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  1. 1. Healthy Eating Meets the Grocery Chain… The Grocery Supply Chain Dr. Gurram Gopal, Assistant Professor, Elmhurst College Kathy Olsen, Motorola Inc. As Seattle Sutton, the founder and president of Seattle Sutton’s Healthy Eating (SSHE), strolled through the company’s 25,000 square-foot kitchen in Ottawa, Illinois, looking at the planned additions and enhancements, she was pondering on the best way to capitalize on the capacity existing at the site for continued growth. The plant could currently produce 200,000 meals per week, but was currently shipping 160,000 meals per week to customers in Illinois and Indiana. She had recently been approached (again) by a national grocery retailer with an offer to distribute her product through its grocery retail chain. With a focus on continued growth and expansion, she questioned whether her decision to sell the company’s line of fresh-cooked meals only through authorized independent distributors or franchisees was the best way to go. Seattle Sutton’s Healthy Eating – “Small” Beginning Seattle Sutton founded the company, “Diet-Carry-Out” in 1985 in Marseilles, Illinois, nearly seventy miles south-west of Chicago (Figure 1). Prior to starting her company, Seattle Sutton, a registered nurse, and her husband, a practicing physician, had been providing nutritional information to patients who needed to lose weight or had to address health-related problems through better eating. The idea for the company grew out of Seattle Sutton’s desire to change the eating habits of her physician-husband’s overweight or Type II diabetic patients. Seattle Sutton found many of these patients eager to lose weight, but unwilling to spend the time planning and preparing a healthy diet. While these patients had tried other plans they had not been able to stick to them. Seattle Sutton wanted to create an offering that would fundamentally improve the Page 1 of 14
  2. 2. eating habits of these patients and would show visible results. This focus on changing the eating habits and demonstrable benefits led her to create a “meal plan” that is still the core of the company’s offering today. The meals are always fresh, not frozen. This offering proved to be a hit with her husband’s patients, who became her initial customers. Seattle Sutton’s Healthy Eating – The Core Offerings The core products of SSHE reflect Seattle Sutton’s fundamental desire to change the eating habits of her customers, not just to provide a “meal replacement.” They have not changed significantly over the past twelve years. Customers have to sign up for and order a weekly meal plan that provides three meals a day, seven days a week, for a total of 21 meals per week. Meals are delivered (or available for pickup) twice a week to ensure that they are always fresh. The first set is delivered on Mondays and includes Monday dinner through Thursday lunch. The second set is available on Thursdays and includes Thursday dinner through Monday lunch. Two meal plans are offered with different portion sizes, one with 1,200 calories per day and another with 2,000 calories per day. The meals are never frozen, but are transported in refrigerated trucks and kept cold. The meals require only microwave re-heating. The price for a weekly plan is approximately ninety one dollars. The menu rotates every five weeks so that there is a variety of food for the customer and the same meal is consumed only about ten times a year. A key element of the offering is to “condition” the customer to adapt to smaller “portion sizes.” The meal plan is flexible in that if a customer chose to go out to eat one evening, he or she can freeze the SSHE meal scheduled for that evening and consume it the following day. Meals can also be shared with other family members. Page 2 of 14
  3. 3. The “Home-Meal Replacement” Market SSHE is widely regarded as a leading ‘niche’ player in the broad category of “home-meal replacement market.” The definition of the meal replacement category varies widely, and many market reports include dine-in restaurants, fast food outlets, cereal bars, and supplements in addition to packaged prepared meals eaten (but not cooked) at home in this category. The subcategory of meal replacements where the replacements are consumed at home includes companies such as Slim-Fast, Jenny Craig, SSHE, Medifast, Lean Cuisine, and others. These companies often promote their products as convenient low-calorie meal options. The convenience/nutrition combination is a vital one, according to the market research company Information Resources, which notes: “To date, manufacturers and retailers have done a respectable job of responding to demands for convenience. However, the convenience trend has certainly not passed. Those who grab the bull by the horns, with respect to nutritionally responsible, convenient food alternatives, will raise the bar and define the playing field of the future.” UK research company Leatherhead estimated the global weight loss market in 2002 at $240 billion, with meal replacements making up a small but growing proportion of this figure. In the US, the market for meal replacement food and drink rose from $800 million in 1998 to $1.2 billion in 2002—of which $800 million was spent on beverages. Unilever’s Slim-Fast brand dominates, accounting for 75 per cent of supermarket sales and 50 per cent of the weight loss snack bars sector in the US. Market researcher Freedonia predicts the US meal replacements market will be worth $2.4 billion by 2013 out of a total weight control market of more than $86 billion. SSHE has positioned itself as a science-based healthy eating home meal replacement company, with the focus on medically proven benefits of eating “smaller portions.” While a very small Page 3 of 14
  4. 4. player in the industry when compared to Unilever or Nestlé, SSHE is the leading provider in the Midwest of meal (not snack) products that replace home-meals. Unlike low calorie shakes or diet bars, SSHE provides regular ‘meals’ but the portions and the nutritional contents are managed for the customer’s long term health and weight management goals. SSHE’s production facilities and products are licensed by the USDA or Department of Agriculture in each state, which requires ingredient labeling and nutrition fact panels on meals containing chicken or turkey. The vegetarian and fish meals have ingredient lists on the security label, as required by the FDA. The Distribution Model After starting the company in 1985 Seattle Sutton grew the business by using distributors, many of whom were her initial customers. Each distributor had an exclusive coverage area. The distributors were independently owned and run. The distributors purchased fresh meals from Seattle Sutton and resold them in their territories. The meals were sold at storefronts maintained by the distributors, or delivered to customers at their homes for a delivery fee. As the meals came from Seattle Sutton’s kitchen, the distributors did not need to make significant capital investments. There were no initial fees, but the distributors were expected to invest in marketing in their territories. In 1991 Seattle Sutton, like many entrepreneurs, sold the thriving business to a former Campbell’s Soup executive with a background in new product development. The Campbell executive promptly changed the menus, added high fat food, and enlarged the portions. The results nearly drove the company out of business. Seattle Sutton bought the company back in 1993, hoping to restore it to its original mission and its original vitality. She changed the name to Seattle Sutton's Healthy Eating, and put the focus back on healthy, low-calorie meals. The changes have resulted in revenues growing by an average of 25% per year over the past ten years. Page 4 of 14
  5. 5. Providing performance-based incentives to distributors was another key goal of Seattle Sutton. Rather than providing cash or travel rewards like the prevailing norm, SSHE provides financial resources for advertising to distributors with superior performance. A distributor who has signed up fifty clients is awarded a $2000 budget for use towards advertising. The distributor has control over how this money is spent, as long as it directed towards advertising. Based on performance distributors can realize upwards of $30,000 per year for advertising support from SSHE corporate office. A New Era Using the above distribution model with her kitchen as the single production facility, Seattle Sutton increased SSHE’s coverage and sales in Illinois. But her desire for further geographical expansion was limited by the capacity of her kitchen and by the logistical constraints and expenses in moving her products over longer distances. Beginning in 1998 the company started experimenting with selling franchises, where the franchisees would operate a production facility and sell the meals to distributors in their area. However, the formula that had proved so successful in SSHE’s Ottawa kitchen was extremely difficult to successfully duplicate. The first franchise kitchen, opened in Omaha, Nebraska in 2002. It lasted only a year before being forced to close its doors for lack of operating funds. The second franchise kitchen opened in Minnesota the same year and took a year before it began to break even. The high start-up costs and a complex, just-in-time production process created difficulties for franchisees. The initial franchisees had to invest in new kitchens for meal production. For meal production of a hundred thousand per week a new kitchen cost upwards of a million dollars in facility and equipment. Franchisees also had to invest upwards of a hundred thousand dollars in sales and marketing. The high start-up costs presented a significant barrier for potential franchisees. Page 5 of 14
  6. 6. To address this issue SSHE invested in a new 25,000-square-foot kitchen in Ottawa in early 2002. This facility cost $2.3 million and could produce more than 200,000 meals a week. This would permit franchisees in Michigan, Iowa, and Indiana to begin operations without a new kitchen as they would be able to access the capacity of the new Ottawa kitchen facility. A franchisee would identify and develop distributors in its geographical area for the SSHE meal plans and create demand for the product while the products were delivered from SSHE’s Ottawa facility. As the business grew, a franchisee would build his own kitchen facilities for production. The company currently has franchisees in Minnesota, Nebraska, Wisconsin, Indiana, Iowa, Michigan and Georgia and nearly all franchisees have their own production facilities. Franchisees and distributors are assigned territories based on zip codes, and there is no geographical overlap across franchisees or across distributors, thus guaranteeing ‘exclusivity.’ In the past year SSHE began offering its “weekly meal plans” throughout the entire continental United States. Customers can call an (800) number and order weekly meal plans over the phone. The order is then placed by SSHE corporate office with the distributor closest to the customer location, even if the distributor is in another state. The meals are delivered by the distributor using refrigerated trucking. Figure 2 illustrates SSHE’s current distribution channels. Grocery Stores and Home-Meal Replacement Products Over the past ten years consumers looking for quick microwaveable ready-to-eat meals had turned to major grocery stores, enabling the latter to become major players in distributing home meal replacement products. Jewel-Osco, part of Albertsons family of grocery stores, is one of the largest grocery and drug retail chain in Illinois, along with Dominick’s (a division of Safeway Inc.) and Kroger. An observation of the packaged meal sections of Jewel-Osco, part of Albertson’s family of grocery stores and one of the largest grocery and drug retail chain in Page 6 of 14
  7. 7. Illinois, revealed that apart from Lean Cuisine, the only fresh-cooked offering she found was a high fat, sodium-laced chicken spinning around on a rotisserie. Similarly, limited offerings were available at Dominick’s and at Kroger. Seattle Sutton began to be approached by grocery chains who indicated that consumers would like to be able to stop at their local Jewel or Dominick’s grocery store and pick up one of SSHE’s healthy, freshly cooked meals. In addition, SSHE offered a lot of variety, which was very attractive. On the other hand Seattle Sutton believed that selling through retail channels would put her in conflict with her distributors, many of whom had been with her company for years. Her preference was to grow SSHE through more franchises in other mid-west geographical markets including Michigan and Nebraska and eventually franchise in far-away states like California. Rather than cannibalizing her existing market she favored an “exclusive coverage” model in which a distributor did not compete with another seller of SSHE’s products. She also believed that her end-consumers were loyal to her unique product offering, and would be willing to deal with her distributors to get their meals in lieu of the convenience of picking up the meals at a grocery store. While an “intensive coverage” model of distribution might be appropriate for Lean Cuisine, she did not believe that it was appropriate for her company. However, there was a segment of the market that SSHE was not capturing; people who wanted SSHE’s healthy options, but did not want to commit to a full weekly purchase. Furthermore, busy suburban moms and dads who weren’t willing to make an extra stop at the SSHE’s distributor’s store on the way home might be great candidates to be enticed into purchasing a SSHE meal during a routine stop at Jewel or Dominick’s.. Page 7 of 14
  8. 8. Seattle Sutton started considering the operational issues involved in selling through the grocery retail channel. She acknowledged that if SSHE sold individual meals through retailers as opposed to selling weekly meals, then new meal products might be needed. She was not sure if the meal products sold through the retail channel needed to be “branded” separately or should be sold under the “Seattle Sutton’s Healthy Eating” umbrella. If SSHE sold individual dinners in retail, Seattle Sutton anticipated that demand would be difficult to forecast initially. However, SSHE had learnt to be flexible, and responsive, and the current excess capacity could help SSHE handle any upside to the forecasts. Seattle Sutton also realized that by watching leading indicators and obtaining point of sale data, SSHE could improve on forecasting demand and also become more responsive to changes in demand. All the large grocery retailers had some type of customer loyalty programs in place- Jewel-Osco had its “Preferred Card” and Dominick’s had its “Fresh Values” card. Customer purchase date obtained from these loyalty programs would enable SSHE to do targeted marketing to consumers who might be looking for a healthy meal options. Further, once her company had data on which stores were selling well and what kind of volumes were involved, SSHE could run a more functional model leveraging its existing production and distribution efficiencies. Potential Threats Until now, SSHE had faced very limited competition, in part because its “weekly plan” based products engendered high customer loyalty. However, if SSHE sold through retail channels, Seattle Sutton was concerned about the threat of backward integration by grocery retailers. These retailers had an entire stock of raw material in the stores and could decide to start making their own line of healthy meals. She was also apprehensive about the retailers’ bargaining power. Grocery and food retail industry’s typical margins were only a few percentage points. The major Page 8 of 14
  9. 9. focus of the retailers’ business models was on increasing their margins by pressuring their suppliers. She was aware that retailers might learn about her double digit margins and use it to their advantage. SSHE’s competitive advantage was its ability to efficiently produce high-quality product with high consistency, and it had developed processes that were beyond what grocery chains could hope to replicate any time soon. While current trends leaned more toward outsourcing, grocery and food retailers were also selling many “private label” products made by contract manufacturers. Food for Thought Seattle Sutton had realized that with franchise start-up costs of nearly $1 million, her ability to expand through this method quickly was somewhat limited. While she could serve consumers nationwide using the “home meal delivery” plan, distribution costs for refrigerated trucking over long distances ate into profit margins. As she walked through the kitchen she realized that selling through the grocery retail chain required weighing the risk of channel conflict between the retail distribution network and her existing loyal distributors. A major unknown that would need investigation was the extent of the switching effect, i.e. the percent of her current customers who would switch from their current weekly meal plan purchase from her distributors to buying their “Healthy Eating” at the grocery stores. She would also have to stray from her core beliefs and values that she had held from the beginning- that her meal plans would change the eating habits of her customers and lead them towards a healthier lifestyle. If customers could purchase her meals individually she would lose control over changing their eating habits or portion sizes. She wondered about what, if any, changes should be made to her distribution strategy and what her response should be to the grocery chain’s offer. Page 9 of 14
  10. 10. Figure 1: SSHE’s Location (from Mapquest) SSHE Ottawa Franchisees Distributors MI, GA, IL, IN MN,NE,IA Direct Home Delivery in Other States sing Distributors National Shippers Consumers Figure 2: SSHE’s Channels of Distribution Page 10 of 14
  11. 11. Teaching Note Case Synopsis Seattle Sutton’s Healthy Eating (SSHE) is a leading provider of healthy meals in the Midwestern United States. An entrepreneurial success story, the founder, Seattle Sutton, had started and grown the business by cooking the meals in the company’s Ottawa kitchen and selling them through independent distributors. An early experiment with franchising had met with limited success. SSHE had opened a new kitchen in Ottawa that provided it with capacity for further growth. Seattle Sutton was considering whether SSHE should go after a larger market by using the major grocery chains for product distribution. Position in Courses This case is intended for use in marketing courses and in supply chain management courses, at the undergraduate or early graduate level. In an undergraduate marketing class, it has been used to illustrate the various channels of distribution available to producers, the potential for conflict among channel members, and the long-term nature and impact of channel selection. In a graduate course on marketing and supply chain networks this case was used to introduce the notion of channels of distribution as a potential growth strategy for producers and to illustrate the various issues surrounding channel selection. Teaching Objective The teaching objectives of the case are to enable students to a) understand the linkage between a company’s capacity plans and the need for growth , b) analyze alternate channels of distribution, and Page 11 of 14
  12. 12. c) incorporate the potential threat of “private labels” or backward integration by channel partners into the decision making process. Teaching Approach The case was written for a class discussion lasting a half hour or more. The case can be used in an introductory supply chain class or in a marketing class dealing with channels of distribution. Students are expected to read the case prior to coming to class. For the undergraduate level students can be encouraged to go to their local grocery stores and peruse the healthy packaged meal section prior to discussing the case in class. Teaching Plan Introduction This case is introduced by observing the changing trends in distribution and how it is impacting the various players in the supply chains. The instructor can also guide a discussion on the impact of large mass merchandisers like Wal-Mart on food distribution. Students are then asked to put themselves in the shoes of Seattle Sutton. She is a nurse running a profitable growing company. She started the company because she wanted to help her husband’s patients lead a healthier lifestyle. She now serves customers in a number of mid-western states but in order to serve nationally she needs a scalable model of distribution. This leads to the first question. 1. What needs should lead SSHE to consider pursuing alternate channels of distribution? a) Students should be able to identify the need for growing the customer base. SSHE has been growing in excess of 25% per year over the past ten years. It can push for continued high growth by acquiring more customers and getting more business out of current customers. Since its customer base is loyal, and as the business mode dictates that Page 12 of 14
  13. 13. customers sign up for weekly meal plans, customer acquisition becomes a key initiative for growth. The instructor can then question whether the growth can be achieved through the primary distribution channel used historically (selling through distributors), or through expanded franchising, or by pursuing other channels. Astute students can make the connection that one customer on a meal plan for one year (Yearly Customer Equivalent or YCE) is worth $ 4,732 in revenues. As SSHE is a private company and margins are not revealed, students can make reasonable assumptions and estimate the profit potential per YCE. b) Students should also be able to identify capacity utilization as another need for pursuing alternate channels. They should observe that capacity is often a step function over time, i.e. it is often added in sizeable quantities. SSHE’s new Ottawa kitchen can serve 200,000 meals per week. With current utilization, SSHE has spare capacity for an additional 60,000 meals per week. Astute students can estimate that this additional capacity is worth $13.52 million in annual revenues, and can serve 2,857 YCE. The question that can be posed here is how quickly can the existing distribution channels create additional demand in order to soak up this capacity? Discussion will center around the time taken to identify and establish franchisees and then finding distributors to support the franchisees. The limitations of the direct-to-customer model for delivery of food from the Ottawa kitchen to the coastal states are topics explored by students. These discussions then lead to the second major question to be posed to students. 2. Should Seattle Sutton pursue the grocery supply chain? This question segments the students into two broad groups, those in favor and those opposed to selling SSHE products through the grocery chain. Students supporting the grocery chain Page 13 of 14
  14. 14. distribution will point the advantages including a wide footprint for distributing products and providing convenient shopping for busy customers. They point out the ‘customer conditioning” effect, i.e. customers know where to look for specific products in a grocery store, thus saving search time, and that storage requirements like refrigeration are often easily met. Students opposed to the grocery chain idea identify the disadvantages that include pressure from retailers on margins, possible trade promotion dollars required by retailers, and the potential for the retailers to introduce their own “private label” versions. Students will also point out the potential switching of customers to this channel, causing some cannibalization. The instructor can question students on the penetration of private label products in other categories like soft drinks and assessing the effect on branded manufacturers. The question that can be asked is how to estimate the potential increase in sales volume through this channel and its change over time. Depending on the course, sales response models may be brought into discussion here. Astute students will observe that going through a retail grocery chain is a major departure from the core philosophy of Seattle Sutton. Selling a weekly plan to change eating habits is at the center of SSHE. With a single meal option through the retail channel, the ability to change customer eating habits is greatly diluted. The instructor can then lead the discussion of how closely the core philosophy is linked to SSHE’s core competence (making and delivering healthy fresh meals conveniently for plan-based home consumption), and whether the retail channel is in alignment with that core competence. Page 14 of 14