Strong Numbers, Systemic Question

We are pleased to present this year's Retail Operations Survey. Please get out your yellow pad and be ready to take notes. (See sidebar "Using the Data.")

This year's survey respondents, representing about 35 percent of the co-ops in the country and about 60 percent of the total annual volume, reflect wide cooperative diversity:

• Annual sales ranged from $82,000 to $63,000,000.
• Profits and losses ranged from +9.74% to -10.45%.
• Percentage of sales to members ranged from 8% to 100%.
• Board seats ranged from 2 to 16.
• 36 states and 1 Canadian province were represented.

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Synopsis: Synapses

Our most significant conclusion is that economic conditions and industry changes have negatively affected co-ops in sales growth, productivity, gross margin, and net income. Co-ops are not alone in feeling the effects of these trends, but have taken a greater hit than some of our competitors.

At the same time, cooperatives have taken giant steps to collectively and systemically address these economic, industry, and competitive challenges. Establishing regional and national associations and projects are examples of our successful efforts to combat these strong trends.

Our assessment from this year's survey, however, is that we must build on these structures to do more, to do more quickly, and to do more effectively. If the trends continue without an appropriate response, our chances for continued survival and success will decline. An analog example would be the fate of the old wave cooperatives: there were hundreds of retail food co-ops in the 1930s, but only a handful remain.

Compared to our strongest competition, we are hampered structurally -- e.g., by not being able to share our strong balance sheet capacity. Nor have we figured out a way to start and incubate new co-ops at an expeditious and competitive rate. The data imply that we must also be more focused on improving our productivity. Personnel expenses carry the most variance in determining operating profits in co-ops -- more than growth rate, margin, or occupancy costs.

Finally, we must continue to pursue ways to spread best practices in utilizing our cooperative advantage -- our inclination to be closer to our customer. According to a Gallup poll on public attitudes toward cooperatives, replicated by several regional studies, the general public prefers to patronize cooperative businesses when the goods and services delivered are as good or better than the alternatives. This predisposition, according to the survey, comes from the trust that consumers feel in cooperatives. We need to practice the principle of cooperation among cooperatives in order to learn the best ways to expand our cooperative advantage.

Average sales growth for the 118 stores from 102 responding co-ops was 11.8%, slightly less than the 12.6% Natural Foods Merchandiser (NFM) reported for natural products stores. Median sales growth was 8.5% for all co-ops, marking a downward trend from last year's 10.7% median sales growth.

Cooperatives' net income averaged 0.74%, down a full percentage point from last year and substantially less than the NFM average of 5.67%. About 70% of cooperaives reporting were profitable this year, down from almost 90% last year. In 2000, average gross margins for cooperatives decreased for the first time in at least 8 years. Payroll costs declined, but not as much as gross margin. As a result, the critical Margin Minus Labor (MML) indicator fell 7%.

Approximately 10% of the cooperatives reporting expanded their selling space last, and 20% are planning remodels or expansion in 2001. In comparison, 25% of the NFM stores remodeled. Because cooperatives expand or establish new stores at a slower pace than our competitors, cooperative market share is shrinking.

Compared to Whole Foods (WFI) and Wild Oats (WOI), cooperatives did very well in terms of growth, profit, and balance sheet strength. For all co-ops, median same store growth (8.5% was higher than either of the chains (3% for WOI and 8% for WFI), as was net income. Both WFI and WOI had losses for their last fiscal years, although the WFI loss can be attributed to investment losses. However, WFI was more profitable from operations than cooperative stores are. Average same store sales growth for large cooperative stores (7.65%) was slightly below WFI but significantly above WOI. Overall 84% of co-ops reported sales growth in 2000 compared to 90% in 1999.

The cooperative balance sheets continue to be "stronger" then WFI or WOI. WFI current ratio (liabilities due within 1 year, compared to assets that can be quickly converted to cash) is a little over 1:1, while WOI has serious negative working capital.

Income Statement

Summary: Perhaps the most important point to be drawn is that, for the first time in Cooperative Grocer survey history, gross margins have gone down. Combined with slower growth than last year and a slower decrease in personnel expenses, co-op net profit decreased substantially.  Key points: Lower Margins, Slower Growth, Less Net, More Expansions.

• Lower Margins:  In the march-April 1999 issue of Cooperative Grocer an article on the "Experience Curve" predictd that natural food gross margins would start to fall as the industry entered a new stage of its life cycle. That prediction is being borne out by the data from both the Cooperative Grocer and the NFM report.

Co-op gross margins declined for the first time in the history of the survey, from 36.4% to 35.1% (only co-ops with predominantly natural food lines were used in the margin analysis). A fall in margin might have several explanations, including competitive pressure, a change in product mix, ppor buying, or a planned lower price.

Gross margins were higher for our large and medium sized co-ops when compared with our competitors listed in NFM, but lower for our small co-ops. This may be good news or bad news. Maybe we buy better, maybe we have different product mixes, or maybe we price higher.

Among survey co-ops, margins tended to increase for small stores and decrease in large stores. Health and Beauty Aids (HABA) and deli margins tended to decrease, while grocery and produce margins tended to increase.

• Personnel Costs Conundrum:  Co-op personnel costs did not decrease as fast as our competitors' personnel costs. Average co-op Labor costs decreased from 23.0% last year to 22.6% this year (see the Income Statement summary) and median personnel costs increased from 22.3% last year to 22.8% this year (see the Ratios summary).

To appropriately compare co-ops with privately owned stores, we modified the NFM survey numbers to make them comparable with the Cooperative Grocer survey. We added back an assumed salary for store owners and then we compared payroll by size (using the NFM square footage categories).

In every case, co-ops show labor expenses substantially above the NFM numbers. In large stores, co-ops are 32% higher, in medium stores 16% higher, and in small stores 21% higher. What does this imply?  Possibilities included lower productivity, a different product mix, and higher administrative costs for our stores, or higher owners salary than our assumption for private stores.

More detailed personnel numbers and discussions are available in the March-April 2001 issue of Cooperative Grocer, which is a summary of the Human Resources survey completed earlier this year.

• Margin Minus Labor:  Margin Minus Labor (MML) is a very valuable tool when comparing your store's data to aggregate data such as the Cooperative Grocer report. If you just compare gross margin, or personnel costs, you are comparing applies to oranges. Our stores have many different product mixes and therefore have significantly different mixes of margin and payroll.

For example, if your co-op has a scratch bakery (a high margin department) and you compare your overall margin with other stores, most of which don't have a scratch bakery, you will be delighted. But when you compare your labor expenses (which are higher in a scratch bakery), you will be disappointed. The same is true if you have a very big or very small deli, meat, HABA, or produce section.

Margin Minus Labor, however, will substantially reduce the difference between the gross margin and the labor expense. And it allows a better comparison between stores with different product mixes than taking either variable alone. Basically, when compared to other cooperatives, MML indicates how well your cooperative is managing gross margin and labor -- two of the most controllable expenses.

As you can see from the chart, MML significantly correlates with net income -- the higher the MML the higher the net income. If you want your cooperative to be in the Upper Quartile, emphasis on managing MML is key.

After tending to climb for 4 years, overall MML has declined for the last 4 years. Since MML is going down, the remaining profit percentage is also shrinking. This explains why we can have sales growth, but not as much profit growth. While good sales growth and operational efficiency in our stores does not ensure success, they are becoming increasingly importanat if we are going to continue our success.

Compared to the NFM report, we find that large co-ops have a MML that is 15% below the NFM stores while medium stores operate at about the equivalent MML. Small stores are 36% lower in MML than comparable NFM stores.

• Slower Growth:  Basically, the natural foods industry growth rate is slowing down. The first sentence of the June 2001 NFM report says, "...lt was the first year since 1990...that the industry saw less than double-digit growth." The 7% industry sales growth figure reported by NFM refers to all channels of natural food distribution including supermarkets, mail order, natural product retailers, and multi-level marketers. For natural products retailers, including natural foods stores, health food stores (40-80% supplement sales), and vitamin shops (greater than 80% supplement sales), the sales growth was 8.7%. For natural food stores (co-ops, privately ownerd stores, WFI, and WOI), the growth rate was 12.7%.

Median co-op sales growth was 8.5% last year, while the average co-op sales growth was 11.8%. This avaerage was slightly less than the natural food store average growth reported in the NFM annual industry review (12.7%). Co-op numbers are not included in the natural products section of the NFM again this year -- co-op store info is grouped with specialty/gourmet, personel care, gyms, herb shops, and mall stands. The information in the NFM report is very valuable and should be studied, but co-op data is missing from much of the detailed analysis.

Similar to conclusions in the NFM report, there is a negative correlation between store size and growth. That is, the smaller the store, the higher the sales growth percent tends to be. The small co-op stores that grew did so at a higher average rate than stores in other size categories.

The percent of co-ops reporting positive growth was significantly higher than our competition. NFM reported an average of 71% of the stores with positive growth, while the proportion of co-ops with positive sales growth was 84%, down slightly from last year.

• Less Net:  Net income declined substantially this year compared to last -- from a median of 1.9% to 0.7%. One explanation is the decline in margin and the slower decline in personnel expense. While margin decreased 1.3% points, personnel costs only decreased by about 0.4% points. Margin minus labor, therefore, declined by about 0.9% points.

When bottom lines are compared, all sizes of co-ops performed substantially worse than comparably sized stores in the NFM surveys.

• More Expansions:  The rule of thumb that "expansions will take about 2 years to pay for themselves" is borne out by the data. Almost all the co-ops that expanded substantially in the previous two years lost money in 2000, but about three-quarters of co-ops that expanded three years ago were again profitable in 2000.

Balance Sheet

Ratios:  Ratios link disparate elements of financial statements to one another and inform us about their relationship.  They can tell us about root strengths and fundamental weaknesses, and they allow us to compare current co-op operations with prior periods and with others in the industry.

As we do every year, we caution readers that the ratios presented here are not exhaustive, nor are the results necessarily good or bad. The yellow pad is an important tool when examining ratios. When comparing your store to these ratios remember that service departments, unusually large or small HABA departmentys, the own vs. lease question, and other factors could make some comparisons less relevant. For example, co-ops that own their buildings almost surely have a lower Sales to Total Assets ratio.

Of course ratios will also vary becasue not all the same co-ops report each year. However, since we do have a sample of over one-third of the 300 co-ops, the overall numbers should be accurate when comparted to previous years' surveys.

Sales per Square Foot is a measure of how well the co-op is using its space. This measure will also be influenced by product mix. For example, a large herb section could lower overall store Sales per Square Foot. A buyer and merchandiser who is experienced at adding new products, dropping products appropriately, and knowing how to price and merchandise will have a higher sales per square foot results than someone with less skill. Compared to the NFM data, co-ops perform slightly better than the competition in this area.

Sales to Total Assets and Sales to Net Fixed Assets are an indication of how hard your assets are working. Both will be significantly influenced by whether you own or lease your building because the land and building asset will show up on the balance sheets for those co-ops that own their buildings but not for those that lease. The median Sales to Total Assets ratio is 3.02, and the Sales to Net Fixed Assets ratio is 5.55 for co-ops that own their buildings; and 4.66 and 11.49 for co-ops that lease. Use these median figures rather than the aggregate ones to make your comparisons.

The Inventory Turns ratio is a very important one. It is one of the indicators of your effectiveness in category management and can reflect how well you pick products, discontinue products, price products, and manage your inventory. It is another ratio that is signficantly affected by product mix. A large HABA department might have inventory turns of 6 times a year, while a large produce department might have turns of 100 times a year. In the Cooperative Grocer survey, changes in the inventory turns ratio from year to year reflect systems effectiveness as well as product mix changes. You may want to pursue departmental inventory turns numbers by loking at the CoCoFiSt numbers.

Current Ratio: The current ratio and working capital are measures of a co-op's ability to meet obligations that are coming due within a year. Current ratio is calculated by dividing current assets by current liabilities. You calculate working capital by taking the difference between these two items.

At the end of December 2000, Wild Oats was operating with negative working capital (current assets minus current liabilities), and Whole Food's working capital was barely positive. Their current ratios (current assets divided by current liabilities) were .38 and 1.06 respectively, compared to the cooperative median current ratio of 1.73. Higher is stronger in terms of the ability to meet obligations, so co-ops clearly show a stronger position here.

Debt:Equity:  Lower is stronger in this case because debt:equity indicates how much total liability a company has compared to the owners' equity. For the co-ops' median, there are 68 cents in debt for every dollar of equity, while WFI and WOI both have more debt than they do equity. At year end, WFI's debt:equity ratio was 1.48 and WOI's was 1.49, while the co-op median was 0.68.

For the individual co-ops in the upper quartile, this is a very enviable position, but is a stronger current ratio and a stronger debt:equity ratio better? Probably yes in the short run and no in the long run. When compared to WFI and WOI, the low debt:equity indicates that we are underleveraged (borrowing too little money to maximize the benefits to members). WFI and WOI stated strategies are to rapidly grow their businesses, although recently WOI has had to scale back their growth strategy substantially. Their strategies are classic market share capture ones.

While we have several innovative co-ops that have demonstrated financial and managerial capacity to successfully open new stores, as a group we have not yet figured out how to effectively use our considerable talent and significantly underleveraged balance sheets to organize and open new cooperatives. This is a shame for two reasons: 1) new, effectively organized and run cooperatives can have  meaningful social and economic impact on a community and for a workforce, and 2) without this kind of growth, we will not be able to fully realize the best economic benefits for our members. Furthermore, there's something intrinsically beneficial about cooperatives; and with the right leadership, organizing, and capital, they are more likely to grow in more communities.

As shown by the composite data, cooperatives are not undercapitalized. What we lack is an efficient and effective mechanism for sharing balance sheets. This is no simple task and would involve significant management and organizational changes so that the leveraged balance sheets end up creating more successful cooperative opportunities for consumers and employees.

Return on Equity (ROE) is a measure of the financial results earned in comparison to what our members have invested and accumulated in the cooperative. It is an important measure. You might compare it to how much money is earned in a savings account or an Internet stock. Our median ROE is 8.47% and may be understated each year because it does not directly include cash register discounts and patronage refunds. Last year, the ROE was 11.28%, so we aren't doing as well.

Return on Assets (ROA) is a measure of the financial returns generated by the assets that the cooperative employs. Like Sales to Total Assets, the ownership vs. lease issue influences this ratio. Co-ops that lease their buildings have a median ROA of 4.66, while stores that own their building realize a median ROA of 3.02.

Member Measures

Our survey also looks at member sales and member investment. The median "sales to members" (50%) is about the same as last year. There is a slight tendency for more member sales in larger stores.

Direct member investment is hard to survey because some co-ops have a membership fee rather than a member equity plan. The fees end up in retained earnings and therefore in the total equity section of the balance sheet. In the Small category these fees, which also show up under other income on the income statement, account for co-op profitability. As stated previously, return on equity is down this year compared to last, although patronage dividends are not reflected in the Return on Equity formula.

Boards of Directors

The boards of directors range in size from 2 to 21, with 7 or 9 directors being the most common. Over 95% reported board terms of 2 years or more, and most of the boards meet monthly.

About two-thirds of the boards have employee directors; in most cases these employees are elected by members at large, while about 20% are elected by other employees.  Mail or drop off balloting is allowed in two-thirds of the co-ops, and a like proportion of co-ops indicates that their boards are either practicing policy governance or are considering it.

Information on board compensation was included in the March-April Cooperative Grocer Human Resources survey.

Conclusions: Our Yellow Pad

Significance: The cooperative sector is significant. There are about 300 retail food cooperatives in the U.S., representing approximately $700 million in sales. The 102 co-ops that responded to our survey amount to over $400 million alone! We prepared an estimate for each of the rest of the co-ops. Viewed as a chain, co-ops are third in volume behind Whole Foods (almost $2 billion) and Wild Oats (just over $800 million) and first in number of natural retail food store outlets (WFI 117 stores, WOI 110 stores, Co-ops 300 stores).

Share: To compete in the long run, co-ops will need to increase market share by developing new co-ops, expanding existing ones, or opening new stores. The problem is that expansions are expensive in the short run; 70% of the co-ops who reported losses this year had expanded in the last three years. Another problem is that we haven't figured out a way to leverage our balance sheets and access other sources of capital in order to expand existing co-ops, start new ones, and spread development costs over a wider range of co-ops.

Synapses: The natural foods industry and the economy are swiftly changing, and while co-ops have demonstrated their abilities to change significantly, the data indicate that we may not be reacting fast enough.

Structure: Co-ops have created structures to deal with these challenges. Even if not technically a chain, our "cooperation among cooperatives" principle reinforces and encourages our endeavors in this areaa. Our yellow pad asks how we can speed up our improvement cycle.

Some directions to take:

Develop an improvement plan for your co-op and the co-op movement. How can we buy better, be more productive, and bolster our cooperative advantage in order to improve faster than our competitors -- so that more and more people buy more and more products through more and more cooperatives?

Improve your own co-op. Use this data to compare your store with the upper quartile stores in your size category. Remember that efficient use of labor is the factor that correlates most highly with profitability, so that is probably a good place to start. Use CoCoFiSt data to supplement the survey.  Find counterparts to learn from and/or hire a consultant who can speed your improvement efforts.

Increase your support and participation in regional and national cooperative efforts. We need to begin to realize the advantages of being a virtual chain or we'll continue to fall further behind our competition. This year, the National Cooperative Grocers Association will be rolling out two very important cooperative buying programs -- Co-op Advantage Program and Co-op Label. These programs have the potential to reverse the decline in gross margin and put us on a course to compete in the critical area of purchasing.