the reality is that there are costs associated with awarding an item shelf space. If the funds are simply received by the retailer and used for general operating expenses hat include advertising, bookkeeping, and warehousing, then the notion that a slotting fee is commercial bribery does not fit within the actus reus, or the required conduct, for criminal prosecution.92 Regardless of legalities, the use of slotting fees creates an atmosphere of confusion. It is unclear how slotting payments are made and where the payments are reported. Many small business owners report that the payments they make to grocery retailers must be made in cash. Some owners report that payments are made in cash both to the chain and to individual store managers. The atmospheric result is that there are large amounts of cash changing hands among sellers, managers, and purchasers. The former CEO of Harvest Foods, a food retailer in the South, has been indicted on charges of bribery and other related offenses for the alleged receipt of hundreds of thousands of dollars in cash for slotting fees. Because slotting fees are nonuniform and even nonuniversal, it is impossible to understand how the fee structure works, how much the fees should be, and whether the fees are actually related to the costs incurred by retailers in getting a new product to the shelf. The secretive and inconsistent nature of slotting fees and their payment in cash create an atmosphere similar to that in the drug trade.93 Market entry rights are unclear, fees change, not everyone is permitted to buy into the system, and the use and declaration of revenues are unknown. In at least four reports on the practice of slotting fees, parties on both sides referred to slotting as the grocery industry’s “dirty little secret.” Cost recoupment, the public airing of the fees, and public accounting disclosures are nonexistent for slotting fees. The secrecy of the fees and the industry’s unwillingness to discuss or disclose them are problematic for manufacturers. From the cost figures offered in Table 8.1, it is safe to conclude that slotting fees could make market entry prohibitive for many small companies. In some instances, fees have gone beyond the initial slotting costs, with some grocery chains now demanding up to $40,000 per year for a company to maintain just a square foot of retail space for its product. Even some of the larger companies have difficulty competing because of the large fees. Frito-Lay recently purchased Anheuser-Busch’s Eagle Snacks after Anheuser had spent over $500 million trying to increase its 17 percent market share. Frito-Lay now holds 55 percent of the snack market and pays the largest slotting fees in the grocery industry. Borden ended its foray into the snack market in 1995, and barely survived before it did so. Nearly thirty regional snack companies have gone out of business from 1995– 1998. A vice president of Clover Club Foods, a Utah-based snack company, believes Frito-Lay’s goal is to be the only salted-snack food company in the country. The Independent Baker’s Association has described the current situation with slotting fees as being “out of control.” The following questions and results reflect the attitudes of those in the retail food business toward slotting: Slotting allowances are a way of penalizing manufacturers for inadequate market tests. 52 percent of retailers, 72 percent of wholesalers, and 77 percent of manufacturers said they disagreed or disagreed strongly. If a supplier can demonstrate adequate market testing of a new product, slotting fees should not be charged 54 percent of retailers, 50 percent of wholesalers, and 0 percent of manufacturers said they disagreed or disagreed strongly. Slotting fees hamper a retailer’s ability to maximize the effectiveness of his product assortment. 58 percent of retailers, 54 percent of wholesalers, and 94 percent of manufacturers agreed strongly or agreed somewhat.94 A 1997 survey by Supermarket Business found the following: At present, some slotting fees are an “under the table” form of payment. 83 percent of retailers, 85 percent of wholesalers, and 79 percent of manufacturers strongly agreed or agreed somewhat with the statement. Slotting and Accounting Issues Slotting has received additional attention since 2003 because of questions and confusion surrounding the accounting for such fees. For example, if promotional fees are to be paid as part of an arrangement between a manufacturer and a retailer, how are those fees to be carried on the retailer’s financial statements? Promotional fees may be paid over time, may be tied to the amount sold, or may be conditioned on certain forms of advertising and results. The flexibility in booking those promotional fee revenues has brought attention to several major retailers including Royal Ahold N.V. and its U.S. subsidiary, U.S. Foodservice. The New York Times ran the following description of the activities and issues that resulted in the U.S. Food Services investigation and accounting restatement: Representatives of U.S. Foodservice are rewarded regularly with goodies like Palm hand-held computers, fax machines, vacation travel and even help with college tuition. All they have to do is earn points by persuading their customers to buy more crackers, coffeecake, plastic forks or other products that have made the company’s list for intense promotion. Under the program, known as Points of Focus, U.S. Foodservice sales representatives amass points if they increase their sales of certain brands, which include the company’s own labels as well as brands from nationally known “preferred vendors.” Preferred-vendor status may have more to do with cash than cachet. The companies that get it have been willing to pay U.S. Foodservice for special treatment, former executives of the company say. Such payments are not illegal, and many other food companies have similar programs. But the former executives and others say that the passion with which U.S. Foodservice managers chased those payments shaped the culture of the company, the second-largest food service supplier in the country. The parent company of U.S. Foodservice, Royal Ahold N.V., one of the biggest supermarket operators in the world, is under investigation in the United States after acknowledging that it overstated earnings by at least $500 million over the last two years. The problem, which Ahold disclosed last month, involved U.S. Foodservice inflating promotional payments from its suppliers, falsely increasing its profit. Two top Ahold executives have quit, and others from U.S. Foodservice have been suspended. The Justice Department and the Securities and Exchange Commission are now investigating the company’s accounting.95

Every major food distributor, with the exception of Sysco, has been the subject of accounting restatements or SEC investigation for issues related to the booking of revenues.96 Two former vice presidents of K-Mart were indicted on federal charges that they lied to accountants about a payment from a supplier and that they used that payment to supplement earnings for the company. Joseph Hofmeister was a divisional vice president of merchandising in K-Mart’s drugstore division. Enio Montini was a senior vice president and general manager of the same division. Former CEO Charles Conaway and Chief Financial Officer John McDonald were also charged by the SEC with making materially false financial disclosures about K-Mart.97 They are charged with attributing larger amounts of inventory to seasonable demand (i.e., it was being carried for the Christmas season as opposed to disclosing that sales were down) and with failing to disclose agreements to postpone payments to creditors. Interestingly, a panel used by K-Mart’s board to arbitrate Conaway’s termination found that Conaway acted in good faith and had not committed any fraud. The panel ruled that Conaway was entitled to his compensation package. The SEC charges, accusing Mr. Conaway of fraudulent reporting, followed several days later.98 The charges center on a payment of $42.4 million from American Greetings in 2001. The payment was called an allowance or rebate, and covers joint advertising as well as rebates and markdowns.99 The payment was fully booked for that quarter despite accounting rules that require an examination of possible refunds for those fees. Many argue that the accounting there is a gray area on which experts disagree and that there was no criminal intent. In fact, the area of allowances between manufacturers and retailers is one in which many stores are under SEC investigation. K-Mart purchased Sears in November 2004 under new ownership.100

Question

1. Are slotting fees a means of allocating risk?

2. What possible employee temptations exist?

3. Would a schedule of fees help?

4. Are slotting fees ethical?

5. Are the perceptions of the industry participants a reflection of their questions about the ethics of slotting?

6. Are the accounting issues the result of the secretive nature of the payments?

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