The Fair Tax. The Time Has Come

I thought I would talk about something a bit different today than the usual rantings of retail dysfunction. Something that I believe will have huge impact on all types of retail,every tax payer, and that would be the The FAIR TAX.

If you are not familiar with the Fair Tax, let me take this opportunity to tell you a bit about the Fair Tax, along with the why and how I think it will impact all things retail. Not to mention your pocketbook.

First let's look at the overall premise of the Fair Tax, which is in essence a proposal to replace all federal withholding taxes on income with a national 23% sales tax. No more social security, medi-care,or INCOME TAXES are taken out of your paycheck. The federal government collects taxes with a national 23% sales tax. Not only for individuals, but for corporations as well. Now before you go and say that there is just no way I can afford to pay a 23% sales tax on top of what I pay today, just take a breath and let me explain a bit further. And remember with the Fair Tax, you bring home all of your paycheck.

Before we get into the meat and potatoes of the actual workings of the Fair Tax and what its passage means for you and me you have to stop and think about how the current tax system impacts the retail selling price of every single item or service that you purchase today. Understanding that the current tax system has a direct impact on every purchase you make is the key to understanding the beauty of the Fair Tax.

The reason that the current income tax system impacts your every purchase is because each and every for profit company in existence passes their tax bill directly to you. That's right,every company out there that performs a service, manufactures a product, grows and apple, or sells you a TV passes every single penny of taxes they pay directly to you through the selling price of their goods or services. Why? Because their tax burden is part of their overhead expense and the profit margin they sell their goods for is developed to not only cover their overhead, but return profit. A dollar spent on taxes is no different than a dollar spent on labor, or raw materials. If companies want to stay in business, they have to pass on the taxes they pay directly to whomever buys their products or uses their services. If you have ever worked in the corporate world, you know this is true.

Now that you see how all corporate taxes are passed on to each consumer through current retails, what do you think would happen if all of those taxes went away? Well, the best way to think about this is that every link in the distribution chain, from the original producer, to transportation, to packaging, to distribution, to retailing the final product realizes an overhead savings that will be passed on through the distribution chain directly to you, the final consumer! That is where the 23% figure for the sales tax comes in. All of the research done by the Fair Tax Group has shown that on average 23% of the selling price of most goods and services reflect the tax burden associated with getting that item, or service to you, the final consumer. Now what this means to you is that an item that retails for about a buck today would retail for about the same after the Fair Tax is instituted.

Let's say you spend $50.00 on a new shirt today. According to the Fair Tax group, 23% or $11.50 of that retail price is caused by all of the tax burden from all of the companies that had anything to do with getting that shirt to retail. So the actual retail selling price of that shirt after the Fair Tax should be around $38.55 and when you add the $11.50 in taxes back to the new retail you have a shirt that is still costs you around $50.00 to purchase after all your federal taxes are paid. I suggest you go to www.faritax.org and read all the research that proves these tax implications.

I know what you must be thinking; retailers will just keep the extra profit for themselves and I'll be paying $61.50 for that shirt! Well, give me a break. The beauty of our economic system of capitalism is that it thrives of competition. I can name five companies that will reduce retails appropriately for every one that someone thinks will keep retails high. Retailers will be forced by competition to lower retails.

A huge key to the Fair Tax is that every service and new retail item is taxed exactly the same rate of 23%. No exemptions. EVERYONE IS TREATED THE SAME. Say good by to the power of tax lobbyists and tax special interests. Not only that but the IRS will go away as well.

Key Points To The Fair Tax:

• Pre-Bates. To help offset the impact of the necessities of life such as food, clothing, shelter, and medical care costs the Fair Tax includes something called a PRE-BATE. The pre-bate is paid to each and every family regardless of income. Its calculation if based on the number of people in a household and the official poverty rate. I believe that for a family of three, the pre-bate is in the neighborhood of around $400.oo per month. So if you are family of three the pre-pate is like a TEN PERCENT raise on top of fact you bring home your entire paycheck less any state taxes.
• Only new items are taxed at the 23% rate. All used or pre-owned items are exempt. Those taxes have already been paid; right?
• The Fair Tax is progressive: Today many of the super rich do not pay income taxes. They live on accumulated or inherited wealth. Meaning that at the most they pay 15% on capital gains, but they don't pay income taxes like you and I. What will the Fair Tax change about that? Well let's say that Paris Hilton wants to go out and buy a brand new Bentley for $150,000. When she does she just paid $34,500 in TAXES. Every new pair of $500.00 shoes is another $115.00 in taxes! That $1,000.00 dress, that's right $230.00 in taxes.
  
• The Fair Tax Taps The Underground Economy: Think about this. There are upwards of 20,000,000 illegal aliens in our country. How many of them do you think pay income taxes? Well each and everyone of them will with the Fair Tax. Every time they buy food at the grocery store they will pay taxes just like you and I. What about drug dealers, or any other type of criminal that lives on unreported income. Every time they spend a dollar on a new car, clothes, a huge mansion, or food, they pay their taxes.
  
• The Fair Tax Will Boost Our Economy: If you owned a corporation, where would you headquarter it? Where the tax laws are simple, or complex? If you had 15%, 20%, or 35% more money in your pocket to spend, would you? What do you think that would do to our economy? If you invest in a 401k, can you day DOW 20,000?

Gripes About The Fair Tax That Hold No Water:

• If new items have the sales tax and pre-owned don't, what will that do the sales of new items like new homes? NOTHING. You have to remember that a new home will cost about the same after the Fair Tax and it did before the Fair Tax and there is no tax on pre-owned homes. It's just a fact so sorry Mr. Romney, your objection to the Fair Tax holds no water.
  
• What about exemptions, or managing the collection of the sales tax? How will that get done? First there are no exemptions, and sales taxes are collected and paid every day today. So sorry Mr. Giuliani, your objections to the Fair Tax hold no water either.
  
• The Fair Tax is Unfair to the Poor! Give me a break, everyone gets the Fair Tax pre-bate, you take home your entire paycheck, the rich pay taxes they never paid before, and retails don't go up with the Fair Tax. Come again on how this is unfair to the poor?
  
• How is the government going to manage all these pre-bates? They manage sending out social security and other entitlement checks on a monthly basis.
  

I hope you take the time to research the Fair Tax at www.fairtax.org, and read the Fair Tax Book by Neal Boortz and John Linder. After you have seen the light, I urge you to call your Congressman, and Senator to find out where they stand on the Fair Tax. This could very well be one of the greatest changes our country experiences.

Rantings of a Produce Guy

While visiting a local supermarket yesterday I took note of the everyday retail on White and Red Seedless grapes; an astounding $2.99 lb.! You just have to scratch your head. Based on current FOB costs, freight, and D.C. up-charges, I estimate that their store level cost to be no more than $.95 lb. Which means that this retailer is generating a whopping 68% gross on their number one seasonal sales generator, or what should be their number one sales generator. With a $2.99 lb retail, no wonder the grapes on display looked tired in their gigantic two row spread on each.

When you see retails like these in the height of the summer sales opportunity, you sense retailer dysfunction. A state where merchandising and operations are in C.Y.A. mode. A situation more than likely brought on by a sales decline from a new competitor. It goes something like this. New competition opens, sales falter, operations cut labor in an effort to maintain budget, shrink increases, merchandising raises retails to offset shrink. And so it goes.

Meetings are called to discuss shrink and retailer reduces displays to reduce inventory. Sales fall off once again, labor is reduced, and retails are raised in an effort to maintain margin budget by offsetting increased shrink. Before you know it you have grapes retailing at $2.99 lb in the third week of July. This is a classic case of operations and merchandising not working together to develop plans to increase sales through investing labor from the operations side and margin from the merchandising side. Instead you have operations doing what it can do: control labor, and merchandising doing what it can do: raise retails. This way each division can say that they are doing what they can do.

If this retailer had a reasonable retail on grapes; say $1.69 lb with a July vs. February spread, they wold probably move roughly four times as many pounds and cut shrink by half. That is of course if they have enough help to maintain the displays. Because if grapes are at these ridiculous retails, everything else in the department reflects the same retail strategy. And you can count on the fact the balance of the departments int he store reflect same.

All of this while suppliers of summer fruits are in a panic. They see the lowest FOB costs in years and then look at retails in supermarkets and can not understand what the heck is going on.

The sad thing is that all retailers are not in the same boat as the one described above, but enough are to the point that they allow other retailers to maintain inflated retails. That and the fact that produce operations by and large must return a FORTY PLUS gross margin. For some this is easy, other it is difficult. There must be a BETTER WAY.

More About Mark Up and Bill Out

I was looking at ads today; specifically at a few of the feature ad items in the produce section. Two of the major retailers in my area had Green Grapes advertised in a feature position. Retailer A at $1.99 LB. and the other; let's call them retailer B, at $1.69 LB.

Based on current FOB's on Green Grapes of around $12.00 for a large berry, these Retailers probably landed them at their D.C. at around $14.60 - $14.85 per lug and when you add on a D.C. up charge of let's say, 12% you have a store cost of about $16.35, or $.90 LB. Based on these assumptions; retailer A is out there at around a 50% gross on a lead ad item and retailer B is out there at about 46%. No wonder suppliers scratch their heads and ask why retails don't reflect costs.

Well let's look at this a bit further.

I remember when I got my first job running a produce operation. We had a 6% D.C. up-charge and I had to manage a 30% store level gross, so our company actually achieved a 33.50% gross for the produce operation with D.C. and Store gross combined.

At my second stop some three years later, we had no D.C. up-charge, so store level gross had to 'pay for" the D.C. operation. Therefore we had to achieve a robust 43% gross, but then again that was in a very heavily populated area where per store sales and were very high and shrink was very low. Based on the area of the country the retailer was in a D.C up-charge of about 10% would be right on, so in reality the store level operation after D.C. Deductions actually achieved a 37.50 gross margin. Not really too bad at all. And not that much higher that where we were when I left my first stop.

During my third and last stint, we had a D.C. up-charge of a whopping 12%. Before I got there that retailer had made a decision to do away with all the up-charges except for the produce up-charge. They had postponed nixing the produce ups because the other departments had not reflected any margin increases when they did away with their ups. NO KIDDING. I mention this because these folks wanted me to achieve a 42% gross with a 12% up-charge. It took quite a few meetings to convince them that they were asking me to deliver a 47.50% gross margin! Based on competition and the lack of density in our marketing area, that was just crazy. We got that worked out, but I wonder how many retailers today force their produce departments to double dip on margin. By that I mean to conveniently forget about any D.C. up-charges when they develop their gross margin forecasts.

How many retailers out there that buy through a third party don't include the increased cost of goods in their budgets. I mean the whole point in utilizing a third party is to save the time, carrying costs, and overhead costs associated with managing a D.C. and inventory. If you know that your cost of goods are increased, but your overhead costs are decreased, then your margin budgets should reflect those facts, but I wonder how many retailers budgets actually do?

Just makes you wonder.

China's Apple Production

USA Today Ran a story that outlined the coming onslaught of Apples From China. I did not know this but according to the story fifteen years ago, China grew fewer apples than the United States. Today, China grows five times as many apples, almost half the apples grown on the entire planet.

Beyond that, harvest workers make an average of $.28 per hour, or $2.00 per day while those that harvest apples in the U.S. make between $9.00 and $14.00 per hour; depending on where the apples are grown; according to the story.

This is nothing new I suppose, we've seen many industries move production to countries where labor is cheap. In my mind though this is different. Apple growers in the U.S. can not just close down shop in the U.S. and build some manufacturing plant in China, or locate all customer service to India like so many other industries do. If China is allowed to import apples to the U.S. at prices that reflect a $2.00 per day labor rate, then we have a huge problem. We're talking about our food supply here. Not cars, or trucks or memory chips, but FOOD. In my mind we simply can not let any country, especially a Communist regiem like China, replace, or displace any part of our domestic food production. The ramifications are too far reaching. It's one thing to compete in an open and fair market. It is another to compete in a market where one side employs virtual slave labor.

If there is something good in this, it is that today's apple growers are looking at ways to bring a new level of efficiency to their operations, looking at ways to cut costs, and increase productivity. After all, that is the American Way, not to mention that necessity is indeed the mother of all invention.

WHAT DO YOU THINK?

What's Up With Mark Up PART TWO

I will never forget the day I sat in a regional office of a dairy department category manager for a rather large supermarket chain. She was talking about how she had to maintain a 35% gross in her category and she was describing how she was determining which retails to raise in order to offset her ad markdowns and maintain her budgeted margin bill out. I was shocked, she was actually raising everyday retails in order to manage her ad markdowns. I still shake my head when I think about that admission. With that being said, perhaps it is time to talk a bit more about markup and gross margin.

First however, we should probably define markup; or rather define the difference between markup and gross margin, according to produce guy anyway. Markup achieves the retail necessary to generate a given gross margin need. It is not the same as the gross margin markup.
Typically one may hear a retailer say something like "we have to mark everything up 50%". When what they actually mean is that they have to maintain a 50% gross margin, or 50% gross margin bill out. So here is the difference; if you take an item that costs one dollar and mark it up 50% you end up with a $1.50 retail and a 33.3% gross margin, not 50% (.50/1.50=.33.3). In order to reach a 50% gross .margin, the retail of any item must be twice the cost. So, if that one dollar item is marked up enough to generate a 50% gross profit, the retailer is actually marking that item up 100%, not 50%. Just do the math: An item that cost one dollar and sells for two dollars has a one dollar profit, and one dollar profit divided by a two dollar retail equals 50% gross margin. Now I know this may be splitting hairs, but facts are facts. However, for the purpose of this article we will use these terms the way one usually hears them; markup is margin.

OK, so now we have my version of the difference between markup and gross margin. Now let's take a look at how markup is used and in many cases misused. Since I am talking within the world of produce specifically and retail in general, it only seems appropriate to talk about markup/bill out as it relates to produce operations.

Like other perishable departments, produce has a myriad of categories from fresh bulk to fresh packaged to shelf stable branded, to packaged, dated items that require refrigeration. The question is how they should be managed from a "markup" standpoint. Should every SKU be marked up 50% to maintain bill out? I hope not. But more and more, it seems that retailers are overburdened with, or perhaps preoccupied with bill out. Why is this?

It is just my opinion, but the expectation of margin return for most produce operations is just too high! I would hazard to guess that the average produce operation has to produce gross profit margins somewhere in the 41% to 44% range. That is not to say that in the big picture there are those operations in areas of the country with very dense populations and high sales per store that probably have to achieve a 47% or 48% gross while stores in rural areas may be in the 37% to 38% gross profit range. Either way, just think about what that means for bill out. If one considers the fact bill out need is moderated by shrink factors; chances are that the average produce operation generates a bill out somewhere in the neighborhood of 50% to 55%. Now that includes ad markdowns that are in the range of 20 to 25 points on gross, and comprise oh, lets say 25% of sales on average. What does that mean? First it means that 25% of your sales have a bill out of only 20% to 25% margin. Secondly it means that individual SKU markup has to be through the roof to maintain margin "bill out"! No doubt about it. Managing enough bill out to maintain margin is difficult.

Okay you say, so what is the result of such a demand on bill out? Well first lets start with retail creep. I would define retail creep as the process in which retails begin to creep higher and higher in order to maintain an ever ending demand to increase bill out and margin results. After all how are you going to support your quarterly BUY ONE GET ONE FREE ad if you don't have something north of 50% gross built into items suited for such an ad? Or better yet, what are you going to do if the market is keeping your banana retail down so low you can only achieve a 38% gross on your number one SKU?

Before you know it, retails on items that are not primary consumer focal items with low to no shrink begin to rise in retail. As a result these items (that only move a fraction of the dollars high volume fresh items) require a 50% gross when in actuality they should only require a gross in the 33% to 38% range to maintain movement and relevance to the consumer. Once that margin bill out is tasted though, it is like a drug addiction. We should probably call it "Bill Out Crack". Not only does this never ending need for higher bill out hurt the movement of items currently in stock, it hurts the chances of new items being successful because of the markup a retailer feels they must place on any new item. As a result many items are turned away because the retailer feels the retail will be too high for it to be successful! Think about that for a second. If a retail might be too high for a new item, what does that say about retails currently in stock if the same markup criteria is used? Wouldn't 35% gross on a new $1.00 sale be better than 50% of no sale?

There is no doubt that managing the appropriate bill out for a retail operation; produce or other wise is a difficult proposition. However, the fact is that there are perils in raising bill out too high. Especially in highly competitive markets. Retail creep can negatively impact those areas of you operation that bill out is meant to overcome. So how does one start to re-evaluate bill out and start to maximize sales and margin with out taking a margin hit first? Well I guess that is the million dollar question. One we will work to uncover.

Stay Tuned
Produce Guy
Alliance Fresh Produce Solutions.

Wal-Mart: Part Two

In my last article, I talked about my experience with the inception of what we know today as Wal-Mart Super Centers and how so many retailers of fresh produce seem to have a misconception regarding the margins Wal-Mart is probably achieving in their produce operation. I say probably because although I don't have any inside knowledge or information, I do have some insight into the EDLP pricing format and how it can work.

As I mentioned in Wal-Mart: Part One, I was involved in the pricing and purchasing development process for the First Hyper Mart in Garland Texas, I also mentioned that at the time we did not have the array of tools available today to develop a sound EDLP pricing format based on thorough information analysis. In as much, hitting a target of generating a 21% gross margin, which was our goal with the first Hyper Mart, meant targeting those retail margins on a daily basis vs. analyzing and understanding annual average margins

So what, you might say, well this is a very important point when one evaluates today's Wal Mart EDLP prices vs. HI-LO operators retail margin targets.

To prove this point, let's compare the annual average bill out margin and associated retail of the Apple Category of your average HI-LO supermarket operator and compare the resulting average retail to Wal Mart's EDLP price.

Rather than make assumptions, I will rely on an acutal EDLP initiative I was involved in while running the produce division for a regional Southeast Supermarket Chain.

Let's make this as simple as possible. In evaluating our EDLP pricing formula, we looked at our total cases of apples moved on an annual basis and the retails and costs associated with that movement. What we found was that our average annual retail for the apple category was $1.06 per lb and our annual bill out was 40%. Now our weekly target for the category was to achieve a 48% gross meaning our average weekly non ad retail was $1.29, but when you threw in all the $.89, $.99, $1.09, and $1.19 ads, we actually managed a 40% gross and a $1.06 lb average retail!

What was amazing was that at the time, Wal-Mart had an average retail on apples of $1.12 per pound. This was truly and epiphany. Wal-Mart was actually selling apples at a higher retail than we were on an annualized basis, and in all likely hood generating a much healthier gross margin! We found this not only to be true in the apple category, but in all categories in our produce operation. Think about that for just a moment and then the next time you start wondering how Wal-Mart sells produce so much cheaper than your operation; think again. Question is what are you going to do about it.

Breaking Down The Wal Mart Mystery: Part One

I've been fortunate in my career to have had the opportunity to work in various parts of our great country for retailers operating a wide variety of formats. I cut my retail teeth working for Tom Thumb Page in Dallas Texas. Looking back, I see that from the perspective of management style, that company was well ahead of it's time with regard developing people, but that is not what I really want to talk about today. I do want to talk about Wal Mart and how retailers should open their eyes and learn how to compete with the Mega Super Center that is Wal Mart.

In the Mid to Late 1980's the parent company of Tom Thumb; Cullum Companies entered into an agreement with Wal Mart Stores to open a Hyper Market in Garland Texas. As far as I know, this was the first "Super Center" opened by Wal Mart.

Our mission was to develop the operating procedures, and merchandising/buying/pricing philosophies for the the food side of the store while Wal Mart developed the general merchandise side. At the time I was just leaving responsibilities as the head produce buyer for Tom Thumb and entering into the merchandising side of the business. My responsibility with the new Hyper Mart was in working with Bud Godwin; the VP of produce for Thumb at the time to develop the buying and pricing model.

I remember very clearly that we landed on an EVERY DAY LOW PRICE retail structure along with unexpected in store specials as our go to market strategy. Our goal was to maintain a 21% gross margin and operate on a 7% wage cost. At the time this represented a margin that was about nine points lower than the average Thumb produce department margin and a wage cost that was about three points lower. While most of the produce for Hyper Mart came through the Thumb D.C. the produce manager had the purview to buy from the local Dallas Farmers Market.

That first Hyper Mart opened with a boom and after the initial opening the produce department settled down to $125,000 per week. Not too bad for 1987 dollars, and considering the fact we went about developing those retails without the advantage of Excel or any other type of computer program, I know today that our EDLP structure was way too low. I'll prove that later on.

We eventually opened a second location in Arlington Texas before Wal Mart bought Cullum Companies share of that joint venture and we went our separate ways. What a mistake by Cullum Companies!

There must have been some type of non-compete in that agreement because I left Tom Thumb in 1993 and we did not have many Super Centers open in our marketing area during those years. I left Dallas for Boston, where Wal Mart Super Centers still do not roam only to find myself in Birmingham Alabama in 1995 working for a chain under full Super Center Siege.

What struck me as I got out into the many Wal Mart Super Centers in central Alabama was that the initial lay out we developed back in Dallas had not changed! The departments still looked just like the Hyper Mart department back in Garland Texas. Frankly, I was shocked.

From a pricing standpoint, they were much cheaper than we were on our everyday retails, and because of my previous experience with Hyper Mart, I was under the false notion that they were still working on a twenty to twenty five percent gross margin and that their sheer volume drove their margin dollars. Boy, just like most every other retailer that competes with Wal Mart, I could not have been more wrong.

Come Back Later and I will tell you why, or contact me at Alliance Fresh Produce Solutions:205-277-6609.